Compliance

A number of best practice deficiencies can render an agency inefficient and can lead to squandering of scarce missions resources.  However, failure to be in compliance with relevant regulatory requirements can seriously cripple the effectiveness of an agency, and at worst put that agency out of business.  The following list of issues are a sample of those which would be addressed in a typical compliance review.  The list is not comprehensive, but rather is based on the actual experience of one agency – herein referred to as ABC.  Obviously, this document is often quoting other sources.

The following issues, while not comprehensive, are part of that larger list of potential weaknesses often seen in missionary agencies:

  • Inurement and Private Benefit
  • The “Conduit” Trap
  • Ministry expense – Substantiation Timing
  • Employee vs. Independent Contractor
  • Personal Offerings

Note:  We are not attorneys, and do not provide legal advice.  These comments are the opinion of the author.

ABC MISSIONARY FELLOWSHIP INTERNATIONAL

MISSIONARY COMPENSATION PROJECT

To be tax-exempt under section 501(c)(3) of the Internal Revenue Code, an organization must not only (a) be organized and operated exclusively for purposes set forth in section 501(c)(3), but also (b) none of its earnings may inure to any private shareholder or individual.  In addition, (c) it may not attempt to influence legislation as a substantial part of its activities and it may not participate in any campaign activity for or against political candidates.
The purpose of this review is to help ensure that the private benefit rules of subpoint b) are not violated.  The following are areas where ABC may be at risk.

Our objective will be to equip ABC with the ability to quickly and effectively respond to an IRS inquiry with reasonable and conclusive evidence of due diligence and intended compliance, thus giving them an advantage in any in-depth review.

 ABC COMPLIANCE ISSUES

ABC serves the local church and individual donors as a service agency, providing the required level of screening, resourcing, and accountability, which would be difficult and very expensive for  individual churches to do.  In essence, ABC provides the churches and donors the administrative control required by 501-C-3, tax-exempt status.

Following are key points which are essential to compliance and will need to be clearly communicated to those who will be effected by the upcoming changes.  It was felt that this effort to pull together the basic requirements and expectations would give ABC the tools to support the necessary changes.

Following are key points which are essential to compliance and will need to be clearly communicated to those who. will be effected by the upcoming changes.  It was felt that this effort to pull together the basic requirements and expectations would give ABC the tools to support the necessary changes.

USE OF EXEMPT RESOURCES

Exempt resources must be used exclusively for exempt purposes. This is a fundamental provision of tax law, as well as state law, as set forth in an exempt organization’s articles of incorporation and bylaws. There is an absolute prohibition of any part of an organization’s resources inuring to the benefit of private individuals.

In at least two precedent setting cases (Founding Church of Scientology v. U.S. and Spokane Motorcycle Club v. U.S.), even a small amount of private inurement was fatal to exempt status under 501-C-3.

Another case that speaks directly to the needed ABC changes is that of ________ Ministries, Inc.  Following is a summary of that case:

The case began with an IRS audit in 1989, and was finally settled in 1998.  (____ filed in court for a declaratory judgment, but the case was settled without a trial.)   Fortunately,_____ was represented by Chip Watkins of the firm, Webster, Chamberlain, and Bean, and the case did end well, but not before much expense and an extensive overhaul of _____’s administration.  Out of nearly 300 current workers and more than 2000 historic files, purported excessive compensation was noted by the IRS in about 40 cases, principally because of the perceived intent of many of the donors, and a lack of adequate documentation regarding the work for which the missionaries were being paid.  (Many of those donors were also audited, and had deductions disallowed, though many of their cases were also settled for a relatively small loss of deduction.)  While the monetary impact to the donors turned out to be minimal, the damage to donor relationships would be devastating.  In the case of church donors, the church could be called into question, concerning inappropriate use of exempt funds.

