We’d like to pay an annual honorarium of $1,000 to each member of our church board as an expression of appreciation for their service. Any legal or tax implications with this?
There are several legal and tax issues that need to be considered. Let me mention seven of them.
1. Workers’ compensation
Workers’ compensation laws provide for the payment of benefits to employees who sustain work-related injuries or illnesses. These laws generally define the term “employee” broadly. It is possible that a board member receiving annual compensation of $1,000 would be deemed an employee under your state’s workers compensation law.
If so, then in most states the church would be obligated to provide workers’ compensation insurance to cover work-related injuries and illnesses. A failure to do so might create an uninsured risk since a church’s general liability insurance policy typically excludes such injuries and illnesses on the assumption that they are covered by workers’ compensation. Check with your workers’ compensation insurer to see if the board members would be employees under state law.
2. Employee Polygraph Protection Act
The federal Employee Polygraph Protection Act prohibits any “employer” (defined as an employer “engaged in or affecting commerce”) from requiring or even suggesting that an “employee” submit to any lie detector test. A narrow exception applies to some cases of employee theft.
The term “employee” is defined broadly by the Act, and so it is possible that a church board member who receives any remuneration from the church would be an employee subject to the Act’s protections. Because of the possibility that board members who receive honoraria may be deemed “employees,” do not suggest or request that they take a polygraph exam without the advice of legal counsel.
3. Tax withholding
Is a church required to withhold income taxes and Social Security taxes from an honorarium paid to a board member? Section 31.3401(c)-1(f) of the income tax regulations states:
All classes or grades of employees are included within the relationship of employer and employee. Thus, superintendents, managers, and other supervisory personnel are employees. Generally, an officer of a corporation is an employee of the corporation. However, an officer of a corporation who as such does not perform any services or performs only minor services and who neither receives nor is entitled to receive, directly or indirectly, any remuneration is not considered to be an employee of the corporation. A director of a corporation in his capacity as such is not an employee of the corporation.
This regulation makes a distinction between corporate officers and directors. Officers generally are treated as employees, unless they do not perform any services or perform only minor services and who neither receive nor are entitled to receive, directly or indirectly, any remuneration.
According to this language, an officer of a church corporation would be an employee with respect to any remuneration received from the church for service performed as an officer, and so the church should withhold income taxes and Social Security taxes from any honorarium or other compensation paid to such a person.
In Revenue Ruling 58-505 the Internal Revenue Service (IRS) observed:
Under the regulations applicable to the federal employment taxes, an officer of a corporation is, in that capacity, an employee thereof unless he performs no services or performs minor services and he does not receive or is not entitled to receive remuneration, directly or indirectly. Therefore, the officers, as such, here involved are employees of the company for the purposes of the federal employment taxes under the Federal Insurance Contributions Act, the Federal Unemployment Tax Act, and the Collection of Income Tax at Source on Wages.
On the other hand, the regulation specifies that “a director of a corporation in his capacity as such is not an employee of the corporation.” According to this language, which is in a regulation pertaining directly to tax withholding responsibilities, persons who are members of a church board in the capacity of a director rather than an officer are deemed employees. This means that the church would not be required to withhold income taxes or Social Security taxes or issue a Form W-2.
However, if the church pays an honorarium or other compensation to a director of $600 or more, the church should issue the person a Form 1099-MISC reporting the taxable compensation. The board member would pay both income taxes and self-employment taxes on this amount.
Of course, board members (whether officers or directors) who are also compensated church employees are subject to the same tax withholding rules that pertain to any other employee.
If you are required to withhold taxes from honoraria paid to officers or directors, then you will need to obtain their Social Security Number. If some officers or directors refuse to provide this information, then you are required by law to engage in backup withholding. See the instructions to IRS Form 945 for additional information.
4. Limited immunity from liability
Most states have enacted laws limiting the liability of church officers and directors. In some states, these laws protect all church volunteers. In some cases, the statute may protect only officers and directors of churches that are incorporated under the state’s general nonprofit corporation law. The most common type of statute immunizes uncompensated directors and officers from legal liability for their ordinary negligence committed within the scope of their official duties.
These statutes generally provide no protection for “willful and wanton” conduct or “gross negligence.” “Compensation” ordinarily is defined to exclude reimbursement of travel expenses incurred while serving as a director or officer. Churches that compensate their directors and officers over and above the reimbursement of travel expenses should reconsider such a policy if they are located in a state that grants limited immunity to uncompensated officers and directors. Obviously, these statutes will not protect ministers who receive compensation from their church.
