IRS Denies Tax Exemption to Non-Traditional Church Friday, Aug 21 2009

The term “church” is not actually defined in the Internal Revenue Code but when the IRS determines what a church is for tax exemption purposes, in more recent rulings it has exhibited a disturbing lack of predictability.

The ECFA recently reported on a non-traditional church that was denied church status by the IRS earlier this year.  The organization applied for exemption as a church and religious organization (accounting for 60% of its activities) and as an educational organization by way of its seminary (40%).  Every service, from sermons to seminary classes was offered online.  There was no established physical meeting or teaching space.

In this case the IRS based its finding on several grounds in denying the organization tax exemption status; the primary basis in its adverse determination letter (found at http://www.irs.gov/pub/irs-wd/0912039.pdf) related to the characteristics needed to meet the definition of a church.

Since 1978, the IRS has typically relied upon its own fourteen-point criteria to define a church:

1. Distinct legal existence
2. Recognized creed and form of worship
3. Definite and distinct ecclesiastical government
4. Formal code of doctrine and discipline
5. Distinct religious history
6. Membership not associated with any other church or denomination
7. Organization of ordained ministers
8. Ordained ministers selected after completing prescribed courses of study
9. Literature of its own
10. Established places of worship
11. Regular congregations
12. Regular religious services
13. Sunday schools for the religious instruction of the young
14. Schools for the preparation of its members

This list was recognized in American Guidance Foundation v. U.S., 490 F. Supp. 304 (D.D.C. 1980).  The court however chose to emphasize certain aspects from the list above, namely factors No.6 (Membership not associated with any other church or denomination), No.10 (Established places of worship), and No.12 (Regular religious services).  Additionally, the court declared to be of central importance “the existence of an established congregation served by an ordained ministry, the provision of regular religious services and religious education of the young, and the dissemination of a doctrinal code.”

The 14 factors stated above were not accepted as a definitive test in Foundation for Human Understanding v. Commissioner, 88 T.C. 1341 (1987).  Rather the court said that the IRS must consider all facts and circumstances.

But in analyzing the facts and circumstances of this case, the IRS appears to have actually narrowed the definition of a church.  Some of its reasoning on what is considered the most important criteria is as follows:

• Sunday School.  “Your Sunday school classes exist entirely on the Internet . . . Because there are no tests or final examinations required of these students, there is no way to establish that the students are learning their religious lessons.  Thus, as a practical matter, you have no Sunday schools for the religious instruction of the young.”

The IRS appears to expect characteristics that are present in only some American churches.  Catholic churches, for example may have “tests and final examinations” for the children to assure that they have learned their “religious lessons,” but that is not typical of most Protestant churches – traditional or otherwise.  Furthermore, not every gathering of believers has the necessary resources or teachers available to conduct Sunday school.

• Exclusive Membership.  “You state that you do not require prospective members to renounce other religious beliefs or their membership in other churches or religious orders to become members of your church. . . .This membership is insufficient to be treated as a regular congregation.”

Certainly many churches today do not inquire into all memberships of past churches and require renunciation when the congregant is willing to accept the creed of the present church.  This again may mark a line between highly organized Catholic churches and more informal Protestant ones.

• Size of Pastorate & Congregation.  “You have one minister, [name], ministering to your ‘congregation,’ which is composed of only [number] people.  Thus you do not have a complete organization of ordained ministers ministering to their congregations.”

Size is not listed as a factor on the 14-point list; however, this factor seems to play an important role in the IRS’s consideration.  Many churches in our country have only one pastor.  We are not privy to the size of the congregation rejected here, but in our country small churches, including spin-offs, startups, and rural churches are perhaps more the rule than the exception.

• Internet.  “Your services are held only on the Internet.  This is not a building or a physical place.  Thus you have no established places of worship.”

The internet has generated a plethora of never anticipated legal questions.  Some examples include acceptable methods to serve process, unauthorized practice of law across state lines, and intellectual property issues.  Simply because location is difficult to pin down does not mean it does not exist, as argued here.  As the world becomes smaller through tools such as video conferencing, this issue will increase in relevance.

