Pastor, Church & Law


§ 2.03

Key point 2-03. Clergy compensation consists of a number of items that often are not well understood. Clergy compensation that is unreasonable in amount may jeopardize a church’s tax-exempt status or trigger “intermediate sanctions” in the form of excise taxes that can be assessed against a recipient of unreasonable compensation.

There are four aspects to clergy compensation that should be understood by church leaders:

  1. the definition of compensation;
  2. the concept of reasonable compensation;
  3. legal entitlement; and
  4. compensation planning and strategies. Each of these four topics is addressed below.

Resources. The definition of compensation and the compensation planning are addressed fully in the following two companion resources—the annual Church and Clergy Tax Guide and the biannual Compensation Handbook for Church Staff. You can obtain both resources from the publisher of this text.


It is important for church leaders to have a clear understanding of the definition of compensation. Such a definition is needed both for compensation planning and for income tax reporting. Unfortunately, many church leaders do not have a good understanding of this important term. A full analysis of the definition of clergy compensation is contained in a companion text.47 See R. HAMMAR, CHURCH AND CLERGY TAX GUIDE chapter 4 (published annually by Christianity Today International).


One of the conditions a church must meet in order to qualify for exemption from federal income taxes is that no part of its net earnings may “inure to the benefit of any private … individual.”48 I.R.C. — 501(c)(3).The courts have held that although payment of “reasonable compensation” by a tax exempt organization to its employees does not constitute the inurement of net earnings to the benefit of a private individual, the payment of unreasonably high salaries does.49 See, e.g., Harding Hospital, Inc. v. United States, 505 F.2d 1068 (6th Cir. 1974); Mabee Petroleum Corp. v. United States, 203 F.2d 872 (5th Cir. 1953).As a result, church leaders should be familiar with the concept of reasonable compensation. A companion text defines this term in the context of current income tax regulations, IRS rulings, and court decisions.50 See R. Hammar, Church and Clergy Tax Guide chapter 4 (published annually by Christianity Today International).

Few churches and other charities have lost their tax-exempt status because of the payment of unreasonable compensation. The IRS has been unwilling to impose so harsh a penalty upon an entire organization because a single individual receives excessive compensation. In 1996 Congress responded to this dilemma by giving the IRS authority to impose “intermediate sanctions” on individuals who receive excessive compensation from a charity.51 I.R.C. § 4958.These sanctions are in the form of substantial excise taxes of 25% of the amount of an excess benefit, plus an additional 200% of the amount of the benefit if the recipient does not “correct” the excess benefit (i.e., return it) within the “taxable period” defined by law. In some cases the IRS can even impose sanctions against board members who authorized excessive compensation. Intermediate sanctions are addressed fully in a companion text.52 See note 50, supra, and accompanying text.

Here are the key points that pastors, church treasurers, and church board members need to understand about intermediate sanctions.

• Section 501(c)(3) of the tax code prohibits tax-exempt organizations (including churches) from paying unreasonable compensation to any employee or other person. A violation of this requirement will jeopardize an exempt organization’s tax-exempt status. The IRS can revoke an exempt organization’s tax-exempt status if it pays an excess benefit to a disqualified person. However, in most cases, the IRS will pursue intermediate sanctions rather than revocation of exempt status.

• Section 4958 of the tax code permits the IRS to assess “intermediate sanctions” in the form of excise taxes against insiders (called “disqualified persons”) who receive an excess benefit from a tax-exempt organization.

• A disqualified person includes an officer or board member of an exempt organization, or a relative of such a person.

• An “excess benefit” is any benefit paid by an exempt organization to an insider in excess of the reasonable value of services performed. It includes excessive salaries, “bargain sales” to an insider (sales of an exempt organization’s property at less than market value), use of an exempt organization’s property at no cost, and payment of an insider’s personal and business expenses under a “nonaccountable” plan (without a proper accounting of business purpose)—unless the payment is reported as taxable income on the insider’s W-2 or Form 1040.

• If an excess benefit is not reported as taxable compensation when paid, then the IRS will assume that the entire amount of the benefit exceeds the value of any services provided by the recipient, and therefore the entire benefit constitutes an “automatic” excess benefit resulting in intermediate sanctions, regardless of the amount of the benefit.

