By Tom Burbrink
No one else is paid quite like ministers. This is why even experienced accountants may make mistakes in handling minister’s compensation.
Ministers are dual status employees—employees for income tax purposes, but self-employed for Social Security and Medicare taxes. The church treasurer is often a volunteer who may not be familiar with the numerous federal, state, and local regulations related to ministers and other church employees. As a result, many errors occur in reporting ministerial compensation. Among them:
Giving the minister a Form 1099 instead of a W-2. Since the late 1970s, the Internal Revenue Service has considered most ministers to be employees of the church:
Generally, you are an employee if your employer has the right to control both what you do and how you do it, even if you have considerable discretion and freedom of action. . . . If you are employed by a congregation for a salary, you are generally a common-law employee and income from the exercise of your ministry is considered wages for income tax purposes (IRS Pub. 517, page 3).
Regardless of the church leaders’ or the minister’s opinion on this issue, ministers of independent Christian churches and churches of Christ definitely are employees of the church. But this is to the minister’s advantage tax-wise. For example, if the minister is self-employed, he cannot have any of the nontaxable benefits that are available to employees. A properly structured compensation package and an accountable expense reimbursement plan will reduce income and Social Security taxes to the legal minimum.
Incorrect amounts on the minister’s W-2. Due to the above mentioned problems, it is difficult for church treasurers to know which parts of the minister’s pay package should be included in his W-2.
Medical insurance premiums, group term life, disability insurance, and retirement contributions are nontaxable employee benefits that should not be included in the W-2. Ministry expenses that were reimbursed and accounted for with proper documentation should not be shown anywhere on the W-2.
A properly designated housing allowance should be shown in Box 14 (Other). Contributions to a tax-sheltered annuity, 403b, should be put in Box 12, preceded by the letter E. State and local taxes withheld go in Boxes 17 or 20.
Withholding of taxes is voluntary. If the church and the minister both want to do it, income taxes can be withheld. The law permits but does not require withholding from the minister’s paycheck. Taxes voluntarily withheld for federal income tax go in Box 2.
FICA and Medicare taxes should not be withheld from a minister’s paycheck. Regardless of whether or not the minister has exempted out of Social Security, Boxes 3, 4, 5, and 6 should be blank. An amount equal to the Social Security tax (SECA) can and should be withheld, but it must be added to “federal income taxes withheld” in Box 2.
Failure to properly designate an adequate amount for housing allowance. One of the most costly errors tax-wise is failing to designate an adequate amount for the minister’s housing allowance. The church should allow the minister to determine the amount of his housing allowance. The Rick Warren tax court decision (Richard D. Warren and Elizabeth K. Warren v. Commissioner of Internal Revenue, Docket No. 14924-98, [114 T.C. No. 23] filed 16 May 2000) confirmed that 100 percent of a minister’s compensation can be designated as housing allowance.
The IRS closely examines the housing allowance designation. The minister’s housing allowance can be documented in the church budget, in board minutes, in payroll records, or other written church records.
The church or organization that employs you must officially designate the payment as a housing allowance before the payment is made. A definite amount must be designated. The amount of the housing allowance cannot be determined at a later date (IRS Pub. 517, p. 8).
The housing allowance can be changed at any time during the year, but it must be changed from the current date forward. It cannot be changed retroactively. The key words are “before the payment is made.”
Failure to file timely federal, state, and local tax reports. If the only employees of the church are ministers and no taxes are being withheld, the forms to be filed with IRS, state, and the local taxing agencies may be due only once a year. W-2s and/or W-3s must be prepared annually. Although they are to be given to the employee by January 31, they do not have to be filed with the Social Security Administration (not IRS) until February 28. Many states have a filing deadline of January 31. Local filing deadlines vary
If the church has any nonministerial employees (secretary, custodian, musicians, etc.), withholding of income, Social Security, and Medicare taxes is required. Then the church must file IRS Form 941 at least quarterly.
Failure to allow the minister to live in a home of his own. Providing a parsonage for the minister and his family is usually not the best choice. Many congregations today allow their minister to purchase a home. Some churches have either sold the parsonage or converted it into offices, classrooms, or other church-related purposes.
Requiring the minister to live in church-provided housing prevents him from building equity in a home. Although no actual rent was paid by the minister while living in a parsonage, in effect the minister has been “renting” his entire working career. When the minister reaches retirement age, not owning his own home will make it difficult for him to retire.
Failure to reimburse ministry-related business expenses. Most businesses either reimburse or pay directly the work-related expenses of their employees. Most churches fail to do so. Failing to reimburse the minister for using his vehicle for ministerial related miles and failing to reimburse him for books, seminars, conventions, or other ministry expenses is a common error by churches. This means that a significant portion (from $4,000 to $8,000 per year) of his “compensation” is actually used for work-related expenses.
Although these expenses can be reported on his personal tax return, doing so will force the minister to pay some unnecessary taxes. Paying unnecessary taxes is not good stewardship.
Failure to pay adequate compensation. Having worked with hundreds of churches during the past 25 years, I have been amazed and disappointed to see the wide range of compensation paid by similar-sized congregations. Some pay comparable wages for equivalent jobs in the business world, but many pay very poorly.
If your congregation has a history of frequent changes of ministers, perhaps you need to honestly evaluate the amount of compensation you have been paying your ministers. The 24/7 schedule expected of a minister, combined with low pay, convinces many men to look for another church or to consider accepting a secular job that will adequately provide for him and his family.
Growing churches whose ministers have been with them long-term usually are the congregations paying a more reasonable pay package. “Compensation” includes not only salary and housing allowance, it also should include medical insurance, life insurance, disability insurance, and retirement contributions.
If your minister is worth keeping, pay him adequately. If your minister is not earning what you are paying him, replace him. Don’t use low compensation to convince him he needs to leave!
Church treasurers and financial leaders are encouraged to seek advice in the area of ministerial compensation. When talking with accountants, payroll processing firms, and similar professionals, ask them how many ministers and churches they have as clients. Talk with other congregations to find out how they handle this vital area of stewardship. Go to www.irs.gov. Publication 517, Social Security and Other Information for Members of the Clergy and Religious Workers can help you with understanding the tax laws that are applicable to ministers.
Due to the complexity of tax laws, the ministry of the church treasurer can be truly burdensome. We hope this article might be of help to those unsung heroes of the congregation—the church treasurer and the church financial leaders!
Tom Burbrink owns Burbrink Tax Services and Financial Counseling in Grayson, Kentucky (www.burbrink.com). He ministers part-time with Antioch Christian Church near Mount Sterling, Kentucky.