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Information Regarding Churches
Incorporation documents should be kept forever. W-2′s and payroll records should be kept forever. Any receipts or documents relating to investments or investment properties should be kept for 6 years after selling or disposing of the investment. All other receipts, statements, bills, check stubs, etc. should be kept for six years.
Any trade or business that is regularly carried on, which is not substantially related to the charitable purpose of the organization, produces unrelated business income. The fact that the income is used to create funds that are used to further the charitable purpose does not exempt the activity from taxation.
1. Activities in which substantially all the work is performed by unpaid volunteers.
2. Activities carried on for the convenience of the members or employees.
3. Selling merchandise that has been received as gifts or contributions (such as a church bake sale).
4. Dividends, interest, annuities, royalties, capital gains and losses, and rents from real property:
Exception: Debt-financed Property – Property that is held to produce income and is subject to “acquisition indebtedness” (such as a mortgage) at any time during the tax year is unrelated business income unless:
85% rule – if 85% or more of the total property is used for exempt purposes then the income is not considered to be unrelated business income. If less than 85% of the property is used for the exempt purpose than that part of the property, which is not used for exempt purpose, is considered to be unrelated business income.
The neighborhood land rule – If an exempt organization acquires property with the intent of using it for exempt purposes within 10 years (15 years for churches) than income which is produced during that time is not unrelated business income. See IRS publication 598 for details.
Note: Rent on real property is considered unrelated business income when the rent is based on a percentage (such as a percentage of profit). Rent should be a flat rate in order to qualify for any of the exceptions above.
For more information see IRS Publication 598.
Some states require state income tax to be withheld by the employer. Be sure to check your state’s laws to determine your responsibility. You may be required to withhold state income tax from the pastor’s wages, and file a state quarterly form to report and pay the amount withheld.
SS-4 Employers file this forms to request a Federal EIN (Employer Identification Number).
W-4 All employees must fill out a W-4 for your records. This form determines how much federal income tax is withheld. If the pastor pays quarterly, and does not wish to have taxes withheld, he should mark his W-4 “exempt” and sign it.
I-9 All employees must fill out an I-9 for your records. This form verifies the employee’s employment eligibility and must be retained by the employer.
W-2 All employees should be given a W-2 each year. For detailed instructions on filling out a W-2 for the pastor, see the booklet “The Pastor and His Income Tax”.
W-3 One W-3 should be prepared to accompany all your W-2’s. The W-3 acts as a face/summary sheet.
941 This is a quarterly form used to report wages and pay any taxes withheld by the employer (church). This must be filed even when no taxes are withheld. Housing allowance is never included on this form.
Incorporate at the state level. It is not necessary to file IRS Form 1023 (which results in a hefty fee) and obtain formal recognition of your exemption. Incorporation at the state level insures you federal tax-exempt status.
Pastors pay their Social Security and Medicare tax the same way a self-employed person would, through self-employment tax. This tax is 15.3% of income including the housing/parsonage allowance and is calculated on the Schedule SE that is filed with a minister’s tax return each year. They must pay Self-employment tax on their ministry income, including their housing allowance. When a pastor lives in a parsonage he also pays SE tax on the Fair Market Rental Value of the parsonage plus church paid utilities.Regular employees have an advantage when paying their Social Security and Medicare tax. Employers withhold half (7.65%) of every employee’s Social Security and Medicare tax from their wages. The employer pays the other half and the employee does not pay any taxes on the employer’s “matching” part.Pastors pay the entire 15.3% without the benefit of a non-taxable “matching” employer part.Many churches have realized the tremendous burden this places on a pastor and his finances and are paying a 9.8% (7.65% = half of SE tax + additional amount to help offset the additional taxes incurred when the salary is increased) “matching” portion as additional salary.
According to the IRS gifts to staff members would be valued at under $25 and would never be cash or a gift card. Gift cards which are given for a specific item may qualify - such as a certificate for a one pound box of assorted chocolates from a specified candy company. Otherwise gift cards would never be a qualified gift. An example of a qualified gift to an employee would be a turkey at Thanksgiving. Cash gifts which are given to employees, pastors or volunteers are always taxable compensation.
Yes, there are several steps you can take to protect your church and those that handle money.
1) Offerings should be kept in a locked/controlled situation and counted as soon as possible.
2) Offerings should be counted by two individuals who are not related.
3) The results should be reported on a tally sheet and signed by both counters.
4) The treasurer (not a counter) receives a copy of the tally sheet.
5) The treasurer compares the tally sheet with the bank statement.
