Can a Church Loan Money to Its Members?

Churches operate as tax-exempt entities under Section 501(c)(3) of the U.S. Internal Revenue Code. This status provides significant benefits, including exemption from federal income tax and the ability to receive tax-deductible contributions. A central question for these organizations is whether a church can extend loans to its congregants. While churches serve important charitable purposes, their financial activities, including lending, are subject to regulations to maintain their tax-exempt status and operate for the public good.

Permissibility under Tax Law

The core legal framework for church loans to members centers on prohibitions against “private inurement” and “private benefit” for 501(c)(3) organizations. Private inurement occurs when any part of a tax-exempt organization’s net earnings benefits an “insider,” which includes individuals with substantial influence over the organization, such as board members, officers, or key employees. This prohibition is absolute.

A loan from a church to an insider, especially with favorable terms, could be seen as private inurement. This suggests the organization’s assets are used for personal gain, not its charitable mission. The Internal Revenue Service (IRS) scrutinizes these arrangements, as tax-exempt status requires serving a public interest.

Beyond insiders, “private benefit” prohibits a tax-exempt organization from operating for private interests. While private inurement targets insiders, private benefit applies to any individual or entity. If a loan primarily serves a private interest rather than an exempt purpose, and the private benefit is more than incidental, it could jeopardize the church’s tax-exempt status.

Any church loan must align with its charitable mission and not unduly benefit private individuals. The IRS considers the qualitative and quantitative aspects of private benefit. A private benefit must be a necessary byproduct of advancing a public purpose and be minimal compared to the public benefit.

Conditions for Permissible Loans

For a church loan to a member to be permissible without triggering private inurement or private benefit issues, several specific conditions and requirements must be met. The loan must serve a bona fide charitable purpose consistent with the church’s mission, such as providing emergency assistance. This purpose should be documented to show how it furthers the church’s exempt activities.

The loan must be properly documented with a written agreement, such as a promissory note, outlining terms and conditions. This documentation should specify the loan amount, interest rate, repayment schedule, and any collateral. The loan should carry an adequate interest rate, typically at or above the applicable federal rate (AFR), to avoid being classified as a disguised distribution or impermissible benefit.

There must be reasonable repayment terms and a realistic expectation of repayment. The church must actively enforce these terms, similar to a commercial lender, to demonstrate the loan’s legitimate financial nature. Failure to enforce repayment can be seen as an additional benefit, potentially jeopardizing tax-exempt status.

Loans should not be made to “insiders” or “disqualified persons.” If a loan is made to such an individual, it must meet strict exceptions and be treated as an excess benefit transaction, subject to specific rules and potential excise taxes. Approval for any loan should come from an independent body within the church, such as a board or committee, where the recipient is not involved.

The total amount of such loans should remain small relative to the church’s overall assets to avoid the appearance of operating as a lending institution. Transparency in the loan process and clear, consistent policies for all potential borrowers are important for demonstrating compliance. These measures help ensure lending activity is incidental to the church’s primary exempt purpose.

Consequences of Non-Compliance

If a church makes loans that violate IRS private inurement or private benefit rules, the repercussions are significant. The most severe consequence is potential revocation of the church’s 501(c)(3) tax-exempt status. If this occurs, the church’s income becomes taxable, and contributions are no longer tax-deductible. This can impact the church’s financial viability and its ability to fund its mission.

In addition to revocation, the IRS can impose excise taxes, known as “intermediate sanctions,” on disqualified persons who receive excess benefits. An excess benefit transaction occurs when a disqualified person receives more value from the organization than it returns. These excise taxes can be substantial; an initial tax of 25% of the excess benefit is imposed on the disqualified person.

If the excess benefit is not corrected, an additional tax of 200% of the excess benefit can be imposed. Church managers who knowingly approve such transactions can also be subject to an excise tax of 10% of the excess benefit, up to $20,000 per transaction. These penalties emphasize personal liability from non-compliant financial dealings.

Intermediate sanctions allow the IRS to address violations without immediately revoking tax-exempt status. However, repeated or egregious violations can still lead to revocation. The financial and operational risks associated with non-compliant lending practices are significant, underscoring the need for strict adherence to IRS regulations.

Internal Governance and Policy Considerations

Beyond IRS tax regulations, a church considering a loan program must establish robust internal governance and policy considerations. Church leadership should assess whether lending money aligns with the church’s core charitable and religious mission. While benevolence is part of a church’s mission, operating as a lender can introduce complexities that deviate from its primary purpose.

Fairness and transparency are essential in any loan program. A church should develop clear, written policies defining eligibility criteria, application procedures, loan terms, and repayment expectations. This ensures an equitable and transparent process for all members, minimizing perceptions of favoritism.

Financial prudence is an important consideration. The church needs to evaluate its financial capability to make loans without jeopardizing its stability or other charitable programs. This includes assessing default risk and establishing clear collection procedures. A church is not a bank; its resources are primarily donations for exempt purposes.

Managing potential conflicts of interest is essential, especially when church leadership or their associates are involved in approving or receiving loans. Independent oversight by a board or committee with no personal interest helps ensure objectivity. This body should review all loan requests and approvals to prevent impropriety.

Establishing a comprehensive written loan policy is a step. This policy should detail who can apply, maximum loan amount, acceptable uses of funds, interest rates, repayment schedules, and default consequences. The policy should also outline the approval process, including the approving body’s composition and required documentation. A well-defined policy provides clear guidelines, promotes accountability, and helps protect the church’s tax-exempt status.