Can You Make Gifts To Your Pastor?

Can you give someone money and not have it considered income?

Of course you can.

One way to do it is to die and leave money as a bequest.

That is a bit extreme for the average person, including me.

Another way is to give someone a gift. Granted, if the gift is large enough, you may have to report it. You do not actually write a check to Uncle Sam until your cumulative lifetime gifting exceeds $11,180,000, but you do have to file paperwork.

Can you make a gift to an employee?

Much harder.

The Code does allow some de minimis things, such as holiday hams – but even that has to be under $75. 

Oh, and it cannot be in cash, whether less than $75 or not. Cash taints the deal.

There is a narrow exemption for length of service or safety awards, but let’s pass on those details.

To a tax geek, the general answer is that anything you give an employee is taxable.

I was looking at a case a couple of weeks back that introduced a spin on this concept.

We have a pastor at a Minnesota church.

For the two years at issue he turned down a salary.

He did take a housing allowance.

And then it got interesting.

The church used donation envelopes. They were different colors, with each color having a different meaning.

The basic envelope was white. That was the weekly offering. It included a space where you could designate the amount of the donation that was for the pastor.

There were gold envelopes for special projects and events.

Then there were the blue envelopes. Blue envelopes were “gifts” to the pastor, and congregation members were instructed that those could not be deducted on their tax returns. The church did not track blue envelope donations, nor did the church make blue envelopes commonly available. If you wanted one, you had to ask for one.

For tax years 2008 and 2009, the pastor received the following;

                                                       2008              2009

          White envelopes              $40,000         $40,000

          Housing allowance          $78,000         $78,000

          Blue envelopes              $258,001        $234,826

When the IRS learned of this, they wanted tax on the blue envelopes.

What do you think?

Here is the Bible:

When I preach the gospel, I may make the gospel of Christ without charge, that I abuse not my power in the gospel.” 1 Cor. 9:18

Here is the Court: 

To decide this case, we must descend from the sacred to the profane."  

What sets up the tension in this case is that the term “gift” has a different meaning for tax than for common law. For common law, a gift is made voluntarily and without legal or moral obligation.

Tax views a gift as made from “detached and disinterested generosity” or “out of affection, respect, admiration, charity or like impulses.”

Huh? What is the difference?

The “disinterested generosity.”

That standard can be hard enough to pin down when reviewing a transaction between two individuals. How much harder can it get when reviewing a transaction between a group and an individual?

But that is what the Court had to decide.

The Court walked us through its decision process.

(1) Were donations provided in exchange for services?

The pastor did provide services, and to a reasonable person those blue envelopes look like an incentive for him to keep providing them.

Looks like a vote for income.

(2)  Did the pastor request the donations?

To his credit, the pastor referred to white envelopes when talking about tithes. He did not talk about blue envelopes, and a congregation member had to ask for one as they were not generally available.

Looks like a vote for a gift.

(3) Were the donations part of a routinized program?

That depends. Is the existence of blue envelopes per se evidence of a “routinized program?”

Can mere existence of a program rise to the level of a “routine?”

One can discern some routine no matter what the facts are, as the repetition of any action can be described as a “routine.” However, is that truly the intent of this test?

Call this one a push.

(4) Did the pastor receive a separate salary and what was the relationship of that salary to the personal donations?

The Court was very uncomfortable here:

We cannot ignore the sheer size of blue-envelope donations in 2008 and 2009, or the facts that they are very similar in amount in both years – within 10% of each other. We find it more likely than not that this means there was a ‘regularity of the payments from member to member and year to year ….’”

Oh, oh. We have our tie-breaker.

The Court had to discern the intent of the group, an almost mythical challenge. It saw blue-envelope donations total almost seven times the amount of white-envelope donations and asked: could it be that the congregation was trying to keep its popular and successful preacher?

CTG: I’ll play along: why, yes they were.

If they paid him more and donated less, perhaps they would not be as concerned.

CTG: By that reasoning, had he won the recent billion-dollar lottery they would not have to pay him at all. 

