Churches typically offer employees a variety of tax-free, tax-deferred benefits. But all too often, church employers take too casual an approach to such benefits. They tell their employees how much money the church has to spend, then ask the employees to decide what fringe benefits they want. Other churches do not adequately document benefit plans.
Better planning would maximize the tax credits of such benefits for employees. It would also help churches to comply with IRS rules about benefits.
Benefits to Include
Health insurance. This is a top priority for church staff. Employer-paid group health insurance premiums are free from income tax and social security tax. Since health plans often cost $10,000 per employee per year or more, the tax-free benefits for churches can run several thousands of dollars per year. This benefit covers group premiums directly paid by a church. (See the Affordable Care Act: Church Administrators Survival Guide by Church Law & Tax for more information on compliance with ACA health insurance regulations.)
Medical expense reimbursement. Coinsurance, deductibles, and other out-of-pocket medical expenses for an employee or his/her dependents can be reimbursed under a Flexible Spending Account (FSA). FSAs are capped at $2,500 per year adjusted annually for inflation.
FSAs can be paid by the church or by a reduction of the employee's salary. If an FSA is funded through salary reduction, excess funds cannot be paid to the employee without causing all of the benefits to be treated as taxable compensation. Likewise, excess money in a church-funded FSA cannot be carried over to the next year without tax implications for the employee.
Churches cannot offer FSAs only to their highly compensated employees without violating discrimination regulations.
Churches must be careful to comply with changes in the reimbursement rules established under the ACA. Noncompliance can be very costly! (See the free download 5 Roads to Healthcare Reimbursements by Churches and Ministries from ECFA for more information.)
Retirement plans. Most denominations sponsor tax-sheltered annuity plans (403[b] plans), which allow churches and staff to contribute to a retirement account. Contributions to church-sponsored retirement plans are especially important for pastors because income taxes and social security taxes are deferred. Distributions from these plans generally are designated for the housing-allowance benefit. Therefore, the withdrawals are tax-free for social security purposes and may be tax-free for federal and state income taxes.
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