Jump directly to the content
Setting Pay Packages for Pastors
Setting Pay Packages for Pastors
Why churches need to get three tax issues right with compensation.
PAGE 1 of 3Single Page

Compensation planning for clergy and other church staff presents several unique tax issues that are not well understood by many church leaders and their advisers. Here are three key considerations to review when structuring compensation plans.

1. Salary

The most basic component of church staff compensation is salary. There are two important considerations to keep in mind with respect to staff salaries: (1) the amount of the salary, and (2) the use of "salary reduction agreements." If a church pays unreasonably high compensation to a pastor or other employee, the church may lose its tax-exempt status or face intermediate sanctions, including tax on disqualified persons, additional tax on disqualified persons, and tax on organization matters.

Recommendation:Churches that pay a minister (or any staff member) significantly more than the highest 25 percent for comparable positions should obtain a legal opinion from an experienced tax attorney confirming that the amount paid is not "unreasonable" and will not expose the employee or the board to intermediate sanctions.

Many churches have established "salary reduction agreements" to handle certain staff expenses. The objective is to reduce an employee's taxable income since only the income remaining after the various reductions is reported on the employee's W-2 at the end of the year. It is important for churches to understand that they cannot reduce an employee's taxable income through salary reductions unless specifically allowed by law. There are three ways taxable income can be reduced through salary reduction agreements: (1) tax-sheltered annuity contributions, (2) "cafeteria plans," and (3) housing allowances.

2. Housing and equity allowances

The most important tax benefit available to ministers who own or rent their homes is the housing allowance. Ministers who own or rent their home do not pay federal income taxes on the amount of their compensation that their employing church designates in advance as a housing allowance to the extent that the allowance represents compensation for ministerial services, is used to pay housing expenses, and does not exceed the annual fair rental value of the home (furnished, plus utilities). Housing-related expenses include mortgage payments, rental payments, utilities, repairs, furnishings, insurance, property taxes, additions, and maintenance.

Ministers who live in a church-owned parsonage that is provided "rent-free" as compensation for ministerial services do not include the annual fair rental value of the parsonage as income in computing their federal income taxes. The annual fair rental value is not "deducted" from the minister's income. Rather, it is not reported as additional income anywhere on Form 1040 (as it generally would be by nonclergy workers). Further, ministers who live in a church-provided parsonage do not pay federal income taxes on the amount of their compensation that their employing church designates in advance as a parsonage allowance, to the extent that the allowance represents compensation for ministerial services and is used to pay parsonage-related expenses such as utilities, repairs, and furnishings.

From Issue:

Subscribe

If you found this article helpful, subscribe to ChurchLawAndTax.com for access to more articles like this one.

View All
from our store
2018 Church & Clergy Tax Guide

2018 Church & Clergy Tax Guide

Find comprehensive help understanding United States tax laws as they relate to pastors and churches.
20 Finance Questions Churches Ask

20 Finance Questions Churches Ask

Richard Hammar shares his answers to 20 of the most widely asked and relevant tax and finance questions for church leaders.
Preventing Top Tax Pitfalls

Preventing Top Tax Pitfalls

Learn the background you need on tax laws to know what questions to ask.
Setting a Pastor's Pay

Setting a Pastor's Pay

Richard Hammar explains legal and tax matters for planning the pastors compensation.