Pastor Ordered to Pay Taxes on Salary He Never Received

By Raul Rivera

Imagine with me for a moment the moving scenario where a church pastor tells his board of directors to no longer pay his salary so that the church can make it through a downturn in the economy.  His sacrificial leadership begs the respect of all in the room, and demonstrates the nature of a true shepherd.  Now imagine the IRS auditing his tax return and telling him that though the church did not pay his salary, he still has to report the full amount and pay taxes on it.  Does that sound unreasonable and unjust?  Not according to the legal definition of income when the Constructive Receipt Doctrine is applied.  The IRS' tax assessment against the pastor lies in the way the board secretary documented the minutes of the board meeting in its corporate records book.  Let me explain. 

Pastor of church defers income

The pastor of a 200-member church made the difficult decision to tell his board of directors to no longer pay the $75,000.00 salary it had agreed to pay him.  With the downturn in the economy, a larger-than-usual number of the church members was either unemployed or under employed.  As a result, in order for the seven-year old church to survive, the pastor chose to forego receiving a salary until such time as the church would be able to afford paying him again, without injury. 

His relationship with the board of directors was stellar.  With genuine concern for their pastor's well being, the board members made every attempt to convince him to continue receiving his salary, but their efforts proved futile.  Finally, after realizing that their pastor could not be swayed otherwise, one of the board members suggested, "Why don't we suspend his salary temporarily, with the following terms: at any point that he feels the church can satisfactorily afford it, he can notify the church secretary and restart his salary?  And any amount that he does not receive this year can simply be pushed forward so that he can receive it in the future, as soon as the church can manage to pay it."

How a good-hearted decision can still have bad consequences

The pastor agreed with the suggestion and so the board unanimously voted and documented in its minutes to do three things:

1.     Abate the pastor's weekly paycheck until the pastor decided it was time to start again;

2.     Roll over into the next year any amounts not received by the pastor that current year;

3.     Create a provision whereby the pastor could request to have all roll-over funds paid to him immediately and in one large sum, if at any point in the future the church recovered enough to do so without adverse effect.

Though we can all see the nobility of the pastor in foregoing some of his income, the church's desire to bless him by crediting back pay to his account ended up in a tax bill to the pastor because it activated the Constructive Receipt Doctrine found in Regulation 1.451.

The Constructive Receipt Doctrine

Treasury Regulation 1.451-2(a) establishes that money not paid to a taxpayer is considered constructively received by a taxpayer in the same year that it was "credited to his account, set apart for him, or otherwise made available so that he may draw upon it at any time . . ." by giving notice.  This is precisely what happened to the pastor:  though he only received $35,000.00 of the $75,000.00 salary in his contract, he still had to pay taxes on the full $75,000.00

In the court case Harrison v. Schaffner - 312 U.S. 579 (1941), The United States Supreme Court ruled that one who is vested with the right to receive income does not escape the tax if he exercises any control over it.   That is exactly what the pastor had; control as to when he would get paid.

What they should have done

Looking back, the pastor and the church learned that they should have done things differently.  They realized that in the future, if they ever need to defer the pastor's salary again, they would do the following:

1.     At a board meeting, document that the pastor no longer wishes to receive his weekly salary.

2.     Document that upon forfeiting his salary, the pastor cannot control or dictate the terms upon which it will pay him a salary in the future.

3.     Document that any forfeited salaries for this year will not be rolled forward into future years, unless the board, on its own, decided in a future year to do so.

4.     Vote and approve the measures above and save the minutes in the corporate records book.

How to get right

Having consulted 1,000's of churches about their compliance issues, it is clear that the overwhelming majority want to live above reproach in this vital area.  Often all they need in order to make this critical transition is a partner that will help guide and equip them to make the leap.  StartCHURCH exists to help pastors and ministry leaders do just that!  Either on the phone or through our Church Compliance Conferences, we provide one-on-one time with pastors whereby they can privately share the state of their house and receive the insight and tools they need to move forward with confidence.  If you would like to get started on your road to real compliance, please call 770-638-3444 or register for one of our conferences coming up in your area. 

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