What Tax-Compliant Payroll Looks Like, and How to Fix Your Church’s Payroll If It’s Incorrect
What is payroll for churches? Here’s the tl;dr.
Payroll for churches involves understanding the tax implications of being a minister, non-clergy employee, contractor, and volunteer. You must compensate each properly, knowing the rules behind a pastor’s dual tax status and housing allowance.
To get your church’s payroll in order:
- Correct historical wages if you withheld incorrectly
- Classify employees and contractors properly
- Review and approve housing allowances in writing annually
- Set tax-compliant policies and procedures for payroll
- File 941 tax forms on time
Want to know more? Keep reading!
When it comes to payroll for your church, we hear you banging your head against the desk!
We don’t know when this happened, but pastors—and their staff—have to be experts at everything. Whether it’s marital counseling, a land purchase, or an overflowing toilet, you have to figure it out!
Also, you have to get your church’s payroll right. That means you:
- Know that you don’t withhold Social Security or Medicare for any staff classified as ministers—but you do for the rest of your non-ministerial staff
- Have pastoral housing allowances in writing and approved by your governing body
- File your 941 forms on time
- Understand the difference between employees and contractors and pay them accordingly
- Aren’t paying volunteers and still classifying them as “volunteers”
- Know that every one of your staff pastors understands their paystub and how much to save for tax time
But too many churches get each of these items wrong, overpaying taxes or putting the integrity of their church at risk.
In this article, we’ll start by covering common problems with church payroll.
Then, we’ll show you what steps to take to fix them … the steps we would take if you were our partner.
Ready? Let’s get into it. We’ll start in a dark place, but there’s a light at the end of this tunnel!
Church Payroll Glossary: Form 941, FICA, SECA, and Dual Tax Status
Before we get ahead of ourselves, here are four terms you need to know.
You use IRS Form 941 to report the taxes you’ve withheld from your employees’ paychecks to the government. You file them at the end of each quarter, and you can read all about them here.
You withhold income tax and FICA for your church’s employees who are not ministers.
FICA means “Federal Insurance Contributions Act,” which is money set aside for Social Security and Medicare. As an employer, you’re on the hook for half of FICA (7.65% of each employee’s income). Then, you withhold the other half of FICA from your employee’s paycheck.
This is not the same as income tax because it’s a tax used to fund Social Security and Medicare, not to pay for everything else the government does.
For self-employed contractors, you don’t withhold income tax or FICA. Instead, the self-employed contractor must pay their income and SECA taxes. (This is not your problem.)
SECA, the Self-Employed Contributions Act, says a self-employed person must pay both the employer share and the employee share of Social Security and Medicare, which is 15.3%. They also pay income tax, but once again—not your problem.
However, don’t forget about SECA, because…
Can a church pay FICA for a minister? Here’s what you should know about Dual Tax Status for Ministers.
For clarity: When we say “pastors” or “ministers,” what we mean is “staff classified as ministers,” which we’ll cover later. That said…
If you read nothing else: Ministers have dual tax status, which is where church payroll gets super sticky. And where pastors get the ugliest tax-time surprises.
When it comes to income tax, ministers are considered employees of the church. Withhold income tax for a pastor like you would any other employee.
However, regarding Social Security and Medicare, ministers are considered “self-employed.” They must save for and pay SECA—15.3% of their gross income—at tax time.
And churches must not withhold or pay FICA for their ministers. If they do, they’re overpaying taxes and setting their pastors up to do the same.
Common Problems with Payroll for Churches
Problem 1: You’re withholding Social Security and Medicare for pastors
For “staff classified as ministers” alone, churches should not withhold Social Security and Medicare taxes, aka FICA. (You still have to do this for non-ordained employees.)
But when churches abide by the rules of FICA for their ministers, they’re paying a tax not required by the federal government and withholding taxes ministers are not required to pay. Then, at tax time, ministers will still have to pay 15.3% of their gross income for SECA.
In short, don’t withhold FICA for your pastors!