But he needs a certain amount just to pay his bills.

CTG: True, but how many parents across the fruited plain are giving their post-college kids money to live on? Is that income too?

The relationship between a parent and child is different.

CTG: The relationship between a faithful and his/her religious leader can also be different.

But being a minister is his job. Anything he receives for doing his job is – by definition – income.

CTG: Thank you. This is the clearest statement of your reasoning thus far. Why four criteria? Seems to me you could have fast-forwarded to the last one – the only one that really mattered.

The Court decided the pastor had income. He owed tax.

Register my surprise at zero, none, nada. I knew the ending of this movie from the first scene.

Our case this time was Felton v Commissioner.

Does The IRS Want 1099s For Your Contributions?

I have been thinking about a recent IRS notice of proposed rulemaking. The IRS is proposing rules under its own power, arguing that it has the authority to do so under existing law.

This one has to do with charitable contributions.

You already know that one should retain records to back up a tax return, especially for deductions. For most of us that translates into keeping receipts and related cancelled checks.

Contributions are different, however.

In 1993 Congress passed Code section 170(f)(8) requiring you to obtain a letter (termed “contemporaneous written acknowledgement”) from the charity to document any donation over $250.  If you do not have a letter the IRS will disallow your deduction upon examination.

Congress felt that charitable contributions were being abused. How? Here is an example: you make a $5,000 donation to the University of Kentucky and in turn receive season tickets – probably to football, as the basketball tickets are near impossible to get. People were deducting $5,000, when the correct deduction would have been $5,000 less the value of those season tickets. Being unhappy to not receive 100 percent of your income, Congress blamed the “tax gap” and instituted yet more rules and requirements.

So begins our climb on the ladder to inanity.

Soon enough taxpayers were losing their charitable deductions because they failed to obtain a letter or failed to receive one timely. There were even cases where all parties knew that donations had been made, but the charity failed to include the “magic words” required by the tax Code.

Let’s climb on.

In October, 2015 the IRS floated a proposal to allow charities to issue Forms 1099s in lieu of those letters. Mind you, I said “allow.” Charities can continue sending letters and disregard this proposal.

If the charity does issue, then it must also forward a copy of the 1099s to the IRS. This has the benefit of sidestepping the donor’s need to get a timely letter from the charity containing the magic words.

Continue climbing: for the time-being charities have to disregard the proposal, as the IRS has not designed a Form 1099 even if the charity were interested.  Let’s be fair: it is only a proposal. The IRS wanted feedback from the real world before it went down this path.

Next rung: why would you give your social security number to a charity – for any reason? The Office of Personnel Management could not safeguard more than 20 million records from a data hack, but the IRS wants us to believe that the local High School Boosters Club will?

Almost there: the proposal is limited to deductible contributions, meaning that its application is restricted to Section 501(c)(3) organizations. Only (c)(3)s can receive deductible contributions.

But there is another Section 501 organization that has been in the news for several years – the 501(c)(4). This is the one that introduced us to Lois Lerner, the resignation of an IRS Commissioner, the lost e-mails and so on. A significant difference between a (c)(3) and a (c)(4) is the list of donors. A (c)(3) requires disclosure of donors who meet a threshold. A (c)(4) requires no disclosure of donors.    

You can guess how much credibility the IRS has when it says that it has no intention of making the 1099 proposal mandatory for (c)(3)s - or eventually extending it to also include (c)(4)s.

We finally reached the top of the ladder. What started as a way to deal with a problem (one cannot deduct those UK season tickets) morphed into bad tax law (no magic beans means no deduction) and is now well on its way to becoming another government-facilitated opportunity for identity theft.

The IRS Notice concludes with the following:

Given the effectiveness and minimal burden of the CWA process, it is expected that donee reporting will be used in an extremely low percentage of cases.”

Seems a safe bet.

UPDATE: After the writing of this post, the IRS announced that it was withdrawing these proposed Regulations. The agency noted that it had received approximately 38,000 comments, the majority of which strongly opposed the rules. Hey, sometimes the system works.