In these cases, the actual amount of the compensation would not have been excessive had ____ been able to document that the compensation was actually earned.  This was a very small percentage of total activity, but gave rise to charges by the IRS of “personal benefit” and “private inurement.”  Again, the basis was that, “Even a small amount of private inurement is fatal to exemption under 501-C-3.”  These failures were the catalyst for the critical violations that did lead to a temporary (3 years) revocation of _____’s exemption.  These violations were not by design on the part of _____, and reflected no fraudulent intent.  They simply resulted from careless and uninformed finance policies and procedures, and a resultant lack of controls.

“The two critical aspects of _____’s settlement were (1) _____’s institution of a salary policy, which took into account the type of work the missionary was doing, whether the work was full-time or part-time, the geographic area (for cost-of-living purposes), and the missionary’s experience and highest attained educational level; and (2) a requirement that missionaries provide detailed activity reports to _____ at least quarterly.  In addition, when missionaries raise money in excess of their salary and substantiated expenses, it is held by _____ in a reserve account, to be available when it might be needed in the future.

Private benefit ordinarily pertains to activity or resources that benefit outside individuals, not in furtherance of the organization’s charitable purposes. Whereas, private inurement occurs when an insider receives a benefit that is not in furtherance of, or is incidental to, the organization’s 501(c)(3) purposes. Private inurement may also result from compensation that is not properly reported for tax purposes or from unreasonable compensation.

A US Donor cannot give a tax deductible contribution directly to a foreign charity.  The only way for such a transaction to work is for the offering to be routed through a US Charity for proper disbursement and reporting.  The foreign entity must be an extension of, and controlled by, the US Charity, or must properly qualify as the recipient of a grant.  We need to exercise care as to what receipts say.  It can look illegal if labeled inappropriately

ABC needs to know what offerings will be for, before they receipt them.  Of course, in the absence of donor language restricting the use of the offering, it could be assumed the offering is not restricted, other than to the support account of the named missionary.  If a project or program is known and approved, and designated offerings come in for it, it is for the exempt purpose of ABC.  However, if the purpose is not known, gifts cannot be donor driven unless there is a predesignation by the agency.

In order to accomplish these objectives, ABC will need to raise the level of administrative control over the use of exempt resources by increasing the level of accountability in missionary funding and reporting.  This can be accomplished without dramatically impacting the Fellowship culture.

AVOIDING THE APPEARANCE OF BEING AN ILLEGAL “CONDUIT.”

The most definitive document we have addressing the topic of deputized fundraising is a letter from the IRS Exempt Organization Office, dated February 28, 2000.  It was signed by David Jones, then Chief of the Review Branch.  It is consistent with earlier regulations and rulings, and with court cases where specific deputized fundraising practices were upheld.  It represents a major concession on the part of the IRS with respect to the topic.  It seemed for a while that they were trying to move toward a position disallowing deputized fundraising as a valid funding model for ministry.  It is the consensus of virtually every attorney who specializes in religious not for profit law that it would be foolhardy to elect any position not consistent with this letter.  For the time being, it is our safe haven and its provisions are not unreasonable.  Following are excerpts from that letter:

Rev. Rul. 62-113, 1962-2 C.B. 10, provides guidance regarding potential conduit giving, stating that the test of whether a gift is intended by a donor for the use of the organization and not as a gift to an individual is whether “the organization has full control of the donated funds, and discretion as to their use, so as to insure that they will be used to carry out its functions and purposes.”  The purpose of the following questions and answers is to clarify the application of the control test in the context of organizations that utilize deputized fundraising…

1. Question:  If an organization otherwise described in IRC 501(c)(3) and IRC 170(c)(2) receives substantially all of its revenues through deputized fundraising, i.e., through individual missionaries, staff members, or volunteers conducting grass-roots fundraising to support the organization, can the organization be described in IRC 501(c) (3) and IRC 170(c)(2)?

