In most churches, the board determines compensation packages for church staff. Here are five considerations to bear in mind:
- Salaries must be reasonable. Federal law imposes a penalty tax against any board member who decides to pay a pastor or other staff member an unreasonable amount of compensation, and the pastor may be subject to additional taxes, known as intermediate sanctions, if their pay is determined to be unreasonable.
- A salary reduction agreement reduces a minister or staff person’s salary by a specified amount. Most churches assume that they can treat the amount of a salary reduction as nontaxable. Only a few salary reduction arrangements actually result in nontaxable income to the recipient—403(b) plans or tax-sheltered annuities, and cafeteria plans or flexible spending arrangements.
- The housing allowance exclusion for ministers who own or rent their home. It involves a redesignation of part of a minister’s salary as a housing allowance. This amount is tax-free to the pastor in computing federal income taxes so long as it’s used to pay housing expenses and doesn’t exceed the home’s fair rental value plus utilities.
- Accountable business expense reimbursement policy arrangement. This allows for reimbursements of business expenses that are properly substantiated with date, amount, place, and business purpose. One tax advantage is that church staff reports their business expenses to the church rather than to the IRS. A second tax advantage—employees avoid the limitations that apply to the deductibility of business expenses. Churches can also reimburse employee business expenses through a nonaccountable arrangement—any reimbursement lacking substantiation as to the amount, date, place, and business purpose of the expense. Nonaccountable reimbursements may expose the employee, and members of the church board, to substantial penalties if the church fails?to report the reimbursements as taxable income on the employee’s W-2 form.
- Many churches provide a church-owned car to their pastor. Any personal use of the car by the pastor must be valued by the church and reported as income on the pastor’s W-2 form.
This is an adapted excerpt from the Essential Guide to Money for Church Boards eBook. For more help with pay and benefits for clergy and church staff, see the biannual Compensation Handbook for Church Staff and the downloadable resouce Setting a Pastor’s Pay. All are available on ChurchLawAndTaxStore.com.
This article first appeared in Church Finance Today, October 2012.
