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10 Apr 2018

6 Mistakes Made When Paying Pastors

Raul Rivera

There are many factors to consider when establishing pastoral compensation. We often speak with pastors and church leaders who have little to no experience in creating salary agreements for pastors, and they are unaware of the common pitfalls in this area.

Typically what will happen is these pastors and church leaders will decide what and how to pay pastors based on what they have heard from other churches or on what they think is correct.

While their intentions are pure and their hearts are in the right place in wanting to bless their pastor with a salary, uninformed decisions can lead to costly, yet avoidable, mistakes.

In this blog, I want to give you some insight on six common pastoral compensation mistakes that every church and ministry should avoid.

Pastoral compensation mistakes to avoid

One might think that setting pastoral compensation should be pretty straight forward and easy. While that’s not totally untrue, it’s not totally true either.

In actuality, because churches are nonprofit organizations, there are various considerations that pastors and church boards must take into account when setting pastoral compensation.

Below we will take a look at six pastoral compensation mistakes that can easily be avoided when armed with the right information.

(Recommended reading: "5 Common Myths Surrounding MInisters' Taxes")

Mistake #1: Paying the pastor before board approval

The bottom line is that any compensation paid by your church must first be approved by the board of directors. This is especially so when it comes to paying pastors because of the pastor’s role and influence in the affairs and decisions of the church.

When a pastor receives compensation from the church without it first being approved by the board of directors, it can be viewed and treated as an excess benefit transaction.

Treasury Regulation 53.4958 defines and explains that an excess benefit transaction “is the amount by which the value of the economic benefit provided by an applicable tax-exempt organization directly or indirectly to or for the use of any disqualified person exceeds the value of consideration.”

When compensation is not pre-approved by the board of directors, there is no value of consideration, thus resulting in the compensation being deemed excess benefit.

In short, excess benefit transactions could be subject to a tax penalty of up to 225% of the amount deemed in excess, depending on the facts and circumstances.

Mistake #2: Not paying the pastor a “reasonable” compensation

If a pastor’s compensation is deemed by the IRS to be in excess of “reasonable” compensation, then the excess amount of compensation could be subject to a tax penalty of up to 225% depending on the facts and circumstances.

That is a hefty penalty that no one wants to face.

For this reason it is important that you have an accurate understanding of what constitutes compensation and how to make sure the amount set is “reasonable.”

In a previous blog I addressed four steps churches can take to pay pastors a reasonable compensation.

Those four steps are as follows:

  1. Know what is considered compensation.
  2. Consider the overall health and goals of your church.
  3. Research comparable pastoral salaries.
  4. Create a pastoral compensation agreement.

You can read more about each step by clicking here.

Learn More About Establishing Minister’s Compensation

Click Here

Mistake #3: Not having a job description for the pastor

Having a job description for the pastor can help your church determine and justify a reasonable salary for the pastor as mentioned above.

Job descriptions may seem trivial; however, a job description serves several important needs:

  • It makes the expectations of the employee clear for the employer and employee, eliminating any confusion in the future about the standard to which the employee will be held.
  • It serves to support the reasonableness of the compensation by showing the function of the position and validating the pay that will be approved is comparable to the work expected of the employee.

Our Compensation Suite™ contains job description templates for multiple types of jobs within a church.

If you would, however, like to receive a job description template for a Senior/Lead Pastor, give us a call at 877-494-4655, and we’ll be happy to provide you with one.

Mistake #4: Giving the pastor a Form 1099

Some churches give their pastors a Form W-2 while others provide their pastors with a Form 1099-MISC.

So, which tax form is correct?

In short, pastors who are on staff at a church, either full-time or part-time, should receive a Form W-2.

If this is so, then why do some churches give their minister(s) a Form 1099-MISC?

The truth of the matter is that many churches mistakenly believe that determining which tax form to give their ministers is up to their discretion.

In reality, such a decision is not up to the discretion of a church.

Instead, churches should consider common-law rules to help determine who receives a Form W-2 and who receives a Form 1099-MISC. Common-law rules are used to determine if an individual is an employee or contract worker.

(Recommended reading: “Should Pastors Receive a W-2 or 1099?”)

Mistake #5: Assigning value to the minister’s housing allowance

I know this fifth mistake may seem counterintuitive, but let me explain.

At all of our conferences I teach pastors and ministry leaders that when establishing their housing allowance, the board of directors should approve their housing allowance at “up to 100%” of his or her salary.

Now this does not mean that 100% of the pastor’s salary will be deemed housing allowance.

Rather, this is a strategy that allows ministers to maximize their housing allowance.

When a board of directors predetermines a certain amount of a minister’s income as housing allowance, there is a possibility the minister will “leave money on the table” as the saying goes.

Ministers will still need to track actual housing expenses and determine a fair rental value of their home for the year. Whichever of the two amounts is lower will be the amount ministers can exclude from federal income tax.

Mistake #6: Withholding taxes for the pastor

Ministers often think that they are exempt from having to pay income taxes. However, that is simply not true. 

Rather, a minister’s wages are exempt from income tax withholding. In essence, a church should not withhold federal income tax from a minister’s pay without first signing a voluntary withholdings 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.”

However, if the church and minister choose not to enter into a voluntary withholding agreement, then the minister will be responsible to use Form 1040-ES to pay income tax.

What you do next matters

Clearly understanding ministerial compensation is of vital importance to both the minister and the church.

Since understanding ministerial compensation is so vitally important, I invite you to join us at one of our Ultimate Church Structure Conferences for a day of learning and growing together.

Or, if you are needing assistance in creating a ministerial compensation agreement, click on the link below, or give us a call today at 877-494-4655.

Find a Conference in a City Near You!

Click Here

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Please feel free to comment. We always appreciate good dialogue. However, we do moderate each comment to ensure that it is on topic and not derogatory to other participants. We ask that you keep your comments brief and pertinent to the topic so that others may benefit.

Blessings,
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.