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Mass Shooting Preparation is All About Planning—Not Panic

Churches need to first think through safety basics, not active-shooter scenarios when preparing mass shooting response plans.

Matthew Branaugh

Mass shooting preparation is top-of-mind for many faith leaders nationwide.

But has this anxiousness unintentionally overshadowed other, more common risks confronting churches? The statistical probabilities of a mass shooting at a church remain remarkably low. By contrast, the chances of an abuse allegation or personal injury claim are much higher.

Editor’s Note: This article is part of the Advantage Membership. Learn more on how to become an Advantage Member or upgrade your membership.

“The likelihood (of a shooting) is extremely rare,” said Kevin Robertson, a former law enforcement officer who heads security for Saddleback Church and its multiple locations throughout Southern California.

Yet experts like Robertson still note the threat of gun violence against churches cannot be ignored, either. “Don’t bury your heads in the sand,” he tells churches. “But don’t micro-focus on it, either.”

Troubling events

The desire to “micro-focus” is understandable. Shootings generating widespread media attention have hit schools, retailers, music concerts, and movie theaters in recent years, not to mention faith communities. For instance:

A man fueled by a hatred of Christians launched separate attacks on the New Life Church in Colorado Springs, and a Youth With a Mission (YWAM) training center in suburban Denver (5 killed, 5 injured).
A man driven by racial hatred opened fire at Emanuel African Methodist Episcopal Church in Charleston, South Carolina (9 killed, 2 wounded).
A man motivated by a “domestic situation” stormed the First Baptist Church of Sutherland Springs in Texas (26 killed, 20 hurt).
A man reportedly expressing a desire to “kill Jews” attacked the Tree of Life synagogue in Pittsburgh (11 killed, 6 injured).

The ripple effects from these acts of violence have been felt. Attorney and ChurchLawAndTax.com senior editor Richard Hammar said one large church insurer’s general counsel recently told him the top question his legal department receives from churches each year pertains to active shooters and armed security.

On a larger scale, uneasiness is visibly evident—as demonstrated by two separate, nationwide polls, conducted in the spring of 2019, that were focused on church security and shootings. In one, 12 percent of the 2,001 adults polled said they did not feel safe in a house of worship, and their top concern was an armed intruder. In the other, which surveyed an undisclosed number of evangelical Christian leaders, 71 percent said they increased security at worship services in recent years due to mass shootings.

These events, combined with these sentiments, undoubtedly prompted this provocative headline in the October 2019 issue of Christianity Today magazine: “Armed Security at Churches Is Becoming a New Normal.” (Christianity Today is a sister publication of Church Law & Tax.)

Sorting through the statistics

Statistically speaking, though, the likelihood of an active shooter—or any violent activity—on church property is unquestionably the exception, not the rule.

There are an estimated 350,000 houses of worship in the United States. Based on Robertson’s detailed tracking, only 121 church shootings have occurred nationwide since 1999, 80 of which took place during a church service or event.

Carl Chinn, who helped develop New Life’s security program and was at the church the day it was attacked, has tracked violent incidents since 1999 as well. Chinn casts his net wider, both incorporating the properties of parachurch ministries and religiously affiliated schools and including all types of violent incidents, not just ones involving guns. While the numbers in his report continue to grow each year, the annual total typically remains fewer than 250.

Some of those situations occur during church functions, but many happen on church properties when the church is closed. Domestic violence has been the leading cause of an incident, Chinn has previously noted.

Churches still should be aware of the threat of an active shooter, said Chinn, who leads the Faith Based Security Network and consults with churches across the country. “Just because those life-taking events are low probability, we also have to keep in mind they are still high impact,” he said. “But we should keep it in check. We should focus on the things most likely to happen.”

Basic safety as a ministry

Troubling to both Robertson and Chinn are the number of churches that inquire about shooting prevention and armed security training, only to reveal they have no basic safety or risk management efforts underway at all. Robertson, who fields half-a-dozen inquiries a week from church leaders nationwide, estimates about three-fourths “don’t have anything in place.”

That’s problematic because church safety basics are foundational to solving more complex and challenging situations like a violent threat. Chinn said New Life’s efforts to develop a comprehensive safety ministry likely saved lives, even though a handful of deaths still occurred. “Because we were good at the smaller things, we were better at responding to true evil,” he said.

Robertson, whose security books follow a “crawl-walk-run” model, puts it this way:

I encourage [churches] not to micro-focus on the active shooter, but to micro-focus on what’s more likely. What are you going to do if you have a medical issue? What are you going to do if you have a verbal disruption? What are you going to do if you have a noncustodial parent show up? Those are the ones that are more likely to happen. Those are the ones to micro-focus on.

Robertson sees safety as a ministry. The starting point is to build a team of people primarily committed to helping others, and avoid using the terms “security” or “security guards.” This posture often helps draw support from the senior pastor and church board, Robertson added, and creates long-term buy-in. When Robertson personally interviewed volunteers and staff members for Saddleback’s team, he said his first question was whether the person was comfortable praying with an attender. “It’s a ministry. It’s no different than ushers or greeters,” Robertson added.

Chinn agreed, describing the initial process as a “start-with-what-you-have” philosophy. New Life intentionally called its program the “Life Safety Ministry,” and sought “people serving on that team because of a compassion for their fellow man, not because of the sensationalism associated with the word ‘security,’” he said.

But also note: 41 states regulate the security operations of private parties—and that’s true whether or not the team members of those operations will be armed, Chinn said. Many local jurisdictions, like the city of Denver, do the same. Churches must be aware of these local and state laws and the requirements they must keep to maintain compliance for any team they assemble, he said.

“Keep it simple”

Once a team is established, Chinn said churches should avoid the temptation to rapidly expand policies and procedures. “So many of those inclined to start or head up a security program for their church make it too complicated at first,” Chinn said. Among his 10 standards for starting or improving security (see “10 Standards for Starting a Program”), he emphasizes No. 4 in particular: “Keep it simple.”

As far as first priorities, Robertson said child safety ranks first (if a church has only one volunteer interested to help with safety, he said he advises that church to place the person in the children’s ministry). Second is medical emergencies, followed by responding to verbal disruptions. (Added Chinn: “Our lips are what keeps much of the evil at bay. Whether it’s a violent act about to occur or an obnoxious one, we’ve got to get better at de-escalation training.”)

Leaders also should consult with their insurance agents for resources and to ensure those agents know the steps and measures the church plans to take, Robertson said.

Additional simple steps include securing building doors (the YWAM attack was likely minimized because doors properly latched and locked) and posting at least one person to watch the church parking lot and lobby during services (most attacks start outside the building), Chinn said.

In time, the conversation about active-shooter situations will emerge—as they should, Chinn and Robertson said. Leaders again should contact their insurance agents for possible resources and guidance. Local law enforcement agencies often want to connect with churches about prevention and response plans, and frequently provide low- or no-cost training workshops. Additionally, attorney Richard Hammar recommends hiring off-duty law enforcement if a church decides to implement armed security.

If a church decides to use outside help beyond law enforcement, and considers using security consultants (which have proliferated in number over the past decade), it should look for options that “truly understand the environment of faith-based places,” Chinn said. “Look for someone who has served in churches for years, understands the culture, and has the heart and experience of a protector.”

Require referrals from other churches they have served. Research their standing in the business community, too, he added.

Above all, remember that active-shooter prevention and response is a “run” step on the crawl-walk-run spectrum, Robertson said. Get started with crawl steps that simply focus on physically protecting the church and minimizing legal liability.

“Churches need to build up a foundation first,” he said.

Related resources

Kevin Robertson provides local churches nationwide with about a dozen types of documents, including sample policies and procedures, a sample safety team member application, and a manual covering how to use force when necessary during an escalated situation. Church Law & Tax Advantage Members are encouraged to contact Robertson about these documents, available for free, at kevinr@saddleback.com.

Advantage Members have access to the following on ChurchLawAndTax.com:

“5 Steps for Building a Volunteer Safety and Security Team”
“Responding to Gun Violence Concerns at Church”
“Stopping a Shooter” and “Developing an Emergency Operations Plan”
“Drawing the Line on Danger” (including tips for de-escalating disruptive individuals)
“Minimizing the Risks of Child Molestation in Churches”
“The Legal and Moral Case for a Defibrillator”

Advantage Members also receive a 20-percent discount on these resources when they log into ChurchLawAndTaxStore.com using their email address:

New Email Scam Targets Payroll

Churches should verify that requests for bank account changes are legitimate.

The Editors

A new email scam poses a significant threat to employers including churches, says Batts Morrison Wales & Lee (BMWL). The accounting firm issued this warning on September 13:

BMWL has learned from multiple sources about a new attempted scam related to employee payroll direct deposit accounts. In yet another version of “spear phishing,” fraudsters send a genuine-looking email to the payroll department in an organization purporting to be from an employee, requesting a change in the bank account to which the employee’s payroll direct deposit is sent.

BMWL stressed that payroll departments should verify email requests for any changes “with employees independently of email,” which could include a phone call or an office visit.

For more articles on best practices for payroll, see the following articles:

Image: Getty

The Changing Dynamics of the Church Treasurer Role

Five key developments that have reshaped the position during the past 25 years.

Bob Smietana

Last Reviewed: January 12, 2024

During a normal Sunday morning service at a local church, while the congregation read the overhead screens during the sermon, someone in the congregation decided to check email. That church member’s smartphone synced with the church’s projectors and took them over. All of a sudden, the whole congregation was reading that person’s email.

“It was a glitch in the system,” said CPA Stan Reiff, a partner with the accounting firm CapinCrouse. The church shut down the screens and fixed a backdoor in the software. But the incident was a reminder, he said, of the blessings and challenges of modern technology.

The past 25 years have brought significant changes to how churches do business. Many have made life easier for church treasurers and other church leaders. But the changes have also brought new complications and challenges—here are five of the most significant.

Rapid changes in technology

Twenty-five years ago, churches had limited options on how to take in money and how to keep track of it, said CPA Vonna Laue, a senior editorial advisor for Church Law & Tax. Most of the tithes, offerings, and other donations came in by cash or check. Some churches had begun using spreadsheets or software like Quicken or QuickBooks to keep track of those funds.

Today, churches have a wealth of options, including fully integrated software packages that track giving, expenses, and other financial records—along with membership details and room scheduling. That’s made life easier, Laue said, because church leaders at even small congregations can readily access the data they need and create sophisticated reports.

And churches can easily accept electronic giving. “Twenty-five years ago, churches weren’t accepting credit card donations,” Laue explained. She said that a growing number of churchgoers are using ACH payments, texting, and other electronic forms of giving.

“Technology has significantly impacted how donations, tithes, and offerings are handled,” Laue said.

Tip. Churches should be cautious when it comes to choosing new technology, Laue said. Some staff or church leaders may have their favorite software, but that software may not be a good long-term choice for the church. Laue’s advice: Do your research ahead of time. Don’t rush out to buy the latest version of a program. And don’t think that new software will solve all your problems. “When you do that, you can trade one set of problems for another,” she stressed. (For additional guidance for software purchases, see chapter 6 in Church IT: Using Information Technology for the Mission of the Church by Nick Nicholaou.)

The rise of the Cloud

Closely tied to developments in technology, online options have radically affected the way finances and other business is conducted by churches.

Round the clock access to the internet has been a boon to churches, Reiff said. Pastors, church treasurers, and lay leaders can have access to financial information whenever they need it. And it’s easy to disseminate that information at the click of a button.

Using smartphone apps also makes it easy for churches to keep track of expenses. Rather than turning in paper copies of receipts, church staff and volunteers can take a photo of a receipt and file an expense report on their phone. Often those apps can be linked to the church’s general ledger, Reiff explained.

“No more worrying about lost receipts,” he said.

The rise of cloud-based applications, where the software and data are kept off-site, makes it easier for churches of all sizes to keep their financial records in an orderly fashion. Those cloud-based services often offer better cybersecurity than most churches could afford in the past. That’s important, Reiff said, because hackers target churches large and small for fraud—stressing the downside of an unprotected church computer network.

On a number of occasions, Reiff has worked with churches where a hacker has broken into a church’s email when their pastor is traveling—especially on mission trips. In one situation involving a traveling pastor, the hacker sent a fake email from the pastor, asking the treasurer to wire $10,000 for a mission project.

The treasurer was fairly new and was not inclined to question any of the pastor’s decisions.

“Fortunately this treasurer made a mistake when entering the routing number, so the transaction failed,” Reiff said.

After the pastor returned, the treasurer apologized for the delay in sending the funds. When the pastor looked confused, they both realized the request had been a fraud. This kind of situation is more common than you’d think, he stressed.

It also underscores an important point: Churches must be diligent about creating and enforcing policies regarding computer and internet use. Key decision-makers need to develop accounting and financial policies that deal with cybersecurity issues, said CPA Rob Faulk, a partner with CapinCrouse who spent about 15 years in church ministry.

“If hackers get into the network, they can get into your database,” Faulk said. He suggests that churches delete identifying information, like account numbers for donors, as soon as possible. And even the smallest churches should talk with a cybersecurity expert. “You may think, ‘We’re a small church and no one will bother us,'” he explained. “But hackers don’t care how small a church is.”

For help keeping your church and its finances safe, take a look at our recent work on the topic:

“Church Cybersecurity Starts with The Human Firewall” – (Sept., 2023)

“Hacking a Church is About Exploiting its Weakest Link” – (Sept. 2023)

“Navigating Cyberliability Insurance” – Sept. 2023

On the positive side, the internet has made it easier for churches to keep in touch with and raise support for missionaries who are located around the world, Faulk said.

Tip. Rather than visiting a church while on furlough every few years, a missionary can visit with a church via live video conferencing during a service, said Faulk. It can be a major savings for any church budget. And in general, a church can also have direct contact on a regular basis with missions via video or email. When a mission trip team from the church goes out, church members can often get daily updates instead of waiting for the team to return.

People are working longer and seeking second careers

Churches have benefited from two major staffing trends in recent decades, said Laue. The first is that Americans are retiring later. In fact, the fastest growing portion of the American workforce is made up of workers 65 and older, according to the Bureau of Labor Statistics. And second, many older Christians who started out in the for-profit world have begun working for churches.

“We’ve seen a lot more of second career people come into the church—looking for work or volunteer opportunities that have more meaning,” Laue said. “And they’re bringing their business skills with them.”

Those changes have helped raise the competency of church administrators, Laue said. And despite the advances in technology, people remain a church’s most important assets, she added.

Tip. While often skilled in numerous business and financial areas, people coming out of the for-profit sector need training and tools that help them adjust and understand the unique aspects of a church and nonprofit organization. Take advantage of all the training that’s available for church treasurers and other administrative staff, said Laue. Groups like the ECFA and CapinCrouse offer training for church staff, often for free or at very little cost. Those can include webinars, podcasts, and local workshops. Also, find various resources for training staff at CLTStore.com.

The growing use and value of outsourcing

Twenty-five years ago, outsourcing was mostly for corporations and other for-profit companies, said Bryan Miles, cofounder of Belay Solutions—a company that provides virtual/outsourced services to churches, nonprofit organizations, and for-profit companies.

In recent years, outsourcing has found its way into churches. Along with often being less expensive than hiring full- or part-time on-site staff, many churches are discovering that outsourcing can fill specific employment needs—and do so with people who share a church’s values.

“We’ve worked with hundreds of churches and they are facing the same struggles that businesses face—finding the right people to help them fulfill their mission,” Miles said.

Steve Dawson, the president emeritus of Chicago-based National Covenant Properties, agreed. That’s why the Evangelical Covenant Church—the denomination National Covenant Properties serves—decided to outsource all the bookkeeping for its church plants.

“We’ve got a couple people scattered around the country who understand churches—and they handle 20 or 25 church plants at a time,” he said..

Those outsourced bookkeepers can help churches get their finances in order from the start. As a result, pastors can focus on building the congregation and not on making sure all the bills get paid and all the accounting is done. It’s one less thing for a church planter to worry about.

Like businesses, Miles added, churches are looking for skilled workers—and they have the same needs as businesses do. They’ve got to pay their bills, produce financial reports, schedule events, and communicate with church members and the public. But they are also looking for people who share the church’s beliefs. An outsourcing company like Belay can help a church solve that problem—by matching them with someone who has the right skills and shares their faith.

Miles stresses that outsourcing can be a huge help for small churches or churches in rural areas, where there’s a limited pool of candidates.

That’s especially true when it comes to payroll and bookkeeping, said both Dawson and Miles. Churches have some unique needs when it comes to their finances and not every community has people who understand how churches work. Using an outsourcing firm allows them to draw from a larger pool of potential experts.

Dawson stressed that churches consider using a payroll service whenever possible. Those services can file all the paperwork that churches need to file for tax purposes—and do so on time, he said. That’s one less headache for a church to worry about.

Outsourcing can offer pastors and other staff at small churches a sense of relief, stressed both Dawson and Miles. Rather than worrying about financial reports and procedures on their own, they can partner with an outside firm.

Tip. Make a list of the most essential tasks the church has to accomplish and prioritize them, Miles advised. Then think about which tasks would be easiest to outsource. And then do your research, he said, to make sure the company you’re thinking of working with has a good reputation and has experience with churches.

Updated accounting practices

For most of the last two decades, accounting practices for churches have remained fairly unchanged. However, the Financial Accounting Standards Board (FASB) released a new standard in 2016 that that could impact churches, said Laue.

This standard is required for churches that release external financial reports like audited statements, said Laue, and not for internal reports. But, she says, following the standard can be helpful for all churches.

One change has to do with designated funds. In the past, nonprofits like churches separated those funds into three categories in their external financial reports: unrestricted, temporarily restricted, and permanently restricted.

Under the new standard, those funds will be separated on external financial reports into two categories: without donor restrictions and with donor restrictions.

Again, “this is only applicable if you issue external financial statements,” said Laue. “It will not impact how accounting is done but the reporting will look different, especially if you have both temporarily and permanently restricted amounts because they will now be grouped together,” she explained.

Another key change: External financial statements need to include a liquidity disclosure, Laue explained. That disclosure, she said, could give church members a better sense of the church’s financial health.

“Even if a church isn’t required to make those disclosures, they’re helpful—especially so that the less financially savvy church members will know how well the church is doing,” Laue said.

Tip. Add a liquidity statement to financial reports, even if it is just for internal use. That statement would show the liquid assets the church has available to pay expenses. “It may be a very positive experience for church leaders to truly think about the financial position their church is in,” said Laue. (For more information on the FASB standards, go to capincrouse.com/preparing-fasb-financial-reporting-standards-changes.)

The Masterpiece Cakeshop Ruling and Religious Freedom

This case and two others reflect the complexities of issues related to public accommodation.

Richard R. Hammar

Background

Masterpiece Cakeshop is a bakery in Lakewood, Colorado, a suburb of Denver.

The shop offers a variety of baked goods, ranging from cookies and brownies to elaborate custom-designed cakes for birthday parties, weddings, and other events.

Jack Phillips is an expert baker who has owned and operated the shop for 24 years. Phillips is a devout Christian.

He has explained that his “main goal in life is to be obedient to” Jesus Christ and Christ’s “teachings in all aspects of his life.” And he seeks to “honor God through his work at Masterpiece Cakeshop.”

One of Phillips’ religious beliefs is that “God’s intention for marriage from the beginning of history is that it is and should be the union of one man and one woman.”

To Phillips, creating a wedding cake for a same-sex wedding would be equivalent to participating in a celebration that is contrary to his own most deeply held beliefs.

Phillips met Charlie Craig and Dave Mullins when they entered his shop in the summer of 2012. Craig and Mullins were planning to marry. At that time, Colorado did not recognize same-sex marriages, so the couple planned to wed legally in Massachusetts and afterward to host a reception for their family and friends in Denver.