• In four private rulings issued in 2004, the IRS assessed intermediate sanctions against a pastor because of the personal use of church property by himself and members of his family, and the reimbursement of expenses by the church under a nonaccountable plan without any substantiation of business purpose. Most importantly, the IRS concluded that these benefits were “automatic” excess benefit transactions resulting in intermediate sanctions, regardless of amount, since they were not reported as taxable income on the pastor’s W-2 or Form 1040 for the year in which the benefits were paid.53 See IRS Private Letter Rulings 200435019, 200435020, 200435021, and 200435022.

• Churches that allow staff members to use a church-owned vehicle or other church property for personal purposes, or that reimburse business or personal expenses of a staff member (or relative of a staff member) under a nonaccountable arrangement, may be engaged in an “automatic” excess benefit transaction that will subject the staff member to intermediate sanctions under section 4958 regardless of the amount of the benefits. This result can be avoided if the church, or the pastor, reports the benefits are taxable income during the year the benefits are received; and, they may be partly or completely “abated” if the pastor “corrects” the excess benefit within the “tax period” defined by section 4958. This generally means returning the excess benefit to the church by the earlier of (1) the date the IRS mailed the taxpayer a notice of deficiency with respect to the 25% excise tax, or (2) the date on which the 25% excise tax is assessed. If a disqualified person corrects an excess benefit transaction during the taxable period, the 200% excise tax is automatically abated. If the disqualified person corrects the excess benefit transaction during the correction period, the 25% excise tax is abated only if the disqualified person can establish that (1) the excess benefit transaction was due to “reasonable cause,” and (2) was not due to “willful neglect.”

Case study. A church pays its senior pastor an annual salary of $45,000 this year. In addition, it reimburses expenses the pastor incurs for the use of his car, out of town travel, entertainment, and cell phone use, but does not require substantiation of the amount, date, location, or business purpose of reimbursed expenses, Instead, the pastor provides the church treasurer with a written statement each month that lists the expenses incurred for the previous month. The treasurer then issues a check to the pastor for this amount. This is an example of a nonaccountable reimbursement arrangement. Assume that the church reimburses $5,000 under this arrangement this year, and that the amount is reported as taxable income by the church on the pastor’s Form W-2 for this year. Since the full amount was reported as taxable compensation by the church in the year the benefit was paid, it is not an “automatic” excess benefit resulting in intermediate sanctions, Rather, the IRS will consider the benefit along with any other compensation the pastor received to determine whether the total compensation was unreasonable (and therefore an excess benefit transaction resulting intermediate sanctions). A salary of $45,000 plus $5,000 in reimbursements of nonaccountable expenses is not unreasonable, so the IRS will not assess intermediate sanctions.

Case study. Same facts as the previous example, except that the church did not report the $5,000 as taxable income on the pastor’s W-2 in the year it was paid, and the pastor did not report it on his tax return (Form 1040) for that year. The church treasurer assumed that the pastor had “at least” $5,000 in business expenses, and so there was no need to report the nonaccountable reimbursements as taxable income. This is a dangerous assumption that converts the nonaccountable reimbursements into an “automatic” excess benefit and exposes the pastor to intermediate sanctions. An “excess benefit” is defined by section 4958 of the tax code as any compensation or benefit provided to a disqualified person in excess of the reasonable value of his or her services. It includes nonaccountable reimbursements of business and personal expenses—unless the reimbursements are reported as taxable compensation by the church or pastor in the year they are paid. Since the church did not “clearly indicate its intent to treat the benefit as compensation for services when the benefit was paid” (i.e., the benefit was not reported on the pastor’s W-2 or Form 1040), the benefit constitutes an “automatic” excess benefit resulting in intermediate sanctions, regardless of the amount of the benefit. So, even though the total amount would not have constituted an excess benefit had the church reported it as taxable income, the fact that it did not do so makes the transaction an “automatic” excess benefit. This will result in (1) an excise tax of $1,250 (25% of $5,000); (2) an excise tax of $10,000 (200% of $5,000); (3) a penalty for failing to file Form 4270 (assuming the pastor failed to do so). If a disqualified person corrects an excess benefit transaction during the correction period, the 200% excise tax is automatically abated, and the 25% excise tax is abated if the disqualified person can establish that the excess benefit transaction was due to “reasonable cause” and was not due to “willful neglect.” For this purpose, “reasonable cause” means exercising “ordinary business care and prudence.” “Not due to willful neglect” means that the receipt of the excess benefit was not due to the disqualified person’s conscious, intentional or voluntary failure to comply with section 4958, and that the noncompliance was not due to conscious indifference. If the pastor can establish that the excess benefit transaction was due to “reasonable cause” and was not due to “willful neglect,” the IRS would abate the 25% excise tax. However, if the pastor cannot establish both of these requirements, he would be liable for the 25% excise tax even though he corrected the excess benefit transaction by paying $5,000 plus interest to the church, and paid federal income tax on the $5,000 as additional compensation.

