Am I Giving Away the Church This Christmas?
Historically, churches have been a source of relief for the needy in their congregation and their community at large. Any movie set in Medieval Europe will almost certainly contain a church scene with a friar or monk seeking “Alms for the poor!” One of the primary missions of the early church was to help the poor, the sick and the wounded. This mission is still being carried out today; however, unlike in the past, the manner in which churches provide benevolence to their communities could potentially result in major problems for both the church and its members.
I. Churches as § 501c3 tax exempt entities
Within the U.S., churches are automatically granted § 501c3 tax-exempt status by the Internal Revenue Service (the IRS). This status is granted to churches regardless of their structure (unincorporated or incorporated) or affiliation with a recognized denomination.
Among the multiple benefits of being granted § 501c3 status is that individuals who give (i.e. money, clothing, vehicles, real property) to the church can claim a deduction for that gift when they file their individual tax returns to the IRS.
II. Limitations on Charitable Contributions
Although anyone can give to a § 501c3 public charity, the purpose of that giving determines whether that individual can claim a deduction on their income tax return. Contributions (for purposes of this article, we will focus on monetary contributions) made to a § 501c3 entity, like a church, must be for its benefit and must be used in connection with its religious and charitable purposes. Additionally, that contribution cannot result to the benefit of a private individual. If these requirements are met, then the contribution is deductible on the donor’s individual tax returns. IRC § 170(c)(2).
For a donation to benefit the organization it must have full control over those donated funds and the donated funds cannot be specifically “earmarked” by the donor at the point of transferring the donation. Davis v. U.S., 495 U.S. 472 (1990) (See also Rev. Rul. 62-311, 1962-2 C.B. 10). In Davis, the US Supreme Court affirmed that petitioners’ direct donation to their adult children, who were missionaries, was not tax deductible. Both adult children had been approved and ordained as missionaries by their church and as such were required to raise the necessary funds to support their missionary work. The petitioners notified the church that they would provide the necessary financial support to both children and transferred the necessary funds directly into the missionaries’ personal bank accounts of which they were the only authorized individuals to access funds. The IRS disallowed the petitioners’ claim for a charitable deduction on those transferred amounts.
The US Supreme Court affirmed the lower court’s denial of a tax deduction. The Court, after reviewing the legislative history of the statute, ruled that for a contribution to be deductible the qualified organization must have some legal authority over the funds to assure that the use by the end-result beneficiary uses such funds to carry out the charitable purpose of the organization.
As outlined in the above case, although a church may solicit funds to provide individuals with benevolent aid, the church must be diligent in how it accepts and distributes such benevolent funds either as part of its religious and charitable mission or on behalf of individuals. The first step is developing a written benevolence policy.
III. Creating a Benevolence Policy
So your church feels the call to provide benevolence to individuals in your church and your community who are in need. Now what?
A. Source of Funding
When establishing a benevolence policy, the first decision your leadership must decide is where these funds are going to originate from: the church’s general funds, a separate benevolence fund, a designated fund for the senior pastor’s discretion, or some other designated source? Regardless of the funding source, the policy should identify it as the primary source of benevolence and direct any potential donors to designate their contributions for support of the church’s benevolence fund. In compliance with Court’s decision in Davis, the church should notify all potential donors to its benevolence fund that the church will take all reasonable measures to honor any request by the donor in distributing the contributed funds but that the church retains all control and authority over all contributed funds and has the authority to redistribute those donated funds in connection with the church’s religious and charitable purposes.
If the source is a discretionary fund, the senior pastor will also need to maintain an accounting of this fund and any expenses with the church and distributions should require an additional signature besides his own. Failure to maintain these formalities could cause the funds to be considered taxable income for the pastor and be reported on his personal tax return.
B. The Benevolence Team
Once the source of the benevolence is determined, the next step should be to appoint a group to oversee the application and disbursement of benevolent funds. This group could be your church board, the deacons (if separate and distinct from your board), or a created benevolence committee or team. If at all possible, this group should be comprised of unrelated individuals to avoid the appearance of undue influence. If related individuals do serve on this group, any decisions on the grant of benevolence should be decided by at least two unrelated individuals for this same reason. All decisions by the group should be evidenced in writing and retained in the church’s records for at least the IRS-recommended period of time for similar records.
C. Developing a Written Policy
As with any church policy and procedure, the involvement of legal counsel at the beginning of the drafting process is a prudent decision so as to avoid potential legal and tax exempt concerns like the ones identified above.
A written policy, at a minimum, should identify the following:
- The overall purpose of the policy,
- The procedure on how an individual applies for benevolence,
- The review and approval process of an application,
- The procedure on how benevolence is distributed, and
- The limitations on granting benevolence.