To prepare for their celebration, Craig and Mullins visited the shop and told Phillips that they were interested in ordering a cake for “our wedding.”

Phillips informed the couple that he does not bake wedding cakes for same-sex weddings. He explained, “I’ll make your birthday cakes, shower cakes, sell you cookies and brownies, I just don’t make cakes for same-sex weddings.”

The following day, Craig’s mother, who had accompanied the couple to the cake shop and had been present for their interaction with Phillips, phoned to ask Phillips why he had declined to serve her son.

Phillips explained that he does not create wedding cakes for same-sex weddings because of his religious opposition to same-sex marriage, and also because Colorado (at that time) did not recognize same-sex marriages.

He later explained his belief that “to create a wedding cake for an event that celebrates something that directly goes against the teachings of the Bible, would have been a personal endorsement and participation in the ceremony and relationship that they were entering into.”

Discrimination by places of public accommodation

The Colorado Anti-Discrimination Act (CADA) prohibits several forms of discrimination by places of “public accommodation.” These include discrimination on the basis of sexual orientation as well as other protected characteristics. CADA in relevant part provides as follows:

It is a discriminatory practice and unlawful for a person, directly or indirectly, to refuse, withhold from, or deny to an individual or a group, because of disability, race, creed, color, sex, sexual orientation, marital status, national origin, or ancestry, the full and equal enjoyment of the goods, services, facilities, privileges, advantages, or accommodations of a place of public accommodation.

The Act defines “public accommodation” broadly to include any “place of business engaged in any sales to the public and any place offering services … to the public,” but excludes “a church, synagogue, mosque, or other place that is principally used for religious purposes.”

CADA establishes an administrative system for the resolution of discrimination claims.

Complaints of discrimination in violation of CADA are addressed in the first instance by the Colorado Civil Rights Division.

The Division investigates each claim, and if it finds probable cause that CADA has been violated, it will refer the matter to the Colorado Civil Rights Commission.

The Commission, in turn, decides whether to initiate a formal hearing before a state Administrative Law Judge (ALJ), who will hear evidence and argument before issuing a written decision.

The decision of the ALJ may be appealed to the full Commission, a seven-member appointed body.

The Commission holds a public hearing and deliberative session before voting on the case.

If the Commission determines that the evidence proves a CADA violation, it may impose remedial measures as provided by statute.

Available remedies include, among other things, orders to cease-and-desist a discriminatory policy, to file regular compliance reports with the Commission, and “to take affirmative action, including the posting of notices setting forth the substantive rights of the public.”

Shortly after the couple’s visit to the shop, Craig and Mullins filed a discrimination complaint against Masterpiece Cakeshop and Phillips in September 2012.

The complaint alleged that Craig and Mullins had been denied “full and equal service” at the bakery because of their sexual orientation, and that it was Phillips’ “standard business practice” not to provide cakes for same-sex weddings.

The Civil Rights Division opened an investigation.

The investigator found that “on multiple occasions,” Phillips “turned away potential customers on the basis of their sexual orientation, stating that he could not create a cake for a same-sex wedding ceremony or reception” because his religious beliefs prohibited it and because the potential customers “were doing something illegal” at that time.

The investigation found that Phillips had declined to sell custom wedding cakes to about six other same-sex couples on this basis.

The investigator also recounted that, according to affidavits submitted by Craig and Mullins, Phillips’ shop had refused to sell cupcakes to a lesbian couple for their commitment celebration because the shop “had a policy of not selling baked goods to same-sex couples for this type of event.”

Based on these findings, the Division found probable cause that Phillips violated CADA and referred the case to the Civil Rights Commission.

The Commission found it proper to conduct a formal hearing, and it sent the case to a State ALJ.

The ALJ ruled that it was undisputed that the shop was subject to state public accommodations laws, and that Phillips’ actions constituted prohibited discrimination on the basis of sexual orientation, not simply opposition to same-sex marriage as Phillips contended.

Phillips contended that requiring him to create cakes for same-sex weddings would violate his right to the free exercise of religion.

The ALJ disagreed, relying on a 1990 case in which the United States Supreme Court ruled that “neutral laws of general applicability” do not violate the First Amendment’s protection of religious freedom despite any burden they impose on religion. Employment Division v. Smith, 494 U.S. 872 (1990).

The ALJ determined that CADA is a neutral law of general applicability and therefore that applying it to Phillips in this case did not violate the First Amendment’s guaranty of religious freedom.

The Commission affirmed the ALJ’s decision in full. The Commission ordered Phillips to “cease and desist from discriminating against … same-sex couples by refusing to sell them wedding cakes or any product they would sell to heterosexual couples.”

It also ordered additional remedial measures, including “comprehensive staff training on the public accommodations section” of CADA “and changes to any and all company policies to comply with … this Order.” The Commission additionally required Phillips to prepare “quarterly compliance reports” for a period of two years documenting “the number of patrons denied service” and why, along with “a statement describing the remedial actions taken.”

Phillips appealed to the Colorado Court of Appeals, which affirmed the Commission’s legal conclusions and remedial order.

Phillips sought review by the United States Supreme Court.

The Supreme Court’s ruling

In Masterpiece Cakeshop, LTD v. Colorado Civil Rights Commission, 2018 WL 2465172 (2018), the Supreme Court began its ruling by noting that “our society has come to the recognition that gay persons and gay couples cannot be treated as social outcasts or as inferior in dignity and worth,” and that “the exercise of their freedom on terms equal to others must be given great weight and respect by the courts.” At the same time, however, “the religious and philosophical objections to gay marriage are protected views and in some instances protected forms of expression.”

Nevertheless, while those religious and philosophical objections are protected, “it is a general rule that such objections do not allow business owners and other actors in the economy and in society to deny protected persons equal access to goods and services under a neutral and generally applicable public accommodations law.”

The Court stressed that Phillips “was entitled to the neutral and respectful consideration of his claims in all the circumstances of the case,” but that “the neutral and respectful consideration to which he was entitled was compromised here by the Civil Rights Commission’s treatment of his case which had some elements of a clear and impermissible hostility toward the sincere religious beliefs that motivated his objection.” That hostility

surfaced at the Commission’s formal, public hearings, as shown by the record… . On July 25, 2014, the Commission met again… . [During this meeting] the commissioner stated: “I would also like to reiterate what we said in the hearing or the last meeting. Freedom of religion and religion has been used to justify all kinds of discrimination throughout history, whether it be slavery, whether it be the holocaust, whether it be—I mean, we—we can list hundreds of situations where freedom of religion has been used to justify discrimination. And to me it is one of the most despicable pieces of rhetoric that people can use to—to use their religion to hurt others… .”

To describe a man’s faith as “one of the most despicable pieces of rhetoric that people can use” is to disparage his religion in at least two distinct ways: by describing it as despicable, and also by characterizing it as merely rhetorical—something insubstantial and even insincere. The commissioner even went so far as to compare Phillips’ invocation of his sincerely held religious beliefs to defenses of slavery and the Holocaust. This sentiment is inappropriate for a Commission charged with the solemn responsibility of fair and neutral enforcement of Colorado’s antidiscrimination law—a law that protects against discrimination on the basis of religion as well as sexual orientation. The record shows no objection to these comments from other commissioners. And the later state-court ruling reviewing the Commission’s decision did not mention those comments, much less express concern with their content. Nor were the comments by the commissioners disavowed in the briefs filed in this Court. For these reasons, the Court cannot avoid the conclusion that these statements cast doubt on the fairness and impartiality of the Commission’s adjudication of Phillips’ case.

The court noted that another indication of hostility “is the difference in treatment between Phillips’ case and the cases of other bakers who objected to a requested cake on the basis of conscience and prevailed before the Commission.” In fact, on at least three other occasions

the Civil Rights Division considered the refusal of bakers to create cakes with images that conveyed disapproval of same-sex marriage, along with religious text. Each time, the Division found that the baker acted lawfully in refusing service… . The treatment of the conscience-based objections at issue in these three cases contrasts with the Commission’s treatment of Phillips’ objection. The Commission ruled against Phillips in part on the theory that any message the requested wedding cake would carry would be attributed to the customer, not to the baker. Yet the Division did not address this point in any of the other cases with respect to the cakes depicting anti-gay marriage symbolism… . In short, the Commission’s consideration of Phillips’ religious objection did not accord with its treatment of these other objections.

Before the Colorado Court of Appeals, Phillips protested that this disparity in treatment reflected hostility on the part of the Commission toward his beliefs. He argued that the Commission had treated the other bakers’ conscience-based objections as legitimate, but treated his as illegitimate—thus sitting in judgment of his religious beliefs themselves.

The Supreme Court observed: “The Colorado court’s attempt to account for the difference in treatment elevates one view of what is offensive over another and itself sends a signal of official disapproval of Phillips’ religious beliefs.”

The Court concluded that “the Commission’s treatment of Phillips’ case violated the state’s duty under the First Amendment not to base laws or regulations on hostility to a religion or religious viewpoint.” It added:

The government, if it is to respect the Constitution’s guarantee of free exercise [of religion] cannot impose regulations that are hostile to the religious beliefs of affected citizens and cannot act in a manner that passes judgment upon or presupposes the illegitimacy of religious beliefs and practices. The Free Exercise Clause bars even “subtle departures from neutrality” on matters of religion. Here, that means the Commission was obliged under the Free Exercise Clause to proceed in a manner neutral toward and tolerant of Phillips’ religious beliefs. The Constitution “commits government itself to religious tolerance, and upon even slight suspicion that proposals for state intervention stem from animosity to religion or distrust of its practices, all officials must pause to remember their own high duty to the Constitution and to the rights it secures.”

Factors relevant to the assessment of governmental neutrality include

The historical background of the decision under challenge, the specific series of events leading to the enactment or official policy in question, and the legislative or administrative history, including contemporaneous statements made by members of the decision-making body. In view of these factors the record here demonstrates that the Commission’s consideration of Phillips’ case was neither tolerant nor respectful of Phillips’ religious beliefs. The Commission gave “every appearance” of adjudicating Phillips’ religious objection based on a negative normative “evaluation of the particular justification” for his objection and the religious grounds for it. It hardly requires restating that government has no role in deciding or even suggesting whether the religious ground for Phillips’ conscience-based objection is legitimate or illegitimate. On these facts, the Court must draw the inference that Phillips’ religious objection was not considered with the neutrality that the Free Exercise Clause requires… . The official expressions of hostility to religion in some of the Commissioners’ comments—comments that were not disavowed at the Commission or by the State at any point in the proceedings that led to affirmance of the order—were inconsistent with what the Free Exercise Clause requires. The Commission’s disparate consideration of Phillips’ case compared to the cases of the other bakers suggests the same. For these reasons, the order must be set aside.

Application of the Supreme Court’s ruling

The Supreme Court’s ruling is relevant to clergy, churches, and business owners with sincere religious beliefs for these reasons:

1. Relevance to clergy. While not required by its ruling, the Court made the following gratuitous statement regarding the ability of clergy to perform, or not perform, same-sex marriages based on their religious beliefs:

When it comes to weddings, it can be assumed that a member of the clergy who objects to gay marriage on moral and religious grounds could not be compelled to perform the ceremony without denial of his or her right to the free exercise of religion. This refusal would be well understood in our constitutional order as an exercise of religion, an exercise that gay persons could recognize and accept without serious diminishment to their own dignity and worth. Yet if that exception were not confined, then a long list of persons who provide goods and services for marriages and weddings might refuse to do so for gay persons, thus resulting in a community-wide stigma inconsistent with the history and dynamics of civil rights laws that ensure equal access to goods, services, and public accommodations.

2. Relevance to churches. The Court’s ruling did not address the application of the nondiscrimination provisions of public accommodations laws to churches. For example, many state and local public accommodations laws prohibit discrimination by places of public accommodation on the basis of sexual orientation and marital status. A question that many church leaders are asking is whether a church that rents its sanctuary to the general public for heterosexual weddings violates such a law by barring same-sex couples from using the church for a wedding ceremony. Does generating rental income from weddings performed for nonmembers make it a place of public accommodation subject to all the nondiscrimination provisions of a public accommodations law? This issue was not addressed by the Court’s decision, other than indirectly by the Court’s conclusion that the First Amendment guaranty of religious freedom requires government neutrality toward religion both in language and in the enforcement of public accommodation laws.

3. Relevance to business owners with sincere religious beliefs. The Court’s decision demonstrates that the civil courts cannot adjudicate the application of the nondiscrimination provisions in a public accommodations law to business owners in a way that violates their religious beliefs if there is evidence of hostility to religion by the courts or the civil rights agency tasked with enforcement of the law. Unacceptable hostility or bias may consist of:

Hostile, disparaging statements concerning religious belief (i.e., likening Christianity to slavery or the Holocaust).
More favorable treatment for atheistic or agnostic beliefs (i.e., failure to prosecute bakeshops that refuse to provide services to Christians).
The historical background of the decision under challenge.
The specific series of events leading to the enactment or official policy in question.
The legislative or administrative history, including contemporaneous statements made by members of the decision-making body.

As a result, the response of business owners with sincere religious beliefs in opposition to one or more of the prohibited forms of discrimination under a state or local public accommodations law will be to find any evidence of disparate or less favorable treatment of religious belief.

If the evidence demonstrates that the courts or civil rights agencies have treated religious belief with neutrality and respect, then the substantive issue of the protection, if any, provided by the First Amendment guaranty of religious freedom is raised. It is far from certain that such a defense will be successful. Consider the following two quotations from the Masterpiece Cakeshop ruling. The first is from the majority opinion by Justice Kennedy, and the second is from Justice Kagan’s concurring opinion:

“The religious and philosophical objections to gay marriage are protected views and in some instances protected forms of expression. Nevertheless … it is a general rule that such objections do not allow business owners and other actors in the economy and in society to deny protected persons equal access to goods and services under a neutral and generally applicable public accommodations law.”

“As this Court has long held, and reaffirms today, a vendor cannot escape a public accommodations law because his religion disapproves selling a product to a group of customers, whether defined by sexual orientation, race, sex, or other protected trait. A vendor can choose the product he sells, but not the customers he serves—no matter the reason.”

Two other cases to consider

A few days after the Supreme Court issued its ruling in the Masterpiece Cakeshop case, the Court addressed a similar case in Washington state involving a Christian florist shop owner (Barronelle Stutzman) who was prosecuted for violating the nondiscrimination provision in a state public accommodations law for refusing to prepare floral arrangements for a same-sex wedding.

The Washington Supreme Court ruled that the florist had violated the public accommodations law and rejected her religious liberty defense.

But the United States Supreme Court, in a two-sentence order, vacated the judgment of the state supreme court and remanded the case back to that court “for further consideration in light of Masterpiece Cakeshop.”

The owner of the floral shop has argued that the State of Washington did not treat her religious beliefs with sufficient respect and neutrality, pointing out that at least one other floral shop that refused to provide services to Christians was not prosecuted for violating the public accommodations law.

In another case, decided a few weeks before Masterpiece Cakeshop, an Arizona state appeals court ruled that a city ordinance barring discrimination based on sexual orientation or marital status by places of public accommodation did not violate the constitutional rights of a wedding design business that refused to provide services for a same-sex wedding.

Brush & Nib Studio v. City of Phoenix, 418 P.3d 426 (Ariz. App. 2018). The court sidestepped the question of nonreligious bias by the state courts or civil rights agency that was decisive in the Masterpiece Cakeshop case, and addressed directly the substantive question of a business owner’s right to refuse to provide services for a same-sex wedding on the basis of his religious beliefs.

It concluded that the First Amendment guaranty of religious freedom did not insulate the business owner from liability for refusing to provide services for a same-sex wedding. The court concluded that the city public accommodations ordinance did not violate the First Amendment guaranty of religious freedom because it did not “substantially burden” the exercise of religious beliefs:

A substantial burden on the free exercise of religion requires more than a government action which merely “decreases the spirituality, the fervor, or the satisfaction with which a believer practices his religion,” and instead is akin to the government coercing an individual to act contrary to his religious beliefs or penalizing faith… . Here [the owner] has failed to prove that [the ordinance] substantially burdens his religious beliefs by requiring that he provide equal goods and services to same-sex couples. He is not penalized for expressing his belief that his religion only recognizes the marriage of opposite-sex couples. Nor is he penalized for refusing to create wedding-related merchandise as long as he equally refuses similar services to opposite-sex couples. [The ordinance] merely requires that, by operating a place of public accommodation, he provide equal goods and services to customers regardless of sexual orientation. He is free to discontinue selling custom wedding-related merchandise and maintain the operation of [the business] for its other business operations. What he cannot do is use his religion as a shield to discriminate against potential customers.

Even if [the owner] had met his burden of proof to demonstrate that [the ordinance] places a substantial burden on their religious exercise, it is still constitutional because the city has a compelling interest in preventing discrimination, and has done so here through the least restrictive means. When faced with similar contentions, other jurisdictions have overwhelmingly concluded that the government has a compelling interest in eradicating discrimination… .

It goes without saying that providing equal access to places of public accommodation does “not simply guarantee access to goods or services,” but “serves a broader societal purpose: eradicating barriers to the equal treatment of all citizens in the commercial marketplace.”

The court concluded that the city’s obligation “is to not enact, interpret or apply its laws or regulations based on hostility to a religion or religious viewpoint. There is no evidence in the record to support any suggestion that the city’s adoption of [its public accommodations law] or its interpretation as it relates to [the owner] has been anything other than neutral toward and respectful of their sincerely-expressed religious beliefs.” As a result, it is unlikely that the business owner will find relief under the Masterpiece Cakeshop case unless he can prove that the ordinance was applied in a way that was biased toward religion.

For more on issues related to public accommodation laws, see the downloadable resource Church Issues: Same-Sex Marriage and Gender Identity, available on CLTStore.com.

Image: getty/Yoshiyoshi Hirokawa

Taking the Right Steps to Establish a Retirement Plan

Early planning can avoid IRS trouble—and provide well when retirement comes.

Lisa A. Runquist, Attorney

Bio

As a lawyer who advises churches on a variety of issues, I’ve had many difficult conversations with church leaders. One of the most difficult discussions, however, involves telling a church and its pastor that it’s too late to fund the pastor’s retirement.

Far too many pastors reach retirement age and can’t consider retiring—even if they desire to—because they do not have enough in retirement savings. Alternatively, a church board may want a change in leadership, but faces resistance from a longtime pastor who is unwilling to step down because of the financial uncertainties he or she will face. Then there is the heartbreaking situation in which a pastor dies, leaving no viable means of financial support behind for the surviving spouse.

These problems unfortunately arise more often at churches across the nation than they should. Even more concerning: when a problem is discovered, the quick-fix solutions often proposed to resolve it are usually questionable, if not outright illegal.

Consider the complexity of the following six real-life examples, and the challenges posed to the church and the pastor by the attempt to make things right (resolutions to each are at the end of this article):

EXAMPLE 1 A pastor worked for 50 years for the church. The church paid him an annual salary of less than $30,000, but sometimes much less. He opted out of Social Security, stating he opposed receiving any public insurance, but he really opted out because he did not have the cash to pay into the system. He wasn’t able to save anything. The church membership dwindled over time, so much so that the church voted to dissolve, sell the property, and use the money to purchase an annuity for the pastor’s retirement. The state attorney general challenged the use of the funds for this purpose.

EXAMPLE 2 Over a period of about 15 years, a pastor and the church board talked about setting up a retirement plan, but they never finalized anything. He died, and the church began to pay his widow a small sum of money each month. When the church filed to reestablish its exempt status with the Internal Revenue Service, the IRS questioned the basis for these payments to the widow, as she did not provide services to the church, and never had been an employee of the church. The IRS considered these payments a possible form of private inurement.

