Church Tax Exemptions Explained (And How to Know If You’re Exempt)

U.S. churches were officially recognized as tax-exempt in 1894. Before this, they were unofficially tax-exempt. This move has long been attributed to the separation of church and state, which is a constitutional mandate.

However, to this day, the concept behind churches being tax-exempt is still confusing and a cause for heated debate among scholars and legal minds. 

Their debates are not the gist of this piece. Instead, we’ll dive into what it means for a church to be tax-exempt, what qualifies a church for that status, and how much oversight the IRS has over the churches’ books.

How does the IRS Define a Church?

The IRS has a strict definition for a church that prevents anyone from naming a gathering a church and enjoying federal tax exemption. For tax purposes, the IRS defines a church as a place of worship. Its definition also covers mosques, synagogues, temples, and other worship places.

In most cases, it’s obvious whether an organization is a church or not. However, the IRS requires that the organization has:

  • A distinct legal existence
  • A form of worship and recognized creed
  • A definite and distinct ecclesiastical government
  • A formal code of discipline and doctrine
  • A membership not associated with any other church or denomination
  • A distinct religious history
  • Ordained ministers who minister to the congregation
  • A literature of its own
  • Ordained ministers selected after completing prescribed studies
  • Established places of worship
  • Regular religious services
  • Regular congregations
  • Schools for preparing its ministers and
  • Sunday schools to provide religious instruction for the young

Not all requirements must be fulfilled by the church. However, IRS uses it as a checklist to confirm whether an organization is a church on a case-to-case basis.

Why Don’t Churches Pay Taxes?

Churches fall under charities in the American tax law, with the advancement of religion being viewed as a charitable activity. Charities are exempted from paying tax. They’re given a 501(c)3 status. 

Moreover, as per the First Amendment of the Constitution, separation of church and state is a constitutional mandate.

That means the government avoids any involvement with religion, allowing churches to operate without imposing taxes or tax-exempt filing requirements in most cases.

Most organizations obligated to pay tax are also audited by the government. The government provides rules over what counts as legitimate business expenses and regulates how the businesses do their accounting. 

Such kind of oversight, when applied to churches, goes against the separation of church and state. The constitution requires that religious freedom is fundamentally respected.

Qualifications for Tax-Exempt Status

The IRS has the following qualifications that categorize a place of worship as a charity organization eligible for a 501(c)3 status.

  1. The organization must operate solely for religious, scientific, charitable, or educational purposes
  2. The net earnings of the organization should not provide any benefits to a private individual or shareholder
  3. The organization cannot devote a significant portion of its activity to influencing legislation
  4. The organization cannot intervene in political campaigns
  5. All activities of the organization must be legal and in line with public policy

How to Apply for Tax Exemptions

As long as your church has met all the qualifications of the IRS, there’s no need to apply for a federal tax exemption. The status is automatically granted. 

However, some churches may still opt to apply for the status to assure church members, leaders, and contributors that the church is tax-exempted and all contributions are tax-deductible.

If you are starting a religious organization instead, the IRS defines it differently and requires that you formally apply for a charity 501(c)3 status. However, if the organization makes less than $5,000 annually, you are not obliged to make the registration.

If you wish to apply for 501(c)3 status, the IRS has an online Tax Guide for Churches and Religious Organization PDF file that documents the process.

Generally, you’ll have to:

  • Ensure your organization has an active employer identification number (EIN) and is recognized as an association, trust, or corporation.
  • Review whether your organization has a tax-exempt purpose that qualifies the tax-exempt status
  • File IRS Form 1023 for exemption of tax-exempt recognition
  • Gather and attach all required documents, including the organization’s organizing documents
  • Provide three years of financial statements and tax documents detailing revenues and expenses
  • Get your organization’s attorney, if you have one, to file appropriate paperwork as part of the application
  • Pay the required fee

The IRS then gets back to you with the status of your application or a request for further information.

Record-Keeping Requirements for Tax-Exempt Organizations

Despite the IRS having limited oversight over churches, any tax-exempt organization still has to adhere to strict record-keeping requirements from the tax body. The IRS provides specific record-keeping information that helps make the application process easier.

Generally, all organizations qualified for a 501(c)3 status must document all expenditures, receipts, expenses, income, and credits and file IRS Form 990 annually. The organizations must also ensure their books are available for audit by the IRS on request.

As long as an organization adheres to this protocol and maintains up-to-date records, it can keep its tax-exempt status.

Tax Status for Churches that Make Money

Churches need money to operate efficiently. As per federal tax exemption, churches never have to pay taxes for unearned income such as gifts, donations, investment income, and grants.

However, if a church regularly engages in commercial activity unrelated to its religious mission that generates income, it must pay a special tax for the profits earned. This tax is called the unrelated business income tax (UBIT).

An example of when a church is required to pay UBIT is when its members are regularly hired for seed-planting exercises in private forest land and pocket the money earned.

The following income channels are not subject to UBIT:

  • Thrift shops
  • Bingo games
  • Donor lists
  • Volunteer work
  • Advertising
  • Low-cost giveaways

If a church earns more than $1,000 annually in gross receipts from unrelated business or trade, it must file IRS Form 990-T, Exempt Organization Business Income Tax Return.

Keep Better Track of Your Church’s Contributions and Giving using Church Management Software

Contributions and giving form a substantial portion of most churches’ revenue. To keep your records up-to-date and comply with parts of federal law on a 501(c)3 organization, invest in proper church management software that will digitally record every contribution or giving made to make accounting easier.

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