Case study. Same facts as the previous example, except that the pastor is a church’s youth pastor. Assuming that the youth pastor is not an officer of the church, a member of the governing board, or a relative of someone who is, he is not a disqualified person and therefore is not subject to intermediate sanctions. While the nonaccountable reimbursements constitute taxable compensation, and the failure by the church and pastor to report them as such exposes the pastor to back taxes plus penalties and interest, they are not an “automatic” excess benefit resulting in intermediate sanctions since the youth pastor is not a disqualified person.

Case study. Same facts as the previous example, except that the youth pastor is the senior pastor’s son. Assuming the senior pastor is president of the church corporation or a member of the governing board, he is a disqualified person and so is his son. As a result, the nonaccountable reimbursements that were not reported as taxable compensation are an “automatic” excess benefit resulting in intermediate sanctions. The senior pastor and his son are jointly and severally liable for the intermediate sanctions, meaning that the IRS can collect them from either person.


A minister who works for a church without a written contract or with a contract that does not specify the compensation to be paid is entitled to receive reasonable compensation for services performed. If a church and its minister enter into a contract specifying the compensation to be paid, the minister is legally entitled to receive that compensation. One court has stated: “[T]he question of liability for the salary of a minister or pastor is governed by the principles which prevail in the law of contracts, and it is generally held that a valid contract for the payment of such a salary will be enforced.”54 Way v. Ramsey, 135 S.E. 454, 455 (N.C. 1926).As a result, if a church fails to pay a minister the full compensation specified in a written contract, the minister may be able to sue for breach of contract.

If the salary specified by contract is reduced by action of a church, the minister may immediately sue for breach of contract. But a minister who consents to a reduction in compensation will not be allowed to recover the loss.

Some courts have ruled that they are barred by the First Amendment guaranty of religious freedom from resolving disputes over pastoral compensation. To illustrate, a federal appeals court ruled that it was barred by the so-called “ministerial exception” from resolving a complaint by a kosher inspector at a predominantly Jewish nursing home that he was not paid overtime pay in violation of the federal Fair Labor Standards Act.55 Shaliehsabou v. Hebrew Home of Greater Washington, 363 F.3d 299 (4th Cir. 2004).The ministerial exception is a court-made rule, based on the First Amendment that prevents the civil courts from resolving employment-related disputes involving clergy and churches. As one court noted in a case involving a dismissed minister’s claim of unlawful discrimination:

This case involves the fundamental question of who will preach from the pulpit of a church, and who will occupy the church parsonage. The bare statement of the question should make obvious the lack of jurisdiction of a civil court. The answer to that question must come from the church.56 Simpson v. Wells Lamont Corporation, 494 F.2d 490 (5th Cir. 1974).

The ministerial exception has been applied by the courts to several other discrimination laws, including those banning discrimination in employment on the basis of age and disability. But what about the Fair Labor Standards Act? Does the ministerial exception prevent the civil courts from resolving cases involving the entitlement of ministers to overtime pay? The court noted that in a previous case it concluded that it did.57 Dole v. Shenandoah Baptist Church, 899 F.2d 1389 (4th Cir. 1990).In the Dole case the court noted that the ministerial exception “is derived from the congressional debate [about the FLSA] and delineated in guidelines issued by the Labor Department’s Wage and House Administrator.” The relevant portion of those guidelines provides:

Persons such as nuns, monks, priests, lay brothers, ministers, deacons, and other members of religious orders who serve pursuant to their religious obligations in schools, hospitals, and other institutions operated by their church or religious order shall not be considered to be “employees.”58 Field Operations Handbook, Wage and Hour Division, U.S. Department of Labor § 10b03 (1967).

