How to Pay a Minister a Holiday Bonus

Written by Kristen Calicott on Nov 10, 2020 in IRS Compliance

The holidays are coming up fast! That means it's time to prepare for everything that comes with them: the food, the time with family and friends, and the gifts given to those you love and appreciate.

Traditionally, this season also provides a special opportunity to bless your pastor and ministry leaders who have given so much throughout the year. How can you express your gratitude for your pastor or ministry leader this upcoming season? One of the most common ways is through a holiday bonus!

Now let's take a look at how to create a reasonable bonus plan and accurately report compensation at the end of the year.

Creating a reasonable bonus plan

A bonus of any amount is considered taxable compensation, and it must be included as part of the pastor's total compensation package. One of the most important steps when deciding to give your pastor a bonus is making sure the amount is "reasonable." If the pastor's salary exceeds what the IRS considers a "reasonable" salary, then the church could pay up to a 225% tax penalty. Check out this blog for guidelines on how to determine whether your pastor's compensation agreement is reasonable.

One of the final steps to establishing reasonable compensation is creating and approving a compensation agreement. Does your church have a compensation agreement for the pastor? If not, our Minister's Compensation Service can help you set one up! Give us a call at 877-494-4655 or click the link below to learn more!

Learn More About Minister’s Compensation

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Establishing bonus guidelines

When establishing a bonus plan for your pastor, the board of directors should:

  • Define the merits of a bonus,
  • Decide when the pastor will receive his or her bonus, and
  • Determine how the pastor will be paid his or her bonus.

Not all pastors will receive a bonus at the end of the year. By no means does this speak to the pastor's performance. Instead, the church may simply not be in a financial position to afford a bonus this year, and that's okay! Additionally, if the pastor does not meet the set standards or requirements of a bonus but still receives one, the board of directors needs to provide a justified reason and document it.

Bonus limitations

Remember: the pastor's compensation, including a bonus, shouldn't exceed a reasonable amount. Some churches erroneously believe paying the pastor based on a percentage of income the church receives during the year is automatically reasonable. To clarify, a percentage-based bonus isn't an incorrect way to pay the pastor, but it is necessary to set a maximum limit.

Another form of compensation often gifted to pastors and ministers around this time is a love offering! To listen to our latest Beyond the Call podcast, a Practical Guide to Love Offerings, click the link below! Subscribe for weekly episodes to help you protect what God has called you to lead!

W-2 vs. 1099

Along with setting a reasonable compensation amount, selecting the appropriate tax form can be a stumbling block to some churches. Near the end of the year, I am often asked by church staff if they should issue a Form 1099 or a Form W-2 to their pastor. Many churches believe they can choose to give their pastors whichever tax form is more convenient. However, this decision isn't up to the church. The IRS created common-law rules to determine if an individual is an employee or a contract worker for tax purposes.

IRS Publication 15-A states,

"Under common-law rules, anyone who performs services for you is generally your employee if you have the right to control what will be done and how it will be done. This is so even when you give the employee freedom of action. What matters is that you have the right to control the details of how the services are performed."

Common-law rules are composed of three factors: behavioral control, financial control, and the relationship of the parties. Below is a brief explanation of each:

  • Behavioral control: Does the church have the ability to dictate how and when the person performs his/her duties? If so, the individual is an employee.
  • Financial control: Does the church control the business aspects of the person's job? Is the individual able to seek other job opportunities? If the worker is not permitted to explore other job opportunities, then he/she is an employee of the church.
  • Relationship of the parties: Does the individual provide duties/services vital to the church's existence? If so, he/she is an employee.

Additionally, pastors have dual-tax status, which means they receive payment as employees with a W-2, but they are responsible for withholding and reporting their own taxes like a contract worker. In other words, a church is not allowed to withhold taxes from a minister's paycheck unless the two parties (i.e., the church and pastor) have entered into a voluntary withholding agreement. (See IRC section 3401 and Treasury Regulation 31.3402(p)-1.)

Understanding and applying the common-law rules can help the church avoid costly penalties in the future.

Honoring our leaders

Pastors and ministry leaders work so hard throughout the year, providing spiritual guidance for their church members with little to no compensation. They often sacrifice their time and pay for so many things out of their own pockets. Blessing these leaders God has placed over us with a year-end holiday bonus is a great way to show our gratitude for all of the work they do.

Besides honoring pastors with a bonus at the end of the year, we must also honor them by paying them correctly and reporting their income accurately. If you need help keeping track of your income and expenses, we have a service for you!

With StartCHURCH's Bookkeeping Service, you'll work with a ministry-minded bookkeeper who will guide you through the steps and protocols your church needs to follow to comply with the IRS. Click the link below or give us a call at 877-494-4655 for more information!


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Raul Rivera

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