1. Answer:  Yes, the organization can be an organization described in IRC 501(c)(3) and 170(c)(2) if it has full control of the donated funds and has discretion as to use of the funds.  Control and discretion can be shown by the following factors:

 Control by the governing body of donated funds through a budgetary process;

  • Consistent exercise by the organization’s governing body of responsibility for establishing, reviewing, and monitoring the programs and policies of the organization;
  • Staff salaries set by the organization according to a salary schedule approved by the governing body.  Salaries must be set by reference to considerations other than an amount of money a deputized fundraiser collects.  There can be no commitments that contributions will be paid as salary or expenses to a particular person;
  • Amounts paid as salary, to the extent required by the Internal Revenue Code, reported as compensation on Form W-2 or Form 1099-MISC;
  • Reimbursements of legitimate ministry expenses approved by the organization pursuant to guidelines approved by the governing body.  Reimbursement must be set by considerations other than the amount of money a deputized fundraiser collects;
  • Thorough screening, of potential staff members pursuant to qualifications established by the organization, and that are related to its exempt purposes and not principally related to the amount of funds that may be raised by the staff members;
  • Meaningful training, development, and supervision of staff members;
  • Staff members assigned to programs and project locations by the organization based upon its assessment of each staff member’s skills and training, and the specific needs of the organization;
  • Regular communication to donors of the organization’s full control and discretion over all its programs and funds through such means as newsletters, solicitation literature, and donor receipts; and
  • The financial policies and practices of the organization annually reviewed by an audit committee, a majority of whose members are not employees of the organization.

ACMin Comment:  The current project of revisiting ABC missionary financial relationships should address the shortcomings of the system by:

  1. Committing the missionary fundraising effort to a preapproved budget.
  2. Establishing a defined compensation arrangement for missionaries
  3. Capturing all the compensation elements and ensuring they find their way into taxable income.
  4. Educating the missionary family more fully as to what is work and what is personal in nature.
  5. Discussing the work of an audit committee

2. Question:  If the facts are the same as in question 1, except that, in the organization’s discretion, substantially all the contributions received by the organization are tracked for internal accounting purposes as having been raised through the efforts of a missionary, staff member, or volunteer and are generally used to pay for the reasonable salary or other reasonable and necessary organization-related expenses of the designated individual, can the organization be described in IRC 501(c)(3) and IRC 170(c)(2)?

  1. Answer:  Although such tracking by an organization may show that contributions are earmarked for a particular individual and that the organization is not retaining discretion as to the use of funds, the organization may by the totality of the facts and circumstances demonstrate that it has full control of, and discretion over the use of, the donated funds so as to ensure that they will be used to carry out the organization’s functions and purposes, and thus be an organization described in IRC 501(c)(3) and IRC 170(c)(2).

TIMELINESS OF SUBSTANTIATION (REG 1.62-2).

Reporting on cash advances and/or returning excess amounts must be done in a timely manner.   “What is timely depends on the facts and circumstances.”  There are two safe havens.  One simply states that advances should not precede actual expenditure by more than 30 days, and reporting should not be more than 60 days after the expenditure.  The other safe haven directs the mission to notify the missionary periodically of the amounts advanced in excess of the substantiated amounts and then the worker has 120 days to report.  It is often advantageous to operate outside the safe haven.  When doing so, compelling rationale must be carefully documented.

Given the above facts, it is safe to say it would be acceptable to ask ABC missionaries to report no less than quarterly on the amounts advanced for business (ministry) expenses.  Further, the deadline for reporting should follow the end of the reporting period by an adequate period of time for credit card statements and bank statements to be received and reconciled.  Therefore, a deadline of 30 days from the reporting date would be appropriate.  Then, an additional 30 day grace period should not place the mission or the missionary at risk.  At that point, action would need to be taken, particularly for chronic offenders.

