Background. It is important for church treasurers to know how much taxable income the church is paying a minister so that the correct amount can be reported on the W-2 or 1099 the church issues to the minister. Unfortunately, the concept of “taxable income” is complex and confusing. Church treasurers often issue W-2 or 1099 forms that do not fully reflect all income received by a minister.
Key point. This article focuses on items of taxable income received by ministers that often are overlooked by church treasurers when completing the minister’s W-2 or 1099 form. Many of the items summarized in this article apply equally to non-minister staff members as well.
Bonuses. Any “bonus” paid by a church to a minister represents taxable income, and must be reported on the minister’s W-2 or 1099.
“Love gifts.” Churches often pay ministers a “love gift” on special occasions such as Christmas, birthdays, or anniversaries. Many church treasurers are not sure how to report these “gifts.” Are they nontaxable gifts, or do the represent taxable compensation for services rendered? Here is the basic test: If the purpose of a “gift” is to more fully compensate a minister for faithful services rendered on behalf of the church, the amount represents taxable compensation for services rendered and is not a nontaxable gift. It must be included on a minister’s W-2 or 1099. This is so even though the amount is called a “love gift.”
Key point. The United States Supreme Court has observed: “What controls is the intention with which payment, however voluntary, has been made. Has it been made with the intention that services rendered in the past shall be requited more completely, though full acquittance has been given? If so, it bears a tax. Has it been made to show good will, esteem, or kindliness toward persons who happen to have served, but who are paid without thought to make requital for the service? If so, it is exempt.” Bogardus v. Commissioner, 302 U.S. 34, 45 (1936).
Here’s another important point—since 1987 federal law has specified that the term gift does not include “any amount transferred by or for an employer to, or for the benefit of, an employee.” An exception is a traditional employer holiday gift of low fair market value (such as a turkey, fruitcake, etc.). These items are nontaxable.
Note the following general principles:
- Special occasion gifts made to a minister by the church out of the general fund should be reported as taxable compensation and included on the minister’s W 2 or 1099.
- Members are free to make personal gifts directly to their minister, such as a card at Christmas accompanied by a check or cash. Such payments normally are tax free gifts to the minister (though they are not deductible by the donor).
- Special occasion “gifts” to a minister funded through members’ contributions to the church (i.e., the contributions are entered or recorded in the church’s books as cash received and the members are given charitable contribution credit), should be reported as taxable compensation and included on the minister’s W 2 or 1099.
- Members who contribute to special occasion offerings may deduct their contributions if (1) the contributions are to the church and are entered or recorded in the church’s books as cash received, and (2) they are able to itemize deductions on Schedule A (Form 1040).
- Some churches collect an all cash special occasion offering with the understanding that the entire proceeds will be paid directly to the minister and that no contributions will be tax deductible. Whether or not these amounts represent taxable income to the minister will depend on the following factors: (1) the intent of the donors who contribute to the offering (e.g., if they are simply wanting to provide additional compensation to their minister in recognition of services rendered, then the transfer will be taxable compensation rather than a tax free gift); (2) whether or not a church adjusts the minister’s compensation on the basis of the special occasion offerings collected on his or her behalf; and (3) whether the contributions were spontaneous and voluntary as opposed to fixed amounts established under a “highly structured program” for transferring money to the minister on a regular basis. One court ruled that such “gifts” represented taxable compensation to a minister in part because “[t]he transfers were initiated, sponsored, collected and distributed by the congregation.”
Key point. An aggressive argument can be made that in some cases a Christmas offering collected by a congregation for its minister represents a nontaxable gift rather than taxable compensation if the following factors are present: (1) The members are not receipted for their contributions. (2) Members are informed that they are giving directly to the pastor. (3) Members do not deduct their contributions. (4) The church acts merely as an intermediary. The gifts in reality are made by individual members directly to their pastor. (5) The church’s minimal involvement in the arrangement (collecting and turning over the offering) does not amount to sufficient church involvement to prevent the offering from being characterized as several individual gifts from members directly to their pastor. (6) Only 1 special occasion offering is collected each year. (7) Members are not pressured or coerced into making contributions. Participating in the offering is entirely voluntary. (8) The pastor is adequately compensated through salary and fringe benefits mutually agreed to between the pastor and church board. (9) Most members contribute to such an offering out of sincere affection, respect, and admiration, and not out of a desire to compensate the pastor more fully for services rendered. Pastors and churches should not select the “aggressive approach” without the advice of a tax professional.
Retirement gifts. Most churches present retiring ministers with some form of “gift.” Are these “gifts” nontaxable, or should church treasurers treat them as taxable compensation and add them to the minister’s W-2 or 1099? In the vast majority of cases, retirement gifts represent taxable compensation. This is because federal law (since 1987) has specified that the term gift does not include “any amount transferred by or for an employer to, or for the benefit of, an employee.”