The court concluded that “the ministerial exception to the FLSA applies only where the employer is a religious institution and the employee’s primary duties are ministerial in nature. The exception does not apply to the religious employees of secular employers or to the secular employees of religious employers.” It concluded that the kosher inspector’s duties were ministerial, that his employer was a religious institution, and therefore that the ministerial exception prevented it from resolving the inspector’s FLSA complaint.

Some courts have been willing to resolve lawsuits by ministers for unpaid compensation despite a church’s claim that such a controversy is purely ecclesiastical, so long as they can do so without interpreting church doctrine. In one case, a Catholic priest sued his diocese for wrongfully withholding his salary. The diocese maintained that the civil courts could not entertain suits involving the administration of church affairs and the relationship of a church to its minister, even with respect to salary, since these are matters of purely ecclesiastical concern. The court disagreed:

It was not the intent of [the First Amendment] and it has been so held in many cases, that civil and property rights should be unenforceable in the civil courts simply because the parties involved might be the church and members, officers, or the ministry of the church. It was not intended as a shield to payment of a just debt when the purpose of the First Amendment is not being violated. Ministers have been awarded their salary in suits against the church.59 Bodewes v. Zuroweste, 303 N.E.2d 509, 511 (Ill. 1973).

Other courts have observed:

  • “A church can contract with its own pastors just as it can with outside parties. An agreement for wages and benefits is governed by principles of civil contracts law and can be enforced by our courts.”60 Jenkins v. Trinity Evangelical Lutheran Church, 825 N.E.2d 1206 (Ill. App. 2005).
  • “Nothing forbids the enforcement of church-made contracts which have been fully performed. Enforcing vested secular, contractual rights is clearly different from reviewing the subjective, ecclesiastical, personnel-appointment process of the church.”61 Gabriel v. Immanuel Evangelical Lutheran Church, 640 N.E.2d 681 (Ill. App. 1994).
  • “Rabbi Goodman served as the Temple’s spiritual leader until the conclusion of the first contract. … Notwithstanding his service the Temple has failed to pay all the compensation due him and has failed to reimburse his expenses advanced by him [in attending a conference]. This claim does not create excessive entanglements with religious beliefs, and thus does not preclude civil court intervention.”62 Goodman v. Temple Shir Ami, 712 So.2d 775 (Fla. App. 1998).
  • “We agree that it is not the place of the court to decide matters that are ecclesiastical in nature, but we disagree that the doctrine applies to this case. The issues before the court and jury involve an employment contract, its alleged breach, the various reasons asserted for the breach and the damages related to that breach. Simply because a church is involved in the litigation does not make the matter ecclesiastical. The church argues that the reasons the board listed for discharging [the pastor] were primarily ecclesiastical and for the court to rule on those issues is beyond its jurisdiction as a court of law. The jury was not asked, however, to decide whether the asserted reasons for terminating [the pastor] were objectively valid, nor whether the action taken by the board was an ecclesiastical punishment. Instead, the jury was asked to determine if the reasons the board listed were, in fact, why the church fired [him] and whether that action was proper under the church’s own bylaws. The bylaws were not simply church rules governing religious doctrine and policy, but were, rather, the bylaws of an Idaho non-profit corporation governing its corporate affairs.”63 Fellowship Tabernacle, Inc. v. Baker, 869 P.2d 578 (Ida. App. 1994).
  • “A civil court may decide a church and clergy dispute if the methods of resolving it avoid questions of ecclesiastical doctrine or belief. In general, the determination of money damages arising from a breach of contract does not create an excessive entanglement in ecclesiastical matters.”64 Dobrota v. Free Serbian Orthodox Church St. Nicholas, 952 P.2d 1190 (Ariz. App. 1998).
  • “The controversy here is not whether it was proper for the church … to revoke the [pastor’s] ministry. It would not be proper for a court to determine whether the church acted consistently with its religious laws and doctrines, its system of discipline and administration in revoking his ministry. That would be a quintessentially ecclesiastical matter over which a court could not exercise jurisdiction. This case presents a different question. The issue here is the effect of the revocation of his ministry on the pension agreement he had with the church. This case simply requires the application of neutral principles of contract law and very little inquiry into religious law.”65 Pearson v. Church of God, 478 S.E.2d 849 (S.C. 1996).