Generally, organizations send acknowledgments to donors no later than January 31 of the year following the donation. That’s because donors must receive the acknowledgment by the earlier of 1) the date on which the donor files his or her individual federal tax returns for the year of the contribution; or 2) the due date of the return (including extensions).
The IRS provides the following 3 examples of written acknowledgments:
- Thank you for your cash contribution of $300 that First Baptist Church received on December 12, 2006.
- Thank you for your cash contribution of $350 that First Baptist Church received on May 6, 2006. In exchange for your contribution, we gave you a cookbook with an estimated fair market value of $60.
- Thank you for your contribution of a used oak baby crib and matching dresser that First Baptist Church received on March 15, 2006. No goods or services were provided in exchange for your contribution.
Organizations are required to provide a written acknowledgment to a donor who receives goods or services in exchange for a payment in excess of $75. If a donor gives you a gift of $100 in exchange for concert tickets with a fair market value of $40, then you must provide a written acknowledgment because their gift exceeded $75. The donor will not be able to deduct more than $60. The written acknowledgment must include the name of the organization, the date and amount of the gift, and the following statement “In exchange for your contribution, we gave you __________ with an estimated fair market value of ____.” Goods and Services are considered to be insubstantial if (1) the fair market value of the benefit does not exceed 2% of the contribution or $76 or (2) the gift is at least $43 and the only items provided bear the organization’s name or logo and the cost of these items is less than $8.60.
According to the IRS churches are not appraisers and should not assign a value to a gift of property. A donor should be provided with a receipt which includes the name of the church and the date of the contribution. The receipt should also include a detailed description, but not a value, of the donated property. When the donated property is a vehicle the church should prepare Form 1098-C and provide a copy to the donor as a receipt.The value of time or services is not deductible and can not be receipted. See page 7 of IRS Publication 526 for more information.
Donors are only able to deduct their charitable contributions when contributing to a 501(c)3 organization (such as a church) and if they are able to obtain a receipt. Therefore it is advantageous for churches to give receipts to their donors. A receipt should include the name of the church and the amount and date of the contribution. The receipt should also include the following statement: “No goods or services other than intangible religious benefits were provided in exchange for the contribution(s)”. Although the giving for the year may be added together and reported as one total, individual contributions of $250 or more must be itemized separately. Refer to IRS Publication 1771 for more information.
When the contribution is designated to an individual who is not an employee of the church:(1) Return the check to the donor or(2) Accept the check but stamp it “NONDEDUCTIBLE” on its face with red ink.When the contribution is designated to a fund or for a specific purpose:
(1) Use the funds as designated by the donor or
(2) Contact the donor and request permission to use the funds in a different way.
One way to ensure that the church maintains control is to have a written policy regarding designated contributions. This policy should state that the church (or established team such as a finance committee or board) has exclusive control and discretion as to the use of all contributions and the church is not bound to honor the recommendations of the donors nor will donors be able to recover a contribution because the church failed to honor the donor’s designation.Honoring a donor’s designation encourages future giving and generates goodwill. It is in the best interest of churches to honor such designations whenever the designation is in line with the church’s ministry purpose.
According to Revenue Ruling 62-113 contributions earmarked for a particular individual are treated as being gifts to the designated individual and are not deductible. Churches should not issue tax-deductible receipts for contributions that are designated for individuals. Exception: Contributions earmarked for individuals who are employed or supported by the church are deductible when the church maintains control of the funds. This would include pastors and missionaries. When these funds are paid to the pastor or missionary as part of their support, they become taxable income and are included on their W-2. Contributions received for missionaries should be sent to the mission board or the employer who issues the W-2 so that these amounts can be included on the W-2 when appropriate.
Designated Contributions are contributions made to the church for a specified purpose. Usually a donor designates his contribution to a specific fund or to an individual.
W-2′s should be kept forever, and all other receipts, statements, bills, check stubs, etc. should be kept for six years. Any receipts or documentation relating to incorporation should be kept forever.
Typically we do not recommend a two signature requirement because it can become cumbersome. Some churches may require two signatures when a check exceeds a maximum amount such as $5,000.The pastor(s) should not be a signer on the checks.
Every couple of years someone(s) from within the church should conduct an internal audit focusing on procedures as their main objective.
Pastors pay their Social Security and Medicare tax the same way a self-employed person would, through self-employment tax. As a result it is incorrect to withhold and match Social Security and Medicare taxes for a minister. When these taxes have been withheld in error the quarterly 941′s and W-2(s) need to be corrected.You will need an original W-2c and W-3c. The downloaded version of these forms are for informational purposes only. You may find forms at your post office or library. You may also call 1-800-TAX-FORM and ask for copies to be mailed to you.