Regardless of whether the organization considered should have received church status recognition, if this is the analysis to be used in making future determinations, how many of our existing churches would survive this test?

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Alternatives to Forming a Charitable Nonprofit Friday, Aug 7 2009

In the July/August 2009 edition of the American Bar Association’s Business Law Today, nonprofit attorney Gene Takagi and assistant Emily Chan write about the alternatives to setting up a tax exempt charitable organization. They point out that in an environment that is increasingly competitive, the majority of new charities do not succeed.

Charity founders and their attorneys should consider many things before proceeding to file for exemption – beyond the simple questions of how, when, and what are the costs.  First, the authors stress the importance of good planning and research.  The charity should develop a business plan.  “The plan should define the nonprofit’s mission and identify its core activities, potential supporters, and targeted beneficiaries. It also should contain an assessment of the nonprofit’s environment, including its potential allies and competitors, and a projected multiyear budget.”  If there is not a “plan for viability,” good intentions alone will not provide for the needs of the intended recipients.

Secondly, charity founders need to be aware of the implications of tax exemption.  The prohibition of private inurement is a pillar of a nonprofit organization.  An ignorance of these rules could result in heavy penalties for the leadership or even a loss of tax exemption.  In addition, charities must comply with many ongoing reporting and governance obligations.

Takagi and Chan recommend considering the following alternatives:  (1) an alliance with an existing nonprofit, (2) fiscal sponsorship, or (3) a donor-advised fund.

There is no need to reinvent the wheel.  The authors point out that many charity founders do a poor job scanning other charities (over 1.8 million nonprofits last year) to find out if there are other that are already doing the same kind of work.  Collaboration may reduce a beginner’s risks while also giving the benefit of the older charity’s experience and established access to the contribution market.

A “fiscal sponsorship” is when the founders of a new charitable project form a relationship with an existing charity.  This can be set up many different ways, but it usually involves the sponsoring charity allowing the new project to benefit from its tax exempt status and other administrative support in exchange for a small portion of the funds generated for the new project.  The authors commend this arrangement but stress the importance of a well-drafted fiscal sponsorship agreement.

Takagi and Chan would direct those planning to form a grant-making private foundation to consider the benefits of using a donor advised fund instead.  These funds allow the donors to advise the sponsoring organization how they would like their contributions to be used, and these wishes will be consistently honored, though the donor technically loses control over the direction of money.  The authors list some advantages of using this method: 1) No formation costs, 2) Possibility of making immediate deductible contributions, 3) More generous deduction limits (because the sponsoring organization is a public charity), 4) No administrative, investment, or governance responsibilities (and associated risks), and 5) No need to provide oversight over grants.

The authors encourage both charitably-minded individuals and the attorneys they approach to consider some of the alternatives to forming a new tax exempt organization before assuming there is but one way to accomplish their charitable goals.

The complete article can be found at http://www.abanet.org/buslaw/blt/2009-07-08/takagi.shtml.

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Minimum Wage Requirements as they Apply to Churches Saturday, Aug 1 2009

On July 24, 2009, the federal minimum wage increased from $6.55 to $7.25 for those covered by the Fair Labor Standards Act (FLSA).  Where the state and federal minimum wage both apply but differ, the federal rate will apply when higher.  Some states have a higher minimum wage, some lower, and some mirror the federal rate.  Another major provision for employees under the FLSA is time and a half pay for work done in excess of 40 hours a week.

When does the FLSA apply?

Application of the Fair Labor Standards Act

There are two general cases under which an employee is covered by the FLSA rules:

• Enterprise Basis – All employees working for organizations that engage in interstate commerce and that do at least $500,000 of business each year are covered.  Also included are all employees of hospitals, businesses providing medical or nursing care for residents, schools and preschools, and government agencies.
• Individual Basis – All employees whose work regularly involves them in “interstate commerce” are covered.  This includes employees that regularly phone, mail, or travel out of state.  Also most “domestic service workers,” such as day workers, housekeepers, chauffeurs, cooks, or full‑time babysitters are included.