For a tax-exempt organization, like a church, to legally provide benevolence, it must identify that the applicant has both a legitimate need and lacks the resources to satisfy that need. A “need,” as defined by Webster’s dictionary, equals a “necessity.” Basic necessities in the US typically include food, shelter, clothing, transportation, and basic health care. For IRS compliance, the need must be a legitimate one. Because deciding whether a need is legitimate is a subjective decision, the policy should include some basic guidelines to help the group make a decision. For example, a request by a single mother for assistance in buying a winter coat for her child is a legitimate need; a request for assistance in buying her child a $200 pair of Air Jordan sneakers is not a legitimate need.
The second part to this determination is whether the applicant has additional resources to satisfy the identified need. Depending on the request, a church typically requests a copy of his or her financial resources such as a tax return, a paycheck stub, or a bank statement as proof of the applicant’s inability to pay.
The policy should also expressly state that no benevolent funds will be distributed directly to the applicant. Any approved funds should be forwarded by check from the church’s designated account to the service provider or other creditor (i.e. landlord, utility provider, etc.) for satisfaction of the debt owed.
As stated above, a benevolence policy should explicitly state the limitations of whom, how much, and how often the church may provide benevolence. Most church benevolence policies exclude employees or those with authority over the church (i.e. administrators, executive pastors, and volunteer leaders) from being eligible for benevolence. Any type of grant of benevolence to an employee (whether ministerial or support staff) is always considered taxable income by the IRS and the church must withhold the appropriate employee tax from that grant of benevolence. A grant of benevolence to an individual in authority comes with even greater of a risk to the church. If the IRS determines that the grant does not represent a valid “need,” then the benevolence is considered an excess benefit transaction. If determined to be an excess benefit transaction, the IRS will force the recipient to repay the amount received as well as impose an excise tax on both the recipient and the group.
Additionally, the IRS pays close attention to any substantial or regular grants of benevolence claimed by individuals. If the church has granted benevolence to volunteers on a regular basis (i.e. one a month or every other month), the IRS may consider the benevolence to be wages and that the appropriate employee taxes be accounted for. Additionally, if the amount of the benevolence is determined by the IRS to exceed any potential legitimate needs of the recipient, the IRS may consider the grant to be a private benefit. If so, this would seriously jeopardize the church’s tax-exempt status.
In order to reduce the possibility of either of these IRS actions, the church’s benevolence policy should expressly limit grants to identified individuals to a specific number of times within an identified period as well as provide a ceiling on how much benevolence may granted (i.e. once within a 6-month period but not to exceed $500 in a calendar year).
For the same reasons above, a written application should also be developed as part of the policy. This application should identify the individual, the amount of benevolence requested with supporting documentation, and evidence that the applicant lacks the resources to resolve the issue himself. In addition, the application should briefly outline the limitations on grants of benevolence, ensuring the applicant is aware of these limitations upon submission to the church.
D. Adhering to the Policy
Once the leadership has developed and implemented a benevolence policy, the final step is for the benevolence group to consistently follow the policy and maintain adequate written records of the application forms with attachments, the group’s decisions and the basis for those decisions, and any and all distributions made out of the benevolence fund.
In summary, the Church’s historic place in providing help to needy individuals is still very much in demand in today’s society. However, with the increased scrutiny of tax-exempt organizations by the federal government as well as the inherent sinful nature of people, the Church must be a good steward of its resources. The development and implementation of a benevolence policy is one of the best ways to protect the church. To be compliant with IRS requirements, such a policy should:
- Be in writing,
- Be reviewed by competent counsel,
- Require all funds to be directed to the church’s designated account,
- Require potential recipients to demonstrate an objective legitimate need,
- Require all payments from the designated accounts to be forwarded to the identified service provider or creditor, and
- Identify limitations on grants of benevolence
Should the IRS ever question a church’s grants of benevolence and the church has consistently followed its written policy, it will have adequate documentation to prove that such grants are within the church’s religious and charitable purpose and do not jeopardize the church’s tax-exempt status.
Disclaimer: This memorandum is provided for general information purposes only and is not a substitute for legal advice particular to your situation. No recipients of this memo should act or refrain from acting solely on the basis of this memorandum without seeking professional legal counsel. Simms Showers LLP expressly disclaims all liability relating to actions taken or not taken based solely on the content of this memorandum. Please contact Robert Showers at firstname.lastname@example.org, or Justin Coleman at email@example.com specific legal advice on this issue for your needs. Simms Showers LLP © 2014
 See IRS Publication 1828. http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/How-long-should-I-keep-records