With the best of intentions, churches often want to present a monetary thank-you gift (sometimes called a “love gift”) to a pastor who is either retiring or leaving to serve another congregation. Churches must keep in mind that such gifts are subject to special rules.
Costly missteps
When it comes to presenting monetary gifts, two issues must be addressed: (1) whether the gift will create excessive compensation for the minister, and (2) whether the gift(s) given by the individual(s) will be deductible.
To properly structure a thank-you gift, you will likely need to engage a compensation expert with lots of experience with nonprofit organizations. You will also likely need the assistance of a nonprofit attorney. I do not say these things lightly. A single misstep can cost three to four times the amount of the gift in tax penalties and legal fees.
It is expensive to structure a thank-you gift correctly. If the gift is relatively small (less than 2 percent of the minister’s total annual compensation), you still must meet all the requirements discussed below, though you can reduce the cost by not hiring a compensation expert. As a minimum, budget at least $1,500 for attorneys’ fees and other costs.
Compensation rules
The church cannot pay the pastor more than reasonable compensation, including the thank-you gift. The church must determine whether it has adequately compensated the pastor during his or her tenure. This rule requires the church to gather data and compare the pastor’s compensation with what would be the expected reasonable amount of compensation for the pastor during his or her tenure. For larger gifts (gifts that exceed 5 percent of the pastor’s total compensation), this data gathering is better accomplished by a qualified compensation expert. I anticipate that the compensation expert will cost between $5,000 and $50,000, in addition to the $1,500 in attorneys’ fees mentioned earlier.
Second, your church board or finance committee must evaluate the compensation data and determine whether the minister has been undercompensated during his or her tenure. If so, the board or committee needs to determine the maximum amount of a thank-you gift it will authorize. If the minister has not been undercompensated, then no thank-you gift can be given by the church. Stated another way, if the minister has been adequately compensated or overcompensated over the years, then the church may not give him any additional compensation, including a thank-you gift.
Third, the board will then notify the members it is raising funds to help with its approved thank-you gift, but donations received will be subject to the control of the church and it cannot guaranty that the donated funds will go toward the minister’s gift. If excess funds are received, they will be used for other church purposes. If funds are received prior to the board approving the thank-you gift and amount, those donations should be returned to the donors.
Donation rules
To be tax deductible, the donor must unconditionally transfer control over the funds to the church. Also, the donor may not direct the use of the funds to benefit any individual. The rules outlined in the prior paragraph demonstrate that the church assumed complete control over the donations received for the thank-you gift. By returning the donations received before approving the gift, the board is assuring the IRS that no donor can tell the church it must send their gift to the pastor.
Gifts must be reported
Finally, you will need a qualified nonprofit attorney to assure that the church documents the above requirements so the thank-you gift will not cause the pastor to pay up to 225 percent of the amount that is considered compensation over a reasonable amount in penalties under Section 4858 (Intermediate Sanctions).
In all cases, gifts from employers to employees are always taxable and reportable on Form W-2 in Box 1. The thank-you gift should be included in Box 1 of the pastor’s Form W-2.
If a pastor is already compensated fairly, thank-you gifts may be more trouble than they’re worth due to the risk of invoking the severe penalties outlined above. I recommend that the church seriously consider the potential adverse consequences to the minister if it gives a thank-you gift. If the church still wants to provide a thank-you gift, it will need the guidance of a qualified nonprofit attorney, meaning minimum costs of around $1,500.