It has not always been clear to what extent the FLSA affects churches and other nonprofits.  The “Enterprise Basis” can apply to a church that brings in over $500,000 a year in activities that compete with for-profit business, such as the rental income provided from leasing their facilities to others.  Many churches run schools, which also puts them under the “Enterprise Basis.”[i] Under the “Individual Basis” church employees are regularly doing activities that can be construed as interstate commerce, such as telephoning, mailing, or traveling out of state.  In addition, most churches have domestic service workers that would be covered by the Act.

If these organizations are involved in interstate commerce, they are not exempt from the FLSA rules on the basis of their tax-free status.  The Supreme Court in Alamo Foundation v. Secretary of Labor[ii] was referring to the FLSA when it stated, “[T]he statute contains no express or implied exception for commercial activities conducted by religious or other nonprofit organizations, and the agency charged with its enforcement has consistently interpreted the statute to reach such businesses.”[iii]

But how do churches know whether they are engaging in “interstate commerce?”

One view comes from Kathleen Turpin, an expert in employment law and author of Working Together, A Guide to Employment Practices for Ministries.  She recommends asking the following questions to help churches determine if the FLSA applies to them:

• Do we order teaching materials or other supplies from out of state?
• Do we send newsletters or other information to people out of state?
• Does anyone on staff travel out of state as part of their job?
• Does our ministry have a Website where people out of state order items?

According to Turpin if the answer to any one of these questions is in the affirmative, the organization is probably engaging in interstate commerce and needs to comply with the FLSA.

Possible Exemptions for Clergy & Other Religious Workers

Even if an organization’s employees are determined to be engaging in interstate commerce, some of its employees may yet be exempt from FLSA coverage.  One exception is found in the language of the FLSA which excludes “administrative, executive, and professional employees.”  The Dept. of Labor explains that this generally includes those that would otherwise be covered by the FLSA but earn at least $455 a week on a salaried basis.  Because this category is already above the minimum wage, the only noticeable difference from being covered under the Act is the lack of required overtime pay.

The 4^th Circuit Court has also recognized a “ministerial exemption” to the FLSA, first argued in Shenandoah Baptist Church[iv] and discussed more fully in the 2004 case of Shaliehsabou v. Hebrew Home of Greater Wash., Inc.[v] The exemption can exclude a member of the clergy from being an “employee” within the FLSA meaning.  The notion of this exemption derived from a debate on the floor of Congress that was later delineated in some guidelines issued by the Dept. of Labor’s Wage and House Administrator.[vi] The relevant portion of those guidelines provides:

“Persons such as nuns, monks, priests, lay brothers, ministers, deacons, and other members of religious orders who serve pursuant to their religious obligations in schools, hospitals, and other institutions operated by their church or religious order shall not be considered to be ‘employees.’”[vii]

The 4^th Circuit went on to use Title VII descriptions of “ministerial duties” to come up with the “primary duties” test to determine whether the exception applies.  They focused on “the function of the position,” rather than whether the person was formally ordained.  “[A]s a general rule, if the employee’s primary duties consist of teaching, spreading the faith, church governance, supervision of a religious order, or supervision or participation in religious ritual and worship, he or she should be considered ‘clergy.’”[viii]

Therefore, even though the clergy of a church are not covered by the FLSA due to the “ministerial exemption,” exemptions to the general rule are construed narrowly, and other employees may be covered by the FLSA.  Thus regarding these employees, the church is obliged to comply with minimum wage and overtime regulations.

Volunteers Not Covered by FLSA

Although the definition of “employee” under FLSA (found in Title 29 § 203 of the U.S. Code[ix]) is more sweeping than its use in other government regulations (such as ERISA), it does not include those who volunteer their time to a charitable organization.

