Church Tax Bill Becomes Law.

By James E. Guinn & David O. Middlebrook 1996
Published in Ministries Today magazine

Recently, Congress overwhelmingly passed, and President Clinton signed into law, new legislation called the "Tax-Payer's Bill of Rights." As part of this new law, the Internal Revenue Service may now impose "intermediate sanctions" against individuals involved in certain types of transactions with churches and other tax-exempt organizations. Essentially, these "intermediate sanctions" take the form of excise taxes.

The passage of this law provides new evidence that the respect for churches by our society has lapsed into a widespread distrust of those involved in the ministry. Supporters of this legislation point to the extreme excesses of a few ministers and ministries as proof that this law is necessary. The result is, however well-intended, this law adds an unnecessary layer of complexity to church administration and demonstrates an increased willingness on the part of the Federal government to meddle in the affairs of the church.

Essentially, the new legislation imposes a series of excise taxes, also referred to as "intermediate sanctions," on individuals who are involved in any transaction that results in any "disqualified person" receiving an "excess benefit." For purposes of this bill, a "disqualified person" receives an "excess benefit" if that person, directly or indirectly receives an economic benefit from a non-profit organization that exceeds the value of the consideration received by the non-profit. For example, if any "disqualified person" sells a sound system to his/her church for $10,000 and the sound system is only worth $5,000, that "disqualified person" has received an "excess benefit" of $5,000. Similarly, if a church pays its pastor $200,000 per year (being the sum of the pastor's total compensation package including salary, housing allowance, benefits, etc.) and the value of the pastor's services is deemed by the IRS to be only $100,000, the pastor has received an "excess benefit" of $100,000. One of the major problems with this bill is the severity of the penalties involved.

For each "excess benefit" transaction, the following series of penalties are involved:

1. The "disqualified person" who receives the excess benefit must repay the benefit to the organization, plus pay an excise tax equal to 25% of the excess benefit.
2. Those "organization managers" who participated in and were aware of the excess benefit transaction are liable for an excise tax equal to 10% of the excess benefit, up to a maximum of $10,000.
3. If the "disqualified person" who received the excess benefit does not repay the organization within the same tax period, the IRS imposes a 200% tax on the excess benefit.

Who is a Disqualified Person? For purposes of this law, a "disqualified person" is (i) any person, or family member of any person, who is in position to exert substantial influence over the church, or (ii) any entity (i.e., corporation, partnership or trust) in which any disqualified person or persons described owns 35% or more of the voting, profit or beneficial interest. Clearly, this definition will encompass all officers, directors, founders, and major contributors, as well as their respective family members and businesses.

Finally, the law includes a five (5) year "look back" period from the date of the transaction. Therefore, the term "disqualified person" includes anyone who would meet the qualifications of a disqualified person at any point in the five years prior to the date of the transaction in question. Who is an Organizational Manager? "Organization managers" include all officers, directors, or trustees of any tax exempt organization. This definition also includes anyone having similar powers to an officer, director, or trustee. As a result, the IRS will look to the substance of an individuals position, and not his or her title in imposing the penalty tax. These persons are liable for the 10% tax if they knowingly participated in the excess benefit transaction. However, a safe harbor exists when the participation is not willful and is due to reasonable cause.

To better illustrate the potential impact of this law, consider the following hypothetical situation: A 500 member church decides to build a new sanctuary and hires ABC Construction to complete the project. Bob is a 50% partner in ABC Construction. Bob's father was the previous pastor of the church but resigned four years prior to construction of the sanctuary. Bob is a well respected member of the community, and the church board accepts his one million bid without considering competing bids. During an IRS examination, an investigator determines that the work was only actually worth $800,000. Under this new law, ABC Construction is a "disqualified person" because Bob, a family member of the church's former pastor, owns more than 35% of ABC Construction. Because of the 5-year look-back rule, the fact that Bob's father is no longer pastor of the church does not remove Bob from the reach of this new legislation. As a result, ABC Construction must repay $200,000 to the church and pay a $50,000 excise tax to the IRS. Also, the directors of the church will likely be held liable for a $10,000 excise tax, unless they can prove they acted reasonably in their selection of ABC Construction.

Recall the example above of the pastor whose total compensation is $200,000, but the value of his service is deemed to be only $100,000. Under this new law the pastor must repay $100,000 to his church. If the pastor cannot correct the excess benefit within the same tax period, then a $200,000 tax is imposed on the pastor. Additionally, the pastor must
pay a $25,000 tax to the IRS. Finally, all organization managers of the church may be subjected to a tax of $10,000 each.

James E. Guinn, CPA, is a founding partner of Guinn, Smith & Company, 2408 Texas Drive, Irving, Texas, 75062, 972-255-7120. Mr. Guinn is also a regular columnist for "Ministries Today Magazine".

David Middlebrook is an attorney for the law firm of Brewer, Anthony, Middlebrook, Burley & Dunn, 1159 Cottonwood Ln #150, Irving, Texas, 75038, 972-870-9898. Mr. Middlebrook's practice places a special emphasis on legal issues concerning non-profit organizations.