North Carolina Pastor Ordered to Pay IRS $85,000.00

By Raul Rivera

Hearing from a judge that you have to pay the IRS $85,000.00 is not easy for anyone.  It was especially hard for the pastor in North Carolina because for the last several years she had been experiencing very difficult family times.  To make matters worse, mistakes that the church's previous administrator had made ended up costing her in penalties and interest...personally!  But the reason why she was fined had to do with how the bylaws gave her too much control of the church.  No one in ministry ever thinks it will happen to them, but the reality is that it does happen to ministers...mostly because they lack knowledge of the complexity of tax laws and they have deficient language in their ministries bylaws.  Let me explain.

IRS assesses penalty against a minister

A United States bankruptcy court ordered the North Carolina pastor to pay $85,814.69 in taxes plus penalties and interest because the court agreed with the IRS that she was considered a "responsible party" because her bylaws stated that she was in direct control of all the affairs of the corporation.  Section 6672 states that any person required to collect, truthfully account for, and pay over any tax . . ." or " . . . fails to collect such tax, or truthfully account for and pay over such tax, . . . shall, in addition to other penalties provided by law, be liable to a penalty equal to the total amount of the tax evaded, or not collected, or not accounted for and paid over."  Furthermore, IRS Policy Statement 5-14 states that the "penalty may be asserted against those determined to have been responsible and willful in failing to pay over the tax."

The pastor appeals the ruling

Upon hearing the order from the judge, the pastor filed an appeal with the United States District Court for the Eastern District of North Carolina.  She argued that the court did not have judicial authority to interpret the ministry's bylaws because First Amendment principles preclude a court from deciding issues of religious doctrine and practice, or from interfering with internal church government (Dixon v. Edwards, 290 F.3d 699, 714 (4th Cir. 2002)).  She also argued that by interpreting the ministry's bylaws "the state was establishing a state-regulated religion through judicial fiat."  In rejecting her appeal, the court ruled that the "bankruptcy court's analysis of the ministry's bylaws was limited to a few paragraphs..." because it only focused on the following:

• She was CEO of the ministry and a member of all boards and committees
• She authorized in the name of the ministry to execute deeds, bonds, mortgages, contracts and other documents
• She was given the powers and duties of supervision and management usually vested in the office of president of a corporation
• She was given decision-making authority and supervision over business matters.

This ruling shows us that bylaws must be strategically drafted to protect the pastor from such liabilities without compromising the biblical convictions of the church's disciplines of faith in how the church will be governed.   

How it happened

When a new employee was hired to take over accounting, the employee discovered that the previous administrator at the church had not properly remitted the employment taxes to the IRS.  The new employee immediately informed the pastor about the problem, which had clearly existed for a few years.  Her ministry made some efforts to pay the taxes plus the penalties and interest.  Soon after entering into a payment plan with the IRS, the ministry suffered some financial setbacks, as all ministries do from time to time.  However, the pastor's husband became very ill and it required her to focus much of her time on caring for him.  The ministry could no longer keep up with the payments to the IRS.  This forced the IRS' hand to move against her, using the power of Section 6672, and to declare a responsible party.  As you will see later, once the IRS declares you a responsible party, the burden of proof falls on you to prove that you are not.

Two common ways churches and board members fall into the trap

In my experience with thousands of churches over the past several years, the most common way a church falls in this trap is by not properly filing 941 forms and paying the proper payroll taxes.  The second most common way is the way they treat musicians, nursery workers, and other individuals doing small tasks at the church.  The vast majority of churches treat these individuals as self-employed and they either give them a 1099-misc form, or they do not give them anything at all.  This error will add up over a period of time.  The IRS can very easily reclassify these individuals as employees, charge the church back taxes, and hold the responsible party personally liable for the tax.  This often times ends up being the pastor and/or treasurer or financial secretary.

Why the pastor and church treasurer are most at risk

In a court case, Verret v. U.S., 542 F.Supp.2d 526 (2008), the court ruled that Stephen K. Verret was a responsible party and was ordered to pay the penalty of $408,918.66.  The court noted the following points that contribute to one being a responsible party:

1.         Someone who is an officer or member of the board of directors;

2.         Someone who runs day-to-day operations;

3.         Someone who makes decisions as to the disbursement of funds and payment of creditors; and

4.         Someone who possesses the authority to sign checks.

The court also noted that one might be considered a responsible party even if he/she does not have knowledge that he/she has such a duty or authority for collecting, accounting for, or paying over employee withholding taxes.  Just having significant decision-making power over the disbursement of funds is enough to be considered responsible.

Burden of proof

Once the IRS determines whom the responsible party is, the burden of proof falls on the taxpayer to prove that he/she is not the responsible party.  In the Verret case, the court noted that, "Once the government offers an assessment into evidence, the burden of proof is on the tax-payer to disprove his responsible-person status . . ." 

Ways to avoid the Section 6672 penalties

There are numerous ways in which a church and its board members can avoid falling into this type of tax trouble.  I am only going to briefly mention them because the details of each are separate conversations and teachings altogether.  We continually cover these topics at our conferences and also detail them in our conference manual.

1.     Opt the church out:  I am sure you have heard about ministers opting out of self-employment tax.  But you may not have heard about a church opting out.  However, the law allows a church to file form 8274 and simply opt out of having to be responsible for collecting payroll taxes.

2.     Properly classify workers in the church:  All staff, such as musicians (even if they play only once a week on Sundays), nursery workers, staff preachers, teachers, cleaners, volunteers who get occasional love offerings, church secretaries, or any persons doing any work for the church where the church pays them on a regular basis and in which the church has some say so or control as to where and when the work is done, are legally employees and must have FICA and Medicare taxes withheld and paid to the IRS using the EFTPS system. 

3.     Avoid the 28% and 30% penalty:  Many churches have guest speakers and lamentably, many do not give them form W-9 if they are U.S. Citizens or a W-8 with form 8233 if they are foreign nationals.  The law provides that when you fail to make them fill out the form and turn it in to you before you make a payment for services they render, you may be assessed a 28% penalty in the case of a U.S. citizen or a 30% penalty if they are a foreign national.  Both of these are assessed with penalties and interest for lack of compliance.

Create a system for success

These law requirements may sound burdensome.  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 everything I just mentioned automatic.  One day at our conference and I assure you, your ministry will never be the same.

*The information I shared about the pastor is in no way intended to bring negative exposure to her or her ministry.  The information is available through public records (re Gilbert Vaughn, Corletta J. Vaughn, Debtors, U.S. Bankruptcy Ct. (E.D.N.C., 2011) and (Gilbert Vaughn and Corletta J. Vaughn, Appelants v. Internal Revenue Service, Appelee., U.S. District Court, E.D. North Carolina, 2012-2 U.S.T.C. ¶50,487, (Jul. 24, 2012)).  With that said, we hope that it helps pastors and church officers to invest the time needed to learn how to steer their ministries in such a way that they avoid tax trouble.  If you want to support her ministry please go to http://www.gotellit.org and click the donate button.

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