Taxpayer Loses Charitable Deduction for Lack of Appraisal

Joseph Mohamed seems a good sort. He and his wife live in Sacramento, California. He is a successful real estate professional. In 1998 they formed the Joseph Mohamed Sr. and Shirley M. Mohamed Charitable Remainder Unitrust II. Tax pros call this a “CRUT.”

QUESTION: What is a CRUT? This is a special trust involving a charity. You can guess that a purpose of the trust is to make a charitable donation. In a CRUT, an annuity goes to the donor (in this case, Joseph and Shirley) for a period of years. At the expiration of that period, the remainder goes to a charity. In the Mohamed’s case, that period is twenty years. Why would you do that in place of simply donating twenty years out? Because the CRUT allows you to claim the charitable deduction now.

In 2003 and 2004 the Mohameds donated several properties to the CRUT. The properties were worth somewhere between $18 million and $21 million. Joseph Mohamed prepared his own taxes. This means he ran into Form 8283 to report the property donations. He did not read the instructions though, as he did not think he had to. The form seemed straightforward enough.

Form 8283 has several parts. Part 1 Section B required a description of the donated property and “can be completed by the taxpayer and/or appraiser.” It also had the following text:

“If your total art contribution deduction was $20,000 or more you must attach a complete copy of the signed appraisal. See instructions.”  

Mohamed was contributing real estate, not art. He read that to mean that he did not have to attach an appraisal. He did attach all types of statements and documentation to his return, including his own valuation of the real estate.

The return gets audited (who is shocked?). The IRS was displeased that Mohamed had self-valued such a large dollar donation of property. The IRS first goes after the valuation. Makes sense. Mohamed then gets an independent appraisal which shows that the properties are worth more than he claimed.

The IRS then pulls back and realizes something. Regulation 1.170A-13(c) requires the following for donations of this nature and amount:

1.      A qualified appraisal must be made not more than 60 days before the donation and no later than the due date of the return.

2.      It must be signed by a qualified appraiser, who cannot be the donor or person claiming the deduction.

3.      The qualified appraisal must contain defined information, such as a description of the property, its basis and fair market value.

Mohamed had a problem. You see, he did not have a qualified appraisal. That requires an independent appraiser, and he obtained that after the filing of his return. There was of course no signature, as there was no qualified appraisal. While he attached numerous statements to his return, they did not completely address the litany of questions that the IRS wanted in Reg 1.170A-13(c).

The IRS disallowed the donations. Mohamed goes to Tax Court and raises three arguments:

1.      The extreme result indicates that the Regulations are invalid.

2.      The IRS-designed Form 8283 misled him.

3.      He substantially complied with the documentation requirements.

The Court quickly dismissed arguments 1 and 2. It went through an analysis (which we will skip) and concluded that the Regulations were valid and reflected Congressional intent. The IRS, for example, was ordered by Congress to issue Regulations requiring appraisals for donations of property in excess of $5,000. A Regulation that implements Congressional intent is difficult to rule invalid. The Court was sympathetic to argument 2, but it pointed out that the form is not the tax law. The Court even added that “a taxpayer relies on his private interpretation of a tax form at his own risk.”

Now we get to argument 3. What does “substantially comply” mean? There was a previous case (Bond) where the Court found substantial compliance, but succeeding cases have ever compressed the reach of that decision. The Court determined that substantial compliance meant complying with the “essential requirement” of the statute. Problem is, the “essential requirement” of the statute is the need to obtain a qualified appraisal. With that verbal loop, there was no way that Mohamed could substantially comply.

Here is the Court:

We recognize that this result is harsh – a complete denial of charitable deductions to a couple that did not overvalue, and may well have undervalued, their contributions – all reported on forms that even to the Court’s eyes seemed likely to mislead someone who did not read the instructions.”

MY TAKE: I am sympathetic to the Mohameds, but I am also confused. They must have used a tax professional in the past to establish the CRUT. They then make a near-$20 million donation but do not hire a pro to walk it through? It doesn’t make sense to me.

