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From his column God, Government and Me—Money in the Church

god-government-me-09-14-1After a hiatus of several years, it appears the IRS is ready to again audit churches. Let’s walk through some of the documents they often request in church audits and some of the related issues that may arise. By the way, the IRS rarely audits the most recent year—more than likely they are looking at the earliest open year, two or three years back.

General Ledger

You are ready and at ease when the IRS agent asks for the general ledger. The debits and credits balance—what could possibly go wrong? Well, your general ledger is the “GPS” for all things good and bad. We will see how true this is. Read on!

Form W-4 – The file of Forms W-4 will be another one of the first records the auditor looks into. The auditor can propose a penalty for failure to have appropriate forms in the file for each employee relating to all tax years under audit.

Form W-2 – No problem—you know where your W-2 file is located. You filed them on time. What could possibly go wrong? Well, here are a few possibilities:

 

  • The auditor notices that one W-2 shows no federal income tax withholding and asks why. You tell her the W-2 is for the senior pastor. That leads the auditor to ask why that W-2 shows FICA withheld and matched. The auditor observes that the senior pastor (with ministerial status under the tax code) is not subject to FICA—he is subject to SECA calculated on the pastor’s Form SE. This discussion just took a wrong turn for the church.
  • The auditor reconciled the data on Forms W-2 to the general ledger. The dollars posted to the general ledger were higher than the W-2 data. Upon inspection, she found the Christmas bonuses given to the staff had not been reported as compensation on either Forms 941 or Forms W-2. Additionally, gift cards had been purchased by the church at intervals during the year, given to the church staff, and recorded in the payroll account but not reported on Forms W-2. Thus, compensation was understated for each affected staff person and for lay employees, resulting in FICA taxes being under-withheld and matched.

Form 1099-MISC – Good news: the church filed Forms 1099-MISC; Bad news: the auditor found an account in the general ledger labeled “Fees Paid.” The auditor asks for supporting documents for each of these expenses. She found three payments to individuals for services rendered (in each case more than $600 per individual). A Form 1099-MISC was filed for only one of the individuals, so the auditor proposed a penalty for failure to file the Forms 1099-MISC.

Contract Labor The auditor also finds an account in the general ledger: “Contract Labor.” The auditor determines that payments to a person working in the office a few hours each week represent salary to that employee. Thus, the expenditures were subject to federal and state income tax withholding and FICA tax withholding (plus matching the FICA tax withheld).

Employee Expense Reimbursements – Good news: the church had a well-written accountable expense reimbursement plan; bad news: some of the pastoral staff were inconsistent in documenting the business purpose of expenses. The auditor reviewed all of the expense reimbursements and determined that thousands of dollars of expenses lack adequate substantiation.

The auditor also looked at the timeliness of expense reimbursements and found many of them were made six months or more after they were incurred, significantly missing the 60-day safe harbor.

The auditor took the position the amounts that were inadequately substantiated and those that were reimbursed far beyond the 60-day safe harbor should have been added as compensation to Forms W-2. For lay employees, the amounts should have been subjected to federal and state income tax withholding and FICA withholding, with the church matching the FICA amounts.

While reviewing employee expense reimbursements, the auditor noticed travel expense payments to certain spouses of staff members. After questioning the purpose for the travel, the auditor determined there was no business purpose for the spousal travel. Although there was a business purpose for staff member travel, the spouses had merely gone along on trips to accompany staff, and there was no bona fide business purpose for this. The auditor decided that spousal travel expenses should have been added to Forms W-2 of the respective staff members.

A Final Reminder

The IRS may never audit your church, but wise church leaders make noble plans in case of an IRS payroll tax audit. “But the noble man makes noble plans, and by noble deeds he stands” (Isa. 32:8 NIV).

Dan Busby is president of the Evangelical Council for Financial Accountability (ECFA)—an accreditation organization that sets standards for governance, financial management, and fundraising/stewardship for churches and other nonprofits across the country.

 

 

 

 

 

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