Amounts not timely reported are to be included in taxable income to the missionary.  It would appear that an easy “out” would be to just clear the support account each month and include the total on the Form W-2 and allow the missionary to report unreimbursed business expenses.  This practice would be undesirable and/or illegal for the following reasons:

  1. To do so would, in effect, allow the missionary to set his own salary.  As we have seen in the previous section, that is absolutely unacceptable with the IRS, since it would allow for open-ended private benefit and would call the donor’s intent into question.
  2. Substantiation of expenses to the mission will be the missionary’s best option.  It is necessary to only provide “enough” information to the mission for the mission to determine that the expenditure was attributable to the mission’s ministry activities.  It is almost certain that an IRS agent would hold the missionary to a higher standard in an audit, especially if any degree of carelessness was perceived.  A review of a few ABC missionaries’ monthly reports suggest a perception of carelessness would be likely.
  3. A tax return that suggested less than adequate financial controls on the part of the mission could trigger wider missionary audits and could result in an audit of ABC and donors.

COMPENSATON REPORTING STATUS:  IRS PUBLICATION 15A.  (FORM 1099 VS. FORM W-2)

The general rule is that an individual is an independent contractor if you, the person for whom the services are performed, have the right to control or direct only the result of the work and not the means and methods of accomplishing the result.

Consequences of treating an employee as an independent contractor. If you classify an employee as an independent contractor and you have no reasonable basis for doing so, you may be held liable for employment taxes for that worker.  See Internal Revenue Code section 3509 for more information.

Facts that provide evidence of the degree of control and independence fall into three categories: behavioral control, financial control, and the type of relationship between the parties.

Behavioral control.

Facts that show whether the business has a right to direct and control how the worker does the task for which the worker is hired include the type and degree of:

Instructions that the business gives to the worker.
An employee is generally subject to the business’ instructions about when, where, and how to work. All of the following are examples of types of instructions about how to do work.

  • When and where to do the work.
  • What tools or equipment to use.
  • What workers to hire or to assist with the work.
  • Where to purchase supplies and services.
  • What work must be performed by a specified individual
  • What order or sequence to follow.

The key consideration is whether the business has retained the right to control the details of a worker’s performance or instead has given up that right.

Training that the business gives to the worker. An employee may be trained to perform services in a particular manner. Independent contractors ordinarily use their own methods.

Financial control.

There is an inherent stress in this area.  The 501-C-3 status requires a high level of administrative control on the use of funds.  At the same time, independent contractor status requires a minimal level of administrative control.  So, care must be taken here.  Facts that show whether the business has a right to control the business aspects of the worker’s job include:

The extent to which the worker has unreimbursed business expenses. Independent contractors are more likely to have unreimbursed expenses than are employees.  Fixed ongoing costs that are incurred regardless of whether work is currently being performed are especially important. However, employees may also incur unreimbursed expenses in connection with the services that they perform for their business.

The extent of the worker’s investment. An independent contractor often has a significant investment in the facilities he or she uses in performing services for someone else. However, a significant investment is not necessary for independent contractor status.

The extent to which the worker makes his or her services available to the relevant market. An independent contractor is generally free to seek out business opportunities. Independent contractors often advertise, maintain a visible business location, and are available to work in the relevant market.

How the business pays the worker. An employee is generally guaranteed a regular wage amount for an hourly, weekly, or other period of time. This usually indicates that a worker is an employee, even when the wage or salary is supplemented by a commission. An independent contractor is usually paid by a flat fee for the job. However, it is common in some professions, such as law, to pay independent contractors hourly.

The extent to which the worker can realize a profit or loss. An independent contractor can make a profit or loss.

Type of relationship. Facts that show the parties’ type of relationship include:

  • Written contracts describing the relationship the parties intended to create.
  • Whether or not the business provides the worker with employee type benefits such as medical insurance, a pension plan, vacation pay or sick pay.
  • The permanency of the relationship
  • The extent to which services performed by the worker are a key aspect of the regular business of the company

Any individual who receives a Form 1099 from the agency should be weighed against these guidelines.

