The details surrounding a church’s federal tax-exempt status can be confusing, especially when a specific question arises. The issue of tax-exempt status is important for two reasons. First, exempt status allows a church to avoid paying corporate taxes. Second, exempt status allows those who donate to the church to claim a tax deduction in certain situations.
Churches automatically qualify for exempt status under Internal Revenue Code Section 501(c)(3). The only requirement is that the organization really is a “church” as understood by the Internal Revenue Service.
Yet even though churches automatically qualify for exempt status, they have no way to prove that status to third parties unless they apply for, and receive, a recognition letter from the IRS. A church may need this recognition letter for proof in order to:
- receive an estate gift,
- receive a transfer of stock or other investment proceeds from a donor,
- receive a real-estate transfer,
- qualify for a property-tax exemption,
- qualify for a sales-tax exemption,
- receive a grant,
- obtain non-profit rates on a bulk mailing permit from the postal service, or
- obtain an exemption for paying state unemployment tax.
All of these issues can lead to significant financial detriment to a church that is unable to provide a letter proving its 501(c)(3) tax-exempt status.
In order to apply for a recognition letter, churches can complete and submit Form 1023. This form must be submitted electronically by creating an account at pay.gov. Form 1023 is a lengthy and complex form that requires detailed information about a church’s programs, financial projections, compensation practices, and board governance. A legal or tax professional should be consulted to assist in completing the application. The IRS requires a $600 filing fee. Though the professional costs and filing fee may cause some churches reluctance, the financial benefits listed above will often outweigh the costs associated with preparing and filing the application form. The application usually takes about five months to be reviewed and approved by the IRS, though the time can be shorter or longer. Because of the lengthy processing time, a church should plan ahead to file the application long before they anticipate needing the approval letter.
Another issue that often arises surrounding exempt status is determining what kinds of donations are deductible by a church donor. Donations of cash and property usually qualify. The church should provide a donor statement describing the gift given by the donor. If the gift is cash, then the amount of the donation is simple enough to report. However, if the donor gives any other kind of property, the church’s donor statement should merely describe the property given, but should not assign a monetary value to the property. It is up the donor to determine the value of the property for tax purposes. Vehicle donations are governed by special rules and require additional steps that should be researched carefully to determine if the church will accept them.
Also, it is important to realize that donations of time (volunteering) are not deductible.
Clergy Financial Resources serves as a resource for clients to help analyze the complexity of clergy tax law, church payroll & HR issues. Our professionals are committed to helping clients stay informed about tax news, developments and trends in various specialty areas.
This article is intended to provide readers with guidance in tax matters. The article does not constitute, and should not be treated as professional advice regarding the use of any particular tax technique. Every effort has been made to assure the accuracy of the information. Clergy Financial Resources and the author do not assume responsibility for any individual’s reliance upon the information provided in the article. Readers should independently verify all information before applying it to a particular fact situation, and should independently determine the impact of any particular tax planning technique. If you are seeking legal advice, you are encouraged to consult an attorney.
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