THE MINISTER’S COMPENSATION AND TAXES
By: Jesse Williams
“Even so hath the Lord ordained that they which preach the gospel should live of the gospel” (I Corinthians 9:14). Living off the income from preaching is not always easy. We can be thankful that, for the most part, the days are gone when a minister barely subsisted with a meager income and whatever meat, eggs, and vegetables the generous church folk would bring. Along with better compensation, however, has come a greater need to be well informed and to use wisdom in this area. The day has passed when a minister could just put whatever he received into his pocket and then live out of it as best he could.
The church and pastor should agree on the method of determining the minister’s compensation. In the case of a smaller church, all of the tithes may be needed to support the pastor. For a larger church, however, the total tithing receipts may far exceed reasonable compensation; in such a case the pastor should take a salary or a percentage of the tithes, releasing the rest of the tithes to support other aspects of the church’s ministry. This amount should be reevaluated annually.
However the compensation for a minister is determined, a number of things need to be taken into consideration. (By compensation, we mean what the minister receives for the support of him and his family. Professional expenses are something altogether different and should be considered apart from his or her personal income.) Personal income should be equitable and reasonable.
Reasonable compensation should be determined after taking into account the cost of living in the locality and the financial level that would be proper for the minister’s position. Naturally the financial strength of the church comes into play here. Sometimes it is not possible to support a minister to the level desired, and sacrifice is called for.
The financial level afforded the minister should give consideration to his position in the community and reflect his leadership and professionalism. Though it is usually not a problem, we must remember that a church, being nonprofit, can only provide “reasonable compensation” for services if it is to abide by the tax laws.
The pastor does not need to discuss his compensation, benefits, and expenses with the entire church; the church board can act for the church in such matters.
Employee or Self-employed?
At present, under United States law, a minister is always considered to be self-employed for the purpose of Social Security taxes. However, for income taxes, a minister could be an employee or self-employed. Traveling evangelists and people involved in special ministries are usually self-employed, but the Internal Revenue Service would consider most pastors of local churches to be employees. If some local pastors are classified as self-employed, not all employer benefits apply to them. For example, most ministers will benefit from being classified as an employee because the church can purchase tax-free medical and health insurance for them and provide a tax-free term life insurance policy up to fifty thousand dollars. It should also be noted that the risk of
being audited is up to twenty times less than for a self-employed person.
If a minister is classified as an employee, the church should report his income on Form W-2; if he is classified as self-employed, the church should report his income from the church on Form 1099. In either case, most pastors will have some miscellaneous income from funerals, weddings, or other services that does not come from the church he pastors. These amounts should be reported on Schedule C as self-employment income and the net amount carried to page one of Form 1040.
A church is not required to withhold income taxes from wages paid to a minister even when the minister files as an ernployee. Ordinarily the minister (whether filing as an employee or as self-employed) is required to pay estimated taxes quarterly. A church and a minister who files as an employee can agree for voluntary withholding ank thereby spread the tax payments evenly over the year. Simply filing Form W-4 with the church is deemed a request for voluntary withholding. The amount withheld can include enough to cover income taxes and Social Security taxes, thereby eliminating quarterly paymerlts by the minister. This arrangement is reasonable when the church has other employees and is already filing quarterly reports of taxes withheld.
Insurance and Pension Plan
When an employer/employee relationship exists, the tax laws allow certain parts of the employee’s total compensation to be tax free. They are employer-furnished benefits and should be paid directly by the church. First, the church can make contributions to an accident or health plan that compensates the employee for personal injury or sickness incurred by him, his spouse, or his dependents. This means a church could pay health insurance premiums on behalf of a minister and his family. If the insurance does not fully cover the cost of an injury or health care, the church may also have a stated policy of reimbursing the employee for those uncovered amounts.
The church may also pay the premium for a term life insurance policy on the minister when the coverage does not exceed fifty thousand dollars per employee. Both of these benefits are tax free for an employee but not for a self-employed person.
One benefit a church can extend, whether a minister files as an employee or as self-employed, is pretax contributions to a tax-deferred pension plan. In some cases, the church can make such a contribution and it not be reported as income. The minister may also choose to set aside part of his pay through salary reductions and place it in a qualified retirement fund, and it would be tax-deferred as well.
The point of the foregoing paragraphs concerning compensation that is not paid directly to the minister is that careful planning can save taxes and produce higher net income for the minister. If a minister receives all of this compensation as his income and pays for these items himself, he will have to pay taxes unnecessarily on the money received to pay for these benefits. Moreover, it is important for all of the matters concerning a minister’s compensation to be specified in duly passed resolutions of the church membership or church board.
It is advisable to obtain professional advice in deciding on insurance and retirement plans. Information about a tax-deferred retirement plan is available from the Minister’s Retirement Fund of the United Pentecostal Church International, and information about health and life insurance plans is available from the Insurance Department. Insurance agents and financial planners offer a variety of other plans as well. If these items are not part of the minister’s compensation package, it is important for him to make adequate provisions for himself and his family with respect to health insurance, life insurance, and retirement.
The most significant benefit that the Internal Revenue Code provides for ministers is the housing allowance. Even if a minister pays for the cost of providing a house and furnishings out of his income, he does not have to report this amount as income for income tax purposes. For him to be eligible for this benefit, the church must designate a certain portion of the minister’s income as a housing allowance. The designation must be made prior to the cost being incurred. Ideally, it should be made at the beginning of each year by the church board or at a church business meeting.