However, the courts also have ruled that they have no authority to review claims by clergy that their compensation is too low. To illustrate, a federal appeals court refused to resolve a lawsuit by Catholic priests who taught at a Catholic university and who claimed that the university’s salary scale discriminated against them.66 Granfield v. Catholic University of America, 530 F.2d 1035 (D.C. Cir. 1976).The court observed that “the salary scale for priests in a church-related institution clearly appears to be an internal matter of the religious institution affected. In other contexts, courts have traditionally refused to become involved in the resolution of internal religious questions.”

Compensation paid to a minister must be in the amounts authorized by appropriate action. If a church authorizes a specified salary, and the church treasurer pays the minister an amount in excess of the authorized salary, the minister will have to account for the difference.67 Harrison v. Floyd, 97 A.2d 761 (N.J. 1953).

Ministers should scrupulously avoid any diversion of church funds to their own personal benefit in excess of their agreed upon compensation. Ministers should also avoid “commingling” their own funds with church assets. Diversions of church funds by clergy to their personal benefit have resulted in (1) a charge of embezzlement and fraudulent conversion;68 Commonwealth v. Nichols, 213 A.2d 105 (Pa. 1965).(2) a tax fraud conviction for failure to report interest earned on an alleged “church account” that was used essentially for a minister’s personal benefit;69 United States v. Moon, 718 F.2d 1210 (2nd Cir. 1983).and (3) the placing of a church in receivership by order of a state attorney general to prevent further diversion of church funds.70 Worldwide Church of God, Inc. v. California, 623 F.2d 613 (9th Cir. 1980)..


Sometimes a minister or lay employee refuses to accept the full amount of his or her church-approved salary, often because the church is experiencing short-term financial problems. Should the church report the amount that is refused as taxable income to the minister or lay employee? The constructive receipt doctrine specifies:

Income although not actually reduced to a taxpayer’s possession is constructively received by him in the taxable year during which it is credited to his account, set apart for him, or otherwise made available so that he may draw upon it at any time, or so that he could have drawn upon it during the taxable year if notice of intention to withdraw had been given.71 Treas. Reg. 1.451 2(a).

A number of courts have ruled that this principle requires employees to include in their taxable income any portion of their stated salary that they refuse to accept. On the other hand, some courts have reached the opposite conclusion. Perhaps the most notable case is Giannini v. Commissioner.72 129 F.2d 638 (9th Cir. 1942).This case involved a corporate president whose annual compensation was five percent of the company’s profits. In the middle of one year, the president informed members of his company’s board of directors that he would not accept any further compensation for the year and suggested that the company “do something worthwhile” with the money. The company never credited to the president any further compensation for the year nor did it set any part of it aside for his use. The amount of salary refused by the president was nearly $1.5 million, and no part of this amount was reported by the president as taxable income in the year in question. The IRS audited the president and insisted that the $1.5 million should have been reported as taxable income. The taxpayer appealed, and a federal appeals court rejected the IRS position:

The taxpayer did not receive the money, and … did not direct its disposition. What he did was unqualifiedly refuse to accept any further compensation for his services with the suggestion that the money be used for some worthwhile purpose. So far as the taxpayer was concerned, the corporation could have kept the money. … In these circumstances we cannot say as a matter of law that the money was beneficially received by the taxpayer and therefore subject to the income tax provisions.

The court acknowledged that the United States Supreme Court has observed: “One who is entitled to receive, at a future date, interest or compensation for services and who makes a gift of it by an anticipatory assignment, realizes taxable income quite as much as if he had collected the income and paid it over to the object of his bounty.”73 Helvering v. Schaffner, 312 U. S. 579 (1941).However, the court distinguished this language by observing that “the dominance over the fund and taxpayer’s direction show that he beneficially received the money by exercising his right to divert it to a use.” This was not true of the corporate president in the present case, the court concluded.


Compensation planning for ministers and lay church employees is an important task that involves a consideration of several factors. A full analysis of compensation planning, along with comprehensive survey data, is available on Church

This content is designed to provide accurate and authoritative information in regard to the subject matter covered. It is sold with the understanding that the publisher is not engaged in rendering legal, accounting, or other professional service. If legal advice or other expert assistance is required, the services of a competent professional person should be sought. "From a Declaration of Principles jointly adopted by a Committee of the American Bar Association and a Committee of Publishers and Associations." Due to the nature of the U.S. legal system, laws and regulations constantly change. The editors encourage readers to carefully search the site for all content related to the topic of interest and consult qualified local counsel to verify the status of specific statutes, laws, regulations, and precedential court holdings.

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