Key point. Prior to 1987 a number of courts (and the IRS itself) ruled that retirement gifts to ministers in some cases could represent nontaxable income. These rulings were all overruled by the tax law change that took effect in 1987 prohibiting employers from making tax-free gifts to employees.
Key point. The 1987 tax law change only applies to employees. It does not apply to self-employed workers. As a result, ministers who in fact are self-employed for income tax reporting purposes are not absolutely barred from receiving tax-free retirement gifts. But note—(1) it will be very difficult for most ministers to demonstrate that they are self-employed for income tax reporting purposes, and (2) self-employed ministers still must demonstrate that (a) the retirement gift was not intended to more fully compensate a minister for faithful services rendered on behalf of the church, and (b) the gift satisfied the legal definition of a gift as a transfer that “proceeds from a detached and disinterested generosity … out of affection, respect, admiration, charity, or like impulses.”
Key point. Ministers who receive retirement gifts directly from members may be able to treat them as tax free gifts. Of course, the members receive no charitable contribution deduction since their contributions went directly to an individual. See the above discussion on special occasion gifts.
Property purchased from the church at a discount. Sometimes a church will sell property to a minister at less than fair market value. For example, a church sells its parsonage (with a fair market value of $100,000) to its minister for $25,000. In these cases the church treasurer ordinarily must include in the minister’s W-2 or 1099 the excess of the property’s fair market value over the bargain sale price.
Social Security paid by the church. Ministers are always treated as self-employed for social security purposes with respect to services they perform in the exercise of their ministry. This means that they pay the full “self-employment tax” (15.3 percent) rather than FICA taxes. Some churches agree to pay a portion (or all) of this tax liability. Any amount paid to a minister to help him or her pay the higher self employment tax must be reported as additional compensation on the minister’s W 2 or 1099 form. The amount paid by the church must be reported as compensation for social security purposes as well.
Moving expenses paid by the church. Since 1994, employer reimbursements of an employee’s moving expenses are treated as a tax-free fringe benefit if (1) the moving expenses would be deductible by the employee if paid directly by the employee; (2) the employee did not deduct the expenses in a prior year; and (3) the employer only reimburses those moving expenses that are properly substantiated by the employee (under rules similar to an accountable expense reimbursement arrangement). Employer reimbursements that satisfy these requirements are not reported in box 1 of the W-2 form, but must be reported in box 13. Code “P” is used to identify these nontaxable reimbursements in box 13. Any moving expense reimbursements that do not satisfy the three requirements summarized above represent a taxable fringe benefit and must be reported as taxable income on the minister’s W-2 or 1099.
Personal use of a church-provided car. The important point to note is this—if a church provides a car to its minister, the minister’s personal use of the car is a taxable noncash fringe benefit. The church must determine the actual value of this fringe benefit so that it can be included in the minister’s income and reported on his or her W 2 or 1099 form. There are four ways to compute the taxable value of the personal use of a church-provided car—a general valuation rule and three special valuation rules. These rules are explained fully in chapter 4 of Richard Hammar’s 1996 Church and Clergy Tax Guide.
Below market interest loans. It is common for churches to make below market interest loans to ministers, often to assist the minister in obtaining a home. Church treasurers often are unaware that these loans may generate taxable income that must be reported on the minister’s W-2 or 1099. Here are the basic rules:
Demand loans. A demand loan is a loan payable in full at any time upon the church’s demand. For example, a church loans $20,000 to Rev. B with no indication of when it is to be repaid. If the church charges less than the prevailing interest rate then Rev. B is treated as having received additional compensation from the church in an amount equal to the “foregone interest.” These additional transfers of compensation are deemed to occur annually, generally on December 31. The “lender” (church) must report this amount as interest income to the “borrower” (minister). Foregone interest for any period is the amount of interest that would be payable for that period if interest occurred at the applicable federal rate, over and above any interest actually payable on the loan for the same period. The applicable federal rate is established by the IRS each month in a revenue ruling. You can get this rate from any IRS office.
Term loans. A term loan is a loan that is not a demand loan. These loans are payable over a specified period of time. For example, a church loans Rev. C $15,000 over a 10-year term at no interest. Rev. C is treated as having received an additional payment of compensation on the date the loan was made. The amount of compensation is the excess of the amount of the loan over the present value of all payments due under the loan. You can easily compute this amount with a financial calculator.
Key point. A below market demand or term loan of less than $10,000 is not subject to these rules (assuming one of its primary purposes was not the avoidance of tax)