Compensation Issues Every Church Leader Should Understand

Setting compensation for pastors and church staff is not just a budgeting exercise.

Church compensation decisions have legal, tax, and governance consequences that differ sharply from those faced by for-profit employers. 

Executive pastors, administrators, finance leaders, and board members all play a role—and misunderstandings can expose a church to penalties, audits, or loss of tax benefits.

Here are the compensation issues every church leader should understand.

Churches are tax-exempt organizations, but there are strings attached. The IRS requires tax-exempt entities, including churches, to pay “reasonable compensation”—generally defined as what similar organizations pay similarly qualified individuals for comparable work.

Excessive pay in a church can trigger serious consequences. Excess compensation can jeopardize tax-exempt status, trigger steep excise taxes for the recipient, and expose board members who approved the pay to personal penalties. Compensation decisions should be documented, reviewed, and based on objective data—not assumptions or goodwill.

The minister’s housing allowance is one of the most significant and misunderstood tax benefits in church compensation. Properly structured, it allows qualifying ministers to exclude housing expenses from federal income tax (within defined limits). Improperly handled, it can create compliance problems for both the church and the minister.

Housing allowances must be approved in advance, documented in writing, and carefully limited to actual housing expenses and fair rental value (furnished, plus utilities). Churches should also think long-term: pastors living in church-owned housing may struggle to build equity, making retirement planning more complex.

Churches can offer 403(b) and 403(b)(9) retirement plans, which provide flexibility not available in most for-profit plans. These plans may allow faith-based investment options, unequal employer contributions, and continued funding even after employment ends.

Some retirement benefits paid to ministers can also qualify for housing allowance treatment during retirement. These advantages can strengthen a compensation package—but only if they are set up and administered correctly.

For income tax purposes, most ministers are treated as employees and receive a Form W-2. However, for Social Security and Medicare (the Federal Insurance Contributions Act, or FICA, taxes), they are considered self-employed and must pay self-employment (SECA) taxes covering both the employer and employee portions.

Churches should not withhold Social Security taxes from ministers’ pay, and ministers should understand how this affects cash flow and retirement planning. While some ministers may wish to opt out of Social Security, that decision is typically permanent and should be made only with professional guidance.

Health insurance remains one of the most challenging aspects of church compensation. Options such as QSEHRAs and ICHRAs can help smaller churches reimburse medical expenses or insurance premiums—but these arrangements are governed by strict rules.

Mistakes are common, especially when churches reimburse premiums informally without establishing a compliant plan. Churches must also be careful not to limit certain benefits to ministers only, which can violate federal requirements.

Compensation mistakes rarely announce themselves right away. Problems often surface years later—during an audit, a leadership transition, or a financial crisis. Church leaders who understand these issues are better positioned to protect the church, care for staff, and steward resources wisely.For deeper guidance, expert analysis, and step-by-step explanations, explore resources like Church Compensation, Second Edition, the Church & Clergy Tax Guide, subscribe to Church Law & Tax newsletters, or consider membership for ongoing updates and practical tools.