Church Payroll: Do Churches Pay Payroll Taxes?

There are an estimated 380,000 churches in the US plus over 80,000 religious charities and nonprofits. If you’re one of these organizations, then you have some unique considerations when it comes to payroll for church employees. While there are many similarities with payroll for for-profit organizations, your church or other religious entity may have to follow different rules and regulations, which can get complicated.

To help you understand your obligations when it comes to payroll, here we’ll discuss:

  • What is considered a church or religious organization under the IRS
  • How do I set up church payroll
  • What taxes are churches exempt from paying
  • Do churches pay payroll taxes
  • Are ministers considered employees or self-employed
  • How do I handle a clergy housing allowance
  • Do I have to pay church employees overtime
  • Are church musicians employees

After reading this article, you’ll have the information you need to set up accurate and compliant church payroll so you can focus your time and energy on furthering your mission. For more guidance about understanding the scope of payroll services—and how they align with your organization’s needs, consider downloading our complete guide to payroll solutions.

What is considered a church or religious organization under the IRS?

The Internal Revenue Code doesn’t specifically define a “church” for federal tax purposes. However, there are certain characteristics that the IRS lists as generally attributed to churches, including:

  • Distinct legal existence
  • Recognized creed and form of worship
  • Definite and distinct ecclesiastical government
  • Formal code of doctrine and discipline
  • Distinct religious history
  • Membership not associated with any other church or denomination
  • Organization of ordained ministers

Churches Must Meet Certain Criteria

While the IRS doesn’t provide a precise definition of a church, they do outline 14 criteria that are generally used to determine if an organization qualifies as a church for tax purposes. These criteria include having a distinct legal existence, recognized creed and form of worship, definite ecclesiastical government, formal code of doctrine and discipline, distinct religious history, and an organization of ordained ministers.

It’s important to note that an organization doesn’t necessarily have to meet all 14 criteria to be considered a church by the IRS. However, they should strive to meet as many of the criteria as possible to ensure their status as a tax-exempt religious organization.

The Importance of Meeting IRS Criteria

Meeting the IRS criteria for a church is crucial for several reasons:

  • It establishes the organization’s legal status and protects it from potential legal issues
  • It allows the church to apply for tax-exempt status and avoid paying certain taxes
  • It enables the church to receive tax-deductible donations from members and supporters
  • It demonstrates the church’s commitment to its religious mission and values

By understanding and adhering to the IRS criteria for churches, religious organizations can ensure they are operating within the law and maintaining their tax-exempt status.

How do I set up Church payroll?

church payroll

Setting up payroll for a church or religious organization involves several steps:

  1. Obtain an Employer Identification Number (EIN) from the IRS
  2. Determine which employees are considered clergy and which are non-clergy
  3. Decide whether to handle payroll in-house or outsource to a payroll service provider
  4. Establish policies and procedures for tracking employee hours, calculating wages, and withholding taxes
  5. Ensure compliance with federal, state, and local payroll tax laws
  6. Provide employees with necessary forms and information, such as W-4s and employee handbooks
  7. Regularly review and update payroll processes to stay current with changes in laws and regulations
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Outsourcing Church Payroll

Many churches choose to outsource their payroll to a professional service provider to ensure accuracy, compliance, and efficiency. Outsourcing can offer several benefits:

  • Reduced administrative burden for church staff
  • Access to expert knowledge and guidance on payroll laws and regulations
  • Automated tax calculations and form filing
  • Secure storage and backup of payroll data
  • Reduced risk of errors and penalties

When selecting a payroll provider, churches should consider factors such as cost, ease of use, customer support, and experience working with religious organizations.

Maintaining Accurate Records

Regardless of whether a church handles payroll in-house or outsources it, maintaining accurate and up-to-date records is essential. This includes:

  • Employee timesheets and pay stubs
  • Tax forms and payments
  • Payroll registers and reports
  • Employee handbooks and policies

Keeping thorough records not only helps ensure compliance with payroll laws but also provides a paper trail in case of audits or disputes.

What taxes are churches exempt from paying?

