5 Best Practices for Church Payroll Compliance

By Raul Rivera

“If our church is going to be responsible for payroll, we just won’t compensate anyone.” As the pastor said this, my eyes were opened to the fear and doubt many pastors and church leaders have when it comes to payroll.

Much of this fear and doubt stems from simply not knowing where to begin or how to establish payroll. Managing payroll can be burdensome. The penalties for getting it wrong are enough to make any pastor nervous.

But with just a basic understanding of payroll requirements and the right resources, any church will be able to compensate staff members and confidently establish payroll for the church.

In this post you will be provided with some of the knowledge and resources needed in order to establish a compliant payroll practice. But before we get to that, we will take a look at the audit protections that the IRS has extended to church payroll.

IRS extends protections to church payroll

In section 7611 of the tax code, Congress set limitations on when and how the IRS can conduct an audit on a church. Until recently, section 7611 only applied to inquiries questioning the tax-exempt nature of a church and possible unrelated business income.

In December of 2015, the IRS released an internal memo that extended the same audit protections to employment tax inquiries. The memo reads:

“Section 7611 procedures apply to employment tax inquiries. Examiners should not initiate any examinations on a church. If for some reason an employment tax examiner encounters a church employment tax issue, the examiner should immediately contact the Program Manager, Exam, Programs, and Review (EPR) in TE/GE Exempt Organizations Examinations.”

What does it mean for your church?

When it comes to your church’s payroll, you can take a deep breath knowing that the IRS must now follow a strict procedure before being able to request information about your church’s employment tax documents.

Before an audit begins, a high-level treasury official must reasonably believe, based on written documentation, that a church is failing to comply with payroll regulations. Only then can an investigation begin. And even when it does, a church is provided with written notice and reasonable opportunity to respond. If a church has been questioned and found without error, the IRS cannot begin a subsequent examination for a 5-year period.

Now, this is not to say that you can become lax with your church’s payroll practices. It is still important to do everything with excellence as unto the Lord. Additionally, it is important to be good stewards with what God has given you.

So, let us explore some best practices for your church’s payroll.

5 best practices for payroll compliance

The extension of audit protection to church payroll is a plus. However, you should continue to adopt best business practices to keep in compliance with payroll regulations. Below is a review of some of those best practices for payroll compliance:

1. Classify the employee correctly

When your church decides to compensate an individual for his/her work, you must first decide if that worker is a contract worker or an employee. This important decision will determine how your church treats the individual when it comes to payroll.

Many church leaders mistakenly believe that this decision is up to their discretion. In reality, the federal government uses common-law rules to determine whether a worker is an employee or contract worker.

(For more information on the difference between an employee and a contract worker read "What Should a Church Do When the Pastor Leaves?".)

2. Decide who handles payroll

Choose early who will handle your church’s payroll. If you decide to keep payroll in-house, it is important that the church carefully calculate how much federal income tax to withhold. (See IRS Publication 15 as a reference.)

Keep in mind that your church should not withhold Social Security and Medicare tax from ministers unless there is a voluntary withholding agreement. If you decide to hire a professional payroll company, make sure that the company you choose has experience with churches.

3. Collect a completed Form W-4 from each employee

Form W-4 is used to gather the information necessary to withhold the correct amount of taxes. The IRS requires employers to keep this form in their records at all times.

Whether you have a minister (especially if he or she has entered into a voluntary withholding agreement) or a regular employee, this is an important and necessary step to take to ensure that the correct amount of tax is deducted. This form will not be submitted to the IRS.

4. Choose a payroll frequency

In my experience, most churches that do their own payroll prefer a weekly pay schedule, and those who hire a payroll company prefer a biweekly and sometimes monthly payroll.

No one way is better than the other. The important part is that your church choose a payroll schedule that it can manage.

5. Know which informational returns to use:

Churches are required to file Form 941 each quarter.

Keep in mind that 941s for the 2nd quarter are fast approaching! The due date to file for the 2nd quarter is August 1.

Individuals classified as employees will receive Form W-2 from the church, and contract workers that receive more than $600 in yearly earnings from the church will receive Form 1099-MISC. In addition, it is necessary that you receive Form W-9 from contract workers and guest speakers.

Your church will then need to submit to the IRS copies of all W-2 statements with Form W-3, and copies of all 1099-MISC statements with Form 1096.

Penalties for not withholding payroll taxes

The IRS spends significant time making sure that informational returns are filed correctly and on time. The penalties for noncompliance can be stiff. For example, sections 6721 and 6722 detail the penalties if the church does not file these forms on time and correctly. The penalties can amount to $250.00 per return.

Additionally, once an organization has been found out of compliance regarding withholding payroll taxes, according to section 6502, the IRS may look back into 10 years’ worth of payroll filings to make sure that they were filed correctly.

An easier step than you think

It is as important to work ON your ministry as it is to work IN it. Payroll laws can be burdensome, but with the right information and with the right parters, you can feel confident in compensating your employees for their time and effort.

If you want to learn more about payroll, then you, and/or a church administrator, may be interested in enrolling in our online church compliance course, StartCHURCH University. There is a whole unit, consisting of four chapters, dedicated to this very topic.

Or perhaps you want to learn how to correctly file W-2s and 1099s for your church. In that case, the W-2 and 1099 applet in our Management Suite will give you step-by-step instructions on how to e-file the informational returns for your church.

And lastly, we would always love to have you join us for a day at one of our Ultimate Church Structure Conferences where you will be provided with strategies to lead and navigate your church in today’s world.

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