Minister Required to Pay $6,000 Tax on $2,700 Pay Raise

Written by Raul Rivera on Mar 12, 2019 in IRS Compliance

When it comes to keeping accurate books and paying a minister a salary, churches must navigate many compliance issues. Let me give you an example. 

Four years ago, the elders of a church decided to give their pastor a $2,700 raise. Wanting to make the most of it, the elders inquired how to best give the pastor this money. An accountant told the elders they could pay it to the pastor in the form of a car allowance to reimburse him for the use of his personal vehicle to do ministry. 

Many churches do this and record it in their books as a car allowance reimbursement. What many of those churches do not know is that they are required to inform the pastor to submit to the church an accounting of the miles incurred to conduct church business. 

What went wrong

In the case of the church I mentioned, the pastor was not required to submit mileage logs, thus making the church car allowance paid to him illegal. Our StartCHURCH bookkeepers often come across situations like these when preparing financial statements for our customers.  

Under section 4958, the IRS levied an excise tax of 225% of the car allowance against the pastor for failure to report the income on his tax return. The tax levied was $6,000. The IRS could have also fined the church elders personally up to 10% of the pay raise. 

Under the tax code, ministers, board members, church elders, any others with significant control of church matters, and family members of such individuals are classified as “disqualified individuals.” This classification means that a church has to pay special attention when money is transferred from the church to any of the above mentioned "disqualified" individuals. 

The church I mentioned could have avoided this massive tax on the pastor's pay raise. Here is what could have been done.  

  1. The board of elders vote to pass the car allowance in an official board meeting. They make sure it is recorded in the minutes of the church.
  2. After approving the car allowance, they create an official Travel Expense policy. This policy protects the newly-adopted car allowance.
  3. The board of elders then make sure the pastor turns in the mileage logs. They only reimburse for actual business miles reported in the mileage logs. (For 2019, the rate is $0.58 per mile.)

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Other big mistakes churches make

As mentioned before, we have a bookkeeping service at StartCHURCH. Because we have the honor of doing the bookkeeping for many churches, we get to see and help correct many reporting errors that churches make. This helps them avoid thousands of dollars in fines and many sleepless nights. Below are a few other big mistakes churches make in violation of section 4958.

  • The church pays the pastor’s taxes. Many churches pay the pastor’s social security or Self-Employment taxes. For those of you that have an understanding of payroll and how FICA works, the employee pays one-half of his of social security taxes while the employer pays the other half. Those taxes are withheld from the paycheck and then reported on Form W-2. However, if a church withholds and pays FICA taxes on a pastor’s salary and reports it on his or her W-2 form, the church is inadvertently paying one-half of the pastor's Self-Employment taxes. This overpayment can subject the pastor to a 225% excise tax.
  • The church pays for a family member to travel with the pastor. Spouses often travel with the pastor to church conferences or to other church-sponsored events in which the pastor must spend the night at a hotel. A church can only pay the travel costs of the pastor’s spouse if the spouse is also traveling on official church business. This includes if the spouse is an employee of the church as well or if he or she is a volunteer on official assignment on behalf of the church. Many churches assume it is okay to pay for the travel expenses of both. They often end up recording it in their books as such only to find out that it was not legal, causing the section 4958 excise tax to be levied. 
  • The church pays the pastor's debts. I have come across many excellent pastors who incurred debts from events in their past and struggle to stay financially solvent. Let us not get too caught up in the why's behind the debt. We all fall short some way or another. Often, churches either give the pastor an interest-free loan or pay the debt altogether. Both of these acts, while motivated by love and admiration, are considered taxable events and must be accurately reported on the minister’s W-2. Failure to do so is a violation of section 4958. 
  • Pastor uses his or her personal credit card for church activities. Our lead bookkeeper at StartCHURCH mentioned to me that many pastors get a personal credit card and use it for church purposes. Often, they do this because the church is unable to qualify for a credit card. It is important to know that this is not illegal. However, a church must be diligent to adopt a written credit card policy that very explicitly states that the credit card shall be used exclusively for church business. 

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Final thoughts

A second pair of eyes can go a long way in catching mistakes that have big consequences. One of the best ways a church can have a second pair of trained eyes looking at their books is to have a personal bookkeeper handle the church's finances. 

We know how much pastors and church leaders love the church. I, too, pastored for many years, and there wasn’t anything I would not do for my church. 

At StartCHURCH, our call is to look out for the pastor and the church entrusted into his or her hands. So, I would like to leave you with this thought, “You love the people, and let us love your people’s numbers.” Together, we will make a great team.

If you are curious to learn more about our bookkeeping service, I encourage you to give us a call at 877-494-4655. One of our specialists would be glad to see how we can serve you and your church.

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.

Raul Rivera

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