Churches and other religious organizations enjoy certain tax exemptions, but they are still responsible for paying some taxes. Here are some key points about church tax exemptions:

  • Churches are automatically exempt from federal income tax under Section 501(c)(3) of the Internal Revenue Code (IRC).
  • They are not required to apply for tax-exempt status or file annual tax returns (Form 990). You can find out more about this.
  • Churches are still subject to payroll taxes, such as Social Security and Medicare taxes, and must withhold income taxes from employee wages.
  • They may be exempt from state income taxes, depending on the state.
  • Churches must pay taxes on unrelated business income (UBI), such as income from a business not substantially related to the organization’s exempt purpose.
  • They are generally exempt from paying federal unemployment taxes (FUTA) for employees.

Exceptions to Tax Exemptions

While churches enjoy broad tax exemptions, there are some exceptions and limitations:

  • If a church’s unrelated business income exceeds $1,000 in a tax year, they must file Form 990-T and pay taxes on that income.
  • If more than 15% of a church’s total revenue comes from unrelated business income, they risk losing their tax-exempt status.
  • Churches may be subject to state and local taxes, such as property taxes and sales taxes, depending on the jurisdiction.

It’s important for churches to understand the scope of their tax exemptions and ensure they are complying with all applicable tax laws and regulations.

Do churches pay payroll taxes?

Yes, churches must pay certain payroll taxes and withhold taxes from employee wages, with some exceptions for clergy members. Here’s a breakdown of the payroll taxes churches typically pay:

  • Social Security and Medicare (FICA) taxes: Churches must withhold the employee’s share of FICA taxes from wages and pay the employer’s share.
  • Federal income taxes: Churches must withhold federal income taxes from employee wages, except for ministers.
  • State income taxes: Churches may be required to withhold state income taxes from employee wages, depending on the state.

Payroll Taxes for Ministers

Ministers, pastors, and clergy members are treated differently when it comes to payroll taxes:

  • Churches are not required to withhold federal income taxes from ministers’ wages.
  • Ministers are considered self-employed for Social Security and Medicare tax purposes and must pay self-employment tax (SECA) on their ministerial income.
  • Ministers can enter into voluntary withholding agreements with their church to have income taxes withheld from their wages.
  • Churches must still issue ministers a Form W-2 at the end of the year, even though they are considered self-employed for Social Security and Medicare taxes.

Consequences of Non-compliance

Failing to pay or withhold payroll taxes can result in significant penalties and interest for churches. The IRS can impose penalties for late filing, late payment, and underpayment of taxes. In extreme cases, non-compliance can even jeopardize a church’s tax-exempt status.

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To avoid these consequences, churches should ensure they are properly classifying employees, withholding the correct taxes, and paying taxes on time. Seeking guidance from a payroll professional or tax advisor can help churches navigate the complexities of church payroll taxes.

Are ministers considered employees or self-employed?

Ministers have a unique tax status that combines elements of both employee and self-employment. Here’s a closer look at how ministers are classified for tax purposes:

  • For federal income tax purposes, ministers are considered employees of the church.
  • However, for Social Security and Medicare taxes, ministers are considered self-employed and must pay self-employment tax (SECA) on their ministerial income.
  • This dual tax status means that ministers are responsible for paying both the employee and employer portions of Social Security and Medicare taxes.
  • Ministers can opt out of Social Security by filing Form 4361 if they have a religious objection to public insurance programs.

Voluntary Withholding Agreements

While churches are not required to withhold federal income taxes from ministers’ wages, ministers can enter into voluntary withholding agreements with their church. This allows the church to withhold income taxes and estimated self-employment taxes from the minister’s wages.

Voluntary withholding agreements can be beneficial for ministers because:

  • They eliminate the need to make quarterly estimated tax payments.
  • The amount withheld is used as a credit for both federal income taxes and self-employment taxes on the minister’s tax return.
  • It helps avoid late payment penalties for quarterly estimated taxes.

Both the church and the minister can terminate the voluntary withholding agreement at any time.

Reporting Ministers’ Income

Even though ministers are considered self-employed for Social Security and Medicare taxes, churches must still report their income on Form W-2 at the end of the year. This form provides ministers with a summary of their earnings and any voluntary tax withholdings.

It’s important for ministers to carefully track their income and expenses throughout the year to ensure they are paying the correct amount of self-employment tax. Seeking guidance from a tax professional who specializes in clergy taxes can help ministers navigate the complexities of their dual tax status.

How do I handle a clergy housing allowance?

A clergy housing allowance is a portion of a minister’s compensation that is designated by the church to be used for housing expenses. This allowance is excluded from the minister’s taxable income for federal income tax purposes, but not for self-employment tax purposes.

