Minister Status and Compensation

Below are tips on paying your pastor or minister such as whether to issue a W-2 or 1099 and the legality of paying them a percentage of a church's income.

Minister Dual Status:

The answer to whether to issue the pastor a W-2 or 1099 always lies in determining if the clergy is an employee of the church or considered self-employed.

Many years ago...all clergy were considered self-employed; however, in the mid 1980’s the IRS decided to declare ministers “employees” of the church.

Most pastors should be considered employees. They typically have a governing council they work with or for to determine to work to be performed (which is one of the criteria the IRS uses to determine the status of a person).

Exceptions to this would be supply pastors or missionaries who travel from church to church filling in or working for short periods. Read more potential exceptions in the Church Accounting: How to Guide.

Side Note: Misclassification of workers is a big issue with churches and the IRS, so be very certain you have properly classified your clergy and other workers such as musicians, nursery workers, and, custodians. See this article: Misclassification of Workers

Now remember...even though they are an “employee” of the church...the IRS considers ordained ministers to have a “dual status” . Which means clergy is considered an employee for federal income tax purposes and self-employed for Social Security and Medicare purposes.

That brings us to another frequently asked question: FICA or SECA?

Minister Compensation :

Figuring what is correct for a clergy's salary can be complicated especially when you are a start-up or small church.

Some weeks are good and some weeks are not so good. Which is one of the reasons why some churches base their pastor's salary on a percentage of the church’s revenue...but is this legal? 

I have heard very different opinions on this issue. Many years ago, I attended a church tax conference. The speaker stated that paying a pastor a percentage of the church’s income would endanger the church’s tax exempt status and may also cause the IRS to impose excise taxes on the clergy because it would fall under the private inurement and private benefit regulations. 

I cannot find anything to prove or disprove that statement. However, in the Church and Clergy Tax Guide, Richard Hammar, Attorney, CPA, and Author, states, “Churches are free to pay their clergy reasonable compensation for services rendered. Compensation packages based on a percentage of income are "reasonable" and appropriate so long as the amount of compensation paid to a clergy under such an arrangement is in fact reasonable in amount.”

So if your church decides to or is already paying your pastor a percentage of the church's income, you should do 3 very important things:

• Research the legality of paying the percentage. (Seek the advice of a qualified tax professional)
• Make sure it is considered reasonable compensation for your pastor in regards to the size of your church's income and location.
• Put a cap on the amount and that cap must be recorded in the minutes. Without a cap, any amount paid ...no matter how small would be considered private inurement and excessive benefit transactions which could threaten your church's tax exempt status. The IRS could also impose penalties on your pastor and church leaders.

Whether you pay a percentage of income or more commonly a set amount, the total compensation MUST be considered "reasonable"!

Another area that gets pastors in trouble is in the church paying their personal expenses. See this page on accountable reimbursement plans for more information. 

Estimate Taxes or Volunteer Withholding?

Another area that many churches are not aware of is that a minister is "exempt" from withholding income taxes from their paycheck. Now that does not mean they are exempt from paying income tax! They are subject to income taxes on their taxable ministerial compensation.

However, they are exempt from their employer (the church) automatically withholding federal and state income taxes like they must do with non-minister employees.

So how does ministers remit their income and even self employment taxes mentioned in this article? 

There are 2 different ways.

The first and easiest way is to ask for "voluntary" withholding from their employer. To do this they simply fill out a W-4 and submit it to the church. They can even add an additional amount to help cover their self-employment taxes which the church is not allowed to withhold and match in Step 4 line C of that W-4. Those amounts will be reported in Box 2 of their W-2 (Federal income tax withholding); however the "extra" will be used to cover any additional taxes owed such as the self employment tax on their personal tax return.

NOTE that "extra" amount will be withheld from each payroll, so only write in what extra per paycheck you want withheld! For example, if your tax accountant tells you that you need to "withhold and remit" $400 a month to help cover your SE tax and you get paid twice a month...make sure you write or type $200 in that line =)

If a minister would rather remit their own taxes, they will need to remit estimated tax payments in quarterly installments.

See more on minister’s compensation issues:

• Opt out of Social Security
• Housing Allowance
• Clergy Tax

The Church Accounting: How To Guide devotes a whole section of the book to payroll for churches. It covers payroll terminology and forms and then takes you through the steps necessary to set up a payroll, calculate and file the necessary taxes and forms, and even details how to handle the minister's payroll. It also includes sections on filling out IRS forms: 1099-Misc, 1099-NEC, and 1096.

If you have QuickBooks or are considering using it in the future, go ahead and purchase the QuickBooks for Churches and the How To Guide combo for a complete package on setting up and administering a payroll using QuickBooks.

QuickBooks for Churches & Church Accounting Combo Bundle

References:

flumc.org:Employee or Independent Contractor

Richard Hammar's Church & Clergy Tax Guide 

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The comments above are for general information purposes only and do not constitute legal or other professional advice on any subject matter. See full disclaimer.