Compensation planning for clergy and other church staff presents several unique tax issues that are not well understood by many church leaders and their advisers. This article looks at issues related to three components (or possible components) of the compensation package to review when structuring compensation plans.
The most basic component of church staff compensation is salary. There are two important considerations to keep in mind with respect to staff salaries: the amount of the salary and the use of salary reduction agreements. These two issues will be discussed separately.
Staff salaries ordinarily are set by the church's governing authority, such as a board or committee. Churches generally may pay any amount they wish, with one important exception. If a church pays unreasonably high compensation to a pastor or other employee, there are two possible consequences:
1. Loss of tax-exempt status
In order for a church or any other charity to maintain its tax-exempt status, it must meet a number of conditions. One condition is that it cannot pay unreasonably high compensation to any person. There are two considerations to note. First, very few charities have lost their exempt status for paying unreasonable compensation. The IRS has been reluctant to impose this remedy. Second, the law does not define what amount of compensation is unreasonable, and neither the IRS nor the courts have provided much clarification.
EXAMPLEA federal appeals court concluded that combined annual income of $115,680 paid by a religious organization to its founder and his wife was not excessive.