HANDLING OF PERSONAL OFFERINGS (NOT A UNIVERSALLY ACCEPTED STRATEGY)

In reality, endorsed missionaries are agents of ABC.  As such, all offerings raised for any purpose should be reported to the mission so a determination can be made as to whether they should be on the Form W-2.  Since any amount received must be includable as taxable to the missionary, there is really no rational justification for not reporting the amount to ABC.

Designated personal offerings is an area that is illegal at face value.  To have any chance of being acceptable to the IRS, personal offerings must be handled carefully and diligently.

If done right, this can work because generally, in times of identifiable need, donors are aware of that need and respond with personal offerings.  The needs-based concept allows the mission to set salaries at a lower level, since the constituency will respond to emergencies, and salary does not have to cover every contingency.  This access to emergency personal funding is necessary if missionaries are to survive financially and effectively further the exempt purpose of the mission.

There must be carefully observed restrictions in this area in the absence of documented, unforeseen catastrophic need.  The offerings must be seen as a PRE-designation by the mission.  If the offering is not acceptable, the mission would redesignate it.  If the donor would not accept the redesignation, the mission would have to send the offering back and not issue a receipt.

Comment:  Personal offerings must not be seen as inurement or private benefit.  One mission has seen their maximum grow by 600 percent over 20 years.  What was once a defensible amount, using the above stated rationale, is now not defensible after increasing 30 percent per year.  The mission would never be able to explain the “need” for such an increase, other than the personal benefit of a select group of missionaries.  That group generally has no discernible emergency needs, but is able to generate the maximum, year after year, while others without significantly different needs, are able to generate very few personal offerings.  This raises serious red flags concerning conduit giving.  The issue in this area is the degree of impact this “conduit” principle of personal offerings has on the total.  A negligible impact would not likely ever be challenged under the above reasonable defense.  However, the inflated amount has far more than a negligible impact and would be problematic.

Another mission has the provision that the missionary can receive a very high percentage of his approved, needs-based salary.  The same (only worse) scenario exists.  This is clearly a conduit since private benefit is undeniable.  If there were a way to limit the receipt of those personal offerings to bona-fide documented extraordinary needs, there might be a defense.  Yet another mission sets the “Needs-Based” compensation level so high that virtually no one can raise enough to exceed it.  Under careful review, it might be difficult for this mission to claim their compensation is based on need.

Some missions take a “head in the sand” approach.  They just don’t want to know about the extras.  Missionaries have unlimited ability to receive offerings and have no obligation to report them to the mission.  This is no better…maybe worse.  The open ended excess benefit and personal benefit potential is totally unacceptable.

Extraordinary events should be addressed with extraordinary provisions such as benevolence.   While amounts would most likely be taxable, and go on the Form W-2, they should not be part of the monthly reporting, but rather included in the defined salary calculation.  If this area is abused, there would most certainly be questions about private benefit and/or personal inurement.  Consistent with the “needs-based” compensation philosophy, we do not wish to provide compensation for needs that will likely never be realized.  The way missionary income is generally set limits discretionary income and necessitates a “safety net” of allowable benevolence benefits.  Actually, this is a time-honored ecclesiastical practice. 

In a related 1996 case involving the taxability of “gifts” from a congregation to their pastor, the IRS won a key victory.  In Goodwin v. United States, the Federal Circuit Court held that “special occasion” gifts received by the pastor over a three-year period had to be included in taxable income.  The gifts were received and given to the pastor without being counted.  The church kept no records and had no control over the funds.  The court ruled, nevertheless, that the gifts were made with the intent of providing additional compensation to the minister.  Therefore, they were taxable.  This further points to the fact that care must be taken to capture every element of taxable income to ministers and missionaries, and that churches do not have broad prerogatives when it comes to private benefit transactions.

If you feel there may be compliance issues with your mission’s policies and practices, contact ACMin at 417-861-9897 or email us at jburgess@consultingministry.org.  We will review your policies and identify areas of vulnerability.  We will suggest solutions which you and/or your legal counsel can consider.  You may want your legal counsel to look further for unrelated and/or unidentified deficiencies.