Industry Expertise · July 21, 2020

How to Maintain Tax-Exempt Status for Churches

One of the benefits the government provides to charitable organizations is not having to pay taxes on revenue. The IRS considers religion a charitable activity, under a 501(c)(3) categorization. This creates tax-exempt status for churches and other houses of worship. They aren't required to pay federal, state and local income and property taxes.

Like most programs, however, maintaining this privilege requires churches and religious organizations to adhere to a set of rules. Missteps or oversights could jeopardize your organization's tax-exempt status.


What to avoid

Perhaps the most common error is failing to file the proper IRS paperwork for three consecutive years. But there are other activities that could cause the IRS to remove an organization's 501 (c)(3) categorization.

Inurement

Religious organizations may not use part of their earnings to benefit a private shareholder or individual who has the ability to control or influence its activities. This means that a board member, pastor or officer can't accept payment beyond reasonable compensation for their services. In addition to losing tax-exempt status, those guilty of inurement could be subject to paying excise tax.

Excessive lobbying

Lobbying in substantial amounts could also jeopardize your church's tax-exempt status. Religious organizations may not directly contact government officials to propose, support or oppose legislation, nor can they urge members to do the same. To comply, churches can elect to have any lobbying-related activities measured by an expenditure test, which measures the percentage spent on lobbying against a limit based on the size of the organization.

Political activity

In addition to lobbying, religious organizations are prohibited from directly or indirectly engaging in activities related to political campaigns. This includes making contributions to a campaign, as well as making public statements in support or opposition of a candidate running for public office. Organizations can, however, promote voter registration.

Best practices

Upholding some regular business standards and protocols will help in maintaining the tax-exempt status for churches. For example, even though the church is exempt from paying taxes, it must still properly withhold and pay employment taxes for its employees.

Another practice is reporting income that isn't tax-exempt. Business revenue that isn't wholly related to the organization's core purpose could be taxable. For example, if a church sells coffee during service, it could be considered taxable income. However, if the coffee sold was donated to the church, the income could be exempt. It's important for leaders to work with their accountants to define what types of income are and aren't free from tax.

Churches and religious organizations should also maintain good records, such as collecting receipts. If a staff member or volunteer purchase goods or services on behalf of the church and are repaid, it could be considered taxable income. It's important to keep track of expenses and properly account for the cost.

Finally, while churches don't need to pay taxes, they still must file an annual return, which is IRS Form 990-T. This form, as well as any schedules, attachments and supporting documents, must be available for inspection by the public.

Tax-exempt status gives religious organizations the opportunity to retain more of their donations so they can fulfill their mission and give back to their communities. By implementing some best practices, your organization can keep enjoying this gift that allows you to keep giving back.

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