In both Mohamed and Durden there was no question that contributions were made; there were also no question as to the amounts. The taxpayer may have felt comfortable thinking: what are they going to do, put me in jail? No, they won’t put you in jail, but they will take away your charitable deduction. Don’t think that a court will bail you out, as there may be limits to what a court can do.

What is the answer? I would encourage the use of a tax professional if there is even a whiff of a question on your return. I know – it costs money. The problem is that you may not know you have hit a slick spot until after the IRS contacts you. As Mohamed and Durden have shown, that may be too late.

The IRS is Pursuing 501(c)(4)s

The 2011 Workplan of the IRS Exempt Organizations Division states:

"[i]n recent years, our examination program has concentrated on section 501(c)(3) organizations. Beginning in FY 2011, we are increasing our focus on section 501(c)(4), (5) and (6) organizations."

The (c)(3) is the classic charity – Muscular Dystrophy or March of Dimes, for example. The purpose of a (c)(4) is to pursue a near-endless range of public policy goals through action and advocacy. Many of these entities are barred from (c)(3) status because they express their advocacy through political activity. It is quite common to couple a (c)(3) with a (c)(4). You already know some of the big (c)(4) players, organizations such as AARP and the National Rifle Association.

Now let’s carve-out the meaning of “political activities”:

* Promoting legislation germane to the (c)(4)s purpose is considered a permissible social welfare purpose. Therefore an organization can qualify as tax-exempt under( c)(4) even if the organization’s only activity is lobbying, as long as the lobbying is related to its exempt purpose.
* A social welfare purpose does not include participating in an election in order to advance or defeat a given candidate. Candidate-related activity cannot be the (c)(4)s primary activity. The IRS does not tell us what “primary” means, and advisors differ. Some advisors s feel comfortable with electioneering approaching (but always remaining below) 50% of the organization’s total activities. It is unclear how to even measure activities. What is the measure: dollars spent, time spent by staff and volunteers, a percentage of fixed expenses (such as rent)?

So lobbying is acceptable but electioneering is not.

Donations to (c)(4)s are not afforded the same protection as a (c)(3), and the IRS has held its powder for almost 30 years on whether it would consider (c)(4) donations to be subject to the gift tax.

That has changed.

How would the IRS know who donated to a (c)(4)? A (c)(4) has to disclose to the IRS on its 990 filing contributors who donated $5,000 or more. This list however does not have to be publicly disclosed. Therefore, you and I might not know, but the IRS would. It would not be a difficult task for the IRS to identify donors for audit.

And they have. The IRS has recently sent letters that read as follows:

"Your 2008 gift tax return (Form 709) has been assigned to me for examination. The Internal Revenue Service has received information that you donated cash to [REDACTED], an IRC Section 501(c)(4) organization. Donations to 501(c)(4) organizations are taxable gifts and your contribution in 2008 should have been reported on your 2008 Federal Gift Tax Return (Form 709)."

The federal gift tax applies to a gratuitous transfer of property by an individual. The gift tax is separate from the individual income tax. Not all gratuitous transfers are subject to the gift tax. Transfers between spouses are not considered gifts, for example. An individual can give away $13,000 per year to anyone for any reason without involving the gift tax. Donations to (c)(3)s are not considered gifts, irrespective of the amount. Donations to a 527 organization (that is, a PAC) are not considered gifts. Donations to a (c)(4) are considered gifts.

At least they are considered gifts by the IRS. The IRS pulled out almost 30 years ago, and the limited guidance and cases in this area leaves doubt that the IRS is correct. If one focuses in on the political nature of the contribution, then one has to consider Stern and Carson, for example. In Stern (CA-5, 1971), the IRS lost its argument that campaign contributions were taxable gifts. In Carson (CA-10, 1981) the Tax Court held that Congress did not intend for gift tax to apply to campaign contributions, and the Tenth Circuit affirmed on this point.

We almost undoubtedly will see this matter litigated.