Wednesday, February 24, 2010

Church and Tax-Exemption: Invitations for Fraud

I was recently party to a blog posting discussion thread in which the topic turned to inequalities in the tax code that gave Churches a special pass with regard to tax policy. The details of this discussion are not really relevant to what I want to say here now; they only provide the framework for a story that I want to tell about how inequality in the tax code in terms of its application can create serious distortions that turn into invitations to fraud.

Here's a scenario that I've recently pondered. Let's say an individual member of a church has some money that he or she would like both to shelter from taxation and, at the same time, to provide a tax credit against his or her own income tax liability. What's to prevent this person from making a "donation" to a Church with the unwritten, but clearly understood, notion that this church member would be able to determine when, where, and how this "donation" would be spent -- including having the church make a "good works" contribution to another church member who demonstrates a "need" for such charity? Maybe it could be that the Church uses this earmarked donation to provide a "scholarship" to the donor's nephew to buy his school books and supplies. In this scenario, the donor can presumably claim a tax deduction for this charitable contribution to the Church. The amount of the donation itself is immune from taxation as income to the Church through its tax-exempt status. And the beneficiary of the Church's charity may be exempt from having to claim the "gift" from the Church (which was directed to the beneficiary by the donor, who happens to be related to the beneficiary in some way). Now I'm no tax expert, and I presume there may be some regulations in the tax code that prohibit such kinds of transactions; but I have to wonder how difficult it would be to prove such an arrangement and how likely it would be for the IRS to keep tabs on and audit church finances in a rigorous way.

This seems like such blatant fraud to me, yet it also seems like such an easy thing to do with only minimal risk, that I have to assume this kind of thing happens with some regularity.

In all my years, perhaps due to my naivete about how Church finances are handled (especially since I am Catholic and tithing to the Catholic Church seems so institutionalized and so far removed from the direct financial management by parishoners that tends to characterize Protestant churches), I had never thought about this kind of tax evasion as a possibility.

I would welcome any thoughts on this to enlighten me both on the legal framework regulating/prohibiting such practices and on how pervasive this practice might actually be.


eric said...

I have not really heard of this happening, though I suppose it could. My main issues with churches and taxation are as follows:

1) Ministers who get to opt out of social insurance programs based on concientious objection. (I promise I am as big an objector as any of them, and I don't get to opt out!)

2) The assumption that most or all expenditures associated with church finances are in fact charity.

3) The arbitrary nature of granting "church" status to a group of people.

eric said...

I will say that I know some Baptists who basically look at the church as a sort of piggy bank for hard times... they tithe regularly, and when they find themselves in hard times the church helps them with food purchases or home repairs or babysitting services, etc...

It's not quite the same thing as the scenario you mention above, but it is similar, just occuring over time instead of a lump sum.

Huck said...

Eric - I agree with all of your three items in the first comment. It seems clear to me that there are many church functions which are not charity and should not be treated as such. This is simply a matter of fairness, which I think is essential. And unlike many liberals, though I understand the reasons for the progressivity in our current income tax code, I even have some sympathy for a flat tax on the basis of this notion of fairness.

Also, using the Church as a "piggy bank" for hard times is, to me, a direct violation of tax code and is fraudulent.