Some state laws allow officers and directors to receive a nominal amount of compensation in addition to travel expense reimbursements without affecting their limited immunity from liability. This is the approach taken by the federal Volunteers Protection Act grants “volunteers” limited immunity from liability, and defines “volunteer” to mean “an individual performing services for a nonprofit organization . . . who does not receive (A) compensation (other than reasonable reimbursement or allowance for expenses actually incurred); or (B) any other thing of value in lieu of compensation, in excess of $500 per year, and such term includes a volunteer serving as a director, officer, trustee, or direct service volunteer.”
The Volunteer Protection Act clarifies that it “preempts the laws of any state to the extent that such laws are inconsistent with this [Act] except that this [Act] shall not preempt any state law that provides additional protection from liability relating to volunteers or to any category of volunteers in the performance of services for a nonprofit organization or governmental entity.”
Church leaders should understand fully how the payment of honoraria or other forms of compensation to church board members will affect their limited immunity from liability under applicable state or federal law.
5. Employment discrimination laws
Several state and federal employment discrimination laws may apply to churches. These laws prohibit discrimination by covered employers against employees and applicants for employment on the basis of several grounds.
To illustrate, Title VII of the federal Civil Rights Act of 1964 prohibits employers engaged in interstate commerce and having at least 15 employees from discriminating in any employment decisions on the basis of race, color, national origin, gender, or religion. Other federal laws ban employment discrimination based on age and disability.
Most states have enacted their own discrimination laws, and these are more likely to apply to churches since they generally define covered employers more expansively. Several of these laws contain exceptions for religious employers, although the breadth of these exemptions varies widely.
These laws define protect employees and applicants for employment from discriminatory practices, and generally define “employee” broadly. Church officers and directors who receive honoraria may meet the broad definition of “employee” under some of these laws.
6. Immigrant status
Some churches have elected or appointed board members who are not United States citizens. If so, the church may be exposed to liability for paying honoraria or any other form of compensation to such persons, depending on their status.
7. Recommendations of the Independent Sector
In the midst of the financial scandals involving several prominent companies a couple of decades ago, the media began focusing on allegations of questionable conduct by trustees and executives of public charities. In some cases the alleged abuses were clear violations of the law. In others the issue was whether certain practices met the high ethical standards expected of the charitable sector.
These disclosures caught the attention of Congress. In September of 2004, the chairman of the Senate Finance Committee, Senator Charles Grassley (R-IA), and the ranking member, Senator Max Baucus (D-MT), sent a letter to the Independent Sector, encouraging it to assemble an independent group of leaders from the charitable community to consider and recommend actions “to strengthen governance, ethical conduct, and accountability within public charities and private foundations.” The Independent Sector is a nonprofit, nonpartisan coalition of approximately 500 national public charities, foundations, and corporate philanthropy programs, collectively representing tens of thousands of charitable groups in every state across the nation. The Senate Finance Committee leadership requested a final report in 2005.
The Independent Sector responded by creating a Panel on the Nonprofit Sector consisting of 24 leaders of public charities. The Panel embarked upon a wide-ranging examination of how to strengthen the governance, accountability, and ethical standards of public charities. It convened several public hearings, obtained valuable input from advisory groups and work groups, and consulted with dozens of professionals.
The Panel’s final report was submitted to the Senate Finance committee on June 22, 2005. It consists of nearly 100 recommendations for changes to be adopted by Congress, the IRS, or charities themselves. In one of these recommendations the Panel “generally discourages payment of compensation to board members of charitable organizations.” However, “where compensation is deemed necessary due to the complexity of the responsibility, the time commitment involved in board service, and the skills required,” charities should base compensation on a review of the practices of comparable organizations.
Like several of the Panel’s recommendations, this one calls for voluntary action (without intervention by Congress or the IRS) by charities themselves.
While churches are exempt from many of these recommendation, some church leaders may want to voluntarily comply with them for the same reasons that support voluntary compliance with the Sarbanes-Oxley Act. After all, the recommendations constitute what a large panel of experts believe to be the “best practices” for public charities. Why would a church not want to voluntarily comply with at least some of them? Further, note that some church board members will be aware of the Panel’s work and may see no reason why their church should not comply even if not legally required to do so.