Q: We are giving our pastor and wife of 40 years a cruise. Is this gift taxable to them?
It’s great your church wants to do this. But caution is needed—at least two significant issues are triggered when churches give gifts to ministers.
A gift poses potential income tax consequences for the pastor. It also raises concerns about reasonable compensation.
Chapter 12 of Church Law & Tax Senior Editorial Advisor and CPA Elaine Sommerville’s Church Compensation, Second Edition, does an excellent job of explaining the tax and reasonable compensation issues surrounding gifts:
Where the church pays directly to a minister or an employee, the amounts are not gifts, according to the Internal Revenue Code. This classification includes any payment of cash or transfer of a noncash item unless it is a qualified employee achievement award or a small de minimis item. (emphasis added)
In chapter 2 of her book, Sommerville also notes concerns related to excess benefit transactions, in which a person with presumed influence receives a benefit valued above a reasonable range of compensation for his or her position. An excess benefit transaction occurs “when a church pays a worker more than is reasonable for the services rendered, or when the church fails to report a taxable fringe benefit.”
The penalties for an excess benefit transaction are severe, both for the recipient (the pastor) and the church.
Church leaders also often ask whether the analysis changes for a gift when it involves a pastor who is retiring. Unfortunately, the answer is usually no.
Sommerville notes: Confusion arises when working with retirement gifts. An old IRS revenue ruling states it is possible that a gift to a retiring minister may not be taxable (Rev. Rul. 55-422, 1955-1 CB 14). (The revenue ruling has never formally been made obsolete by the IRS.) The ruling is often cited to support a tax-free retirement gift, but its application has changed with the 1986 change to the definition of a gift in the Internal Revenue Code. Since employers may not give a tax-free gift to an employee, a retirement gift may not be a tax-free payment. (emphasis added)
Also note that how a church collects, handles, and distributes funds matters a great deal in how any special-occasion gifts are analyzed. This article dives deeper into why.
Lastly, in very limited instances, there may be times when a gift associated to a retired pastor may not cause taxable income. A 2018 Tax Court ruling about a pastor who received monetary gifts from church members included an analysis discussing prior federal court decisions involving former ministers who received gifts from their former congregations that did not trigger income tax liability for the ministers.
Attorney and senior editor Richard Hammar, in reviewing the 2018 Tax Court decision, noted that gifts to a retired pastor may not be taxable when specific facts and circumstances are involved. Regarding one of the federal cases cited by the Tax Court (Schall v. Commissioner, 174 F.2d 893 (5th Cir. 1949), Hammar made this observation about the Fifth Circuit court’s analysis and its reason for concluding the gifts were not taxable: “[The pastor] made no request of the congregation that any amount be paid to him after his resignation, and he had no knowledge that the church would agree to do so. He did not agree to render any services in exchange for the gift and in fact did not do so.”
While the 2018 decision is insightful, churches still should evaluate their situations carefully, preferably in consultation with qualified local tax counsel, before reaching a similar conclusion.
Similarly, as noted above, for gifts involving employed pastors, it’s strongly recommended churches retain qualified local counsel to assist them with the income tax treatment of those gifts.