They Aren’t Paid Much – So Be Smart About it!
Proper Structuring can cut Pastors’ Taxes
December 2016 Federal changes help churches and clergy
Many churches are inadvertently costing their pastors thousands of dollars in taxes every year because of poorly structured compensation packages. This is particularly true of small churches with bi-vocational pastors.
Further, Federal laws changed in December 2016 opening additional tax savings for properly structured packages. All churches should review their pastoral compensation packages to maximize their pastor’s tax savings.
This article will help your church save your pastor thousands of after-tax dollars and help every local church avoid penalties and other sanctions from the Internal Revenue Service (IRS) and the Department of Labor (DOL).
Pastors’ compensation packages should always be prioritized in this order.
Tax free medical reimbursements. This is accomplished by covering a pastor’s medical and health care expenses. The laws changed again in 2016, and the ACA rules no longer apply to most churches. In today’s environment, this can provide $10,000 to $20,000 of tax free compensation or more, if structured properly. When these expenses are fully covered, then include…
Tax free expense reimbursements. Churches should reimburse out-of-pocket expenses the pastor incurs performing ministry. A church should reimburse ministry mileage, books and subscriptions, and coffee shop visits for counseling. Properly structured with an accountable plan, these reimbursements will “keep the pastor whole” and with money to be effective.
Only after the tax free payments are completely covered should Salary and Housing Allowance be added to the compensation package. Next, add these taxable elements to the compensation package…
The next addition to the compensation should be entitlements that are taxed at the lowest possible tax rate. In most cases this is Housing Allowance (HA), which is exempt from income tax. The HA exemption is very generous covering virtually every expense connected with providing a home. This “low-tax compensation” can total $40,000 or more in many parts of America. The only tax on HA is the 15.3% Self Employment tax (SE), if properly structured by the church. HA is also excluded from income tax in most states. And only when HA is fully compensated…
Pay salary. Salary is taxed for BOTH Income Tax AND Self Employment Tax, and is the compensation element that is the most highly taxed. Churches must remember that pastors’ salary is treated differently than non-clergy salary. Accordingly, it must be carefully structured within the church’s payroll system to avoid paying taxes twice.
Later on, a 403b plan or denominational retirement plan can be added to provide tax deferred savings for retirement.
Note three things from this analysis.
These elements can be paid simultaneously, but when planning and structuring a pastor’s compensation package always maximize the tax free compensation and structure the package to minimize the taxable compensation.
Each element must be properly structured and documented. This means that:
Proper and timely Board/Council approvals have been done. In the case of medical reimbursements a DOL approved written plan must be approved by the Board/Counsel and updated annually; and,
Proper written policies are in place. In the case of expense reimbursements, a formal Accountable Plan must be in place; and,
Proper documentation/receipts of expenses have been provided to justify expense reimbursements.
Annual Housing Allowance declarations of the Board/Council must be accomplished based upon the pastor’s estimate of housing expenses in the upcoming year; and,
A payroll service should be retained that understands the “dual tax status” that ministers have in their relationship with their church, when salary is paid.
If not properly structured:
The church can be fined or otherwise penalized by IRS or the Department of Labor – or both. This can also include fines upon the officers of the church, and revocation of the church’s 501c3 status in extreme cases.
The pastor can lose the tax advantages that were otherwise available to him/her.
Wisdom Over Wealth offers Pastor’s Compensation Planning that provides the professional advice and documents needed to execute this strategy.
Call 877-823-3101x1 to get started.