EXAMPLE 3 Two churches voted to merge. Both churches had pastors; the pastor of one church said he was ready to retire. But then it turned out that he expected the second church to keep paying him a salary in his retirement years after the merger.

EXAMPLE 4 A church’s board of directors included its pastor, who was also the chief executive officer of the church. Because of the respect board members had for the pastor, decisions made by the pastor and presented to the board generally were rubber stamped. Board members didn’t ask hard questions to assure that each decision made was actually in the best interests of the church. When the pastor decided he wanted to retire in about five years, and he realized he did not have sufficient assets to do this, he asked the church to set up a separate fund with a significant amount of church assets. The pastor planned to handle the investments until such time as he retired, and at which time he would have the church transfer the account directly to him to fund his retirement.

EXAMPLE 5 A religious leader who lived most of his life as a monk had a wife he still supported. He wanted to make sure his wife would continue to receive support after his death, but he recognized this would have to come from church assets, since he personally owned nothing. Like Example 2, the wife never was an employee of the church and on her own would not have been entitled to receive retirement benefits from the church. And because the religious leader lived under a vow of poverty and didn’t receive a regular salary from the church, funding a retirement plan would be difficult. The religious leader understood that the church assets would legally have to remain in the control of the church, but he asked that a method be set up to allow some of the assets to be used for the wife’s support after his death.

EXAMPLE 6 A church pastor served a church for over 25 years. Church elders wanted to figure out how to care for him upon retirement. They decided to create a “Pastor Emeritus” role, and to pay him for the next five years. In return, he would focus on relationships with congregants that he developed over the years, as well as the expansion of an overseas ministry. This raised numerous questions, including whether such an arrangement was legal, how long it could continue, and what amounts could be paid.

Do any of these examples sound familiar? How can they be resolved in a way that protects the church, while providing at least some assistance to the pastor or a surviving family member? Ideally, church leaders and pastors will plan ahead so that these types of problems never arise.

Four key questions

As a first step, let’s examine four questions that should guide decisions all churches make with respect to the retirements of their pastors. Then we’ll come back to these examples and offer some answers to the questions they pose.

1. Are you paying your pastor enough?

Being called to ministry shouldn’t mean unfair or unreasonable compensation. Sometimes the pastor, having felt called by God to the ministry, may be willing to live very modestly. Even so, pastors who feel called should not be required to live with barely enough to cover basic expenses—and this should certainly include setting something aside for retirement. By setting up a compensation budget, and sometimes by asking the congregation for contributions to help fund it, some churches have discovered that they can actually pay their pastors more.

For churches with sufficient budgets to pay reasonable salaries, the board must make sure that the pastor’s salary (including housing allowance) is sufficient for current living expenses, and it also must make certain that the church has implemented an appropriate retirement package.

Although the board should look at salaries that are paid for comparable positions to ensure the compensation isn’t too high (and thus trigger penalties discussed later in this article), even apart from this, a good rule of thumb is that the amount paid to the pastor should be in the median range of the income of the congregants—not at the top of the income range, nor at the bottom.

For some churches, financial realities still make it difficult to pay their pastors the amounts they would like. For instance, a very small church may not be able to pay the pastor what would normally be considered a reasonable salary. Or sometimes the growing pains at mid- or large-sized churches can make reasonable salaries challenging, and may require time for those churches to address. In these situations, the board must have a conversation with the pastor about whether it is appropriate to have the pastor in a full-time position, or whether the pastor should be employed, at least part-time on a bivocational basis, outside of the church until the church can afford to pay more. But even in these situations, church boards still must consider ways to help their pastors set aside funds for retirement, as small or seemingly insignificant as those amounts might seem at that moment.

One caution for all churches regarding compensation packages: the pastor should never set his or her salary. This is the responsibility of the church’s governing or financial board. More explanation about this appears later in this article.

2. Has your pastor opted out of Social Security?

The Social Security program was developed by the government to provide a safety net. It was not intended to replace retirement plans, although many people today retire without any significant savings, instead relying upon Social Security programs to completely cover them during their retirement years. Social Security includes medical care and disability coverage as well as retirement benefits, and when a recipient dies, Social Security will provide assistance to the recipient’s survivors.

During the first two years of receiving compensation for ministerial services, a pastor has an option to elect out of Social Security by filing Form 4361. To make such an election, the pastor must certify his or her opposition to the acceptance of such public insurance based on his or her religious beliefs, and must certify that he or she has informed his or her ordaining body of such opposition. Once the election is made, it is irrevocable.

A significant percentage of pastors have made this election, but not always because of religious-based objections. Many new pastors believe (or are told) that opting out represents a chance to accumulate more money through investments made on their own. This is not a legal reason to opt out. It also isn’t wise: even if a pastor could do a better job of investing the funds than the federal government, such a plan only works if the pastor takes the same funds that would have been paid into Social Security and makes investments every year. Not everyone is financially disciplined enough to do so. And for those who do not have a trusted financial advisor to help them, they may not be savvy enough to make the right investment picks.

The amount paid by a church to a pastor must be reasonable. This includes not just salary, but the contributions made by the church to a pastor’s retirement account.

By opting out, the Social Security safety net disappears. When it does, the pastor must make certain the money he or she saves ultimately replicates that safety net for their medical, disability, and retirement needs, as well as for their beneficiaries when they die. Example 1 above demonstrates the problems faced by a retiring pastor who opted out, but didn’t possess the means to replicate that individual safety net.

So what can a pastor who previously opted out of Social Security do about future retirement plans?

First, it isn’t likely a pastor in such a situation will have an opportunity to reenroll into Social Security. Only twice in the past 30 years has Congress temporarily allowed pastors to opt back in, and there are no indications that Congress intends to offer another chance anytime soon.

Second, any pastor who opted out must consider setting aside funds for a safety net right away if he or she hasn’t done so already.

And third, a pastor should evaluate what role Social Security still might play in their future financial outlook, based on previous, current, or future nonministerial employment. For instance, any pastor who opted out for their ministerial role, but previously or currently held some other line of work, and pays into the Social Security program from the earnings of their nonreligious employment for at least 40 quarters (i.e., 10 years), will be eligible to participate in Social Security when they reach retirement age. Since retirement benefits will be based, in part, on the actual amounts paid in, the Social Security retirement benefits generally will be less than if the pastor never opted out. But it still provides some financial support in the retirement years.

For a pastor who opted out, never worked a nonministerial job, and now hopes to retire, the prospect of working in another job for 10 years is likely unattractive. Of course, if the pastor worked another nonministerial job earlier in his or her career, and only needs a few additional quarters to qualify, it may well be worth considering some additional nonministerial work. Sometimes a member of the church who is a business owner might be willing to hire the pastor for the period of time needed. I have worked with pastors who successfully did this. The business gets assistance, often in the form of strategic planning and direction, and the overseeing pastor obtains the additional quarters of nonministerial work that he or she needs.

It should also be noted that if the minister’s spouse has worked the necessary quarters and qualified for Social Security, the spouse may file to receive Social Security benefits and the minister might also be entitled to receive them as a spouse (of course, there is a moral question of whether this is something that the pastor wants to do if the pastor really held religious objections to receiving public insurance benefits).

Even if the minister has paid partially or fully into the Social Security program, there is a clear question of whether it is—or will be—sufficient to cover the minister’s full retirement needs. Social Security’s original purpose was to supplement other retirement savings plans. And because of the financial difficulties the Social Security system faces, it is recommended that all churches and pastors make sure they have a retirement plan that does not require the pastor to rely solely on Social Security to fully fund his or her retirement.

3. How does your pastor’s current housing situation affect the future?

For most Americans approaching retirement age, a large portion of their assets consists of the equity built through a home they own. This is not always true for pastors, though. If the church provides a parsonage, the pastor can live there without paying taxes on the value of the housing furnished. This seems like a great deal. But this also raises questions, such as:

•Where will the pastor and spouse live upon retirement?

•Has the pastor built up a nest egg similar to the equity most others achieve through home ownership?

Some churches address this by providing an “equity allowance”: additional income paid now to the pastor that, although taxable, makes up for the lost opportunity to build equity through home ownership. Senior Editor Richard Hammar further explains in the 2018 Compensation Handbook for Church Staff: An equity allowance is an excellent idea that should be considered by any church having one or more ministers living in church-provided housing. The equity allowance should not be accessible by the minister until retirement, so it should be placed directly in a minister’s tax-sheltered retirement account. Equity allowances also should be considered by a church whose minister rents a home.

Alternatively, many churches provide pastors with housing allowances. This arrangement allows the pastor the ability to build up equity by purchasing a home. The housing allowance is also excludible from income tax (but not from Social Security tax) to the extent it is actually used to provide a home for the pastor, and so long as the total does not exceed the fair rental value of the house. (Editor’s Note: Pastors and church leaders should note the current litigation challenging the constitutionality of the clergy housing allowance. The outcome, which remains uncertain, could affect the availability of this benefit. Check ChurchLawAndTax.com regularly for updates.)

Whether through an equity allowance or a housing allowance, such an arrangement—though not an alternative to retirement planning—does help ensure a pastor is not left penniless. For more help regarding housing allowances, particularly for retired pastors, see chapters 6 and 10 of the Church & Clergy Tax Guide.

4. What types of retirement plans are available—and how should a pastor and board evaluate them?

What should the church and pastor do to figure out the best retirement plan(s) for their particular situation? The area of retirement law is very complex, and is beyond the scope of this article. However, for further guidance, refer to the first article in this issue and to the Church & Clergy Tax Guide. As for this article, here are some basic thoughts and concerns that churches and pastors should consider together:

Each church should consider the future of its pastor, preferably from the time of his or her hire, but in any event, well before the pastor wants to retire. Most denominational churches already have retirement plans in place, and this should be the starting point for the pastors serving these congregations. It is likely that a complete review of where the pastor wants to end up might require additional planning and contributions, and perhaps the use of additional retirement plans. The church should support the pastor in this process.

A new pastor has the benefit of time. If the pastor starts putting money into a retirement account at the beginning of his or her ministry, by the time retirement age arrives, the principal and interest that has accrued (tax-free in most cases) will allow for a comfortable retirement (the chart on page 3 further illustrates the power of saving for retirement early in one’s career).

A pastor with 10 to 20 years left of his or her ministry will have to plan more diligently, but should be able to reach retirement age with some assurance of funds.

No plan will solve the problem that results when a pastor has served a church for 30 or more years and does not think about retirement until retirement nears. The natural response is to ask the church for help, and to figure out how to save enough in the next several years to catch up to where the individual would have been, had retirement contributions been made regularly for the past 30 years of his ministry. Not only is this approach unrealistic, but it may raise other challenges related to annual compensation levels that exceed reasonable levels and trigger penalties discussed later in this article.

Funding the plan and reasonable compensation

How will the plan be funded? Clearly, it is appropriate for a church to assist its pastor in planning a retirement, and even setting up the retirement plan. However, contributions, when added to the compensation already being paid to the pastor, cannot be in excess of what is reasonable compensation for the position. Different providers and organizations recommend different amounts that a church contributes. For instance, GuideStone, a Christian-based financial services provider, recommends church contributions equal to 10 percent of the pastor’s salary. If a pastor has determined that 10 percent will not be sufficient, he or she may be able to set aside additional amounts, through elective contributions. But all amounts contributed by the church must be weighed along with the pastor’s total compensation to ensure penalties aren’t incurred. Let’s examine how those penalties are triggered.

Limits on compensation: private benefit, private inurement, and intermediate sanctions

We have already talked about the need to pay a minister a decent salary. However, there is a limit to what the church can pay. The most common reason for a church to lose its tax exemption is when the church is found to be operating principally to benefit an individual or individuals. This “private benefit” or “private inurement” occurs when the individual receives a benefit (compensation) greater than the value of what he or she provided (services) to the church.

The amount paid by a church to a pastor must be reasonable. This includes not just salary, but the contributions made by the church to a pastor’s retirement account. Unless there was a prior agreement between the church and the pastor to defer income to a later year (for example, the church agreed to pay the pastor $50,000 per year; however, because of a cash shortage, the church and pastor agreed to $40,000 cash and $10,000 deferred income to be shown as a liability to the church and paid to the pastor in the future, as appropriate), all of the funds will be considered to be earned in the year in which they were paid.

Private benefit. All assets of the church must be used for church purposes—to benefit the purpose for which the church was formed. If the church cannot provide a religious justification for a particular expenditure, it should not be made. Clearly this does not prevent a church from having employees. In fact, the purposes of the church may require a minister and other employees in order to accomplish its purposes. However, the amount paid to each employee, including the minister, must be reasonable, and the primary purpose of any payment must be to advance the ministry of the church. If the primary purpose is to benefit an individual, this will endanger the tax status of the organization.

Private inurement. Private inurement is likely to arise when there is a transfer of church resources to an “insider” solely by virtue of the individual’s relationship with the organization, and without regard to accomplishing exempt purposes. An insider is one with a unique relationship to the church, by which the insider, by virtue of his or her control or influence over the church, can cause the organization’s funds or property to be applied to the insider’s benefit. There is no inurement when the benefit to the insider (or any other private party) is an unavoidable byproduct of actions taken for the church’s exempt purpose.

Intermediate sanctions. In the past, if an exempt organization was operated in a way that benefitted a private person, the only remedy the IRS had was to revoke the exempt status of the organization. This often did not penalize the wrongdoer, but hurt the beneficiaries who no longer received services from the organization whose tax-exempt status was now revoked. In 1996, Congress changed the law by adopting a new provision (IRC section 4958) that imposes penalties on the person(s) who actually benefit from an improper transaction, rather than just revoking the exempt status of the organization. The result of this change is that if a “disqualified person” (defined as someone who is, or within the past five years has been, in a position to substantially influence the organization—and this will normally include the pastor) receives an “excess benefit” (for instance, more than the person is entitled to, based on what he or she provided to the organization), that person must repay the excess benefit (plus interest) along with a penalty of 25 percent of the excess benefit. In addition, if the excess benefit (plus interest) is not repaid in a timely manner, the IRS may impose an additional 200 percent penalty. Further, anyone who approved the benefit, even if he or she did not receive a dime (for instance, the board of directors), is subject to a penalty of up to $20,000 per transaction.

As a result of this law, which is commonly referred to as “intermediate sanctions”—since it is less than total revocation of the organization’s exempt status—it is even more important that the church take steps to determine that the compensation paid to the minister does not exceed what is reasonable (the value of services being provided by the minister).

But why, in talking about retirement, do we care about reasonable compensation and intermediate sanctions?

What is reasonable compensation? Compensation is reasonable if the amount paid would ordinarily be paid for like services, by like enterprises, under like circumstances. In determining the value of compensation for purposes of intermediate sanctions, all items of compensation must be considered, including all forms of cash and noncash compensation (i.e., including salary, bonuses, severance payments, and deferred and noncash compensation at the time it vests or is not subject to substantial forfeiture).

Whether compensation received in a given year is treated as gross (taxable) income that year is a separate question from whether the compensation paid is reasonable for purposes of intermediate sanctions. In determining reasonable compensation, all the benefits provided by the disqualified person to the organization in exchange for that compensation also are taken into account. For example, when a pension plan benefit vests, the services performed for the years leading up to the year of vesting may be considered in determining reasonableness. Let’s say that the reasonable compensation for the pastor is determined to be $100,000 per year. The pastor has worked for 10 years for an annual salary of $90,000, with the church also making annual contributions of $10,000 to the pension plan. At the end of 10 years, the pension plan shows $100,000 as now being the property of the pastor. When the $100,000 vests, the pastor would receive, in that year, his $90,000 salary, plus $100,000 pension plan assets, for a total of $190,000—clearly more than what was considered reasonable for annual compensation. However, by looking back over the 10 years, the reasonable compensation would have been a total of $1 million, of which the pastor has previously received $900,000. When one adds the additional $100,000 which has now vested, the compensation is still reasonable.

What must be treated as compensation? Any benefit received by a disqualified person must be in exchange for some type of service or other benefit provided to the church by the disqualified person, and the church must treat it as such. Otherwise, it is treated as an excess benefit, without further consideration, and without regard to any claim of reasonableness of the total compensation package.

An economic benefit will not be treated as payment for the performance of services rendered by the disqualified person unless the church providing the benefit clearly indicates its intent to treat it as such when the benefit is paid.

Except for nontaxable benefits, a church will be treated as clearly indicating its intent to provide an economic benefit as compensation for services only if the church provides written substantiation that is contemporaneous with the transfer of the economic benefit. There may be other written contemporaneous evidence used to demonstrate this intent, such as an executed and approved written employment contract, documentation showing that an authorized body, such as the board of directors, approved the compensation before paid, or written evidence that supports a reasonable belief that the benefit was nontaxable. If the failure to report was due to a reasonable cause (i.e., the church can establish that there were significant mitigating factors, or that the failure arose from events beyond its control) and the church otherwise acted in a responsible manner, the church will be treated as having clearly indicated its intent. If there has not been the requisite withholding or reporting and the failure to report was not due to a reasonable cause, then the economic benefit will be considered an excess benefit transaction.

Why the date of occurrence matters. An excess benefit transaction occurs on the date the disqualified person receives the economic benefit for federal income tax purposes. If the contract provides for a series of payments over a taxable year, any excess benefit transaction resulting from the payments will be deemed to occur on the last day of the taxable year (or the date of the last payment, if only for part of the year). With qualified pension plan benefits, the transaction occurs on the date the benefit vests. With a transaction involving substantial risk of forfeiture (the nonqualified retirement plans), the transaction occurs on the date there is no longer any substantial risk of forfeiture.

The role of the initial contract with the pastor. An initial contract is a binding, written contract between the exempt organization and a person who was not a disqualified person immediately prior to entering into the contract. Intermediate sanctions do not apply to any fixed payment (as defined below) pursuant to this initial contract, unless the person fails to substantially perform his or her obligations under the contract.

This means that when the church first hires the pastor and sets his or her salary, this salary will not be considered to be subject to intermediate sanctions, because the pastor does not become a disqualified person (e.g., able to exercise substantial influence) until after being hired.

A fixed payment is defined in the regulations as the amount of cash or property specified in the contract or determined by a fixed formula specified in the contract, in exchange for the provision of specified services or property. A fixed formula may incorporate an amount that depends upon future specified events or contingencies, provided that no person exercises discretion when calculating the amount or deciding whether to make a payment. Contributions to a qualified pension plan or nondiscriminatory employee benefit program are treated as fixed payments.

Determining reasonableness of other contracts and payments. For all contracts other than initial contracts, reasonableness of a fixed payment (as defined above) is determined based on the facts and circumstances existing as of the date the parties enter into the contract. However, if there is substantial nonperformance, reasonableness is determined based on all facts and circumstances from the date of entering into the contract up to the date of payment. If a payment is not a fixed payment under a contract, then the determination must be made, based on all facts and circumstances, up to and including circumstances as of the date of payment. However, the organization cannot argue that the compensation is reasonable, based on facts and circumstances existing at the time a contract is questioned.

These rules also apply to property subject to a substantial risk of forfeiture: if it satisfies the definition of a fixed payment, reasonableness is determined at the time the parties enter into the contract; if it is not fixed, reasonableness is determined as of the date of payment.

In reviewing this area of the law, it appears that the question of what is reasonable is not always obvious, and will have to be considered when the salary and benefits are set, when they are paid, and when they vest, or are no longer subject to substantial risk of forfeiture. Because compensation includes both salary and retirement benefits, it is important to make sure that the reasonableness is reviewed on a regular basis.

