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Church Responsible for Payroll Taxes

Pastor deemed responsible for total amount of delinquent payroll taxes.

Key point. Federal law requires churches to comply with several payroll tax reporting obligations. Almost every church will be subject to at least some of these rules. Many states have similar provisions. Church leaders must take these rules seriously, since penalties are assessed for noncompliance. For example, church officers may be personally liable for a penalty equal to the amount of payroll taxes that are not withheld or deposited. It is essential for church leaders to understand these rules.

A federal district court in North Carolina ruled that a pastor was responsible for 100 percent of payroll taxes that her employing church failed to withhold or pay over to the government. A pastor filed for bankruptcy protection from her creditors. The IRS filed a claim for $88,000 with the bankruptcy court based on its assertion that the pastor was liable for $88,000 in unpaid payroll tax obligations of her church since she was a "responsible person" liable for unpaid payroll tax obligations. The pastor asked the court to reject the IRS claim on the grounds that she was not a "responsible person," and that any recognition of the IRS claim was barred by the First Amendment's guaranty of religious freedom. The bankruptcy court rejected the pastor's defenses, and the case was appealed to a federal district court.

The court began its opinion by noting that "federal law requires employers to withhold federal income taxes and Social Security taxes from employee wages and remit those taxes to the United States. The employer holds these taxes in trust for the United States." And, although the employer "remains liable for the unpaid payroll taxes, its officers and agents may incur personal liability for the unpaid payroll taxes." Section 6672 of the tax code states:

Any person required to collect, truthfully account for, and pay over any tax imposed by this title who willfully fails to collect such tax, or truthfully account for and pay over such tax, or willfully attempts in any manner to evade or defeat any such tax or the payment thereof, shall … be liable to a penalty equal to the total amount of tax evaded, or not collected, or not accounted for and paid over.

In order for an individual to be held personally liable under this section: "(1) the party assessed must be a person required to collect, truthfully account for, and pay over the tax, referred to as a 'responsible person'; and (2) the responsible person must have willfully failed to insure that the withholding taxes were paid."

responsible person

The court noted that the question of who within an organization is a "responsible person" required to collect and pay the payroll taxes to the United States, is a "pragmatic, substance-over-form inquiry into whether an officer or employee so participated in decisions concerning payment of creditors and disbursement of funds that he effectively had the authority—and hence a duty—to ensure payment of the corporation's payroll taxes." In other words, the "crucial inquiry is whether the person had the effective power to pay the taxes—that is, whether he had the actual authority or ability, in view of his status within the corporation, to pay the taxes owed."

When making the determination of who is a "responsible person," courts have considered several factors which are indicative of this authority, including whether the employee:

(1) served as an officer of the company or as a member of its board of directors; (2) controlled the company's payroll; (3) determined which creditors to pay and when to pay them; (4) participated in the day-to-day management of the corporation; (5) possessed the power to write checks; and (6) had the ability to hire and fire employees. No single factor is controlling or dispositive in the responsible person inquiry.

The bankruptcy court concluded, and the district court agreed, that the pastor was a responsible person. In support of this conclusion, both courts referenced the bylaws of the pastor's church, which specify that the pastor shall act "as CEO over all spiritual and business matters." Additionally, the bylaws provide that the pastor shall be the "Chief Executive Officer of the said organization and shall be a continuing member of all boards and committees." The pastor "shall be an ex-officio member of all standing committees, and shall have the general powers and duties of supervision and management usually vested in the office of president of a corporation."

freedom of religion

The pastor argued that the courts were barred by the First Amendment guaranty of religious freedom from making a determination regarding "responsible person" status on the basis of a church's bylaws. The court acknowledged that "the civil courts are obliged to play a limited role at times in resolving church disputes, the limited role being premised on First Amendment principles that preclude a court from deciding issues of religious doctrine and practice, or from interfering with internal church government. First Amendment values are jeopardized when church litigation turns on the resolution by civil courts of controversies over religious doctrine and practice." However, the court concluded that the pastor "has not shown how mere citation of the bylaws in the bankruptcy court's order is a challenge to the ecclesiastical decisions or religious customs of the church in violation of the [First Amendment]. In its most favorable light, the pastor asks the court to make the logical leap to hold that the mere citation of the church bylaws as part of the responsible person analysis under section 6672 is prohibited by the First Amendment. The case law, while limited in this specific context, does not appear to support this argument."

The court also stressed that the bankruptcy court's analysis of the church bylaws

was limited to a few paragraphs …. The bankruptcy court noted that the bylaws provide that the pastor shall be the CEO and a member of all boards and committees and … shall execute in the name of the church all deeds, bonds, mortgages, contracts and other documents, and have the powers and duties of supervision and management usually vested in the office of president of a corporation ….

The bankruptcy court interpreted the bylaws as authorizing the pastor to have decision making authority and supervision over business matters. The pastor argues that this interpretation now forces her to concern herself with secular affairs. Putting aside the fact that the plain language of the bylaws suggests that the pastor does concern herself with such affairs, the bankruptcy court did not base its decision on the bylaws alone. Contrarily, close examination of the bankruptcy court's order reveals that it placed great emphasis on what the pastor actually did as the church's pastor, including co-signing a $178,000.00 construction loan, disbursing and withholding payments to vendors and staff, signing a corporate resolution authorizing a bank account which authorized her to sign checks on behalf of the church, and hiring and firing employees.

Appellants do not contest the bankruptcy court's consideration of (the pastor's) actions, nor do they contest the documentary evidence showing that she was a responsible person with authority, a person required to collect, truthfully account for, and pay over GTI's taxes. While appellants argue that the bankruptcy court impermissibly interpreted the GTI bylaws in such a way as to infringe upon appellants' First Amendment rights, the court finds no support in the case law that the bankruptcy court's findings or analysis did anything of the kind. As set forth above, appellants' First Amendment argument is not supported by the case law appellants cite, especially in light of the bankruptcy court's consideration of several other significant factors in its analysis finding (the pastor) to be a responsible person.

What This Means For Churches:

Section 6672 contains no exemption for church officers or employees. As a result, any church officer or employee having the authority to pay withheld taxes to the government, is potentially liable for 100 percent of the taxes owed if the church for any reason fails to withhold or pay them. The court enumerated several functions of the pastor that made her a "responsible person" liable for the unpaid payroll taxes. In addition, the court ruled that the First Amendment guaranty of religious freedom is not violated if a court examines a church's bylaws to determine if a pastor, or other church employee, is a "responsible person." Vaughn v. Internal Revenue Service, 2012-2 U.S.T.C. ¶50,487, (E.D.N.C. 2012).

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Posted:
  • November 1, 2012

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