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13 Jul 2017

5 Steps to Help You Master Church Payroll

Raul Rivera

Payroll can be a daunting task for many churches and ministries. One of the main reasons this is true is because of how ministers are treated for tax purposes. 

Ministers have what is known as a “dual-tax status,” which means they are both employed and self-employed for tax purposes. For this reason, church payroll cannot be done in the same manner as the payroll of a secular business.

Churches tend to rely upon a church administrator or a volunteer to assist with payroll. The person who helps a church with payroll often does so because he/she has previous experience with payroll or is “pretty good” with numbers. 

Pastors are happy to pass this responsibility on to someone else so they can concentrate on the spiritual side of ministry. However, what pastors tend to overlook is the fact that payroll is one of the areas where churches are prone to make mistakes. 

Even if your church uses a professional payroll service, you need to know how to properly establish your church payroll because your church will be held responsible for any penalties that may result from incorrect filings.

The truth of the matter is that with just a basic understanding of payroll requirements and the right resources, your church will be able to compensate staff members and correctly establish payroll. 

This article will provide you with some of the knowledge and resources needed in order to establish a compliant payroll practice within your church. Before we get to that, let us take a look at recent audit protections the IRS extended to church payroll.

Audit protections extended to church payroll

Section 7611 of the tax code sets limitations on when and how the IRS can conduct a church audit. For a long time, section 7611 only applied to IRS inquiries of the tax-exempt nature of a church and potential unrelated business income associated with a church.

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.

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 requesting information about your church’s employment tax documents.

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 and to be good stewards with what God has given you. For these reasons, and many others not mentioned, it is important that your church implement good financial, bookkeeping, and payroll practices.

So, let us explore some best practices that will help you to master your church’s payroll.

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How to begin mastering church payroll

Although the extension of audit protection to church payroll is a plus, you should continue to adopt best business practices to keep in compliance with payroll regulations. 

Below are five of the best practices for payroll compliance:

1. Classify each church employee correctly

When your church decides to compensate an individual for his/her work, you must first decide if that individual 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 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.

(Recommended reading: "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, then 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 the social security and Medicare tax (self-employment tax) from ministers unless there is a voluntary withholding agreement. 

According to IRS Publication 517, a minister “can enter into a voluntary withholding agreement with the church to cover any income and [self-employment] tax that may be due.” 

As a minister, if you choose not to enter into a voluntary withholding agreement with your church, then you will need to use Form 1040-ES to pay your estimated tax in quarterly installments. 

If you decide to hire a professional payroll company, make sure the company you choose has prior experience with church payroll and knowledge of ministerial compensation.

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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 one with 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 is for internal church purposes and will not need to 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 or a monthly payroll.

No one way is better than the other. It is important that your church select 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 the due date for Form 941s for the 2nd quarter is fast approaching! The due date to file Form 941 for the 2nd quarter this year is July 31st.

Individuals classified as employees will receive Form W-2 from the church, and contract workers who 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 Form W-2 statements with Form W-3 and copies of all Form 1099-MISC statements with Form 1096.

What happens if your church does not withhold payroll taxes?

The IRS spends significant time making sure informational returns are filed correctly and on time. The penalties for noncompliance can be stiff. 

For example, Internal Revenue Code (IRC) sections 6721 and 6722 detail the penalties if a church does not file these forms on time and correctly. The penalties can amount to $250 per return.

Additionally, once an organization has been found out of compliance regarding withholding payroll taxes, according to IRC 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

While payroll can be a daunting task, keeping up with the payroll laws can also be a burdensome responsibility. However, with the right information and the right partners, you can feel confident in establishing a church payroll system that is done right. 

If you are in need of a team to help you with your church’s bookkeeping and accounting responsibilities, then you should consider utilizing our bookkeeping service

Our bookkeeping service was designed to meet the needs of pastors and church leaders just like yourself. 

Click on the link below to discover how our bookkeeping service can meet your church’s need. Or give us a call at 877-494-4655 to speak with a team member about how our bookkeeping service can work for your church or ministry.

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Raul Rivera

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About the Author

Church Planter. Speaker. Author. CEO. Raul Rivera has had ample experience in the church planting world. His current venture, StartCHURCH, has helped 1000's of churches to start right. Raul has compiled an array of manuals and software tools that help churches stay compliant with the IRS. He also hosts over 35 national conferences per year, training pastors on how to launch their churches. Raul is married to his wife Genel, and they and their five children live in Atlanta, GA.