In addition, the IRS takes the position that if a pastor has been willing to perform services in exchange for a particular salary, the pastor is not entitled to receive an additional amount as retroactive compensation, since he or she already received the amount that both parties had agreed was acceptable. Of course, the church can increase his or her salary to what is reasonable. But it cannot provide “extra” compensation over what is reasonable at the time it is received to “catch up” for prior years. It would be different, of course, if the parties agreed to a salary of x+y, but with an understanding that a salary of x would be paid now, and that y would be paid at some point in the future.

Safe harbor

There are steps a church can take so that any compensation paid fits into what is sometimes called a “safe harbor.” This safe harbor provides that if certain requirements are met, then the burden switches from the individual to prove that his or her compensation is reasonable to the IRS to prove that the compensation is not reasonable. The safe harbor requires three steps:

1. Approval by disinterested board. The arrangement must be approved by a board or a committee of the board that is composed entirely of people who are unrelated to the person receiving the benefit, and not subject to his or her control. If the individual is a director, he or she must not participate in the decision regarding the salary (although he or she may participate in decisions about other matters). The individual may meet with other directors to answer questions, but should be excused from the rest of the discussion so that he or she is not present during the debate and voting on the transaction or compensation arrangement. For the safe harbor to be available, the decision of the board must be made at or before the payment is made.

2. Based on independent valuation. The board or committee must obtain and rely upon outside objective information to determine that an arrangement is reasonable. For example, the board might look at compensation paid by similar organizations (both taxable and nontaxable) for similar positions, independent compensation surveys compiled by independent firms (including ChurchSalary), actual written offers to the disqualified person from similar institutions, and independent appraisals of any property that is the subject of the transaction. If the organization has annual gross receipts of less than $1 million, it may rely upon data of compensation paid by five comparable organizations in the same or similar communities for similar services. It is clear that the organization can look at what is paid by for-profit entities, as well as by nonprofits, in order to determine what is reasonable.

3. Adequate documentation. The decision must be adequately documented and the basis for determining reasonableness clearly defined. Meeting minutes should set forth:

the terms of the transaction and the date it was approved,
the directors present during the debate and who voted,
the comparability data obtained and relied upon and how it was obtained, and
any actions taken concerning the transaction by any director who had a conflict of interest (e.g., they recused themselves from the meeting).

If the board determines that reasonable compensation/fair market value is actually higher or lower than the comparable information obtained, the basis for this determination must be recorded. Minutes of the meeting must be prepared by the next meeting of the board, and must be reviewed and approved by the board as being reasonably accurate and complete within a reasonable time thereafter.

If these steps are taken, then the IRS will have to furnish additional information to show that the compensation (including retirement benefits) was not reasonable, or that the transfer was not at fair market value, in order to prevail. But remember—the burden only shifts to the IRS if all of the above steps are taken first, before compensation is paid. If not, the burden remains with the individual and the board to prove that the total compensation package, including retirement contributions and other benefits, was reasonable.

The church does not belong to the pastor

Although this might seem obvious, this point needs to be made. Many independent churches look to their pastor to lead and guide all aspects of the church. Often, the board itself is nonfunctional or acts as a rubber stamp for what the pastor decides.

When a director is making a decision on behalf of the church, he or she must look out for the church’s best interests. When a decision could benefit or harm the director personally, then the director is considered to have a conflict of interest. Limiting and regulating conflicts of interest is often addressed in the state law.

If the church plans to set up a retirement plan for its pastor, it should reflect this intention in the minutes of the board meetings, with whatever detail is discussed.

As the safe harbor discussed in the last section suggests, a determination of what to pay the pastor really needs to be made by a disinterested board. Although there are some differences in the laws of the various states concerning conflicts of interest and self-dealing transactions, if the board is not involved in determining the salary and benefits to be provided, the pastor and the board may be subject to penalties, and the church may have its exempt status challenged.

This is a particular concern to the IRS as well as to the states, especially to ensure that the assets of the nonprofit are used to benefit the nonprofit’s mission, rather than principally benefit a private individual. One way to soothe IRS concerns is to adopt a conflict of interest policy (for more help see “Why Churches Need a Conflict of Interest Policy” on ChurchLawAndTax.com). Such a policy allows the board to make decisions in an objective manner without undue influence from interested persons (such as the pastor), assures that the organization fulfills its charitable purposes, and that the compensation paid is reasonable. However, a conflict of interest policy only works if the board takes responsibility to fulfill its duties. Often, the chair of the board, if there is such an officer, will work with the pastor to review his responsibilities, accomplishments, and salary needs, and then will present it to the board. Again, as noted above, the pastor’s salary, including retirement benefits, should be approved by a disinterested board, must be reasonable based on outside objective facts, and documented in the board minutes.

And again, with regard to the retirement plan(s) as part of the overall compensation, it is crucial that this must be addressed by the board.

Setting up a church-wide program to assist ministers

If a church does not take care of its ministers who have dedicated their lives to the church, this is not only unscriptural (see 1 Timothy 5:17-18 and 1 Corinthians 9:9-11), but it does not provide a good witness to others. In addition, taking care of the poor, the widowed, and the orphans is a scriptural requirement. If the church can provide assistance to others in need, there does not seem to be anything that should prohibit the church from also taking care of those in the ministry.

Some denominations have set up programs to assist ministers who are retired or retiring, especially if they are in need of financial assistance. Again, this does not replace the need for retirement planning, but it can provide relief, especially when some unforeseen financial issue arises. This method allows the church to take care of those who have given their lives in service to the church, especially when special needs arise.

Transition to full-time retirement

As noted above, unless it is deferred compensation (earned earlier, but paid at an agreed-upon future date), the church cannot pay compensation after the fact. Once a pastor has ceased to provide services, the church cannot generally continue to pay a salary.

Often the pastor and the church agree to have the pastor continue to provide services for a period of time, on either a part- or full-time basis. These services might be a continuation of the services already being rendered, they might be limited to just some of the pastor’s prior responsibilities, or they might have the pastor moving into a new area of ministry. Sometimes the pastor will actually want to retire, but the church will want the pastor to be available for consultation during the transition period. These are all permitted options. In any event, the church must limit the compensation to what is reasonable for the services rendered. If the pastor is still working full time, even if his responsibilities have shifted, his full-time salary still may be reasonable and appropriate. If he is only working part time, the salary should be reduced so that it remains reasonable for the services rendered. Contributions to retirement plans may also continue to be paid during this time.

Sometimes the transition involving the retirement of the pastor becomes difficult. If the church has determined that it is time for the pastor to retire for whatever reason, especially when the pastor does not agree, the church may want to negotiate a settlement with the pastor where the pastor agrees to a voluntary retirement/termination of his or her employment in exchange for severance pay. This allows the church to settle with the pastor, and thus avoid a potential lawsuit, while also providing the pastor with a sum of money that would help in any transition.

Setting the plan

The steps a church can take to accomplish “safe harbor” with an IRS inquiry also represent best practices, in general, for setting the compensation of the pastor, including the retirement plan or plans set.

If the church plans to set up a retirement plan for its pastor, it should reflect this intention in the minutes of the board meetings, with whatever detail is discussed. As more details are determined, this should again be reflected in the board minutes.

If a full plan is developed and funded, this is best, of course. But do not wait until then to have it addressed by the board. If the board has agreed that, as part of the pastor’s compensation, it will provide a retirement plan, and the pastor continues to perform services for the church for a period of years with the understanding that he or she will continue receiving retirement benefits upon retirement, then there will be a basis for making the argument that the benefits are a legitimate part of the pastor’s salary. That’s because they were earned while he or she was working, and are being paid as part of a contractual arrangement, rather than being provided as an afterthought.

Examples revisited and resolved

Here are resolutions to the real examples from the beginning of this article:

EXAMPLE 1 The pastor in this instance has been hit with a triple whammy. He was never paid enough to allow him to save, the church never set up a retirement plan to help, and he, like many others, opted out of Social Security without providing for an alternative, leaving him with nothing. Our solution was to go back through the church records and show the attorney general that at least some of the initial funding for the church facility came from the pastor. More importantly, we were also able to show that the board intended to provide a retirement but never was able to implement their promise, and perhaps most importantly, the amount that was actually being provided was barely above the poverty line. Although this was not an optimal solution, the attorney general did remove the objection and allowed the annuity to be set up.

EXAMPLE 2 Planning in advance is always necessary. In this case, because the directors had always planned to provide a retirement for the minister and spouse and documented it in the minutes over a period of years, even though a formal church retirement plan was never completed, the IRS was willing to acknowledge that the payment was actually agreed-upon deferred compensation that had been earned by the pastor over his years of service. It also should be mentioned that, as with the first situation, the amounts of money being paid were not large; thus there was little incentive for the IRS to pursue the matter.

EXAMPLE 3 Even if the pastor works out an arrangement to continue to be paid by the merged church, unless he continues to provide services, this would be using nonprofit assets for his personal benefit. This violates the private inurement rule, and also would likely trigger intermediate sanctions. A better solution would have been to discuss the issue with both boards before the merger, and to enter into a contract which specified the work that would be performed by the pastor during the time of transition, and to pay the pastor for that work (either by contribution to his retirement plan or by payment of a salary). For example, in one merger, the pastor who was getting ready to retire actually took a position as an associate director for several years so that there was no dispute over who was the principal pastor of the church.

EXAMPLE 4 This is a situation where the pastor thought of the church as his. He had a board of trustees, but he mostly made decisions for the church unilaterally. The first issue is that a decision like this needs to be made by a disinterested board, not by the pastor who would receive the benefit. This includes determining what amounts would be paid. The second issue is whether the total of this “retirement fund,” when added to his salary, would be considered reasonable. We suggested that there be annual contributions to such a fund, limited by what was approved by the board, and that it also be limited by a determination of reasonable compensation. This might still be more than the limits of what could be contributed to most retirement plans; to the extent it exceeded these limits, it would not be excluded from current income. However it might be possible to use a rabbi trust (which would leave title to the fund with the church until such time as it was distributed).

EXAMPLE 5 This is another example of how planning in advance (in this case approximately 10 years before it was fully implemented) will allow a particular result to be achieved. This particular entity had a fund with assets that had been given specifically to provide support for the religious leader. A separate trust was created, containing assets from this fund, and having trustees approved by the religious leader (since it was not clear who would oversee the religious organization upon his death). This trust authorized a designated amount of support to be paid to the wife each year, and also allowed the wife to live in the parsonage for the remainder of her life. Upon her death, the trust would be dissolved and the assets would revert to the original church fund. The amounts paid to the wife were deferred compensation that was earned by the religious leader during his tenure and were taxable to the wife when received.

EXAMPLE 6 The fact that the pastor is changing positions should not affect the ability of the church to continue to pay him, as long as the amount is reasonable based on his current functions. If it is full time, he can continue to be paid for these services. If the overseas ministry is a ministry of the church, then this clearly can be part of the services that he is providing for the church, as well as the direct church ministry. In addition to his compensation (a part of which should be paid as a housing allowance), the church may continue to pay into his retirement fund. If the pastor assumes a part-time position, then his salary should be reduced so that it continues to be reasonable, based on the services rendered.

The best solution

The best way to avoid the problems in the examples described in this article is always to make retirement planning a priority long before the pastor is in a position where he or she wants to—or may have to—retire. The only way to ensure that the pastor will not end up penniless is to begin the process early. This is something that pastors and their churches must be aware of and address while there is time to come up with a constructive solution.

Lisa A. Runquist has more than 40 years of experience as a transactional lawyer, both with nonprofit organizations and business organizations.

10 Commandments for Pastors, Politics, and Social Media

10 commandments for pastors thinking of preaching, speaking, or posting about politics in an election cycle. Or any other time.

Thom Rainer

There are few topics that evoke as much emotion as politics, and church leaders would do well to remember these 10 commandments for pastors when it comes to engaging in politics—particular on social media.

Pastors and church staff are not oblivious to political emotions. Indeed, some of them can be among the most intensely emotional.

The purpose of this post is not to imply that pastors and staff should abandon their convictions. Nor is it to suggest that silence is always the best option. Instead, I hope it is a gentle reminder of ten issues pastors and church staff may want to consider before posting political views and opinions on social media.

10 Commandments for Pastors Posting About Politics on Social Media

You shall remember you are an ambassador for Christ. All of your written and spoken words should be a reflection of Him.
You shall remember you are your church to many people. Your words, for better or worse, are a direct reflection on your congregation.
You shall not be a stumbling block to unbelievers. Many are watching you. Many are reading your words.
You shall refrain from posting when your emotions are high. Take a break for a day. If you don’t, you will likely regret it later.
You shall remember that others are often posting in the throes of their own anger and emotions. It is usually best not to engage them then.
You shall remember your words are permanent. The moment you post, someone has likely captured your article or post, even if you delete it later.
You shall understand some members of your congregation likely have a different view than you. Is your post worth the disunity that may follow?
You shall not be a distraction to the gospel. Politics are often an easy detour from that which really matters.
You shall be aware of the long political memory many people have. Some people are talking today about the comments Christians made in the presidential election four years ago!
You shall be aware that your political opinions may cause disunity with other churches in the community. Make certain the words are worth the price that is paid.

The writer of Ecclesiastes reminds us in chapter 3, verse 7, that there is “a time to be silent and a time to speak.” For the sake of the gospel, please make certain you have sought God’s wisdom to discern what time it is for you.

Lead Your Church With Confidence—Became a Church Law & Tax Member Today.

This post was adapted from an article that first appeared at ThomRainer.com on March 21, 2016. Thom S. Rainer serves as president and CEO of LifeWay Christian Resources. Among his greatest joys are his family: his wife Nellie Jo; three sons, Sam, Art, and Jess; and seven grandchildren. Dr. Rainer can be found on Twitter @ThomRainer and at facebook.com/Thom.S.Rainer .

For information on the tax and legal guidelines faith-based organizations need to know before jumping into the political fray, see the downloadable resource Politics and the Church .

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The Definition of Taxable Income

Richard R. Hammar, Attorney, CPA

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Richard R. Hammar is an attorney, CPA and author specializing in legal and tax issues for churches and clergy.

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When Churches Give Christmas Gifts

Don’t let generosity trigger costly tax penalties.

Richard R. Hammar, Attorney, CPA

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Most churches provide employees and volunteers with “gifts” at Christmas. Common examples include hams, turkeys, fruit baskets, small amounts of cash, or gift cards. Church treasurers may assume that these gifts are so small that they need not be reported as taxable income, but an Internal Revenue Service ruling suggests that this assumption is incorrect. IRS Letter Ruling 200437030.

Consider the IRS ruling on $35 gift coupons

A charity provided employees with a ham, turkey, or gift basket as an annual holiday gift. Over the years, several employees complained about the gifts because of religious or dietary restrictions, and requested a gift coupon of comparable value. In response, the charity began providing employees with a gift coupon having a face value of $35 instead of a ham, turkey, or gift basket. The coupons listed food stores where they were redeemable. The charity did not withhold or pay any employment taxes for any portion of the $35 gift coupons provided to employees.

Get year-end gift ideas for pastors and staff from this article on our sister site, ChurchSalary.

The IRS ruled that these coupons represented taxable income that should have been added to the employees’ W-2 forms. It rejected the charity’s argument that the coupons were a de minimis fringe benefit that were so low in value that they could be ignored for tax purposes.

The IRS conceded that taxable income does not include any fringe benefit that qualifies as a de minimis fringe benefit. Section 132(e)(1) of the tax code defines a de minimis fringe benefit as “any property or service the value of which is so small as to make accounting for it unreasonable or administratively impracticable.”

The IRS concluded that cash can never be a de minimis fringe benefit since it is not “unreasonable or administratively impracticable” to account for its value. The same conclusion applies to “cash equivalents,” such as gift coupons, even though the property acquired with a coupon would have been a nontaxable de minimis fringe benefit had it been provided by the employer.

The IRS noted:

When an employee attends a staff meeting where two pots of coffee and a box of donuts are provided by the employer, the value of the benefit the employee receives is not certain or easily ascertained. Further, the administrative costs associated with determining the value of the benefit and accounting for it may be more expensive than providing the benefit. In this case, there is no difficulty in determining the value or accounting for it; each employee that received a gift coupon received a cash equivalent fringe benefit worth $35.

In support of its conclusion, the IRS cited the following considerations:

The definition of de minimis fringe benefits in section 132 refers only to “property or services,” and not cash.
The income tax regulations provide several examples of de minimis fringe benefits, and none involves cash. Rather, they include: Occasional typing of personal letters by a company secretary; occasional personal use of an employer’s copying machine; group meals, or picnics for employees and their guests; traditional birthday or holiday gifts of property (not cash) with a low fair market value; occasional theater or sporting event tickets; coffee, donuts, and soft drinks; local telephone calls; and flowers, fruit, books, or similar property provided to employees under special circumstances (e.g., on account of illness, outstanding performance, or family crisis).
A congressional committee report provides illustrations of benefits that are excludable as de minimis fringe benefits, including “traditional gifts on holidays of tangible personal property having a low fair market value (e.g., a turkey giving for the year-end holidays).”
“It is not administratively impracticable to account for even a small amount of cash provided to an employee because the value of the amount provided is readily apparent and certain. Accordingly . . . accounting for cash or cash equivalent fringe benefits such as gift certificates is never considered administratively impracticable under section 132.”

The IRS concluded:

It is our view that the employer-provided gift coupon operates in essentially the same way as a cash equivalent fringe benefit such as a gift certificate. As with a gift certificate, it is simply not administratively impracticable to account for the employer-provided gift coupons; they have a face value of $35. Accordingly, we conclude that an employer-provided holiday gift coupon with a face value of $35 that is redeemable at several local grocery stores is not excludable from gross income as a de minimis fringe benefit.

The IRS acknowledged that some courts have ruled that gift certificates of small amounts may be nontaxable fringe benefits, but it noted that all of these cases were decided many years ago prior to the enactment of section 132 and so they are no longer relevant.

Key point. The IRS based its ruling on the fact that gift coupons and certificates are “cash equivalents.” It should be noted coupons and certificates are unlike cash in some fundamental ways. For example, they generally cannot be used everywhere, they often have expiration dates, in some cases they may be used only by the person to whom they are issued, and in some cases they may be used only once (with any used balance being forfeited). The IRS did not address any of these dissimilarities.

Key point. The IRS rejected the charity’s suggestion that any holiday gift with a value of less than $75 should be considered a nontaxable de minimis fringe benefit.

Relevance to church treasurers

The following examples will illustrate the application of the IRS ruling to common church practices:

Example. A church provides its non-pastoral employees with a turkey at Christmas. This is a nontaxable de minimis fringe benefit and so the value of the turkey need not be reported on the employees’ W-2 forms. The income tax regulations provide several examples of de minimis fringe benefits, including “traditional birthday or holiday gifts of property (not cash) with a low fair market value.”

Example. A church provides its senior pastor with a $250 check as a Christmas gift. This is not a de minimis fringe benefit, and the entire value must be reported as wages on the pastor’s W-2 form.

Example. A church provides employees with a $50 gift certificate redeemable at a local restaurant as a holiday gift. The certificate is a cash equivalent whose value is readily ascertainable. It is not a nontaxable de minimis fringe benefit despite the token amount, and so it should be reported as taxable compensation.

Example. A church provides employees with a $25 gift certificate redeemable at a local Krispy Kreme donut store. The certificate is a cash equivalent whose value is readily ascertainable. It must be reported as additional income on employees’ W-2 forms. It is not a nontaxable de minimis fringe benefit despite the token amount, and so it must be reported as taxable compensation.

