In our experience as CPAs, we have learned that a lot of churches are not properly managing their payroll taxes. There are churches all over the country that pay payroll taxes for their clergy, which creates confusion and the potential for fines, penalties, or extra expenses, not to mention a tax nightmare for their ministers.
For many small churches, in particular, this is not a result of some sort of malfeasance. Rather, volunteer bookkeepers are unaware of the complexities of payroll law when it comes to religious organizations or the nuanced changes that occur from one year to the next.
To avoid confusion, a few definitions can help before we get into the topic of payroll taxes for ministers and clergy. Here are some basics you need to know:
Payroll tax: a percentage of an employee’s salary that is withheld from their paycheck by the employer and is paid to the government on their behalf.
Income tax: A portion of the payroll tax elected by the employee by completing form W-4 and applicable state election form (OK-W-4 form in Oklahoma). This tax is withheld by the employer from the employee's paycheck and paid to the government on their behalf.
FICA: A portion of the payroll tax, which funds Social Security and Medicare. A portion of this tax is paid by the employer on behalf of the employee.
Dual Tax Status: Ministers have dual tax status, which means that for federal income tax purposes, the minister is an employee of the church. However, for FICA (Social Security and Medicare taxes), the minister is considered to be self-employed and must pay both their portion and the employer portion.
The IRS's Standards
There is a lot of misleading information on the internet about how to manage payroll taxes for clergy. There are two main reasons for this: 1) Payroll taxes for churches are complicated. 2) Payroll taxes for churches are a unique niche area of accounting and tax preparation, which means that there are not a lot of reputable sources out there.
Here are a few things you should know about payroll taxes if you are a decision-maker in a church:
- Churches are not responsible for withholding any taxes at all from a minister’s paycheck. In the eyes of the IRS, 100% of the responsibility for the payment of taxes is on the clergy.
- Volunteer bookkeepers and accountants likely do not understand the complexities of the IRS rules regarding clergy payroll taxes.
- Churches need to be aware of the impact of a pastor’s housing allowance and ensure that they obtain updated housing allowance details annually for each minister.
What Happens if the Church Has Been Processing the Pastor's Payroll incorrectly?
There are several things that can happen if it turns out that the church has been incorrectly processing a pastor’s payroll taxes. Let’s go over some of these things!
The IRS Can Go After the Pastor
The IRS can go back up to three years on your taxes for just about any reason. That being said, it is extremely important for the church to process payroll correctly and for the pastor to ensure that they accurately report their compensation on their annual tax return. Not paying FICA on your housing allowance or the church withholding FICA from your pay can raise a red flag with the IRS and be grounds for an audit.
Misstatement of Income
If the IRS determines that there was a misstatement of income, they can go back as far as they want to collect the taxes you owe. This can be a huge hit for ministers. It is important to remember that these problems usually are not the result of churches or ministers trying to intentionally participate in a tax scam, but rather, these are issues that arise from lack of experience or knowledge with tax law. When the IRS sees FICA withheld from a minister’s pay, it essentially revokes the ministers dual tax status and makes them ineligible for the housing allowance. Claiming a housing allowance when you are not eligible creates a misstatement of income.
What Should a Pastor's W4 Look Like?
Check out our sample W-2 for a minister to get an idea of what a clergy member’s tax form should look like.
Worry-Free Church Payroll Services
Ascension CPA knows church payroll law! This unique area of tax law and accounting is our area. We understand the ins and outs of church taxes, including how clergy can ensure that they are paying their fair share without overpaying at all.
We’re always happy to chat with anyone who has questions about our services. That includes churches and clergy! Let us know how we can help.