Pastors can opt out of Social Security (we wrote an article about that here). But most pastors we know haven’t opted out. Because of that, they may become confused and think the church should withhold FICA. That’s a mistake. That said, some churches add 7.65% to their pastors’ paychecks to cover half of SECA. But FYI, that’s still taxable income.
>>Pastoral leaders: Make sure your church is not withholding FICA from your paychecks. Then, ensure you’re saving 15.3% of your income for SECA. You’ll thank us on April 15.
Problem 2: You haven’t set up the housing allowance correctly
First, your board or elders must approve each pastor’s housing allowance in writing. If you don’t do this, the IRS will see the housing allowance as taxable income.
Second, though pastors don’t pay income tax on their housing allowance, they still need to pay their SECA taxes on the housing allowance.
Third, churches often issue housing allowances to people who don’t meet the IRS’s definition of ministers. Housing allowances are for ordained, commissioned, or licensed ministers. As such, these employees must perform “sacerdotal functions.” You know, pastor stuff—weddings, funerals, sacraments, and the like.
But some churches, often innocently, think it’s OK to game the system. They pay an employee less but consider part of that pay a housing allowance. Because of a pastor’s dual tax status, the employee won’t have to pay income tax on that amount, giving them an artificial pay raise.
But if they’re not really a pastor, they’re not eligible for a housing allowance. And if they’re not eligible, at some point, the IRS could figure it out and hit them with a massive tax bill. No fun for anyone!
Problem 3: You’ve misclassified contractors, employees, and volunteers
If your church misclassifies a worker as an independent contractor who does not withhold and pay taxes, your church may be held liable for that worker’s employment taxes.
There are a few ways to determine if someone should be classified as an independent contractor. But to get you in the right direction, here’s a quick way to determine a worker’s status: An independent contractor is doing similar work for multiple organizations, while an employee is working for only your organization.
For example, a person you pay to clean your church every weekend and does not clean multiple churches for pay is probably an employee.
A person who works on a construction project at your church, and does construction projects for several other organizations for pay, is probably an independent contractor.
Sometimes, we’ll notice a church pays an individual contractor something to the tune of $50,000 a year! This person may be a contractor, but in many cases, we find people like this have risen to employee status. But because this arrangement grew over time, nobody noticed that the contractor became an employee, and the Department of Labor would have something to say about it if they noticed.
And stipends? They’re a four-letter word in the world of church payroll. A stipend is a small salary (usually in the education world) to cover expenses for someone like an intern. But it should never be equal to wages, subject to Department of Labor rules under the Fair Labor Standards Act.
Problem 4: You’re not withholding taxes for 100% of your employees’ income
Taxable income goes beyond salary. For example:
Bonuses: When you pay an employee a bonus, you may want them to receive a round number, like $5,000.
But if you want that $5,000 to be your “net check” to the employee, you’ll need to “gross up” so they receive the full $5,000 while you withhold the correct taxes.
Fringe benefits: Sometimes, employees (including pastors) will expense an item that’s a “fringe benefit.”
There are a lot of categories to consider (here’s a good article on fringe benefits), but we often see this with clothing. A pastor will sometimes expense wardrobe purchases meant for the platform. Unfortunately, that’s a fringe benefit and taxable income.
Expenses for health care, soul care, massages, restorative trips, and sabbaticals are taxable fringe benefits you need to capture as income.
4. They’ve turned volunteers into employees without realizing it
Unlike the average business, a volunteer can show up at your church and say, “I’d like to volunteer 40 hours a week.” And you can say yes. Perfectly legal and legitimate.
But then, if you see that faithful volunteer and say, “We can’t afford to hire them full-time, but let’s bless them with a stipend of $500 a month!” (Remember how stipends are a four-letter word?)
Now you’re in a gray area between employee and volunteer, which can get you into trouble.
Or, you want to give them a year-end gift to reward them for their service. You can throw them a party, give them a small gift, or even distribute gift cards that church members pay for.
However, the minute you give them cash, the volunteer should report that gift as income. An organization (like a church) giving cash or cash equivalent amounts to an individual is different than an individual handing cash to a friend to say “thank you.” (Benevolence is another matter entirely, but that’s a different article!) Integrity matters in the church, even when the rules seem unfair.