Example. A church provides employees with a Christmas card containing a $25 check. The value of the check must be reported as additional income on employees’ W-2 forms. It is not a nontaxable de minimis fringe benefit despite the token amount, and so it must be reported as taxable compensation. The fact that the amount of a check is $25 is irrelevant. No cash gift provided to an employee, regardless of how small the amount, can be treated as a nontaxable de minimis fringe benefit. There is no exception, as is often assumed, for gifts of $25 or less.

Example. A church treats its staff to a holiday dinner at a local restaurant. The value of each dinner averages $20. The value of the meals is a nontaxable de minimis fringe benefit. The income tax regulations provide several examples of de minimis fringe benefits, including “group meals, or picnics for employees and their guests.”

Example. At the end of each year a church provides volunteers who work in the church nursery with a $25 gift certificate to a local restaurant in recognition of their selfless services. The IRS ruling addressed in this article suggests that the value of these certificates represents taxable income to the volunteers. However, since they are not employees, the church is not required to report the amount of the certificates on a W-2 form. No Form 1099 is required either, assuming that the volunteers do not receive compensation of $600 or more during the year from the church. It will be up to the volunteers to decide how to handle the certificates for tax purposes.

Give noncash presents

Churches can avoid having the value of holiday gifts constituting taxable compensation by providing both employees and volunteers with noncash items of nominal amounts rather than cash or cash equivalents. Such items include turkeys, hams, gift baskets, and candy.

Richard R. Hammar is an attorney, CPA and author specializing in legal and tax issues for churches and clergy.

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Reimbursing Lunch Expenses

Churches should refer to an important Tax Court decision when reimbursing lunch expenses.

Richard R. Hammar, Attorney, CPA

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There’s a right way churches should go about reimbursing lunch expenses.

In many churches, ministerial lunches are a weekly ritual. Since church matters are discussed, many church treasurers assume that the cost of the lunch can be reimbursed by the church under an accountable arrangement.

As a result, the cost of such lunches is not added to the employees’ taxable compensation for tax reporting purposes.

But is this the correct way to handle lunch expenses? If your church has an accountable reimbursement arrangement, can you reimburse lunch expenses? If so, under what circumstances? Always? Whenever church matters are discussed?

A Tax Court decision addresses this important question.

In Dugan v. Commissioner (T.C. Memo. 1998-373), a medical technician and a physician shared office space.

The two often met at lunchtime to discuss the treatment of their patients and the details of office administration and operations.

The two met at other times as well, but they found that lunchtime was often the best opportunity to meet. They alternated paying for their meals together.

On her federal income tax return, the technician deducted her share of these meal expenses (subject to the 50% reduction that applies to unreimbursed meal expenses).

The IRS disallowed any deduction for the meals on the ground that they were not a legitimate business expense. The technician appealed to the Tax Court.

Were the technician’s lunch expenses deductible?

After all, she discussed both treatment procedures and office operations during these lunches. Unfortunately, the court agreed with the IRS that the expenses were not deductible.

The court began its opinion by noting that “daily meals are an inherently personal expense, and a taxpayer bears a heavy burden in proving they are deductible” as a business expense.

Attorneys’ lunches

The court referred to a previous ruling involving attorneys.

Members of a law firm met every work day at a local restaurant to discuss work-related matters because the lawyers were all litigators and the court was not in session over the noon hour.

A federal appeals court conceded the business purpose for these lunch meetings, and that lawyers “did not dawdle over their lunch,” but it concluded that the meals represented nondeductible personal expenses rather than business expenses.

It observed:

[I]t is undeniable that eating together fosters camaraderie and makes business dealings friendlier and easier. It thus reduces the costs of transacting business, for these costs include the frictions and the failures of communication that are produced by suspicion and mutual misunderstanding, by differences in tastes and manners, and by lack of rapport. A meeting with a client or customer in an office is therefore not a perfect substitute for a lunch with him in a restaurant. But it is different when all the participants in the meal are coworkers, as essentially was the case here …. They know each other well already; they don’t need the social lubrication that a meal with an outsider provides–at least don’t need it daily. If a large firm had a monthly lunch to allow partners to get to know associates, the expense of the meal might well be necessary, and would be allowed by the Internal Revenue Service. But [the law firm in this case] never had more than eight lawyers and did not need a daily lunch to cement relationships among them ….

We may assume it was necessary for the [attorneys] to meet daily to coordinate the work of the firm, and also … that lunch was the most convenient time. But it does not follow that the expense of the lunch was a necessary business expense. The members of the firm had to eat somewhere … Although it saved time to combine lunch with work, the meal itself was not an organic part of the meeting …. Moss v. Commissioner, 758 F.2d 211 (7th Cir. 1985).

Example. The Tax Court ruled that lunch expenses incurred by a group of government attorneys who met for lunch one day each month were not business related despite the fact that business was discussed. The court did concede that “an occasional luncheon meeting with the staff to discuss the operation of the firm would be regarded as an ordinary and necessary expense,” as would “a luncheon to mark an anniversary, retirement or other occasion for an employee” since such expenses “aid in building morale and loyalty and serve as an inducement for others to work more efficiently.” Wells v. Commissioner, 36 T.C.M. 1690 (1977).

The court’s conclusion

Like the attorneys’ lunches, the lunches shared by the medical technician and the physician were not integral to the technician’s business objectives and have not been clearly linked to her production of income.

They met at lunchtime because that was the most convenient and feasible time to meet.

Their business relationship was well established and did not require “social lubrication,” at least not as often as [she and the physician] dined together.

Indeed, the frequency of their lunches together and the reciprocal nature of their meal arrangement belie the existence of any business purpose for the meals …. If taxpayers were permitted to deduct meal expenses in such circumstances then … only the unimaginative would dine at their own expense.

Why does this case matter to how church treasurers reimburse lunch expenses?

Consider the following checklist:

1. Entertainment expenses. Local lunch expenses incurred by church employees qualify as a business expense, and can be reimbursed by a church under an accountable expenses reimbursement arrangement, only if they qualify as entertainment expenses. The requirements for substantiating entertainment expenses are strict. You must demonstrate that the expenses are either (1) directly related to the active conduct of your ministry, or (2) associated with the active conduct of your ministry and the entertainment occurred directly before or after a substantial business discussion.

In order to show that entertainment was directly related to the active conduct of your business, you ordinarily must be able to demonstrate that (1) you had more than a general expectation of deriving income or some other specific business benefit at some indefinite future time; (2) you did engage in business during the entertainment period; and (3) the main purpose of the entertainment was the transaction of business.

In order to show that entertainment was associated with the active conduct of your ministry, you must be able to demonstrate that you had a clear business purpose in incurring the expense, and that the meal or entertainment directly preceded or followed a substantial business discussion.

2. Frequent staff lunches. Frequent lunches with the same members of the church staff are much less likely to qualify as a business expense, even if church business is discussed. For example, if the same three church staff members go out to lunch every Friday, it is very unlikely that any of these lunches will qualify as a business expense. After all, these persons work in the same office, and presumably have considerable interaction during the week. A shared lunch under these circumstances does not constitute an ordinary and necessary business expense.

Key point. It is worth noting that the Tax Court in the Wells case (summarized in an example in this article) met for lunch one day each month. This was considered too frequent to be business related.

3. Occasional lunches with non staff members. Such lunches are more likely to qualify as entertainment expenses, and as a result the costs of these lunches can be reimbursed by the church under an accountable expense reimbursement arrangement. To illustrate, a lunch arranged by a pastor with a local architect to discuss new building plans would qualify as a business expense.

4. Occasional employee lunches. The Tax Court, in a previous decision (the Wells case, summarized in an example in this article) addressing the deductibility of lunch expenses incurred by attorneys one day each month, conceded that “an occasional luncheon meeting with the staff to discuss the operation of the firm would be regarded as an ordinary and necessary expense,” as would “a luncheon to mark an anniversary, retirement or other occasion for an employee” since such expenses “aid in building morale and loyalty and serve as an inducement for others to work more efficiently.”

5. Lunch expenses while traveling. This article only addresses the reimbursement of local lunch expenses. Lunch expenses incurred while church employees are away from town on business travel are business related and can be reimbursed under an accountable arrangement.

6. Other requirements of an accountable arrangement. In order for your church to reimburse expenses under an accountable expense reimbursement arrangement, you must have adopted a reimbursement arrangement that meets the following three requirements: (1) Only business expenses are reimbursed (expenses that would qualify for a business expense deduction on a taxpayer’s personal income tax return). (2) The church only reimburses an expense if the employee substantiates, with written records (including a receipt for expenses of $75 or more), the amount, date, location, and business connection of the expense. In addition, in the case of entertainment expenses (such as local lunch expenses) the employee must document the “occupation or other information relating to the person or persons entertained, including name, title, or other designation, sufficient to establish business relationship to the taxpayer.” (3) Employees must return to the church any reimbursements in excess of substantiated expenses. This article addresses only on the first of these three requirements. Even if a particular lunch qualifies as a business expense, the church may reimburse it under an accountable arrangement only if the other two requirements for an accountable arrangement are met.

If any of these three requirements is not satisfied, the church’s reimbursement of a lunch expense is nonaccountable, and the full amount of the reimbursement must be allocated to the employees’ W-2s.

7. Unreimbursed expenses. This article addresses the tax consequences of a church’s reimbursement of employee lunch expenses. In some cases, church employees pay for their own lunch expenses. Such “unreimbursed” expenses may be deducted as an employee business expense, but only if reimbursement from the church was not available. Further, church employees may deduct only 50% of business related entertainment expenses, including meals. This 50% limitation is incorporated directly into the tax returns (line 9 of Form 2106, and line 24c of Schedule C). Note however that the 50% limitation does not apply to expenses that are reimbursed by an employer under an accountable reimbursement plan. IRS Publication 463 states: “As an employee, you are not subject to the 50% limit if your employer reimburses you under an accountable plan and does not treat your reimbursement as wages.” Publication 463 states that the self employed persons also can avoid the 50% limitation through use of an accountable reimbursement arrangement.

Here are some examples that will illustrate the issues addressed in this article.

Example 1: A church has 3 pastors who for many years have gone out to lunch every Friday. Church business is almost always discussed at these lunches. The cost of these lunches is always charged to a church credit card, and the church treasurer has never reported the church’s reimbursements as taxable income to the pastors by including it on their W-2 forms. This is incorrect. According to the rulings summarized in this article, these lunches do not qualify as business expenses, and as a result they should not be charged to the church credit card. If the pastors continue to charge the lunches to the church credit card, the treasurer will need to allocate the reimbursed expenses to the pastors and report the reimbursements as taxable income on the pastors’ W-2 forms at the end of the year. The treasurer need not withhold additional income taxes because the pastors’ wages are exempt from income tax withholding.

Example 2: Same facts as the previous example, except that nonminister church employees rather than pastors are involved. The answer is the same, except that the church will need to withhold income taxes and FICA taxes from the value of the lunches.

Example 3: A pastor occasionally meets church members for lunch, and charges the cost of these lunches to the church credit card. The purpose of these lunches is for the pastor to become better acquainted with members, and to provide spiritual guidance as needed. These expenses qualify as an entertainment expense. As a result, the expenses reimbursed by the church are accountable so long as the requirements for an accountable reimbursement (summarized in this article) are satisfied.

Example 4: Same facts as the previous example, except that the pastor informs the church treasurer each month of the approximate amount he spent during the previous month on such lunches, and receives a reimbursement check. This arrangement is nonaccountable since the substantiation requirements for an accountable arrangement are not met. As a result, the treasurer will need to add the value of all lunch expense reimbursements to the pastor’s W-2 at the end of the year.

Example 5: A pastor takes the church staff out to lunch twice each year as a means of expressing appreciation for their hard work. The cost of these lunches is charged to the church credit card. These expenses represent a legitimate business expense, and as a result they can be reimbursed by the church under an accountable arrangement so long as they are adequately substantiated. As a result, the church treasurer would not report any of the reimbursements as taxable income. The Tax Court has noted that “an occasional luncheon meeting with the staff to discuss the operation of the firm would be regarded as an ordinary and necessary expense,” as would “a luncheon to mark an anniversary, retirement or other occasion for an employee” since such expenses “aid in building morale and loyalty and serve as an inducement for others to work more efficiently.” Wells v. Commissioner, 36 T.C.M. 1690 (1977).

Example 6: A church’s two pastors go out to lunch once each month. Church business is always discussed, and the cost of the lunches is charged to the church credit card. A federal appeals court has observed that monthly lunches by law firm members “might well be necessary, and would be allowed by the Internal Revenue Service.” Moss v. Commissioner, 758 F.2d 211 (7th Cir. 1985). On the other hand, the Tax Court has ruled that monthly lunch expenses incurred by government attorneys were not business related despite the fact that business was discussed. Wells v. Commissioner, 36 T.C.M. 1690 (1977). In summary, while there is legal support for treating monthly lunch expenses as business-related, but there is also support for the opposite conclusion. This suggests that the business nature of monthly lunch expenses may be challenged by the IRS, but that no penalties would be assessed.

Richard R. Hammar is an attorney, CPA and author specializing in legal and tax issues for churches and clergy.

Reimbursing Business Expenses Through Salary “Restructuring”

The IRS reconsiders its position

Richard R. Hammar, Attorney, CPA

Bio

The IRS reconsiders its position – Letter Ruling 99916011

Article summary. The tax code prohibits employers from paying for the reimbursement of their employees’ business expenses under an “accountable” arrangement through salary reductions. In a 1993 ruling, the IRS extended this prohibition to salary “restructuring” arrangements. Since such arrangements were a common church practice, this ruling had a significant impact on churches. The IRS recently issued a new ruling addressing salary restructuring arrangements. The new ruling repudiates the 1993 ruling, and suggests that salary restructuring arrangements may be used in the context of accountable plans.

In a surprise development, the IRS has issued a private letter ruling suggesting that some salary “restructuring” arrangements may be used in connection with accountable business expense reimbursement arrangements. This is a very significant development for churches, since nearly 90 percent of churches now use accountable arrangements to reimburse staff members’ business expenses, and many use some form of salary “restructuring” to pay for the reimbursements. The recent IRS ruling repudiates a 1993 ruling in which the IRS concluded that employers could not use salary “restructuring” arrangements to fund reimbursements under an accountable plan. This feature article will review the prohibition on the use of salary reductions to fund business expense reimbursements under an accountable arrangement. It also will address the 1993 and 1999 IRS rulings, and evaluate the relevance of the most recent IRS ruling to church compensation practices.

The requirements of an accountable reimbursement arrangement

The income tax regulations list three requirements that must be met in order for a business expense reimbursement arrangement to be accountable:

(1) Business Connection

A reimbursement arrangement meets the business connection requirement if it reimburses employee expenses that could be claimed by the employee as a business expense deduction, and that are paid or incurred by the employee in connection with the performance of services as an employee. The business connection requirement will not be satisfied if the employer “arranges to pay an amount to an employee regardless of whether the employee incurs or is reasonably expected to incur business expenses.”

(2) Substantiation

A reimbursement arrangement meets the substantiation requirement if it requires each business expense to be substantiated to the employer within a reasonable period of time. An arrangement that reimburses business expenses governed by section 274(d) of the tax code (travel, transportation, entertainment, business gifts, cell phones, and personal computers) meets this requirement if the information submitted to the employer substantiates the elements of each expenditure. For example when substantiating expenses for travel away from home, the employee is required to substantiate the amount, time, place, and business purpose of the expenses.

(3) Returning Excess Reimbursements

A reimbursement arrangement, to be accountable, must require the employee to return to the employer within a reasonable period of time any amount paid under the arrangement in excess of the expenses substantiated. If a reimbursement arrangement meets the three requirements, but the employee fails to return, within a reasonable period of time, any amount in excess of the amount of the expenses substantiated, only the amounts paid under the arrangement that are not in excess of the substantiated expenses are treated as paid under an accountable plan. The excess amounts are treated as paid under a nonaccountable plan.

Using salary reductions to fund employee business expenses

The “reimbursement requirement”

The regulations caution that in order for an employer’s reimbursement arrangement to be accountable, it must meet a reimbursement requirement in addition to the three requirements summarized above. The reimbursement requirement is defined by the regulations as follows:

If [an employer] arranges to pay an amount to an employee regardless of whether the employee incurs (or is reasonably expected to incur) business expenses … the arrangement does not satisfy [the reimbursement requirement] and all amounts paid under the arrangement are treated as paid under a nonaccountable plan. Treas. Reg. 1.62-2(d)(3).

Application of the reimbursement requirement

The IRS interprets this regulation to prohibit accountable reimbursement plans from reimbursing employee business expenses through salary reductions. Employers who agree to pay an employee a specified annual income, and also agree to reimburse the employee’s business expenses out of salary reductions, have “arranged to pay an amount to an employee regardless of whether the employee incurs business expenses.”

In explaining this regulation, the IRS observed:

Some practitioners have asked whether a portion of an employee’s salary may be recharacterized as being paid under a reimbursement arrangement. The final regulations clarify that if [an employer] arranges to pay an amount to an employee regardless of whether the employee incurs … deductible business expenses … the arrangement does not meet the business connection requirement of [the regulations] and all amounts paid under the arrangement are treated as paid under a nonaccountable plan …. Thus no part of an employee’s salary may be recharacterized as being paid under a reimbursement arrangement or other expense allowance arrangement.

Let’s illustrate this rule with an example. Assume that a church pays its senior pastor, Rev. G, an annual salary of $52,000 ($1,000 each week). The church also agreed that it would reimburse Rev. G’s substantiated business expenses through salary reductions. At the beginning of each month, Rev. G substantiates his business expenses for the previous month, and he is issued a paycheck for the first week of the next month consisting of both salary and expense reimbursement. To illustrate, assume that Rev. G substantiated $400 of business expenses for January of 1999 during the first week of February. The church issued Rev. G his customary check of $1,000 for the first week of February, but only $600 of this check represents taxable salary while the remaining $400 represents reimbursement of Rev. G’s business expenses. The church only accumulates the $600 to Rev. G’s W-2 or 1099 that it will issue at the end of the year.

Such arrangements are used by many churches. However, they are nonaccountable according to the regulation quoted above, since Rev. G would receive his full salary of $52,000 if he chose not to incur any business expenses. As a result, the church would report the full salary of $52,000 as income on Rev. G’s W-2 or 1099.

The above-quoted regulation (imposing the reimbursement requirement) effectively put an end to a common church practice that allowed many clergy to enjoy the advantages of an accountable plan without any additional cost to the church. Unfortunately, regulation 1.62-2(d)(3), by imposing the reimbursement requirement, makes such arrangements nonaccountable. Such arrangements are not “illegal.” They simply cannot be “accountable.” Churches that continue to use such arrangements must recognize that all reimbursements paid through salary reduction are treated as paid under a nonaccountable plan. This means that all salary reduction “reimbursements” are treated as taxable income to the employee, and the church must withhold any applicable taxes from these reimbursements.

The IRS national office, in correspondence with your editor, confirmed that the regulation prohibits churches from using salary reductions to fund business expense reimbursements under accountable reimbursement arrangements. In explaining its interpretation, the IRS noted that the tax benefits available to accountable reimbursement arrangements (i.e., the employer’s reimbursements are not reportable as income to the employee, and are not subject to tax withholding) are based on the fact that the reimbursements are coming out of the employer’s resources and accordingly it “has an incentive to require sufficient substantiation to ensure that the allowance to the employee is limited to actual business expenditures incurred on the employer’s behalf and for the employer’s benefit.” This justification simply does not apply when an employee’s business expenses are reimbursed out of his or her own salary (through salary reductions). The IRS gave the following example:

for example, assume that an employee working for Corporation A is paid $40,000, designated as salary, and is not entitled to any additional amount under a nonaccountable plan. If the employee decides to incur $2,000 in employee business expenses, that amount is deductible only as a miscellaneous itemized deduction, subject to the two-percent floor. By contrast, assume that an employee working for Corporation B is paid $37,000, designated as salary, and is given an additional $4,000 for the year, designated as an expense allowance pursuant to a nonaccountable plan. Under the arrangement the employee may retain any part of the $3,000 whether or not the employee substantiates to the employer, regardless of the amount of employee business expenses …. [T]here is no justification for different tax treatment of these two employees who receive (and are allowed to retain) identical dollar amounts from their employers and who make identical employee business expenditures.

