Church Payroll: Tax Exemptions & Clergy Payroll Nuances
Understanding church payroll is challenging for many religious organizations. There’s a big misconception that churches don’t pay payroll taxes, and some assume church employees don’t pay taxes on their earnings, but neither is true. There are some nuances you need to be aware of as compared to running payroll for a profit-based business, but there are also many similarities. For example, Social Security and Medicare must be withheld from non-clergy employees’ paychecks (and your church bank account) and paid to the IRS.
If you’d like help processing your church payroll, consider partnering with Cirrus Payroll. We have expertise in nonprofit and church payroll and can help you stay in compliance with payroll regulations. We’ll pay and file the taxes you do owe and keep you updated on any payroll tax exemptions you and your employees qualify for.
|** If your church has 501c3 status, and many do, your organization will be exempt from having to pay any federal unemployment taxes (FUTA) for employees. FUTA is typically 0.6% on each employee’s first $7,000 earned in the year.|
Paying Non-clergy Employees
Before we dive into the glaring differences between church payroll and for-profit payroll, let’s take a look at the similarities.
Employees who are not ministers or part of the clergy are generally paid by the church as regular employees, meaning you will need to withhold money to pay their federal income taxes (and state, if applicable) in addition to 6.2% of their income for Social Security and 1.45% for Medicare taxes. (In combination, these two taxes are known as FICA.) As their employer, you will also pay the IRS a matching amount for Social Security and Medicare out of the church’s funds.
Once you’re finished paying your church employees for the year, you’ll need to report their earnings and tax deductions on a W-2 form and send it to them by January 31 following the year for which you’re reporting.
Compensating Ministers & Other Clergy Members
Processing payroll for pastors and other clergy comes with some unique rules. They have what’s called “dual status”, which makes them both employees of the church for purposes of income taxes, and self-employed workers when it comes to FICA taxes.
With nonclergy employees, church employers are responsible for withholding money for Social Security and Medicare. With clergy, you’re not. Ministers do however have to pay self-employment taxes and file Form 1040 (Schedule SE).
Self-employment taxes (SE taxes) are very similar to FICA taxes–the percentages (6.2% and 1.45%) are the same; however, since ministers are considered partly self-employed, they are responsible for paying the employee portion and the other half that employers usually pay. In addition, they must pay the estimated self-employment taxes on a regular cadence–waiting until the end of the year will likely result in fines and penalties.
This means church employers are not responsible for withholding and paying the funds to the IRS as they are with nonclergy employees. However, ministers and their churches do sometimes come to an agreement for the church to withhold money for the estimated self-employment taxes. It’s entirely optional.
|Ministers can request to be exempted from paying self-employment taxes if paying into a public insurance fund (Social Security & Medicare) conflicts with their religious beliefs. Ministers can fill out Form 4361 if they believe they should be exempt. They should understand that once they opt out, they can not opt back in to receiving those future benefits.|
When it comes to deducting money for federal and state income taxes, you are required to do so for ministers and other clergy. You should provide them with a W-2 form at year-end depending on the type of services they provide for the church (for example, delivering a regular weekly sermon versus officiating a wedding).
Aside from the regular income ministers receive, there can be other monetary benefits that must be accounted for. For instance, a housing allowance is offered to clergy the church chooses and it is typically exempt from income taxes (although not self-employment taxes). Qualifying housing allowances can include the total value of housing accommodations, including utilities, furnishings, and other necessities that keep the house at market value.
Churches that opt to provide housing allowances must define and approve the annual benefit in writing, so it’s clear to all parties and easy to follow in the event of an audit. It’s also important that the designated housing allowance is used in the year it’s received; it can’t be rolled over to future years. The amount must be reasonable and can’t exceed adequate compensation for the services a minister provides. And just a reminder, these housing payments may be used to avoid income tax, but not SE tax.
Reporting Housing Allowances on Form W2
As an employer, you must report any housing allowances you distribute on your employees’ year-end W2 Form. Since it’s not taxable, you should exclude it from Box 1, 3, and 5 and instead add it to Box 14, Other.
If you hire independent contractors, workers who are self-employed and largely direct their own way of working, like self-employed ministers, musicians, maintenance services, etc., you won’t need to withhold any payroll taxes nor pay any taxes on their income. They should complete a W-9 Form upon hire, and you’ll need to report their earnings on Form 1099 NEC (plus provide them and the IRS a copy) if your church pays them $600 or more in a calendar year.
When a church uses volunteers, it needs to clearly differentiate the work they do with the work employees perform. Creating a contract that explains the differences can be useful, and it’s a good idea to have the volunteer sign it so you can protect your church from potential liabilities in the future.
It’s also important to keep in mind that any gifts, vouchers, or forms of compensation you pay your volunteers can’t exceed a certain nominal amount. This means you shouldn’t pay a volunteer more than 20% of what a typical employer would pay for similar work performed.
For more information on clergy earnings, visit the IRS website.