Running Gifts Through the Ministry

Taxpayers generally understand that when they make a gift to a friend, it is not tax deductible. If they pay tuition for their son or daughter to attend college, while the tuition may qualify for certain education tax credits, the tuition is not deductible on Form 1040.

Too often, taxpayers have a desire to “launder” money through a convenient “fiscal agent,” which is often a church or parachurch ministry, in an effort to justify a tax deduction for an expense that is not legitimately tax deductible.

Your ministry may have been contacted with one of the following requests:

  • “I want to help my friends Fred and Mary who live in New Orleans who are going through a tough financial time because of Hurricane Katrina. I realize they have no connection with your ministry but if I give the ministry $500, will you pass it through to them and give me a charitable receipt?”
  • “I want to give $10,000 to the ministry so the funds can be passed on to a college to cover the tuition for the pastor’s daughter. Will the ministry process this gift and give me a receipt?”

Examples like these are often referred to as donations “earmarked” for individuals. They are also called “conduit” or “pass-through” transactions. These terms are not positive references when used by the Internal Revenue Service (IRS) and generally denote amounts that do not qualify for a charitable deduction.

Why do many Christians desire a tax deduction for helping other individuals?  For the most part, I think their intent is pure. These givers generally do not expect to receive anything in return for the gift. But the attraction of perhaps a 30% to 40% subsidy from the Federal and State governments is a strong incentive to have a gift processed by a charity!

How to identify an earmarked gift. A tell-tale sign of an earmarked gift is when someone says they want to “run a gift through the ministry,” “pass a gift through the ministry,” or “process a gift through the ministry.” Of course, it is possible the donor will not so clearly signal an earmarked gift and use more generic terminology. This is why ministries should have a good understanding on the concept of earmarked gifts in addition to an awareness of tell-tale terminology.

Determining whether to accept an earmarked gift. Though the tax law concept regarding earmarked gifts is well-established, it can be hard to apply to specific situations. Because of the murky landscape, too many ministries are very lax in monitoring potentially earmarked gifts. And some leaders cave in when the donor says: “If your ministry won’t process this gift for me, I know of another ministry that will handle it.”

A special category of earmarked gifts is when a giver passes a scholarship gift through a charity for the giver’s personal benefit. One giver served jail time for tax fraud for such a self-serving gift.

Gifts to a ministry for the support of missionaries or other workers (often called “deputized fundraising) are subject to a different set of guidelines than those generally associated with earmarked gifts. Gifts made under a properly structured deputized fundraising program are generally tax deductible to the giver.

What tests can a ministry use to determine whether it should consider accepting a gift that may be an earmarked gift?  Here are three questions a ministry should ask:

  1. Does the gift benefit an indefinite group? Indefiniteness is an essential element of a charitable gift. Earmarking or designating individual donees lacks the element of indefiniteness. The indefiniteness standard is satisfied if the charitable organization retains control of the funds. A pool of potential beneficiaries must be sufficiently large or indefinite that it constitutes a charitable class.

One court observed: “Charity begins where certainty in beneficiaries ends, for it is in the uncertainty of the objects and not in the mode of relieving them which forms the essential element of charity.” So, if a gift is restricted for one person, it generally fails the indefiniteness test.

  1. What are the giver’s intentions? This test focuses on the giver’s intentions. The contributor’s intent in making the payment must be to benefit the exempt purposes of the ministry and not an individual. In one court case, a charitable deduction was denied because the giver intended to benefit a specific college student by sending a check to the college for the amount of tuition with a note strongly encouraging the school to give the specific student a scholarship.
  2. How much control does the ministry have over the contribution? This test focuses on the amount of control the ministry has over the contribution. In a key Revenue Ruling, the IRS described this test as follows: “The test is whether the organization has full control of the donated funds and discretion as to their use, so as to insure they will be used to carry out its functions and purposes.”

A ministry must have control and overall discretion over all charitable gifts. It must determine if the proposed use of the money furthers its own charitable purposes. The ministry may actually use the funds in the exact way the giver intended, but because the ministry executes adequate due diligence over the gift (this involves both process and execution) and selects the ultimate recipient in a totally independent manner, the transaction may avoid the earmarked label.

Gifts earmarked for foreign charities. Earmarked gifts are not limited to gifts earmarked for individuals. Since gifts by U.S. taxpayers to a foreign charity do not produce a charitable deduction, givers will often earmark a gift for a foreign charity and ask a ministry to pass it through to the entity. With the post-9/11 focus on anti-terrorism, this is a time for ministries to be sure they know their foreign charity donees and provide adequate due diligence over funds sent to them.

Example 1:  An individual makes a $5,000 donation to a ministry and restricts the gift for the Sri Lanka Relief Agency (a foreign charity) for its relief and development purposes. While the ministry provides funding for various foreign missionary endeavors, it has no connection with the Sri Lanka Relief Agency and has no practical way to provide due diligence in relation to a gift to this entity. Based on these facts, if the ministry makes a gift to the entity, it has all of the characteristics of an earmarked gift. The funds should probably be returned to the giver.

Example 2:  Same fact pattern as Example 1, except the ministry regularly sponsors short-term mission trips to Sri Lanka and provides funds to the Sri Lanka Relief Agency, based on the due diligence performed by ministry staff and volunteers on mission trips with respect to this particular foreign entity. Based on these facts, the ministry is generally in a sound position to make a gift of $5,000 to the Agency as requested by the giver, avoiding the characteristics of earmarking.

The tax law is clear that money given to an intermediary charity but earmarked for an ultimate recipient is considered as if it has been given directly to the ultimate recipient. It is earmarked if there is an understanding, written or oral, whereby the giver binds the intermediary charity to transfer the funds to the ultimate recipient. The tax law does not allow givers to obtain tax benefits indirectly through a conduit what they cannot obtain directly.

Summary. So, why so much concern about earmarked gifts? Your ministry may be assisting givers to obtain a tax deduction to which they are not really entitled. In other words, you may be inadvertently helping a giver break the law.

Plus, in the most serious examples, your ministry could endanger its tax-exempt status by processing earmarked gifts. The processing of earmarked gifts by a ministry will undoubtedly be a lightning rod for an IRS auditor.

The best practice? Savvy ministries’ leaders establish and follow clear policies to prohibit givers from passing money through the ministry simply to gain a tax benefit. This will add credibility to your ministry and will avoid tarnishing the name of Christ by involvement in questionable transactions.

 


This text is provided with the understanding that ECFA is not rendering legal, accounting, or other professional advice or service. Professional advice on specific issues should be sought from an accountant, lawyer, or other professional.

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