The IRS concluded:

A salary reduction arrangement which “reimburses” an employee for employee business expenses by reducing the employee’s salary will not be treated as an accountable plan because it does not meet the reimbursement requirement. This is the result regardless of whether a specific portion of the employee’s compensation is designated for employee expenses … or the portion of the compensation to be treated as the expense allowance varies from pay period to pay period depending on the employee’s expenses. As long as the employee is entitled to receive the full amount of annual compensation regardless of whether or not any employee business expenses are incurred during the taxable year, the arrangement does not meet the reimbursement requirement.

In summary, regulation 1.62-2(d)(3), by imposing the so-called reimbursement requirement, effectively prohibits employers (including churches) from allowing employees to pay for their own business expenses under an accountable arrangement through salary reductions. Even if such arrangements meet the three requirements for an accountable reimbursement arrangement (described above), they do not meet the regulations’ “reimbursement requirement.” This is so for the following two reasons:

(1) The employer is not “reimbursing” the employee’s expenses. A reimbursement assumes that the employer is paying for the employee’s business expenses out of its own funds. When an employer pays an employee for his or her business expenses through a salary reduction, it is the employee and not the employer that is paying for the expenses. Such an arrangement is not an employer “reimbursement.”

(2) The church has agreed “to pay an amount to an employee regardless of whether the employee incurs (or is reasonably expected to incur) business expenses,” in violation of the reimbursement requirement prescribed by the regulations.

Employers are free to pay for an employee’s business expenses through salary reductions, but they must recognize that such an arrangement is nonaccountable. The effect of this is that the salary reductions must be accumulated to the employee’s taxable income, and the employer is obligated to withhold applicable taxes on the salary reductions. In summary, there are no tax advantages associated with such arrangements.

• Example. First Church agreed to pay its youth minister, Rev. P, an annual salary for 1999 of $36,000 ($692 per week). On February 1, 1999, Rev. P “accounts” to the church treasurer for $300 of business and professional expenses that he incurred in the performance of his ministry in January of 1999. Rev. P receives two checks for the first week in February-a check in the amount of $300 reimbursing him for the business and professional expenses that he accounted for, and a paycheck in the amount of $392 (the balance of his weekly pay of $692). His weekly compensation remains $692, but $300 of this amount constitutes a business expense reimbursement. The same procedure is followed for every other month during the year. Because of the income tax regulation discussed in this article, this arrangement constitutes a nonaccountable plan. As a result: (1) Rev. P’s W-2 (or 1099) for 1999 must include the full salary of $36,000; (2) Rev. P must report $36,000 as income on his Form 1040; (3) if Rev. P reports his income taxes as an employee (or as self-employed but is reclassified as an employee by the IRS in an audit) he can deduct his business expenses only as miscellaneous itemized deductions on Schedule A, to the extent they exceed 2% of adjusted gross income. The key point is this-accountable reimbursement arrangements cannot fund business expense reimbursements out of an employee’s salary.

The 1993 IRS ruling-salary “restructuring” is the same as a salary reduction

Can the regulation prohibiting the funding of business expenses under an accountable arrangement through salary reductions be avoided by proper drafting of an employee’s compensation package?

Let’s illustrate this important question with an example. Assume that Rev. K and his church are discussing compensation for the next year, and that the church board proposes to pay Rev. K $50,000. However, since it will require Rev. K to pay his own business expenses, the church board decides to pay Rev. K a salary of $46,000, and establish a separate church account for $4,000 out of which substantiated business expenses will be reimbursed. At the end of the year, any balance remaining in the reimbursement account would belong to the church, not Rev. K. It would not be distributed to Rev. K as a “bonus” or as additional compensation. Since Rev. K has no right to any of the reimbursement account funds ($4,000) unless he adequately substantiates his business expenses, this arrangement should be permissible under the regulation. The church has not “agreed to pay an amount to an employee regardless of whether the employee incurs deductible business expenses.” Unfortunately, the IRS disagreed with this conclusion in a 1993 private letter ruling. IRS Letter Ruling 9325023.

In the 1993 ruling, the IRS addressed the question of whether the following arrangement could be considered to be accountable:

Company X proposes to modify the district manager’s compensation arrangement to allow each district manager to elect on an annual basis and prior to the beginning of each calendar year to reduce the amount of gross commission payable to him for the upcoming calendar year. Under the arrangement, the district manager may elect to reduce his gross commissions by a percentage ranging from 0 to 40%. In exchange for the reduction in commissions, Company X will pay the district manager’s business expenses for the calendar year up to a maximum amount equal to the amount by which the district manager elected to reduce his commissions. Company X will pay only for expenses that satisfy the business connection and substantiation requirements of … the income tax regulations. If the expenses a district manager incurs in a calendar year are less than the amount by which the gross commissions were reduced, the excess amounts will be forfeited and may not be carried over and used for expenses incurred in the next calendar year.

The IRS began its ruling by noting that “a gratuitous assignment of income does not shift the burden of taxation and the donor is taxable when the income is received by the donee.” The IRS continued:

If a district manager of Company X elects to forgo future compensation under the reimbursement arrangement in consideration of Company X’s agreement to reimburse his business expenses up to an equivalent amount, the district manager is making an anticipatory assignment of future income to Company X for consideration (the reimbursements). Thus, when Company X reimburses a district manager, the district manager is treated as currently receiving the forgone compensation for which the reimbursement is a substitute. Accordingly, we conclude that when Company X reimburses a district manager for employee business expenses, the reimbursements will be includible in the district manager’s gross income in the taxable year when paid just as if the district manager had received the forgone compensation. We also conclude, as explained below, that the reimbursements are subject to employment taxes because they are not paid under an arrangement that is an accountable plan.

The IRS then quoted the following example that appears in the income tax regulations:

Employer S pays its engineers $200 a day. On those days that an engineer travels away from home on business for Employer S, Employer S designates $50 of the $200 as paid to reimburse the engineer’s travel expenses. Because Employer S would pay an engineer $200 a day regardless of whether the engineer was traveling away from home, the arrangement does not satisfy the reimbursement requirement of [the regulations]. Thus, no part of the $50 Employer S designated as a reimbursement is treated as paid under an accountable plan. Rather, all payments under the arrangement are treated as paid under a nonaccountable plan. Employer S must report the entire $200 as wages or other compensation on the employees’ Forms W-2 and must withhold and pay employment taxes on the entire $200 when paid.

The IRS noted that “the conclusion to be reached from this example is that an employer may not recharacterize a portion of an employee’s salary as being paid under a reimbursement arrangement or other expense allowance arrangement.” Further, the example illustrates that

in order to have an accountable plan … the code and regulations contemplate that the reimbursement or other expense allowance arrangement provided by an employer should be amounts paid to an employee in addition to salary. This conclusion is supported by the preamble to the final regulations published in the Federal Register on December 17, 1990, which provides that no part of an employee’s salary may be recharacterized as being paid under a reimbursement arrangement or other expense allowance arrangement.

The IRS concluded that the reimbursement arrangement proposed by Company X would

result in a portion of the district manager’s salary being recharacterized as paid under a reimbursement or other expense allowance arrangement. Therefore, we conclude that the arrangement proposed by Company X would fail the reimbursement requirement of section 1.62-2(d)(3) of the regulations. Thus, the business connection requirement of section 1.62-2(d) would not be satisfied. Therefore, all amounts paid under the arrangement would be treated as paid under a nonaccountable plan. In accordance with section 1.62-2(c)(5) all amounts paid under the arrangement are includible in the district managers’ gross incomes, must be reported as wages or other compensation on the district managers’ Forms W-2, and are subject to the withholding and payment of employment taxes (FICA, FUTA, and income tax).

IRS Audit Guidelines for Ministers

The IRS has issued audit guidelines for its agents to follow when auditing ministers. The guidelines inform agents that if a church has a salary reduction arrangement which “reimburses” a minister for employee business expenses by reducing his or her salary, the arrangement will be treated as a nonaccountable plan. This is the result

regardless of whether a specific portion of the minister’s compensation is designated for employee expenses or whether the portion of the compensation to be treated as the expense allowance varies from pay period to pay period depending on the minister’s expenses. As long as the minister is entitled to receive the full amount of annual compensation, regardless of whether or not any employee business expenses are incurred during the taxable year, the arrangement does not meet the reimbursement requirement.

The guidelines instruct IRS agents to be alert to salary reduction arrangements that are used to fund reimbursements under an “accountable” arrangement. According to the IRS, accountable plans cannot reimburse employee business expenses out of salary reductions. The important point is this-the guidelines are educating IRS agents as to this issue, and so it is now far more likely that salary restructuring and salary reduction arrangements will be discovered and questioned in an audit.

The 1999 IRS ruling

Background

A securities firm employed investment consultants who incur travel and other employee business expenses in connection with the performance of services for their employer. The company adopted a plan to provide for the reimbursement of employee business expenses incurred by the investment consultants. It contains the following features:

The plan is mandatory for all investment consultants within the company.
Investment consultants are reimbursed for employee business expenses that would be deductible as business expenses on their personal tax returns.
Prior to the start of a calendar year, each investment consultant’s manager determines the amount, if any, to be excluded from the consultant’s commissions in the next year. If the manager reduces a consultant’s commissions, such amount is not less than $600 and not more than the reimbursement “cap.” The reimbursement cap equals the greater of $10,000 or 2.5% of the consultant’s commissions in the prior year. The amount of reimbursement that a consultant may receive under the plan in a calendar year may not exceed the lesser of the actual expenses or the reimbursement cap.
If a consultant’s expenses are less than the reimbursement cap, the difference between the expenses and the reimbursement cap will not be received by the consultant and will not be carried over from one calendar year to the next.
If a consultant does not request reimbursement under the plan, he or she receives no additional compensation and remains subject to the base compensation reduction.
All consultants requesting reimbursement are required to prepare an expense report within 45 days after the expense is incurred. In preparing an expense report, a consultant must enter, in detail, the elements of each expense. For business travel expenses, a consultant must show the business purpose, the amount of each separate expense, when the expense was incurred, and the travel locations. For other employee business expenses, the consultant must show the business purpose, amount, and date of each expense item. Consultants must submit a receipt for any expense item exceeding $25 (this amount may be increased from time to time up to the applicable legal limit of $75). Business mileage is substantiated by a record or log indicating when the expense was incurred and the business purpose for the transportation expense.
The employer examines all expense reports prior to payment to determine if the business purpose set forth on the report is reasonable and if the amounts claimed are reasonable. The employer approves, denies, or asks for additional information within 15 days of receiving the request for reimbursement. If additional information is requested, the consultant must provide it within 15 days, or the request will be denied.

The employer asked the IRS for a ruling that (1) the amounts reimbursed under the plan will be fully excludible from gross income of the consultants, and (2) that the amounts reimbursed are not wages subject to employment taxes and withholding, and need not be reported on Form W-2.

The IRS Ruling

The IRS began its ruling by noting that if an employer’s reimbursements of an employee’s business expenses are “accountable,” they are not included in the employee’s income, they are not reported on the employee’s W-2, and they are not subject to tax withholding. To be accountable, the “business connection,” substantiation, and “return of excess reimbursements” requirements explained above must be met. The IRS cautioned that “if an arrangement does not satisfy one or more of the three requirements, all amounts paid under the arrangement are treated as paid under a nonaccountable plan.” The result is that such reimbursements “are included in the employee’s gross income for the taxable year, must be reported to the employee on Form W-2, and are subject to the withholding and payment of employment taxes.”

The IRS concluded that the company’s plan satisfied all three requirements for an accountable plan. With respect to the third requirement, the IRS noted that “because the plan is a reimbursement arrangement, the amount reimbursed should not exceed the amount substantiated; thus, there should not be an excess to return.” As a result, assuming that expenses “are properly deductible and substantiated,” the IRS reached the following conclusions:

(1) Reimbursements made to a consultant under the plan may be excluded from the consultant’s income as payments made under an accountable plan.

(2) Reimbursements made to a consultant under the plan are not wages subject to employment taxes, and are not reportable on the consultant’s Form W-2.

Comparing the 1993 and 1999 IRS Rulings

Features of the employer’s reimbursement plan	*1993 ruling*	*1999 ruling*
Mandatory for all employees.	yes	yes
Employees reimbursed only for those business expenses that would be deductible as a business expense on their personal tax returns.	yes	yes
Prior to the start of each year, each employee’s manager determines the amount, if any, to be excluded from the employee’s commissions in the next year.	yes	yes
Reimbursements cannot exceed a “cap” specified by the employer. If a consultant’s expenses are less than the reimbursement cap, the difference between the expenses and the reimbursement cap will not be received by the employee and will not be carried over from one calendar year to the next.	yes	yes
If a consultant does not request reimbursement under the plan, he or she receives no additional compensation and remains subject to the base compensation reduction.	not mentioned in the IRS ruling	yes
All employees requesting reimbursement are required to prepare an expense report within 45 days after the expense is incurred. In preparing an expense report, an employee must enter, in detail, the elements of each expense. For business travel expenses, a consultant must show the business purpose, the amount of each separate expense, when the expense was incurred, and the travel locations. For other employee business expenses, the employee must show the business purpose, amount, and date of each expense item. Employees must submit a receipt for any expense item exceeding $25 (this amount may be increased from time to time up to the applicable legal limit of $75). Business mileage is substantiated by a record or log indicating when the expense was incurred and the business purpose for the transportation expense.	not mentioned in the IRS ruling	yes
The employer examines all expense reports prior to payment to determine if the business purpose set forth on the report is reasonable and if the amounts claimed are reasonable. The employer approves, denies, or asks for additional information within 15 days of receiving the request for reimbursement. If additional information is requested, the employee must provide it within 15 days, or the request will be denied.	not mentioned in the IRS ruling	yes
The employer’s reimbursement arrangement was deemed to be accountable.	no	yes

What ministers and lay church leaders need to know

Ministers, lay staff members, church treasurers, and church board members should be aware of the following points:

1. Reimbursing employee business expenses out of church funds. Churches and clergy wanting to eliminate any of the questions concerning the use of salary restructuring arrangements should adopt accountable reimbursement policies that reimburse business expenses out of church funds. Churches that are concerned with unlimited reimbursement arrangements can set a maximum amount that will be reimbursed per employee.

2. Salary reduction agreements. Some churches prefer to “reimburse” employee business expenses out of their employee’s own compensation, through a salary reduction arrangement. The objective is to eliminate any additional cost to the church for an employee’s business expenses. The tax code prohibits employers from paying for accountable reimbursements out of salary reductions. Such arrangements are not “illegal.” They simply cannot be “accountable.” Churches that use such an arrangement must recognize that all reimbursements paid through salary reduction are “nonaccountable,” and must be reported on the minister’s W-2. The 1999 IRS ruling addressed above does not change this limitation.

3. Salary restructuring arrangements. What about salary restructuring arrangements? Does the ban on using salary reduction arrangements to fund accountable expense reimbursements apply to these arrangements as well? The IRS answered “yes” to this question in a 1993 private letter ruling. However, in 1999 the IRS issued a private letter ruling that signals a retreat from the 1993 position.

Many churches use salary restructuring arrangements. The 1999 IRS ruling suggests that such arrangements can be accountable, if the following three conditions are met:

(1) Meet the three requirements of an accountable arrangement

These requirements (“business connection,” substantiation, and “return of excess reimbursements”) are summarized above. Each of these requirements must be met in order for a church’s reimbursement arrangement to be accountable.

(2) Meet the reimbursement requirement

Even if a reimbursement arrangement meets the three requirements of an accountable plan (business connection, substantiation, and return of excess reimbursements), it will not be accountable unless it meets the so-called reimbursement requirement. As noted above, the regulations define this requirement as follows:

If [an employer] arranges to pay an amount to an employee regardless of whether the employee incurs (or is reasonably expected to incur) business expenses … the arrangement does not satisfy [the reimbursement requirement] and all amounts paid under the arrangement are treated as paid under a nonaccountable plan.

To meet this requirement, it is essential that a church or other employer not agree to pay an employee a specified amount of compensation out of which business expenses may or may not be reimbursed. Salary reduction arrangements are not accountable because of this requirement. Why? Because with such an arrangement the employer agrees to pay the employee a specified amount of compensation for the year whether or not the employee submits any business expenses for reimbursement. And, when expenses are reimbursed, the reimbursements come out of the employee’s own compensation rather than out of church funds. This kind of arrangement is not really a “reimbursement” plan, since the church is not reimbursing anything. Rather, it is reducing the pastor’s reportable compensation to pay for the expenses.

Can a salary restructuring arrangement meet the reimbursement requirement? Possibly. In fact, this is the conclusion the IRS reached in its 1999 ruling. But this conclusion will not apply to any salary restructuring arrangement. There were several conditions present in the 1999 ruling that must be met for a salary restructuring arrangement to meet the reimbursement requirement.

• Tip. To increase the likelihood that a salary restructuring arrangement will be deemed accountable, a church should consider designating a minister’s salary and establishing a business expense reimbursement account as two separate actions of the board or compensation committee, without any indication that the reimbursement account is being funded out of what otherwise would be the minister’s salary. These separate actions may be viewed as sufficiently unrelated to be consistent with an accountable reimbursement arrangement.

(3) Meet the following essential conditions of the 1999 IRS ruling

The IRS concluded that a salary restructuring arrangement was “accountable” in its 1999 ruling. There were some factors present in that ruling that were essential to the conclusion reached by the IRS. These include the following:

Employees were reimbursed only for those business expenses that would be deductible as a business expense on their personal tax returns.
Prior to the start of each year, each employee’s manager determines the amount, if any, to be excluded from the employee’s commissions in the next year.
If an employee’s expenses are less than the reimbursement cap, the difference between the expenses and the reimbursement cap will not be received by the employee and will not be carried over from one calendar year to the next.
If an employee does not request reimbursement under the plan, he or she receives no additional compensation.

4. Examples. The following examples illustrate the most important principles addressed in this article.

Example 1. A church pays its senior pastor compensation of $50,000 in 1999. In addition, the church agreed to reimburse business expenses incurred by the pastor during the year up to $5,000, if the pastor provided adequate substantiation of each expense within 30 days. This is an accountable reimbursement arrangement. Amounts reimbursed by the church are not reported on the pastor’s W-2, or by the pastor on Form 1040 (line 7).

Example 2. Same facts as the example 1, except that the church also reimburses some personal expenses of the pastor, such as the personal use of a car. The regulations specify that if an employer reimburses both business and personal expenses of an employee, the employer “is treated as maintaining two arrangements. The portion of the arrangement that provides payments for the deductible employee business expenses is treated as one arrangement that satisfies [reimbursement requirement]. The portion of the arrangement that provides payments for the nondeductible employee expenses is treated as a second arrangement that does not satisfy [the reimbursement requirement] and all amounts paid under this second arrangement will be treated as paid under a nonaccountable plan.” As a result, the church does not accumulate “business expense” reimbursements on the pastor’s W-2, and the pastor does not report these reimbursements as taxable income on Form 1040 (line 7). However, the reimbursements of personal expenses are deemed to be nonaccountable. The church must report these reimbursements on the pastor’s W-2, and the pastor must include them as taxable income on Form 1040 (line 7).

