8 Things to Know About Payroll and Taxes

By Raul Rivera

Taxes were withheld from his biweekly paycheck.  Like clockwork, the paystub showed that federal income tax was withheld as well and Social Security and Medicare taxes.    He liked the fact that the church was diligent in hiring a payroll company to do the church's payroll.  Yet after attending our Ultimate Church Structure Conference, he knew he had to make a change.  The way payroll was set up was not correct.  Section 3121(b)(8)(A) prohibits the church from withholding Social Security tax, as well as Medicare.  A minister is responsible to pay 15.3% self-employment tax on his or her salary and housing allowance.  Their goal was to make sure their payroll was done right.  What about your church?  Is it being done correctly? Are you going to start soon? Following are 8 things you need to know.

1.     Decide early in the process who handles it: We recommend that your church decide in its early stages whether to keep track of its own payroll or to hire it out to a professional. If you do it in house, we recommend that the church carefully calculate how much federal income tax, Social Security, and Medicare tax it needs to withhold from each paycheck. To know how much to withhold, use IRS Publication 15. If you hire a company to do your payroll, you must make sure that they understand the difference between ministers and regular employees. Look at step 2.

2.     Learn the difference between the two types of employees:  Payroll for a church can be very different than that of a standard nonprofit, for-profit, or other ministry organization. Churches have to treat employees and ministers differently for tax purposes; additionally, a church can opt out from withholding Social Security and Medicare taxes altogether by filing Form 8274.  This will mean higher taxes for the employees of the church but not necessarily for the ministers.  The church should consider the type of employees it will have when setting up the payroll.  For churches there are two types of employees:

a.     Ordained employees 

b.    Non-ordained employees

Ordained ministers usually do not have taxes withheld from their paychecks while most non-ordained employees have taxes withheld from their paychecks.  Most young churches may have just the pastor on payroll or possibly the pastor and a secretary.

3.     Make sure every employee fills out a W-4 form:  Whether you have a minister or a non-ordained employee, the first step in setting up payroll is receiving a completely filled out Form W-4.  This form is used to gather the information necessary to withhold the correct amount of taxes.  The IRS requires that the employer keep this form in its records at all times, and it will not be submitted to the IRS.

4.    Choose payroll frequency:  Because every church is unique and will vary in preferences, it is recommended that the church choose whether it will run payroll weekly, bi-weekly, or monthly.  We have found most churches that do their own payroll prefer a weekly pay schedule, and those who hire it out prefer a biweekly and sometimes monthly payroll.

5.    Withholding of taxes from employees:  Please remember, all employees must have taxes withheld from their paychecks, with the exception of ministers.  Under section 409A, all wages, whether in cash or check, are considered income and are subject to withholding.  The following taxes must be withheld:

Type of tax	Employee	Employer
FICA	6.2%	6.2%
Medicare	1.45%	1.45%
Medicare Hospital Insurance	0.9%*	0.00%

The wage base limit for FICA is $113,700.00, and Medicare has no limit.

The Medicare Hospital Insurance Tax is a new tax under the health care law.  Certain employees will be subject to this new tax.  Below is a breakdown.

• Employees married filing jointly making over $250,000.00;
• Employees married filing separately making over $125,000.00;
• Employees filing single making over $200,000.00;
• Head of household (with qualifying person) making over $200,000.00;
• Qualifying widow(er) with dependent child making over $200,000.00

These taxes must be withheld each pay period and be matched by the church.  The church does not have to match the Medicare Hospital Insurance Tax.  When the church withholds, it becomes a trust agent for the employee, and these taxes must be paid to the IRS in a timely manner.            

6.     Three things about withholding taxes:  The tax code has very strict rules when it comes to payroll taxes.  Below are three important facts about collecting and paying taxes:

a.     Taxes are required to be collected at the source.  This means that the church must withhold the tax from the paycheck and send it to the IRS.  Failure to withhold is a violation of section 3402(a)(1),

b.    When the church withholds taxes, it is responsible for holding and submitting the taxes of its employees to the IRS.  If the church decides to do its own payroll, it can submit taxes electronically by using the eftps.gov website.

c.     The taxes withheld must be paid in a timely manner or serious penalties will apply as follows:

i.     2% - When taxes are paid 1 to 5 days late.

ii.     5% - When taxes are paid 6 to 15 days late.

iii.     10% - When taxes are paid 16 or more days late, and this also applies to amounts paid within 10 days of the date of the first notice the IRS sent asking for the tax due.

7.     Informational returns:  When it pertains to payroll, the church is required to file 941 quarterly returns as well as W-2 and W-3 tax and wage statements.  The IRS spends significant time making sure that informational returns are filed correctly and on time.  Sections 6721 and 6722 provide for penalties if the church does not file these forms on time and correctly.  The penalties range from $50.00 per return to $100.00, and if the IRS says the failure to file was willful, the penalty can be up to $250,000.00. 

8.     Penalties applied personally:  There are circumstances in which the IRS can assess the penalties on the board of directors personally if the agency believes the non-payment was because of willful neglect. This idea comes from IR Bulletin No.  2005-24 where it describes section 6672(a) as imposing the fine on a person. Additionally, section 3371(b) defines the term "person" as including any officer or employee or member of the corporation responsible to withhold and report.

Working ON the ministry

I am convinced that if you take some time to work ON your ministry and not just IN the ministry, you can create infrastructure that makes payroll and other financial areas of the church IRS-proof.  I invite you to spend one day at our conference and I assure you, your ministry will never be the same.

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