There is not a specific exemption mentioned in the FLSA for church or charity volunteers in the private sector but the enforcers of the FLSA have interpreted it as if there was such an exemption.[x] But it is important to note that even if workers consider themselves “volunteers,” their intent alone will not exclude them from FLSA rules if they are accepting some other form of compensation.  In the Alamo case, former drug addicts who were working for free for the organization, considered themselves volunteers, but they were also residing there for free.[xi] This benefit transformed the workers from the “volunteer” category to “employee status.”[xii]

Churches thus need to be aware of the ramifications associated with rewarding volunteers for their labors.  Volunteers may be compensated for reasonable expenses directly associated with their work (gas money, etc) and accept small conveniences on the job (such as meals) as long as benefits in lieu of compensation do not exceed $500 a year.   If an organization is overly compensating its volunteers, it becomes seen as an employer in the eyes of the government, and the organization could face actions by the worker or the Dept. of Labor for not complying with FLSA wage laws.

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[i] Dole v. Shenandoah Baptist Church, 899 F.2d 1389 (4th Cir. 1990).

[ii] Alamo Foundation v. Secretary of Labor, 471 U.S. 290.

[iii] Id. at 296-7.

[iv] Shenandoah Baptist Church, 899 F.2d 1389 (4th Cir. 1990)

[v] Shaliehsabou v. Hebrew Home of Greater Wash., Inc., 363 F.3d 299

[vi] Shaliehsabou, at 305.

[vii] Id.

[viii] Id., quoting Bruce N. Bagni, Discrimination in the Name of the Lord: A Critical Evaluation of Discrimination by Religious Organizations, 79 Colum. L. Rev. 1514, 1545 (1979).

[ix] Fair Labor Standards Act – Title 29 § 203(e)(1) Except as provided in paragraphs (2), (3), and (4), the term “employee” means any individual employed by an employer;  (g) “Employ” includes to suffer or permit to work.

[x] Walling v. Portland Terminal Co., 330 U.S. 148 at 152, stating “Section 3(g) of the Act defines ’employ’ as including ‘to suffer or permit to work’ and § 3(e) defines ’employee’ as ‘any individual employed by an employer.’ The definition ‘suffer or permit to work’ was obviously not intended to stamp all persons as employees who, without any express or implied compensation agreement, might work for their own advantage on the premises of another. Otherwise, all students would be employees of the school or college they attended, and as such entitled to receive minimum wages. So also, such a construction would sweep under the Act each person who, without promise or expectation of compensation, but solely for his personal purpose or pleasure, worked in activities carried on by other persons either for their pleasure or profit. But there is no indication from the legislation now before us that Congress intended to outlaw such relationships as these. The Act’s purpose as to wages was to insure that every person whose employment contemplated compensation should not be compelled to sell his services for less than the prescribed minimum wage. The definitions of ’employ’ and ’employee’ are broad enough to accomplish this. But, broad as they are, they cannot be interpreted so as to make a person whose work serves only his own interest an employee of another person who gives him aid and instruction.”

See also Alamo, at 295 stating, “An individual who, without promise or expectation of compensation, but solely for his personal purpose or pleasure, works in activities carried on by other persons either for their pleasure or profit, is outside the sweep of the Fair Labor Standards Act.”

[xi] Alamo, at 293, stating “[T]he associates who worked in these businesses were ‘employees’ of the Alamos and of the Foundation within the meaning of the Act. The associates who had testified at trial had vigorously protested the payment of wages, asserting that they considered themselves volunteers who were working only for religious and evangelical reasons. Nevertheless, the District Court found that the associates were ‘entirely dependent upon the Foundation for long periods.’  Although they did not expect compensation in the form of ordinary wages, the District Court found, they did expect the Foundation to provide them ‘food, shelter, clothing, transportation and medical benefits.’”

[xii] Alamo, at 290, stating “The Foundation’s associates are ‘employees’ within the meaning of the Act, because they work in contemplation of compensation. Walling v. Portland Terminal Co., 330 U.S. 148, distinguished.  The fact that the associates themselves protest coverage under the Act is not dispositive, since the test of employment under the Act is one of ‘economic reality.’  And the fact that the compensation is primarily in the form of benefits rather than cash is immaterial in this context, such benefits simply being wages in another form.”

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