Example 3. Same facts as example 1, except that the church accepts the pastor’s signed statement as to the amount of business expenses he incurs each month without any additional substantiation. This arrangement does not meet the “substantiation” requirement, and so is not accountable. Amounts reimbursed by the church are reported on the pastor’s W-2, and the pastor must include them as taxable income on Form 1040 (line 7). He may be able to claim a business expense deduction on his tax return for business expenses that he is able to substantiate.

Example 4. A church provides a pastor with a monthly $400 “car allowance.” The church board is certain that the pastor incurs business expenses of at least this much each month, and so does not require any additional substantiation. This arrangement does not meet the “substantiation” requirement, and so is not accountable. Amounts reimbursed by the church are reported on the pastor’s W-2, and the pastor must include them as taxable income on Form 1040 (line 7). He may be able to claim a business expense deduction on his tax return for expenses incurred in the use of his car for business that he is able to substantiate.

Example 5. A church issues its senior pastor a cash advance of $1,500 to cover all expenses incurred by the pastor in attending a church convention. The pastor is not required to substantiate any of her expenses. The entire amount represents a nonaccountable reimbursement, since the pastor is not required to substantiate expenses or return any “excess” reimbursement (in excess of substantiated expenses). The full amount of the cash advance must be reported by the church on the pastor’s W-2, and the pastor must report it as taxable income on Form 1040 (line 7). She may be able to claim a business expense deduction on her tax return for business expenses incurred during the trip that she is able to substantiate.

Example 6. Same facts as example 5, except that the pastor substantiates $1,200 of business expenses, but is allowed to keep the “excess” reimbursement ($300). The regulations specify that this arrangement is accountable up to the amount the pastor actually substantiates ($1,200), and it is nonaccountable with regard to the excess. As a result, the church must report the $300 excess on the pastor’s W-2, and the pastor must include this amount as taxable income on Form 1040 (line 7).

Example 7. In December of 1998, a church board agreed to pay its senior pastor a salary of $60,000 for 1999 ($1,154 per week). In addition, the church agreed to “reimburse” the pastor’s business expenses by reducing his salary. Each month, the pastor provided the church treasurer with the total amount of business expenses that he incurred for the previous month. The pastor provided no substantiation other than his own statement. Some months the pastor orally informed the treasurer of the amount of expenses for the previous month, while in other months he provided the treasurer with a note showing the total expense amount. The treasurer allocated the next weekly paycheck between salary and business expense “reimbursement”. To illustrate, in the first week of September the pastor informed the treasurer that he had incurred business expenses of $400 in August. The church treasurer issued the pastor his customary check in the amount of $1,154 for the next week-but it was allocated between business expense reimbursement ($400) and salary (the balance of $754). Assume that the pastor incurs $5,000 of business expenses during 1999. The church treasurer issues the pastor a W-2 showing compensation of $55,000 (salary of $60,000 less the “salary reductions” that were allocated to substantiated business expenses). This is incorrect. This arrangement does not meet the “reimbursement requirement” since: (1) The employer is not “reimbursing” the pastor’s expenses. A reimbursement assumes that the employer is paying for the employee’s business expenses out of its own funds. When an employer pays an employee for his or her business expenses through a salary reduction, it is the employee and not the employer that is paying for the expenses. Such an arrangement is not an employer “reimbursement.” (2) The arrangement fails the regulations’ “reimbursement requirement” since the church has agreed “to pay an amount to an employee regardless of whether the employee incurs (or is reasonably expected to incur) business expenses.” The church treasurer should have treated this arrangement as nonaccountable. The full amount of the salary reductions should have been reported on the pastor’s W-2, and the pastor should include this amount with taxable income on Form 1040 (line 7). He may be able to claim a business expense deduction on his tax return for expenses that he is able to substantiate.

Example 8. Same facts as example 7, except that the church requires the pastor to adequately substantiate (amount, date, location, and business connection) each expense in order to be reimbursed for it through salary reduction. Even though this arrangement meets the three requirements of an accountable plan (business connection, substantiation, return of excess reimbursements), it is not accountable since it does not meet the reimbursement requirement for the same reasons mentioned in example 7.

Example 9. In December of 1998, a church board agreed to set aside $60,000 for the pastor’s compensation package for 1999. It allocated this amount as follows: $45,000 salary, and $10,000 housing allowance, for total compensation of $55,000. In addition, the church agreed to reimburse substantiated business expenses of up to $5,000. The pastor was informed that if she incurred business expenses of less than $5,000 in 1999, she would not be paid or credited any portion of the unused balance. This arrangement would have been nonaccountable under the 1993 IRS ruling. However, the 1999 IRS ruling suggests that such an arrangement may be accountable, if the following factors are present: (1) The pastor is reimbursed only for those business expenses that would be deductible as a business expense on his personal tax returns; (2) prior to the start of each year, the church determines the amount to be excluded from the pastor’s compensation for the next year; (3) if the pastor’s expenses are less than the reimbursement cap ($5,000), the difference between the expenses and the reimbursement cap will not be paid to the pastor and will not be carried over from one calendar year to the next; and (4) if the pastor does not request any reimbursements under the plan, he receives no additional compensation. Remember that this conclusion is based on an IRS private letter ruling. Technically, such a ruling cannot be used as precedent for a particular tax position. However, the important point to note is that this ruling is of no less value than the 1993 IRS private letter ruling suggesting that such arrangements are not accountable. To increase the likelihood that this arrangement will be deemed to be accountable, the church board should adopt two resolutions-one establishing the “total compensation” amount (salary plus housing allowance), and the second establishing the reimbursement limit. Churches that use such arrangements should recognize that there is no guaranty that they will be deemed to be accountable by the IRS or the courts. It is still possible that the IRS will challenge the accountable nature of such arrangements. However, as a practical matter, ministers who can show an IRS agent during an audit that their situation is substantially similar to the 1999 IRS private letter ruling have a reasonable chance of prevailing.

Example 10. Same facts as example 9, except that the church distributes to the pastor any unused portion of the reimbursement cap at the end of the year. To illustrate, if the pastor only requests reimbursement of $3,500 of business expenses during 1999, the church treasurer issues her a “bonus” of $1,500 (the unused portion of the $5,000 cap) at the end of the year. The better view is that this entire arrangement is nonaccountable. The full $5,000 “reimbursement account” must be reported on the pastor’s W-2, and the pastor should include this amount with taxable income on her Form 1040 (line 7). She may be able to claim a business expense deduction on her tax return for expenses that she is able to substantiate. These conclusions are based on the following two considerations: (1) The income tax regulations contain the following example: “Employer Y provides expense allowances to certain of its employees to cover business expenses of a type described in paragraph (d)(1) of this section under an arrangement that requires the employees to substantiate their expenses within a reasonable period of time and to return any excess amounts within a reasonable period of time. Each time an employee returns an excess amount to Employer Y, however, Employer Y pays the employee a “bonus” equal to the amount returned by the employee. The arrangement fails to satisfy the requirements of paragraph (f) (returning amounts in excess of expenses) of this section. Thus, Employer Y must report the entire amount of the expense allowance payments as wages or other compensation and must withhold and pay employment taxes on the payments when paid.” (2) The regulations specify that the “return of excess reimbursements” requirement is met, and so a reimbursement arrangement is accountable, “only if the amount of money advanced is reasonably calculated not to exceed the amount of anticipated expenditures ….” A more aggressive view would be to treat only the “bonus” ($1,500) as nonaccountable, rather than the entire reimbursement account ($5,000). This outcome is based on examples in the income tax regulations illustrating that if employees are reimbursed more than their substantiated reimbursed business expenses, only the excess is deemed nonaccountable. This approach should not be adopted without the advice of a tax professional.

5. Private letter rulings. A private letter ruling cannot be used as legal precedent. It is a very limited decision that applies only to the taxpayer who requested it. This means that ministers and other taxpayers cannot rely on the 1999 private letter ruling addressed in this article as a basis for treating a salary “restructuring” arrangement as an accountable plan. On the other hand, the 1993 IRS ruling that treated a salary restructuring arrangement as a salary reduction plan was also a private letter ruling. As such, it is entitled to no more weight that the 1999 ruling. Neither can be used as a legal basis for a particular position. At best, they suggest what an official IRS ruling might be.

© Copyright 1999 by Church Law & Tax Report. All rights reserved. This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is provided 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. Church Law & Tax Report, PO Box 1098, Matthews, NC 28106. Reference Code: m24 m27 c0599

Richard R. Hammar is an attorney, CPA and author specializing in legal and tax issues for churches and clergy.

The Legal Consequences of Clergy Seducing Employees

A federal court issues an important ruling.

Richard R. Hammar, Attorney, CPA

Bio

Article summary. A federal court in Texas addressed the complex legal issues surrounding the sexual seduction of church employees by a minister. The court concluded that the employees could sue the minister for negligence, breach of a fiduciary duty, and intentional infliction of emotional distress—even though the sexual relationships were allegedly consensual. However, the court dismissed the employees’ sexual harassment claims against the minister, all of the employees’ claims against the church, and the minister’s wrongful termination claim against the church. This important ruling is discussed fully in this feature article.

When a minister engages in a sexual relationship with a church employee, several legal consequences may result affecting the minister, church, and employee. Many of these consequences were illustrated in a recent federal court ruling in Texas. The court’s ruling will be instructive to all church leaders. This article will summarize the facts of the case, explain the court’s ruling, and evaluate the importance of the case to other churches and church staff members.

Facts

A church’s minister of education was contacted by a woman seeking marital counseling. At the time, the woman was employed as a waitress at a local restaurant. The relationship resulted in a sexual affair that lasted several months. During this time the minister hired the woman as a receptionist at the church. She later informed the minister that she wanted to quit seeing him.

At the same time that he was seeing this woman the minister was engaging in sexual relations with another woman who had come to him for marital counseling. The second woman, like the first woman, was hired to work in the church office. The second woman informed the minister that she wanted to terminate their relationship after an affair lasting nearly a year and a half.

The two women worked next to each other in the church office. One of them informed the other of her affair with the minister and was shocked to learn of the other’s similar experience. The women informed a church deacon of their relationships with the minister, and the minister was confronted immediately. He confessed to the church’s senior minister that he had committed adultery with both women, and accepted the church’s request to resign. The two women were placed on administrative leave with pay pending an investigation, and a few months later they were dismissed.

The women later sued the dismissed minister on the basis of:

malpractice in pastoral counseling
breach of fiduciary duties
sexual harassment in employment
intentional infliction of emotional distress

The women also sued the church on the basis of:

breach of fiduciary duties
malpractice in pastoral counseling
intentional infliction of emotional distress
negligent hiring
negligent retention
negligent supervision
sex discrimination in dismissing them from employment
sexual harassment in employment
retaliation for disclosing sex discrimination

Both the dismissed minister and church asked the court to dismiss the case. The court’s response to these requests is summarized below.

The claims against the dismissed pastor

malpractice in pastoral counseling

The women claimed that the dismissed minister’s conduct constituted “malpractice in pastoral counseling.” The minister countered by arguing that pastoral counseling is rooted in religion and cannot be the basis for civil liability. The court concluded that the pastor could be sued for his actions. It observed that

[we agree] with the many decisions that have held that an action for clergy malpractice could not be maintained because the evaluation of such a complaint would require the court to extensively investigate and evaluate religious tenets and doctrines. However, tort claims for behavior by a cleric that does [sic] not require the examination of religious doctrine are cognizable. The free exercise [of religion] clause does not relieve an individual of the obligation to comply with neutral laws of general applicability … nor does it shield clergy from all liability for their wrongs.

In addition, while spiritual counseling, including a cleric’s marital counseling, may implicate first amendment rights, the court is not convinced that [the women’s] allegations permit [the minister] to assert a free exercise defense. When the free exercise [of religion] clause is raised as a defense, the threshold question is whether the conduct of the defendant is religious. In the spiritual counseling context, the free exercise clause is relevant only if the defendant can show that the conduct that allegedly caused plaintiff’s distress was in fact part of the belief and practices of the religious group.

In other words, pastoral counseling is protected from civil liability only if the practice is itself religious. In this case, however, the actions of the dismissed minister in engaging in prolonged adulterous affairs with two women were not religious. The court observed:

[The minister’s] preying on [the women], masqueraded in the form of marriage counseling, constitutes conduct that is not subject to first amendment protection. Certainly such conduct is not part of the beliefs and practices of [the church]. Therefore, to the extent that [the women’s] claim is based on [the minister’s] holding himself out to provide services of a marriage counselor, [their] claim under these circumstances is for professional malpractice by a marriage counselor, not clergy malpractice. Although [the lawsuit] labels this claim negligence (malpractice in pastoral counseling), the court will construe the claim based on the facts alleged as one for professional malpractice by a marriage counselor.

In support of this conclusion, the court pointed to the following facts: (1) The minister offered his services to help the women with their marital problems. (2) Each woman claimed that the minister offered “to provide me with marital counseling,” and described the nature and extent of the marriage counseling and the fact that the minister bragged about his “skills and experience as a marital counselor.” (3) The minister held himself out as a skilled and experienced marital counselor with a psychology degree, and undertook to provide such counseling.

• Key point. The courts have consistently refused to find clergy liable on the basis of “malpractice” for their pastoral counseling. However, this case illustrates that this rule only applies to the content of counseling that is religious in nature, and not to inappropriate behavior that is engaged in during the counseling relationship. The court concluded that ministers who engage in sexual contact with counselees in the course of marriage counseling may be sued on the basis of malpractice—as marriage counselors rather than as clergy.

breach of fiduciary duties

The women claimed that the dismissed minister breached his “fiduciary duty” to them by taking advantage of the “special confidence and trust” they had placed in him as a pastoral counselor. Specifically, they maintained that a fiduciary relationship existed on the basis of the following factors:

(1) They entered into a counselor—counselee relationship with the dismissed minister based, in part, on his representations regarding his expertise in marriage counseling.

(2) The dismissed minister solicited their trust and confidence with his alleged ability to help them with their marital problems.

(3) The dismissed minister made misrepresentations to them for the purpose of seducing their affections and emotional dependence for his own benefit rather than their’s.

(4) The dismissed minister breached his fiduciary duty in disclosing to others confidential information he obtained during counseling with the two women.

The church insisted that the position of religious advisor does not impose a fiduciary duty or establish a fiduciary relationship. The church pointed out that no Texas court had recognized a fiduciary relationship between a minister and a member of a congregation. Once again, the court agreed with the women and allowed them to sue the dismissed minister for breaching a fiduciary duty that he owed them as a pastoral counselor. While conceding that Texas courts have not recognized a fiduciary relationship between a minister and counselee, the court did note that the state supreme court had recognized that certain “informal relationships” may give rise to a fiduciary duty. The supreme court stated that such “informal fiduciary relationships … may arise where one person trusts in and relies upon another, whether the relation is a moral, social, domestic or merely personal one.” The supreme court further noted that because not every relationship involving a high degree of trust and confidence is a fiduciary relationship, “the law recognizes the existence of [such] relationships in those cases in which influence has been acquired and abused, in which confidence has been reposed and betrayed.”

The state appeals court concluded that “genuine issues of material fact are present in this case regarding whether confidential relationships existed between [the dismissed minister and the women] in which influence had been acquired and abused, in which confidence had been reposed and betrayed.” As a result, in ruled that the women could proceed with their lawsuit against the minister on the basis of a breach of his fiduciary duties. The court noted that if the women’s allegations were true, it

would have little difficulty finding that [the dismissed minister owed the women] a fiduciary duty as a marriage counselor …. His duty would be created by his undertaking to counsel them. Moreover, [his] alleged undertaking would create a duty to engage in conduct designed to improve [the women’s] respective marital relationships. Thus, entering into the sexual relationships would be clear evidence of a breach of [his] fiduciary duties.

• Key point. A number of courts have ruled that a “fiduciary relationship” arises when a minister engages in a counseling relationship with another person, and that this relationship imposes a duty upon the minister to act in the best interests of the counselee. This duty is breached when the minister engages in sexual contact with the counselee. This may be true even if the sexual contact is consensual.

• Key point. The court suggested that a minister can be sued on the basis of a breach of fiduciary duty if confidential information obtained during the counseling relationship is disclosed.

sexual harassment in employment

The women claimed that the dismissed minister sexually harassed them. The court rejected this theory of liability. It noted that to establish sexual harassment in the work place, a plaintiff must show that:

(1) she belongs to a protected class; (2) she was subject to unwelcome sexual harassment; (3) the harassment was based on sex; (4) the harassment affected a term, condition, or privilege of employment; and (5) the employer knew or should have known of the harassment and failed to take prompt remedial action.

The court ruled that the minister could not be liable for sexual harassment for his activities prior to the time the women terminated their sexual relationships with him. It concluded that the women’s argument that they were incapable of giving psychological consent is without merit … the court finds that [they] freely consented to their respective adulterous affairs with [the minister].

• Key point. The court erred in ruling that sexual harassment cannot exist if the victim consents to the harassment. The law defines sexual harassment as “unwelcome sexual advances, requests for sexual favors, and other verbal or physical conduct of a sexual nature.” Sexual harassment occurs if the offender’s actions are unwelcome, even if the victim consents to them. Many times victims feel they have choice but to consent. The United States Supreme Court, in addressing this question, observed: “[T]he fact that sex—related conduct was voluntary in the sense that the complainant was not forced to participate against her will, is not a defense to a sexual harassment suit …. The gravamen of any sexual harassment claim is that the alleged sexual advances were unwelcome …. The correct inquiry is whether [the victim] by her conduct indicated that the alleged sexual advances were unwelcome, not whether her actual participation in sexual intercourse was voluntary.” In other words, a female employee may engage in voluntary sexual contact with a supervisor because of her belief that her job (or advancement) depends on it. While such contact would be voluntary, it is not necessarily welcome. Sexual harassment addresses unwelcome sexual contact, whether or not that contact is voluntary.

The court found no evidence of sexual harassment after the women terminated their sexual relationships with the dismissed minister. Further, the dismissed minister had no opportunity to punish the women for terminating their relationships with him since he was fired a few weeks later when the women informed church officials.

intentional infliction of emotional distress

The women claimed that the dismissed minister’s misconduct amounted to “intentional infliction of emotional distress.” The court noted that intentional infliction of emotional distress requires proof that (1) the dismissed minister acted intentionally or recklessly; (2) his conduct was extreme or outrageous; (3) his actions caused the women emotional distress; and (4) the emotional distress was severe. The court concluded that the dismissed minister’s misconduct, if proven, could satisfy all four of these requirements. It observed: “[The women’s] allegations that [the minister] sexually harassed [them] at work, made graphic sexual comments and gestures, and engaged in a sexual relationship, at relatively the same time, with two employees who worked within a few feet of each other, could rise to the level of extreme or outrageous conduct under certain circumstances.”

The claims against the church

breach of fiduciary duty, malpractice in pastoral counseling, intentional infliction of emotional distress

The women claimed that the church was liable for the dismissed minister’s breach of fiduciary duty, malpractice in pastoral counseling, and intentional infliction of emotional distress. The court noted that the church could be liable for these “intentional wrongs” only if the dismissed minister was acting “within the course and scope of his employment” at the time he was counseling the women and engaging in sexual contact with them. The court concluded that the women had failed to prove that the minister’s misconduct occurred within the course and scope of his employment:

Counseling was not a part of [the dismissed minister’s] job description or within his job authority. [The senior pastor] informed [him] that he was never to counsel ….

