Churches often rely on a mix of paid staff and outside workers to carry out ministry.
Musicians, custodians, bookkeepers, and technology and other specialists may serve a church in different ways.
But an important question arises whenever someone is paid for their work: Is the person an employee or an independent contractor?
It’s a critically important question because it addresses how income taxes are handled under federal tax law.
CAUTION Determining whether a person is an employee or independent contractor depends on the nature of the inquiry. For income tax purposes, the Internal Revenue Service (IRS) provides certain criteria for determining classifications. For wage and hour law purposes, including overtime pay eligibility, the US Department of Labor provides differing criteria to make the determination. Churches must understand both. Church Law & Tax goes deeper in this article on the wage and hour law analysis.
Misclassifying workers can create costly tax and compliance problems for churches. Church Law & Tax members get trusted guidance on worker classification, payroll practices, and minister tax issues. Join today!
Why worker classification matters
Employees and independent contractors are treated differently under federal tax law.
When a church hires an employee, it generally must:
- Issue a Form W-2
- Withhold applicable payroll taxes
- Follow wage and hour laws (based on whether they are exempt or nonexempt employees)
- Maintain employment records
Independent contractors, on the other hand, typically receive a Form 1099-NEC, and the church does not withhold payroll taxes from their compensation.
Because of these differences, the IRS carefully evaluates whether workers are properly classified.
The key factors: control and independence
The IRS focuses on the business relationship between the church and the worker, evaluating the degrees of control and independence that exist between the two.
In general, a worker is more likely to be an employee if the church:
- Gives instructions on when and where to do the work, the tools or equipment to use, where to purchase supplies and services, and the order and sequence to complete the work
- Gives specific details with those instructions
- Evaluates how the work is performed
- Provides training to do the work
- Guarantees a regular wage amount (hourly, weekly, or some other time period)
- Provides benefits like insurance, pension plans, paid vacation, and sick days
- Reimburses the worker’s expenses
- Hires the worker with the expectation the relationship will continue indefinitely
- Hires the worker for services that are a key aspect of the church’s mission
A worker is more likely to be an independent contractor (also known as self-employed) if the person:
- Controls how the work is completed
- Is hired to complete a specific project or task
- Purchases and uses his or her own tools or equipment
- Does not receive expense reimbursements
- Works for multiple clients and makes his or her services available to the market
- Faces the opportunity for profit or the risk for loss
No single factor determines the outcome. Instead, the IRS looks at the overall relationship between the church and the worker.
Common examples in churches
Certain roles in churches often raise classification questions.
For example:
- Office staff and administrative assistants are typically employees.
- Musicians may be employees or contractors depending on the level of direction and scheduling control.
- Outside specialists, such as attorneys, CPAs, IT consultants, and website designers, are often independent contractors.
Churches should carefully review each working relationship, rather than assume a role automatically fits one category.
The “dual tax status” of ministers
Churches also must carefully handle the way they classify ministers.
Most ministers are employees for federal income tax purposes. However, ministers are considered self-employed for Social Security and Medicare taxes. This is often referenced as the “dual tax status” of ministers.
Ministers must prepay their income taxes and their self-employment taxes using quarterly estimated tax payments. Overlooking their dual tax status can result in payment errors and penalties.
Mishandling their dual tax status also can create other significant problems for ministers. They face jeopardizing their eligibility for tax-free benefits, such as a housing allowance. They also face taxes and penalties if the IRS discovers incorrect classifications.
When in doubt, seek guidance
Worker classification decisions can carry significant financial consequences if they are incorrect. Workers remain liable for their income taxes, even if misclassified, and churches may face penalties for misclassifications.
When uncertainty exists, church leaders should consult a qualified tax professional or legal advisor familiar with nonprofit employment issues.
If misclassifications are discovered, the qualified professional can help with reclassifications and also determine if Section 530 of the Revenue Act of 1978 provides the church any relief.
Taking time to classify workers correctly helps churches stay compliant with tax rules while maintaining responsible financial practices.Church Law & Tax members can access in-depth guidance on payroll practices, worker classification, and other employment issues affecting churches.