It is no secret that no one’s favorite three letters in the alphabet are I, R, and S. However, it is imperative that church financial leaders understand the importance of being in compliance with IRS regulations for employers. Many a church has been penalized for failure to follow proper tax reporting procedures. This may be due to an errant belief that the IRS agrees with the separation of church and state (they don’t), or it may be that the volunteer treasurer, who was most likely voted in while absent from a business meeting, is unaware of proper reporting procedures.
Whatever the reason for the violation, it is important to understand that churches that compensate individuals to do work are considered employers, and it is not optional to ignore the reporting requirements the IRS has in place for employers. Consider the following five common reporting errors made by many churches.
• Treating staff ministers as self-employed for income tax purposes. A minister who works on a church staff is considered an employee for income tax purposes. Failure to treat him as an employee will negate the church’s ability to provide tax-free benefits for him, such as health insurance and retirement contributions. Only ministers who do not have an ongoing relationship with a church (itinerant ministers, revival speakers, short-term interim pastors) would be considered self-employed for income tax purposes.
• Treating staff ministers as employees for Social Security purposes. Ministers have a dual tax status. While they are considered employees for income tax purposes, they are considered self-employed for Social Security purposes. That means ministers must pay both halves of their Social Security and Medicare taxes themselves (SECA taxes, not FICA taxes). Churches who pay the employer half of Social Security and Medicare for a minister on their staff must report the amount paid by the church as taxable income to the minister at the end of the year.
• Providing incorrect tax documents at the end of the year. The dual tax status of ministers confuses many people. If the minister is on the staff of a church, he will receive a W-2, not a 1099-MISC. As mentioned above, ministers are employees for income tax purposes, and employees of any business are required by the IRS to receive a W-2 from their employer to report all taxable income. If an itinerant minister preaches a revival for your church, and the church compensates him $600 or more, (even if it is a “love offering”), the church is required to provide him with a 1099-MISC, which is the document for those who are self-employed for income tax purposes. A church would also be required to provide a 1099-MISC to any sole proprietor with whom the church does business during the course of the year. An example of this would be an individual who owns his or her own painting business that is not incorporated. If the church hires this individual to paint at the church, and the total bill is $600 or more, he must be given a 1099-MISC at the end of the year.
• Failure to provide any tax documents at the end of the year. The IRS requires all employers to provide a W-2 to every employee and a 1099-MISC to every self-employed individual earning $600 or more in a calendar year no later than January 31 for the previous tax year. Many small churches feel that they should not have to meet this requirement, and this causes no small amount of confusion and difficulty, not to mention hard feelings, for their ministry staff.
• Reporting ministers’ voluntary withholdings incorrectly. Churches are never required to withhold taxes from a minister’s check. However, they may if they are willing and the minister wants them to do so. The issue here is how to treat the minister’s SECA taxes on the 941 and the W-2. If a church withholds a minister’s SECA taxes, they should be treated as additional federal income taxes and not as Social Security taxes. The additional amount of income tax is credited by the IRS toward a minister’s SECA tax liability. When completing the 941, all SECA taxes withheld from a minister’s check should simply be added to the total federal income taxes withheld and entered into line 3. On the minister’s W-2, all federal income taxes and SECA taxes should be added together and the total placed in box 2. Keep in mind, this is only for ministers. For non-minister employees, churches are required to withhold income taxes and one half of the Social Security and Medicare taxes from the employee’s wages and match the other half of the Social Security and Medicare taxes. For more information on the proper payroll reporting requirements for churches, click here.
Dealing with the IRS does not have to be a scary proposition. Those church financial leaders who take the time to educate themselves usually have little communication with (or headaches from) the IRS. Take the time to learn the requirements. It will be time well spent.