In addition, the court notes that sexual misconduct by a member of the clergy is, by the weight of the authority, beyond the scope of employment of the cleric. Furthermore, [the church’s] policy provided that adultery by any member of the clergy is immediate grounds for dismissal. Thus, the court finds that [the church] should not be held vicariously liable for any intentional torts attributed to [the dismissed minister].

The court conceded that the dismissed minister’s counseling could be within the course and scope of his employment if church officials were aware that he was counseling with the two women but took no action to stop him. The women pointed to the following incidents to demonstrate that the church knew the minister was counseling with them:

On one occasion an associate minister of the church walked into the dismissed minister’s office and found him alone with one of the two women. The associate minister later informed the woman that the dismissed minister was not supposed to be counseling with anyone. The court concluded that this incident did not prove that the church “knew” that the dismissed minister was counseling with one of the women, because when the associate minister asked the woman if the dismissed minister had been counseling with her she replied “no.”

The two women provided several examples of other women who “felt uncomfortable” around the dismissed minister. The court insisted that this evidence does not show that [the church] knew that [the dismissed minister] was counseling [the women] or that he was engaged in a sexual relationship with them.

The senior pastor told the dismissed minister that his car was seen parked outside the home of one of the two women. Again, the church insisted that this evidence did not establish that the church was aware that the dismissed minister was counseling with the woman. Further, it pointed out that “when [the women] informed [the church] of [the minister’s] conduct [the church] promptly requested [his] resignation.”

The women also claimed that the church was liable for the dismissed minister’s acts on the basis of ratification. The court conceded that an employer that ratifies the misconduct of an employee may be liable for that misconduct. It noted that ratification occurs when the employer fails to repudiate the known acts of an employee. However, it found that the church did not ratify the [wrongful] acts because [the women] have failed to show that [the church] knew or should have known about such conduct.

negligent hiring, negligent retention, negligent supervision

The women claimed that the church was responsible for their injuries on the basis of its negligence in hiring, retaining, and supervising the dismissed minister. The court disagreed. It noted that

In Texas, employers have a duty to inquire as to the competence and qualifications of those the employer considers for employment …. To prevail on a claim for negligent hiring or supervision, a plaintiff must show that the employer retained in its employment an individual who was incompetent or unfit for the job as a result of a failure to make a reasonable inquiry into the individual’s competence and qualifications.

However, the court concluded that the church “made a reasonable inquiry into [the dismissed minister’s] competence and qualifications.” It pointed to the following factors:

A member of the church’s pastoral search committee was informed by a friend that the dismissed minister had a good reputation.

A member of the church’s pastoral search committee contacted three references from the dismissed minister’s previous employer (another church). All three references had favorable comments regarding the minister.

A member of the pastoral search committee met with the dismissed minister on one occasion.

The church’s senior pastor and two other church members met with the dismissed minister on another occasion.

The dismissed minister and his wife met with all of the members of the search committee.

A former pastor of the dismissed minister’s prior church employer, and currently a denominational leader at the state level, told the senior pastor that “I want you to know that if I were to leave denominational work and go back into the pastorate today, that I would do whatever I had to do and pay whatever I had to pay to get [the dismissed minister] on my staff as education minister. He’s the best there is.” The denominational official was the dismissed minister’s supervisor for more than ten years in his prior church.

The church received a very favorable recommendation from another denominational official.

The court concluded: “[The church] was only required to conduct a reasonable search, not an exhaustive investigation. Therefore, the court finds that [it] did conduct a reasonable search into [the dismissed minister’s] competence and qualifications before it hired him.”

In rejecting the women’s claim that the church was guilty of negligent retention and negligent supervision the court pointed out that the church “did not know, nor should it have known, that [the minister] was counseling [the women] and engaging in a sexual relationship with them.” The court noted that the women “worked within a few feet of each other without knowing of each other’s relationship with [the minister].”

• Key point. The court concluded that the church was not negligent in hiring the minister on the basis of (1) the positive comments of several references, including the minister’s former supervising pastor, and (2) a personal interview.

• Key point. The court concluded that a church cannot be responsible on the basis of negligent retention or negligent supervision for the sexual misconduct of a pastor if his two victims worked next to each other in the church office and were unaware of the other’s relationship with him.

sex discrimination in dismissing the women from employment

The women claimed that the church committed unlawful sex discrimination in violation of Title VII of the Civil Rights Act of 1964 by dismissing them from employment. The court noted that to win a sex discrimination case under Title VII, a plaintiff must

first prove by a preponderance of the evidence a prima facie case of discrimination. The plaintiff may prove her case by direct or circumstantial evidence. A plaintiff makes out a prima facie case of sex discrimination by proving: (1) she was discharged; (2) she was qualified for the position; (3) she was within the protected class at the time of discharge; and (4) she was replaced by someone outside the protected class, or otherwise discharged because of her sex. If the plaintiff is successful in making out a prima facie case of discrimination, the burden shifts to the defendant to show a legitimate, nondiscriminatory reason for the adverse employment decision. If the defendant articulates a nondiscriminatory reason of its adverse employment action, then the presumption is rebutted and the plaintiff must prove that the nondiscriminatory reason was a pretext for discrimination.

The court concluded that the women had failed to demonstrate that the church committed sex discrimination, noting that

[they] have offered no evidence to show that they were replaced by someone outside the protective class, or that they were discharged because of their sex. Thus, [they] have failed to make out a prima facie case of discrimination. In addition, even if [they] did make out a prima facie case of discrimination, [they] have produced no evidence to show that [the church’s] reasons for terminating them were a mere pretext for discrimination. Rather, after [the church] learned that [the women and the dismissed minister] had entered into adulterous relationships [the church] placed [the women] on administrative leave with pay pending an investigation and advice from the insurance carrier regarding potential church liability. Furthermore, [the church] promptly requested [that the minister] resign. After [the women] were placed on leave [the church] assigned their former duties to incumbent female employees.

The court noted that the church’s personnel policies provide that any moral conduct that is inconsistent with the “Lord’s standards” is “just cause” for an employee’s dismissal. The women did not dispute that entering into an adulterous relationship was inconsistent with the Lord’s standards. After the church concluded its investigation it offered the women the opportunity to resign. When they refused, the church terminated them for violating the personnel policy prohibiting conduct inconsistent with the Lord’s standards. Based on this uncontradicted evidence, the court concluded that the women “have failed to offer any evidence to show that [the church’s] reasons for terminating them were a mere pretext for discrimination.” The court rejected the women’s claim that their conduct was somehow legitimized by their inability to “consent” to their sexual relations with the minister.

The women claimed that the dismissed minister received a more favorable termination package, and that this amounted to sex discrimination by the church in violation of Title VII. The court rejected this argument, noting that the church asked the dismissed minister to resign immediately, and gave him one month severance pay. The church placed the women on involuntary leave with pay for two months, and paid them for two months of psychiatric counseling. The court concluded that “[a]ny difference in the termination package between [the women and the minister] is immaterial to a proper determination of [the women’s] sex discrimination claim.”

• Key point. Churches are free to dismiss employees for violation of religious standards, so long as such dismissals are not a pretext for unlawful discrimination and “similar cases are treated similarly.” In this case, the church avoided liability for sex discrimination since it treated similarly a male and two females guilty of adultery.

sexual harassment in employment

The court noted that the women had failed to demonstrate that the dismissed minister had sexually harassed them, and therefore the church could not be responsible either. The court further noted that even if the women had proven that the dismissed minister’s actions amounted to sexual harassment, his employing church could not be responsible for his acts unless it “knew or should have known of the harassment and failed to take prompt remedial action.” The court pointed out that the church “did not know, nor should it have known of [the minister’s] conduct.”

This is the second serious error made by the court (the first was its conclusion that “consensual” acts can never constitute sexual harassment). Guidelines published by the Equal Employment Opportunity Commission (a federal agency that enforces Title VII) specify:

[A]n employer … is responsible for its acts and those of its agents and supervisory employees with respect to sexual harassment regardless of whether the specific acts complained of were authorized or even forbidden by the employer and regardless of whether the employer knew or should have known of their occurrence. The Commission will examine the circumstances of the particular employment relationship and the job junctions performed by the individual in determining whether an individual acts in either a supervisory or agency capacity.

With respect to conduct between fellow employees, an employer is responsible for acts of sexual harassment in the workplace where the employer (or its agents or supervisory employees) knows or should have known of the conduct, unless it can show that it took immediate and appropriate corrective action.

To summarize, if the dismissed minister was the church’s agent or was a “supervisory employee” the church could have been responsible for his acts of sexual harassment whether or not it knew or should have known they were occurring—even if they were strictly forbidden by the church’s policies. It is possible if not likely that a minister of education (such as the dismissed minister) would be deemed an agent or supervisory employee.

retaliation for disclosing sex discrimination

The women claimed that the church had committed unlawful “retaliation” against them in violation of Title VII. Title VII prohibits employers from retaliating against employees for conduct protected by Title VII. The women claimed that the church retaliated against them unlawfully by dismissing them for disclosing the relationships they had conducted with the dismissed minister. The court disagreed, noting that the church could not be responsible for retaliation since its decision to dismiss the women was not sex discrimination.

The minister’s claims against the church

The dismissed minister sued the church on the basis of breach of contract and wrongful dismissal. Specifically, he claimed that the senior pastor and a deacon “made unkept promises” to him that induced him to sign his letter of resignation and letter of repentance. One alleged promise was that the pastor would “secure him reemployment without breaching confidences.” Presumably, this meant that the senior pastor would recommend the dismissed minister to other congregations without disclosing the nature of his misconduct. The court pointed out that the senior pastor did not promise to secure reemployment for the dismissed minister, but merely assured him that he would “help him find a job.” The court observed that “this naked assertion does not constitute a binding contract because it lacks consideration.” The court also concluded that the first amendment prevents the civil courts from resolving wrongful dismissal lawsuits brought by dismissed ministers against their former churches:

Civil court review of ecclesiastical decisions of church tribunals, particularly those pertaining to the hiring or firing of clergy, are in themselves an extensive inquiry into religious law and practice, and hence forbidden by the first amendment. Courts have concluded that matters touching the relationship between a church and its minister, determination of salary, and assignment of duties and location, are matters of church administration and government and thus purely of ecclesiastical cognizance. Religious bodies may make apparently arbitrary decisions affecting the employment status of their clergy members and be free from civil review having done so. By its very nature, the inquiry which [the dismissed minister] would have us undertake into the circumstances of his discharge plunges an inquisitor into a maelstrom of church policy, administration, and governance. It is an inquiry barred by the free exercise clause [of the first amendment].

[The minister] argues that this court can decide this case based on neutral principles because it involves a general contractual dispute. [A federal appeals court has] stated that “the neutral principles doctrine” “has never been extended to religious controversies in the areas of church government, order and discipline, nor should it be.” Hutchison v. Thomas, 789 F.2d 392 (6th Cir. 1986). [The dismissed minister’s] claim relates to his employment as a minister …. Therefore, his claim “concerns internal church discipline, faith, and organization, all of which are governed by ecclesiastical rule, custom, and law.” Therefore, the court finds that the first amendment bars [the minister’s] claims ….

Significance of the case to other churches

What is the relevance of this ruling to local churches? Obviously, a decision of a federal district court in Texas is of limited significance since it has no direct or binding effect in any other state. Nevertheless, there a number of aspects to the ruling that will be instructive to church leaders in every state. Consider the following:

1. Malpractice in pastoral counseling. The court acknowledged that ministers cannot be sued on the basis of malpractice if the resolution of such a lawsuit would require a court to “extensively investigate and evaluate religious tenets and doctrines.” On the other hand, when ministers engage in sexual contact with counselees in the course of a counseling relationship they are subject to civil liability for their acts. Further, the court pointed out that the minister held himself out as a qualified marriage counselor, and it was in this capacity that the two women sought out his services.

• Key point. Ministers who hold themselves out as marriage counselors are more vulnerable to malpractice claims than pastors who engage in counseling in the course of their pastoral duties.

2. Breach of fiduciary duties. The court concluded that ministers who engage in marriage counseling may create a fiduciary relationship with their counselees that imposes upon them a duty to act in the counselees’ best interests. Taking advantage of a counselee’s dependence or vulnerability for purposes of sexual gratification represents a blatant violation of this duty that subjects the minister to legal liability.

• Key point. Ministers who engage in sexual contact with a counselee may be guilty of a number of “intentional wrongs” including battery, breach of a fiduciary duty, and intentional infliction of emotional distress. Generally, intentional wrongs are not covered under a church’s liability insurance policy, and so a minister who commits such acts may find that he must pay for his own attorney and any portion of a judgment or settlement attributable to his conduct. Further, such acts constitute a criminal offense in several states.

3. Sexual harassment in employment. The court erred in concluding the minister was not guilty of sexual harassment with respect to “consensual” sexual contacts with the two female employees. As noted above, sexual harassment occurs if the offender’s actions are unwelcome, even if the victim consents to them. The court also erred in holding that the church could not be liable for the minister’s acts (even if they did constitute sexual harassment) since it was not aware they were occurring. As noted above, guidelines published by the Equal Employment Opportunity Commission specify that “an employer … is responsible for its acts and those of its agents and supervisory employees with respect to sexual harassment regardless of whether the specific acts complained of were authorized or even forbidden by the employer and regardless of whether the employer knew or should have known of their occurrence.”

While the court was completely off base in its analysis of the women’s sexual harassment claims, the case does illustrate the potential significance of this basis of liability. Had the court decided these issues correctly, the church likely would have been found liable—assuming that the minister was an agent or supervisory employee of the church.

Sexual harassment is a form of “sex discrimination” prohibited by Title VII of the Civil Rights Act of 1964. Note that Title VII only applies to employers that (1) have 15 or more employees, and (2) are engaged in interstate commerce. Accordingly, it does not apply to most churches (it does apply to many denominational agencies engaged in interstate sales). The court in this case assumed that Title VII applied to the church, without any explanation.

• Key point. Title VII does not apply to most churches. However, most states have enacted their own civil rights laws that often ban sex discrimination and sexual harassment, and it is much more likely that these state laws will apply to churches. As a result, sexual harassment is a theory of liability that all churches should take seriously.

A current EEOC regulation entitled “EEOC Guidelines on Discrimination Because of Sex” specifies, in part:

(a) Harassment on the basis of sex is a violation of Sec. 703 of Title VII. Unwelcome sexual advances, requests for sexual favors, and other verbal or physical conduct of a sexual nature constitute sexual harassment when (1) submission to such conduct is made either explicitly or implicitly a term or condition of an individual’s employment, (2) submission to or rejection of such conduct by an individual is used as the basis for employment decisions affecting such individual, or (3) such conduct has the purpose or effect of unreasonably interfering with an individual’s work performance or creating an intimidating, hostile, or offensive working environment.

This regulation confirms the conclusion reached by numerous state and federal courts that sexual harassment includes at least two separate types of conduct:(1) “Quid pro quo” harassment, which refers to conditioning employment opportunities on submission to a sexual or social relationship, or (2) “hostile environment” harassment, which refers to the creation of an intimidating, hostile, or offensive working environment through unwelcome verbal or physical conduct of a sexual nature.

4. Sex discrimination. One of the most important aspects of this case was the court’s conclusion that the church did not commit sex discrimination when it fired the two female employees since it did not treat them any less favorably than it treated the male minister who was sexually involved with them. This case illustrates that churches subject to Title VII can discriminate in employment decisions on the basis of religious standards. However, there are a few very important qualifications here that were mentioned by the court:

The discrimination must in fact be based on religion. Religion cannot be a “pretext” to discriminate on the basis of sex, pregnancy, or some other protected category.

While a church can discriminate on the basis of religion, it must do so in a way that does not adversely impact a protected group of employees. The dismissed female employees insisted that the severance package the church offered the dismissed minister was more attractive than what they were offered. The court evaluated the terms and conditions of the termination of all of these workers, and concluded that the church had treated the women and the male minister similarly. The dismissed minister was forced to resign immediately, and was given one month severance pay. The church placed the two women on involuntary leave with pay for two months, and paid them for two months of psychiatric counseling. The court concluded that [a]ny difference in the termination package between [the women and the minister] is immaterial to a proper determination of [the women’s] sex discrimination claim.

• Key point. Churches can discriminate against employees on the basis of religion, but they must be able to demonstrate that religion is not a pretext of discriminating against a protected group of workers. If the church had dismissed the women but not the minister, the religious exemption would not apply.

5. Negligent hiring. The court acknowledged that employers can be liable on the basis of negligent hiring for the misconduct of an employee committed in the course of employment if a reasonable background investigation into the employee’s “competence and qualifications” was not conducted at the time of employment. In this case, the court concluded that the church conducted a reasonable investigation into the minister’s competence and qualifications at the time he was hired. It based this conclusion on the following facts: (1) the church obtained favorable references from three persons in the minister’s previous church; (2) the minister was interviewed on three occasions (by a member of the pastoral search committee, by the senior pastor and two church members, and by the entire pastoral search committee); and (3) the church obtained favorable references from two denominational officials—one of whom was the minister’s former supervising pastor.

6. Negligent retention and supervision. The court reached the perfectly logical conclusion that a church cannot be liable for negligently retaining and supervising a minister who commits adultery with two female employees if the employees themselves, who worked next to each other in the church office, were not aware of the other’s relations with the minister. This will be a useful precedent to other churches that are accused, in hindsight, of negligently retaining or supervising a minister.

7. The church’s lack of knowledge. The court concluded that the church was not aware that the minister of education was engaging in unauthorized marital counseling, despite the fact that (1) on one occasion an associate minister of the church walked into his office and found him alone with one of the two female employees who later filed the lawsuit; (2) the two female employees provided several examples of other women who “felt uncomfortable” around the dismissed minister; and (3) the senior pastor told the minister of education that his car was seen parked outside the home of one of the two female employees.

• Key point. Had the church known that the minister was violating church policy by engaging in unauthorized counseling, the court would have found it liable for the minister’s wrongful acts on several grounds. This illustrates a critical point—churches that have adopted policies must be sure those policies are being followed. A failure to abide by stated policies can expose a church to significant legal risks. Church leaders should periodically review policies, and assess whether or not they are being followed. If they are not, efforts should be made to immediately begin enforcing them. If this is no longer possible with respect to a particular policy, it should be abandoned.

8. Ratification. The court concluded that the church had not “ratified” the minister’s wrongful acts since it did not know of them and fail to repudiate them.

9. The what ifs? The church in this case handled matters very well. Consider the following: (1) It thoroughly screened the minister of education before hiring him; (2) church policy prohibited the minister from engaging in counseling; (3) church leaders had no knowledge that the minister of education was engaging in unauthorized counseling or in wrongful conduct; (4) when confronted by the two women with allegations of wrongdoing, the church immediately launched an investigation resulting in a paid leave of absence for the women and a forced resignation of the minister; and (5) the church offered comparable “severance packages” to the two women and the minister, thereby avoiding liability for sex discrimination. What if any of these factors had not been present? What if the church had not screened the minister when he was hired? What if the church was aware of unauthorized counseling by the minister of education? What if the church was aware of the minister’s wrongful acts but took no action against him, or treated the women less favorably than the minister? In any of these situations, the church would have faced potentially significant liability for the minister’s wrongful acts.

This case demonstrates how a church can meaningfully reduce its exposure to legal risk by how it handles employment decisions. Church leaders should ask themselves this question—if a woman in our church made similar allegations against our minister, would we be as successful in avoiding liability? Or, would we be vulnerable? This case will provide church leaders with helpful guidance in reducing exposure to legal risk.

Sanders v. Casa View Baptist Church, 898 F. Supp. (N.D. Tex. 1995)

Richard R. Hammar is an attorney, CPA and author specializing in legal and tax issues for churches and clergy.