With my bookkeeping firm, I see payroll mistakes with churches and nonprofit organizations of ALL sizes. Sadly, even those using a payroll service or payroll software may not be in compliance as many payroll services do not know how to properly set up and administer payroll for churches. Those errors can be very costly. See the top five payroll mistakes I see the most often in the course of my business ...
I have seen several well meaning churches pay their employees' individual health insurance premiums. This can be a nontaxable reimbursement IF set up properly. The payroll mistakes happen when those reimbursements have not been set up according to ACA (Affordable Care Act) guidelines. Those healthcare reimbursements can then be in violation of ACA requirements and subject to related penalties.
Congress passed the 21st Century Cures Act in December 2016 and created QSEHRA within it. A QSEHRA (Qualified Small Employer HRA) is the ONLY way that a church can legally reimbursed an employee’s individual health insurance premiums.
However, there are some strict guidelines with a QSEHRA and you need to be aware of them and make sure that you are in compliance with those requirements.
If you would like to learn more about those guidelines and chat with an HRA expert with PeopleKeep, a company I have teamed up with to help with QSEHRA questions, click the LEARN MORE button below and complete the short form. I get you in touch with one to discuss how this tax-free healthcare benefit option may be able to help your organization.
Before you pay your employee that first paycheck you should have a W-4 and I-9 on file for that employee.
A W-4 is required to give you the correct information to set up that non minister employee in your payroll system. It also let you know how much to withhold for payroll taxes. You do not have to obtain a W-4 for a minister unless he has requested voluntary withholding.
If at any time, the employee wants to change their withholding ALWAYS get a new W-4 completed and signed and on file before you adjust their withholding! You do not want them coming back next year upset because not enough or too much was withheld, and they have no recollection of asking you to change their withholding.
The government also requires you to verify your employee is eligible to work in the United States. You can do this by having them complete and sign and I-9 and obtaining copies of the appropriate supporting documents.
If you direct deposit their paycheck, you should have a direct deposit authorization form signed and completed and on file.
See more on documents you need for payroll.
The following are compensation types that must be examined to determine if the amount should be reported in Box 1 of an employee’s W-2:
Bonuses and Gifts: I encounter this next payroll mistake more times than I can count =(When you give your employees a Christmas or year-end bonus or appreciation gift (cash or gift card) … it must be run through payroll with all applicable payroll withholding taxes applied AND must be reported in Box 1 of their W-2.
SECA Allowance: you can “help” your minister with a portion their self-employment tax by giving them an “allowance” for the 50% that churches are not allowed to “match” like they do for all FICA (non minister) employees… but it is taxable income and must be reported in Box 1 of their W-2.
Car Allowance: you can give your minister a set monthly amount for a car allowance; however, it is taxable income and must be reported in Box 1 of their W-2. A better method is to have an accountable reimbursement policy set up to reimburse them tax free for actual miles driven for church business.
Medical Sharing Costs: as stated above you can “reimburse” your employee for their participation in a medical sharing plan like Samaritan Ministries; however, it is considered taxable income and must be included in Box 1 of their W-2.
Cell Phone Reimbursement: the church can provide a cell phone tax free for a minister or employee that requires one in order to do church business; however, providing or reimbursing the cost of a cell phone for an employee that doesn’t require one to perform their church duties…is taxable.
Tip: If you pay for a cell phone for your employee and they do not have a personal cell phone…there may be some taxable income on the portion of the cell phone monthly charge that was used for personal use.
Unsubstantiated Business Expenses: Got employees that are neglectful in turning in timely receipts? Advise those employees that missing receipts for items purchased for the church and paid for with church money or reimbursed with the church's funds may cause those amounts to be included in their taxable income according to the IRS.
Those of you that have read my newsletter and site articles for many years know that this is something that I harp on quite a bit, but it is one of the top payroll mistakes I see with churches.
A minister has a special status with the IRS. They are considered an employee of their church for income tax purposes, but are considered self-employed in regard to Social Security taxes.
Ministers are paid through the Self-Employment Contributions Act (SECA) System... NOT through the Federal Insurance Contributions Act (FICA) system. This means you cannot withhold and match FICA taxes for ministers! See more in this article on a minister's status with the IRS.
If you are currently paying your minister through the FICA system you are putting his housing allowance in jeopardy and even worse… putting him in danger of being charged with tax evasion.
The number one payroll mistake that I see most often... is misclassifying workers.
The church can have four categories of workers according to the IRS:
It is imperative that you classify each worker correctly as mistakes in classification are costly.
The IRS uses three factors to determine how to classify a worker:
See the IRS site for more details on these three factors.
In a nutshell, behavioral control is the determination that if the organization can tell the worker when, where, and how to work... the worker is most likely an employee.
To determine financial control ask yourself… does the worker use supplies provided by the church? Do you reimbursed them for “business” expenses paid for out of their pocket? If the answer is yes… they are probably considered employees by the IRS.
Does their pay rely on increasing revenue for the church? Do they offer similar services to multiple churches or other organizations? Are they paid a flat fee for services as opposed to a regular hourly, weekly, or annual wage? If the answer is yes… they may be considered an independent contractors by the IRS, but still have to consider the other 2 factors before making that determination.
The last factor is relationship. A worker is usually considered an employee, if you provide benefits such as vacation and sick time, insurance, and retirement. Another relationship factor to consider is the length of time the work is expected to last. An independent contractor is usually hired for a specific time period. So, if your worker is getting a 1099 from your church only ... year after year ... it may raise a red flag with the IRS.
Ministers and especially pastors are usually considered employees of the church.
See more on classifying workers correctly!
Richard Hammer: Church and Clergy Tax Guide
Elaine Sommerville: Church Compensation: From Strategic Plan to Compliance
HR Advisor's article: Factors in Classifying Contractors vs. Employees