You will need to know the following amounts when correcting your 941′s and W-2(s):
1. The “total tax” you paid in error as Social Security and Medicare taxes.
2. Half of the amount of the “total tax” which will be referred to as the “half”. (This is also the amount which was withheld from the pastor’s wages.)
Correct your 941′s:
The following instructions should not result in an overpayment or an underpayment. The net result would be zero balance due.
1. Prepare new quarterly 941′s correctly by not showing your minister’s income in column 1 of blocks 5a & 5c. Neither would you show any taxes for your minister in column 2.
a. Increase block 3 by the “total tax” you are no longer reporting in column 2 of blocks 5a & 5c. (This will move the amounts you paid for Social Security and Medicare into Federal Income tax withholding).
b. Increase block 2 by “half” of the amount you included in block 3. (This is because the matching portion of the Social Security and Medicare taxes need to be included in income.)
2. Prepare a 941-X showing the previously reported amounts (from your incorrectly submitted 941′s) and the correct amounts (from the 941′s you have just prepared).
3. Mail your 941-X to the address where you would file your 941′s if you were not making a payment.
Correct your W-2(s):
1. Prepare Form W-2c.
a. Increase block 1 by the “half”.
b. Increase block 2 by the “total tax”.
c. Decrease blocks 3, 4, 5 and 6 to zero.
2. Mail the top copy of W-2c with a W-3c to:
Social Security Administration
Data Operations Center
Wilkes-Barre, PA 18769-0001
3. Keep a copy of the W-2c for your records and give the rest of the copies to the minister.
Block 1 – Wages, tips, other compensation
This amount would not include any designated housing allowance. Include all other wages, bonuses, gifts, non-substantiated reimbursements, the value of any non-cash gifts, and any other amounts given to the pastor that are not qualified fringe benefits.
Block 2 – Federal income tax withhold
Include any amounts you withheld from the pastor’s wages and paid by filing IRS form 941.
Block 3 – Social security wages
This block should have a zero or the word “none” in it. Ministers are not employees for Social Security purposes and they do not have Social Security wages through their employers (churches).
Block 4 – Social security tax withheld
This block should have a zero or the word “none” in it. Ministers are not employees for Social Security purposes and they do not have Social Security tax withheld through their employers (churches).
Block 5 – Medicare wages and tips
This block should have a zero or the word “none” in it. Ministers are not employees for Medicare purposes and they do not have Medicare wages through their employers (churches).
Block 6 – Medicare tax withheld
This block should have a zero or the word “none” in it. Ministers are not employees for Medicare purposes and they do not have Medicare tax withheld through their employers (churches)
Blocks 7 – 11
Leave these blocks blank.
Block 12 -
Employee benefits are reported in block 12. A code is listed to identify the type of benefit and the amount provided is listed following the code. Here is a list of the most common codes used by churches:
The value of group-term life insurance which is also included in block 1: “C”
The elective deferred salary contributed to a 401(k) retirement plan: “D”
The elective deferred salary contributed to a 403(b) retirement plan: “E”
Moving expenses reimbursed to the employee (not included in block 1): “P”
Employer contributions to a medical savings account: “R”
Employer contributions to a health savings account: “W”
Block 13 -
Check the “Retirement plan” box if employee or employer contributions are made to a retirement plan.
Block 14 – Other
The housing allowance is reported here. List the amount of designated housing allowance and label it “Minister – see Schedule SE Housing Allowance”.
No, the facts and circumstances will determine a minister’s employment status. Creating a contract or giving an individual a title or description in order to appear to be self-employed will not determine employment status – the facts and circumstances make the determination.
An employee should receive a W-2 and the employer should withhold and match Social Security and Medicare on his/her wages.Note: A church can hire a service, a general contractor, or an individual (if the individual is in business and offers his/her services to several churches/businesses) to provide miscellaneous services (i.e. yard maintenance, janitorial duties, secretarial duties, etc.). If a church chooses to hire an individual or church member then an employer/employee relationship has been established and proper employment forms must be completed.
If you pay a self-employed individual more than $600.00 (not including reimbursements), you must give the individual a 1099-MISC.
An employing agency of a minister of the gospel is to treat the minister as dual-status. This means the minister has 2 status’ and is considered both an employee and self-employed. 1) he is an employee for federal income tax purposes and receives a W-2 and 2) he is self-employed for Social Security and Medicare purposes and does not have Social Security or Medicare withheld nor matched on his wages.
