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05 Oct 2017

IRS Taxes Pastor for Salary He Never Received

Raul Rivera

This time of year we get an abundance of phone calls from pastors who have still not filed taxes or from those who feel they have prepared them incorrectly.

Although ministry often requires pastors to “bring things to light,” I am amazed at how many pastors each year leave their taxes and tax-related issues in the dark. Many pastors simply do not know their tax obligations, or they have acted upon wrong information.

I was recently asked a question that caused me to refrain from giving an immediate response. A board member of a church here in the Atlanta area was wondering if salary set aside for the pastor needed to be declared on his Form W-2, even if the pastor decides not to accept the specified amount for the time being.

The pastor’s purpose in doing so was to alleviate budget constraints while the church underwent much needed renovations.

My heart wanted to tell the member, “No, that should not be taxable if the pastor refused to accept it.”

However, knowing that the tax code often has interesting caveats and nuances, I refrained from giving information until I had further researched the matter.

A tax doctrine that pastors need to know about

My research took me to Treasury Regulation 1.451-2(a) and the constructive receipt doctrine, which states:

Income although not actually reduced to a taxpayer’s possession is constructively received by him[/her] in the taxable year during which it is credited to his[/her] account, set apart for him[/her], or otherwise made available so that he[/she] may draw upon it at any time, or so that he[/she] could have drawn upon it during the taxable year if notice of intention to withdraw had been given.

This is saying that according to the constructive receipt doctrine, the amount of salary/income/compensation refused will be taxable if it is: 

  1. credited to the pastor’s account,
  2. set aside for the pastor, or
  3. otherwise made available to the pastor so that he/she may draw upon it or could have drawn upon it.

I was able to conclude that once the income was unconditionally set aside for the pastor, that was the trigger to make it taxable regardless of whether or not he/she received it.

Several courts have supported the fact that employees must include with their taxable income any amount of their salary that they refused to accept.

There are, however, some exceptions!

Learn How You Can Minimize Your Tax Liability!

Click Here

An exception to the rule

In the case of Commissioner v. Giannini*, the director and president of a corporation had his salary set at 5% of the company’s net profits. After receiving a large salary for the first half of the year, he informed the board of directors that he would not accept any remaining compensation for that year.

The board of directors decided to donate what the president would have received for the remainder of the year to the University of California to establish the Foundation of Agriculture Economics.

The corporation never credited to the president any further compensation for the year, nor did it set any part of the money aside for his use.

The IRS audited the president and decided that the salary amount he refused should have been reported as taxable income.

The president appealed the decision of the IRS.

Board of Tax Appeals reverses IRS decision

The Board of Tax Appeals reversed the IRS decision. Furthermore, the United States Ninth Circuit Court of Appeals upheld the reversal of the IRS decision stating,

The taxpayer did not receive the money, and . . . he did not direct its disposition. All that he did was to unqualifiedly refuse to accept any further compensation for his services with the suggestion that the money be used for some worthwhile purpose. So far as the taxpayer was concerned, the corporation could have kept the money. All arrangements with the University of California regarding the donation to the Foundation were made by the corporation, the taxpayer participating therein only as an officer of the corporation. (Giannini, 129 F.2d 638, 641 (9th Cir. 1942))

The court continued, “In this circumstance we cannot say as a matter of law that the money was beneficially received by the taxpayer and therefore subject to the income tax provisions of the statute.” (Emphasis added.) (Giannini, 129 F.2d 638, 641 (9th Cir. 1942)) 

In its opinion, the Ninth Circuit Court of Appeals was careful to note the difference between this case and previous cases that were similar in nature.

The Ninth Circuit indicated that the taxpayer (president) in this case held no “dominance over the fund,” nor did the taxpayer hold direction of the finances that showed “he beneficially received the money by exercising his right to divert it to a use.” (Giannini, 129 F.2d 638, 641 (9th Cir. 1942))

What this means to your church and to you as a pastor 

Most of the pastors I know are more than willing to make a personal sacrifice for the improvement and benefit of their churches. 

While this is an admirable gesture, and one that few other leaders do, there are some important points to consider before refusing your salary.

In order for refused portions of your salary to NOT be considered as taxable income, consider following the five points below.

  1. Make sure the amount of income you refuse is not credited to your account now or at a future point in time.
  2. Make sure no part of the amount of income you refuse is set apart for you to use at your discretion.
  3. Make sure the amount of income you refuse is not made available for you to draw upon at any time.
  4. Make sure the amount of income you refuse does not go towards something that may otherwise benefit you and your family.
  5. Make sure this decision and all pertinent details are recorded in board meeting minutes prior to moving forward with such a decision.

It is what you do today that matters

Income taxes for pastors usually work in one of two ways:

  1. For many pastors, it is a painful time as a lack of foresight leads to money owed and a payment plan with the IRS. 
  2. For others, it is a time where preparation and the proper set up lead to a smooth process and a large return!

We want you to be a part of that second group and take advantage of the laws that are in place to benefit ordained and licensed clergy. In order to be a part of that second group it matters what you do today.

Call us at 877-494-4655 to assist you in setting up your compensation agreement and housing allowance, and help you determine if you qualify for the self-employment tax exemption that can save you hundreds and even thousands of dollars in taxes each year!

Learn How You Can Minimize Your Tax Liability!

Click Here

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* Sources:

  • Commissioner v. Giannini, 129 F.2d 638 (9th Cir. 1942)

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.