Churches, synagogues, mosques and other religious congregations aren’t required to file tax returns, so they might not regularly hire independent accountants. But regardless of size, religious organizations often are subject to other requirements, such as paying unrelated business income tax (UBIT) and properly classifying employees.

Without the oversight of tax authorities or outside accountants, religious leaders may not be aware of all requirements to which they’re subject. This can leave their organizations vulnerable to fraud and its trustees and employees subject to liabilities.

Common Vulnerabilities
To effectively prevent financial and other critical mistakes, make sure your religious congregation complies with IRS rules and federal and state laws. In particular, pay attention to:

  • Employee classification. Determine which workers in your organization are full-time employees and which are independent contractors. Depending on many factors, such as the amount of control your organization has over them, their responsibilities, and their form of compensation, individuals you consider independent contractors may need to be reclassified as employees.
  • Clergy wages. Most clergy should be treated as employees and receive W-2 forms. Typically, they’re exempt from Social Security taxes, Medicare taxes and federal withholding but are subject to self-employment tax on wages. A parsonage (or rental) allowance can reduce income tax, but not self-employment tax.
  • UBIT. If your organization regularly engages in any type of business activity that’s unrelated to its religious mission, be aware of certain tax and reporting rules. Income from such activities could be subject to UBIT.
  • Lobbying. Your organization shouldn’t devote a substantial part of its activities in attempting to influence legislation. Otherwise you might risk your tax-exempt status and face potential penalties.

Trust and Protect
Faith groups can be particularly vulnerable to fraud because they generally foster an environment of trust. Also, their leaders may be reluctant to punish offenders. Just keep in mind that even the most devout and long-standing members of your congregation are capable of embezzlement when faced with extreme circumstances.

To ensure employees and volunteers can’t help themselves to collections, require that at least two people handle all contributions. They should count cash in a secure area and verify the contents of offering envelopes. Next, they should document their collection activity in a signed report. For greater security, encourage your members to make electronic payments on your website or sign up for automatic bank account deductions.

Seek Expertise
Although your religious congregations are subject to less IRS scrutiny than even your fellow not-for-profit organizations, that doesn’t mean you can afford to ignore financial best practices. Contact your advisors for guidance.

The commerciality doctrine was created along with the operational test to address concerns over not-for-profits competing at an unfair tax advantage with for-profit businesses. But even business activities related to your exempt purpose could fall prey to the commerciality doctrine, resulting in the potential loss of your organization’s exempt status.

Several Factors Considered
The operational test generally requires that a not-for-profit be both organized and operating exclusively to accomplish its exempt purpose. It also requires that no more than an “insubstantial part” of its activities further a nonexempt purpose. Your organization can operate a business as a substantial part of its activities as long as the business furthers your exempt purpose.

But under the commerciality doctrine, courts have ruled that some organizations’ otherwise exempt activities are substantially the same as those of commercial entities. They consider several factors when evaluating commerciality, including:

  • Whether an organization has set prices to maximize profits,
  • The degree to which it provides below-cost services,
  • Whether it accumulates unreasonable reserves,
  • The use of commercial promotional methods such as advertising,
  • Whether the business is staffed by volunteers or paid employees,
  • Whether it sells to the general public, and
  • The extent to which the not-for-profit relies on charitable donations. (They should be a significant percentage of total support.)

No single factor is decisive for courts or the IRS.

Possible UBIT Issues
There’s another risk for not-for-profits operating a business. You could pass muster under the commerciality doctrine but end up liable for unrelated business income tax (UBIT).

Revenue that a not-for-profit generates from a regularly conducted trade or business that isn’t substantially related to furthering the organization’s tax-exempt purpose may be subject to UBIT. Much depends on how significant the business activities are to your organization as a whole. There are also several exceptions.

Seek Advice First
If you’re thinking about launching a new business to drum up additional revenues, consult your advisors first. They can help reduce the risk that your organization will run into potential exemption or UBIT issues.

Whether you’re planning to raise funds for your not-for-profit with a simple bingo game or raffle, or with a more elaborate casino night, you need to understand and follow the federal rules that govern these kinds of activities. Gaming activities can open the door to unexpected taxes and trigger requirements for specific IRS filings.

Filings and special taxes

If you regularly conduct a gaming activity, you may be required to report it to the IRS. For example, nonprofits that gross more than $1,000 in unrelated business income from regular gaming fundraisers may need to file Form 990-T, “Exempt Organization Business Income Tax Return.”

Your group also may be subject to a wagering excise or occupational tax, depending on:

  • The type of wagering you engage in,
  • How it’s structured, and
  • How your organization benefits from the proceeds.

Generally, this tax applies to lotteries or wagering pools that involve a sporting event or a contest that’s conducted for profit.

Winnings and withholding

Depending on the type of game and the amount won by an individual, you might be required to report winnings to the IRS. This applies if your fundraiser includes a single instant/pull-tab prize of $600 or more (if more than 300 times the amount of the wager), a single bingo or slot machine prize of $1,200 or more, or a single Keno prize of $1,500. You’ll need to obtain the winner’s name and Social Security number.

Regular income tax or backup withholding is necessary for some games with winnings over a certain threshold. No withholding is required for bingo prizes up to $1,200. But withholding is necessary when raffle and some other types of winnings are $600 or more. Your organization is required to pay these amounts, regardless of whether you get the withholding from the winner.

Tip of the iceberg

These are just some of the federal rules surrounding gaming. In addition, many states and municipalities impose their own regulations on gaming activities, including requiring licenses or permits. To ensure your fundraiser complies with complex IRS rules, contact us.

Jen:  This is the PKF Texas Entrepreneur’s Playbook.  I’m Jen Lemanski, this week’s guest host, and I’m back again with Annjeanette Yglesias, one of our tax managers on our not for profit team.  Welcome back to the Playbook Annjeanette.

Annjeanette:  Thanks, Jen, it’s nice to be here.

Jen:  Well now I’ve heard you talk about unrelated business income tax; what is it?  What do nonprofits need to know about it?

Annjeanette:  Well, first of all, that’s a mouthful so we call it UBI.  UBI is an income tax that is imposed on certain tax-exempt organizations that participate in certain activities that are unrelated to their exempt purpose.

Jen:  So what would qualify for that UBI?

Annjeanette:  UBI is income from a trader business that is regularly carried on and that is not substantially related to the organization’s exempt purpose.

Jen:  So what would a leadership team look for?  How would they know that they need to do something about it?

Annjeanette:  I think the most important thing about UBI to remember is that it hinges heavily on the organization’s exempt purpose.  So I think in most cases the organization should talk to their CPA, just kind of make sure that an activity that they’re thinking about engaging in would qualify under UBI or not because tax could be imposed.

Jen:  What’s an example of something that would qualify under the UBI?

Annjeanette:  Actually it’s case by case.  I think the most important part of UBI to remember is that since it hinges heavily on the organization’s exempt purpose that you have to consider the facts and circumstances of each case.  So for example, one activity that is not considered UBI to one organization might be considered UBI to another organization.

Jen:  So that’s why they need to get you involved so that you can help go through that case by case and you can assist them with that.

Annjeanette:  Exactly.

Jen:  Perfect.  Well thank you so much for being here, I really appreciate it and we’ll get you back to talk about some more stuff impacting on profits.  How does that sound?

Annjeanette:  That sounds great.

Jen:  Perfect.  To learn more about how we can help not for profits visit PKFTexas.com/notforProfit/.  This had been another Thought Leader production brought to you by PKF Texas The Entrepreneur’s Playbook.