The most common error is for a church/mission agency to give their employed minister a 1099 as if self-employed. This error is many times compounded by the housing allowance, expense reimbursements, and fringe benefits. Fringe benefits are available to dual-status ministers not to self-employed individuals. If a minister of the gospel receives a 1099 and employee fringe benefits, he is receiving wrong treatments. These “before tax” benefits are for “dual-status” ministers who receive W-2’s. Self-employed 1099 individuals are not entitled to employee fringe benefits.The second most common error is for churches to withhold and match Social Security and Medicare taxes from a minister’s wages. This is further compounded when the church designates a housing allowance. Employees who have Social Security and Medicare taxes withheld do not qualify for a housing allowance. If a minister of the gospel has Social Security and Medicare taxes withheld, he is receiving wrong treatments. (Click here for instructions on how to correct this error.)
For more information refer to IRS Publication 517.
Pastors are considered dual-status employees, which means they are treated as an employee for federal income tax purposes, and self-employed for Social Security/Medicare purposes. Being an employee, they do receive a W-2.Self-employment tax is simply the vehicle a self-employed individual uses to pay his Social Security/Medicare tax (SECA). Income (whether you are an employee or self-employed) is subject to both federal income tax and Social Security/Medicare tax.Employees pay their taxes throughout the year as their employers withhold taxes from their pay. The amount withheld for federal tax is figured based on the W-4 an employee fills out when employment begins. For Social Security/Medicare the employer withholds 7.65% (6.2% for Social Security tax and 1.45% for Medicare) from the employees salary, then the employer matches that amount (pays an additional 7.65% which is not considered income to the employee).Self-employed individuals pay their taxes throughout the year by making quarterly estimated payments. This amount covers both their federal tax and self-employment tax (Social Security/Medicare). The amount they pay is only an estimate; they figure the actual amount when they file their yearly tax return.
A pastor’s options in paying taxes during the year are:
1. Your treasurer can withhold enough FIT (Federal income tax) to cover both the FIT and Social Security/Medicare taxes.
2. Your treasurer can withhold FIT and you can file Social Security/Medicare taxes quarterly on Form 1040-ES.
3. You can file quarterly on 1040-ES for all taxes.
4. Prepaying your state taxes by withholding or quarterly estimates may also be required.
The pastor pays federal taxes on the amount of his salary not including the actual expenses incurred for his designated housing allowance, and any tax free fringe benefits.*
The pastor pays self-employment tax on his salary, his housing allowance, the fair market rental value of any church owned parsonage, including any church paid utilities. Other outside income, such as honorariums, would be included on Schedule C of the tax return and subject to self-employment tax.*
1. Pay his salary based on a fair and livable wage (the principle of generosity).
2. Fringe benefits should include:
Full family medical insurance
Retirement plan (403b)
$100,000 of term life insurance
add value of $50,000 as income
3. Reimburse pastor for all professional expenses out of general fund category not compensation.
4. Church should pay portion of pastor’s social security obligation as a taxable bonus.
5. Help pastor buy his own home.
6. Give pastor and wife opportunity to attend three church conferences a year at church expense.
7. Church should give pastor four weeks of vacation per year including four Sundays.
I have never recommended a minister in our fundamental circles to apply for exemption from Self-Employment Tax (Form 4361). The election to apply for exemption is very clearly not to be a financial decision. A minister must be “conscientiously opposed to.. any public insurance that makes payments in the event of death, disability, old age, or retirement; or that makes payments toward the cost of…medical care.” In addition, this conscientious objection must be because of his religious principles. Any minister who files Form 4361 must notify his church that, because of his religious principles, he is opposed to public insurance. I see no scriptural support for opposition to public insurance, and therefore, I do not believe a fundamental minister of the gospel can sign such a statement.There is a general misconception about the election, which implies it to be a good financial decision. I would not concur with that notion! The Social Security program is a good one, and the benefits paid upon retirement are usually the only source of income a minister may have available. The important issue financially is self-discipline. Typically those who have opted out of Social Security have not made adequate provisions for retirement, disability, and Medicare insurance.
The following table represents the amount which must be added to income when an employer provided Life Insurance policy has a benefit value of greater than $50,000. For each extra $1,000 above $50,000 you would calculate an amount using the chart below and multiply by the number of months the benefit was provided (usually 12 months).
Cost Per $1,000 of group term Life Insurance protection for 1-Month Period.
For example a 47 year-old pastor who receives a non-taxable life insurance policy of $100,000 for the entire year would have $90 added to his W-2, block 1 (and block 12 of his w-2 would show code “c” and 90).