To properly handle a clergy housing allowance, churches should:

  • Officially designate the housing allowance amount in an official church resolution or employment agreement.
  • Ensure the allowance is used by the minister for qualified housing expenses, such as rent, mortgage payments, utilities, repairs, and furnishings.
  • Report the housing allowance amount on the minister’s Form W-2, but exclude it from the minister’s taxable income.

Limitations on Housing Allowances

There are some limitations on clergy housing allowances:

  • The allowance cannot exceed the fair rental value of the minister’s home, plus utilities.
  • If the minister lives in a church-owned parsonage, the housing allowance is limited to the fair rental value of the parsonage, plus utilities.
  • The housing allowance must be designated in advance of the year in which it will be paid.

Reporting Housing Allowances

Churches must report clergy housing allowances on the minister’s Form W-2, but exclude the allowance from the minister’s taxable income. The allowance should be reported in Box 14 of the Form W-2, with a note indicating that it is a housing allowance.

Ministers should keep careful records of their housing expenses throughout the year to ensure they are using the full amount of the allowance for qualified expenses. Any unused portion of the allowance must be reported as taxable income on the minister’s tax return.

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Do I have to pay church employees overtime?

Whether churches are required to pay overtime to employees depends on the employee’s classification and the church’s policies. Here are some key points to consider:

  • Non-exempt employees, such as administrative staff or maintenance workers, are entitled to overtime pay under the Fair Labor Standards Act (FLSA).
  • Exempt employees, such as ministers and certain administrative staff, are not entitled to overtime pay under the FLSA.
  • Churches should have clear policies in place regarding overtime pay and compensatory time off for non-exempt employees.
  • Overtime pay is calculated at 1.5 times the employee’s regular hourly rate for hours worked over 40 in a workweek.

Compensatory Time Off

Some churches choose to offer compensatory time off (comp time) instead of overtime pay. Under this arrangement, non-exempt employees receive 1.5 hours of paid time off for each hour of overtime worked.

To offer comp time, churches must:

  • Have a written agreement with the employee
  • Provide the comp time off within the same pay period or the next pay period
  • Maintain accurate records of comp time earned and used

Avoiding Overtime Violations

To avoid overtime violations, churches should:

  • Properly classify employees as exempt or non-exempt
  • Maintain accurate records of hours worked by non-exempt employees
  • Have clear policies in place regarding overtime and comp time
  • Seek guidance from a payroll professional or labor law attorney if unsure about overtime requirements

By following these best practices, churches can ensure they are complying with overtime laws and treating their employees fairly.

Are church musicians employees?

The classification of church musicians depends on the nature of their work and their relationship with the church. Here are some factors to consider:

  • Musicians who are hired to perform on a regular basis, such as a choir director or organist, are more likely to be considered employees.
  • Musicians who are hired for occasional performances, such as a guest soloist or instrumentalist, are more likely to be considered independent contractors.
  • The church’s level of control over the musician’s work, such as rehearsal schedules and performance requirements, can also influence their classification.

Classifying Musicians Correctly

Correctly classifying church musicians is important for several reasons:

  • Employees must be paid at least minimum wage and may be entitled to overtime pay.
  • Employees must have payroll taxes withheld from their wages, while independent contractors are responsible for paying their own taxes.
  • Misclassifying employees as independent contractors can result in penalties and back taxes owed to the IRS.

To ensure compliance, churches should:

  • Have a written agreement with musicians that clearly states their classification and the terms of their engagement
  • Maintain accurate records of payments made to musicians
  • Consult with a payroll professional or tax advisor if unsure about a musician’s classification

By following these best practices, churches can avoid potential issues with the IRS and ensure they are treating their musicians fairly and in compliance with the law.

Conclusion

Setting up and managing payroll for a church or religious organization requires careful consideration of the unique rules and regulations that apply. From understanding the IRS criteria for churches to properly classifying employees and ministers, there are many nuances to navigate. However, by following best practices and seeking guidance when needed, churches can ensure they are operating in compliance with the law while also treating their employees fairly.

Ultimately, the goal of church payroll should be to support the organization’s mission and values. By taking the time to set up accurate and compliant payroll processes, churches can focus their energy on serving their community and furthering their religious purpose. With the right knowledge and resources, church payroll doesn’t have to be a burden – it can be a tool for empowering the important work that churches do every day.

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