Tips to Maintain Tax-Exempt Status for Churches

Because churches and religious organizations are considered charitable under section 501(c)(3) of the Internal Revenue Code, they're exempt from paying federal, state and local income and property taxes.

Maintaining tax-exempt status for churches and religious organizations, however, requires adhering to a specific set of IRS rules. Following these rules and implementing some best practices can help these groups keep their tax advantages while giving back to the communities they serve.

Tax-exempt best practices

While not all churches or religious groups have 501(c)(3) status, those that do tend to follow some general best practices.

They act like a business

First and foremost, organizations in good standing adhere to traditional business standards and protocols to maintain their 501(c)(3) tax-exempt status. For example, even though a church may be exempt from paying taxes, it still must properly withhold and pay employment taxes for employees.

They report taxable income

Business revenue that isn't wholly related to an organization's core purpose could be considered taxable, so these groups also typically work with an accountant and report income that isn't tax-exempt. For example, if a church sells coffee during service, it could be deemed taxable income. However, if the coffee sold was donated to the church, the income could be tax-exempt.

They keep good records

Churches and religious organizations that enjoy tax-exempt status also maintain solid records of all transactions and keep track of expenses to properly account for all costs. For example, if someone purchased goods or services on behalf of the church and was repaid, the money could be considered taxable income.

They file taxes

While qualifying churches and religious organizations don't need to pay taxes, they still must file IRS Form 990-T each year. This form—as well as any schedules, attachments and supporting documents—must be available for inspection by the public.

Activities to avoid

While failing to file the proper IRS paperwork for 3 consecutive years is a common oversight, there are many other things that could jeopardize tax-exempt status for churches. Failure to adhere to the rules may result in lost status, back taxes and intermediate sanctions from the IRS. This impact can trickle down to donors, who may find that their contributions are no longer tax-deductible.

Churches and religious organizations can use a tax guide for churches to help keep their status intact. They should also make sure to avoid the following activities.

Inurement

Religious organizations can't use part of their earnings in order to benefit a private shareholder or individual who has the ability to control or influence its activities. This means 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 an excise tax.

Excessive lobbying

Lobbying in substantial amounts could also jeopardize tax-exempt status for churches. 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, or the percentage spent on lobbying against a limit based on the organization's size.

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.

Illegal or questionable activity

While it may sound obvious, the IRS also expressly prohibits 501(c)(3) organizations from conducting activities that are either illegal or that violate fundamental public policies.

The bottom line

Tax-exempt status for churches and religious organizations gives these groups an opportunity to retain more donations so they can fulfill their missions and give back to their communities. By implementing these best practices and avoiding questionable ones, they're able to enjoy this gift so they can keep giving back.