The amount of housing costs that a minister can exclude from income is limited by several factors. It is the lower amount of what the church actually designates as a housing allowance and what he actually spends. It is also limited to the fair rental value of the home and furnishings. It is to the minister’s advantage for the church to designate a greater amount than he is likely to spend. The amount does not really matter to the church, for the total compensation remains the same. The minister can use the housing allowance for all costs of maintaining his house that year, including down payment, mortgage payments, interest, rent, maintenance, utilities, furnishings, and household items.
When the church provides the minister with a Form W-2 or Form 1099, the income it reports should exclude the designated amount for housing. If the minister spends less than the designated amount on housing, he must report the difference as income even though it is not on the W-2 or 1099. It is reported as unused housing allowance on Form 1040.
The housing allowance is not exempt from Social Security tax; it must be added back to other income for calculating self-employment tax for Social Security. All ministers are considered self-employed for purposes of Social Security.
If a minister lives in a parsonage provided by the church, he does not have to pay income tax on the rental value, but he must pay self-employment Social Security tax on the rental value. Because the housing allowance is available for all ministers, there is no tax advantage to the minister’s living in a parsonage, although there may be other advantages, such as not having to worry about buying, selling, or maintaining a home. There are advantages to owning a home. For example, for most people it is the best plan for long-term savings and investment. Therefore, if a church has a parsonage, a minister should carefully consider whether it would be to his advantage to live in the parsonage, to buy the parsonage from the church if the church agrees, or for the church to sell or rent the parsonage to someone else and let him buy his own home.
The foregoing paragraphs have dealt with compensation for a minister in areas where cooperation between the church and minister can increase net income without greater cost to the church. One other area of finances between the church and minister that needs to be mentioned is the area of business or professional expenses.
Ministers should not be expected to pay for the professional expenses necessary to perform their duties. These are rightfully church expenses and should be kept that way. The best policy is for the minister to report and document to the church all professional expenses, identifying the date, amount, and nature of each expense. He should do so regularly, such as each month. The church can then issue a check for the exact amount of those expenses. This money will not be considered income and is not reported to the Internal Revenue Service.
In many cases, the church can pay business expenses directly by check or credit card, so that the minister does not need to be reimbursed. If the church provides expense money in advance, the minister must account for it as already described, and he must return any excess reimbursements. Accounting to the church for all expenses requires some discipline on
the part of the minister; however, the benefits are well worth the effort. When he operates in this manner, the minister’s personal income does not include business expense; therefore his church income does not appear unreasonably high. Moreover, accounting is always required, either to the employer or the IRS. Obviously it is better to report to the employer, who is familiar with the expenses. Further, if a minister who is classified as an employee chooses to report expenses to the IRS, he can deduct them only to the extent that they exceed two percent of his adjusted gross income.
Some ministers would like the convenience of a checking account used at the discretion of the minister from which they could pay all business expenses. The problem with this arrangement is that the IRS will consider all the money put into this account as income to the minister if he has sole control of the account.
In short, the best way to handle professional expenses incurred by the minister is for the church to establish an accountable reimbursement plan. A sample resolution for this purpose can be found in the Church and Clergy Tax Guide by Richard Hammar.
Probably the largest single type of business expense that a minister encounters is automobile expense. The church could own a car, maintain it, and provide fuel for the minister’s business driving. However, this arrangement has its limitations. Unless the automobile is left at the church and used only for business, it will produce some taxable income to the minister. Commuting from home to the church or office is considered personal use, not business use. There are other limitations, and it would be advisable to read IRS Publication 535 before making the decision. The simplest procedure is for the minister to own the automobile and to report his business mileage to the church at the currently allowed rate per mile on a monthly expense report.
Whenever an automobile is driven for both personal and business use, a log must be kept to substantiate the use. When the business use is included in a monthly expense report to the church along with other business expenses, no further accounting is required to the IRS. The reimbursement received from the church is not reportable income.
To document his expenses a minister should keep copies of all expense reports he turns in as well as receipts and other backup information.
The preceding tax information does not cover all the details and is not offered as a legal or accounting service, but rather to point out some important factors to understand and consider. For further information, a minister could consult a certified public accountant who is familiar with ministerial and nonprofit tax questions. There are also a number of publications that address these issues well, including Income Tax Law for Ministers and Religious Workers by B. J. Worth and Church and Clergy Tax Guide by Richard R. Hammar
To summarize matters relating to income, a recommended clergy compensation package includes the following: (1) salary as an employee (for income tax purposes only), (2) housing allowance, (3) accountable reimbursement plan for professional expenses, (4) voluntary tax withholding, (5) tax-deferred retirement plan, and (6) tax-free health and life insurance. Such a plan provides for generous compensation to the minister while minimizing tax liabilities.
The three enemies of the church are the world, the flesh, and the devil. The three most common areas of failure in the flesh have to do with money, sex, and power. Neither the world nor the devil can defeat us if we walk in the Spirit, for if we do so, we will not fulfill the lusts of the flesh. Success depends upon a right relationship with God and with the world. With the world we must have contact without contamination (John 12:25; 15:19; 17:14-17); with God we must submit totally to His will (Romans 12:1-2).
For the minister of God, his attitude toward money and his handling of finances can mean the difference between success and failure. Both need to be in order before a man embarks as a representative of God. “If a man know nt how to rule his own house, how shall he take care of the church of God?” (I Timothy 3:5). “Let these also first be proved; then let them use the office of a deacon, being found blameless” (I Timothy 3:10). The principles suggested in these two verses indicate that a minister needs to conduct himself honestly and honorably in the sight of
(The above material appeared in the July/September 1992 issue of FORWARD.)
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