Churches and other 501(c)(3) organizations are subject to unique federal tax rules covering compensation. Specifically, 501(c)(3) organizations are prohibited under federal tax law from paying compensation above that which is “reasonable” to their leaders. Although situations in which churches pay excessive compensation are rare, these regulations should nevertheless be taken into consideration.
“In a for-profit business, such as a corporation, if the IRS determines there is unreasonable compensation, the deduction for the unreasonable portion of the compensation is disallowed and the business goes on. More taxes will be paid, but the business still exists,” said Elaine Sommerville, a CPA focusing primarily on tax compliance aspects of nonprofit organizations.
However, if the IRS determines a church paid excessive compensation, the church could lose its tax-exempt status, explained Sommerville. Or the recipient of the unreasonable compensation could be forced to return the portion deemed to be “unreasonable” to the church, owe the IRS an intermediate sanction of 25 percent, and if not corrected, be assessed an additional penalty of 200 percent. Those who authorized the payment of the excessive compensation may individually be assessed a penalty of 10 percent of the unreasonable amount.
This article is excerpted from “5 Unique Features of Church Compensation” in the December issue of Church Finance Today. For help with various issues related to taxes and a church’s tax-exempt status, see the 2018 Church & Clergy Tax Guide.
This content is designed to provide accurate and authoritative information in regard to the subject matter covered. It is published with the understanding that the publisher is not engaged in rendering legal, accounting, or other professional service. If legal advice or other expert assistance is required, the services of a competent professional person should be sought. "From a Declaration of Principles jointly adopted by a Committee of the American Bar Association and a Committee of Publishers and Associations."
Due to the nature of the U.S. legal system, laws and regulations constantly change. The editors encourage readers to carefully search the site for all content related to the topic of interest and consult qualified local counsel to verify the status of specific statutes, laws, regulations, and precedential court holdings.