Have you made some mistakes? Here’s how to get your church payroll under control!
Step 1: Correct Historical Wages for Pastors
If you read the above sections and think, “We’ve really messed up withholding on pastors’ paychecks,” you’re not alone. But you can fix it.
If you have been withholding FICA from your pastoral employees, that means both the individual pastors and the church have been paying too much. Here’s what to do:
- Add up what you’ve withheld from your pastors for FICA
- Issue a check for the incorrectly withheld taxes to the pastor and tell the pastor to save that money for tax time
- File an amended 941
- Expect the IRS to refund the church, but it will likely take some time
Correcting historical wages is a tricky calculation. We’re good at it—we’ve done it a lot—but it is some of the most challenging math we ever do. Work this problem with care. (And yes, you can hire us.)
Step 2: Revisit worker classifications for ministers, employees, contractors, and volunteers
Take another look at everyone you’re paying. Make sure you’ve classified each person correctly and that you’re applying the proper withholding rules to their paychecks.
- Besides getting the withholding correct for ministers, ensure your board has approved housing allowances in writing and that your ministers are receiving it.
- If you’re giving a housing allowance to someone who isn’t a “pastor,” it’s time to correct how you compensate them.
- If you’re paying anyone as a contractor who you should classify as an employee, consider changing their status. Seek advice here: You could alert the IRS when you make the change.
- If you have volunteers receiving compensation, reconsider their status.
Step 3: Review housing allowances, and continue to do so annually.
A housing allowance isn’t just about what ministers pay for rent or mortgage, but also what they pay for utilities, furniture, home improvements, and more. And the cost of living keeps increasing! If you’re not reviewing that amount yearly, your pastors may be missing out on tax benefits.
Step 4: Solidify all payroll-related policies and procedures
Controls, policies, and procedures help keep churches and their employees on the straight and narrow. And they’ll ensure employees pay the correct taxes—no surprises later!
Make sure you and a knowledgeable accounting pro have established policies and procedures around the following:
- Fringe benefits and any other non-deductible gifts from the church to its employees
- Benevolence paid to employees
- Health insurance and other benefits
- An accountable reimbursement plan
- W-9 and 1099 forms for contractors (have contractors fill out their W-9s before your first payment to them)
Step 5: Use a payroll platform for your church
There is no easy-button payroll platform for churches.
They’re all created with for-profits and non-profits in mind, so you have to know your stuff when you set it up. Honestly, you need to hire someone like us to do it correctly. (Our payroll teammates rock.)
That said, we recommend Gusto. They’re more of a “people platform” than just payroll, and church is about people. For example, we love that you can welcome new people and sign birthday cards through the platform.
One of the other things we love about Gusto is that they automatically file the required state and federal tax forms on the required schedule. That leads into Step 6 … if you have a great payroll platform, that platform will typically file those forms on your behalf.
Step 6: File 941 Tax Forms On Time
Churches must file Form 941 quarterly to report how much federal income, Social Security, and Medicare tax they’ve withheld from staff paychecks.
Form 941 is due quarterly:
- Q1 (January–March): Due April 30
- Q2 (April–June): Due July 31
- Q3 (July–September): Due October 31
- Q4 (October–December): Due January 31
Add those dates to your calendar. Stick them on your monitor. Write them on your mirror so you see them when you brush your teeth. File each 941 on time and save your church and your pastors headaches!
In addition to filing the 941 form quarterly, the church must send the taxes they have withheld to the IRS on the required schedule – either monthly or semi-weekly depending on the total tax amount. Paying taxes late or not at all is where penalties and interest start happening. And that can add up to a lot of money over time.
Need help with your payroll?
Parable is a team of mission-minded professionals who understand the difficulties of church financial stewardship. We are accountants, bookkeepers, and consultants who ensure every paycheck is correct, and every tax dollar gets where it needs to go.
Still feeling overwhelmed? Book a call with one of our experts today to start a conversation about getting your church’s payroll tax compliant.