James Chestnut and Associates is a one-stop solution for all your payroll needs. Want more information? Please email us at [email protected] to ask a Payroll Specialist.
There’s more to managing nonprofit payroll than writing checks and handing them out to employees on time. You need to keep accurate records, calculate and pay payroll taxes, and communicate effectively with employees. Many nonprofit managers are finding that they can simplify the process by using an outsourced payroll provider to manage the entire process cost-effectively and efficiently.
What happens when the individual you’ve tasked with the responsibility of payroll:
- becomes disgruntled
- leaves the organization
- has a lack of knowledge, usually do to changing tax laws
- becomes ill
- becomes disabled
- passes away
- is over-worked
- needs a vacation
Outsourcing your payroll can provide your nonprofit with a number of important benefits:
Using an outsourced payroll solution is typically more efficient for a nonprofit than processing payroll internally. Leaving payroll to experts frees up hours that you can devote to other important parts of your organization. Whether it is your time, staff time, or a combination, chances are the hours could be better spent researching funding opportunities, improving community outreach, fine-tuning business operations or launching a public service. Among the areas where outsourcing will save time are:
• Processing payroll
• Cutting and distributing paychecks
• Calculating and paying withholding and employment taxes
• Preparing and distributing W-2s and 1099s at year-end
• Handling employee payroll inquiries
Many nonprofit managers underestimate the cost of processing payroll internally by failing to account for all hours spent and resources allocated to pay employees and maintain payroll paperwork. A thorough cost assessment usually proves that a nonprofit saves money by outsourcing the processing, tracking and filing of payroll documents. To assess your own internal payroll costs, consider:
• How much the time spent is actually worth: consider the cost of your time and the time of anyone who processes or “touches” payroll? Often, many people in a small company are involved in the various parts of payroll processing.
• What savings would outsourcing provide: since an outside provider can handle all the responsibilities involved in managing payroll and answering employee questions, a nonprofit can often eliminate or reallocate an internal payroll resource?
Calculating federal, state, and local employment taxes and filing payroll-related tax paperwork can be more than just a hassle. If it’s done incorrectly, your nonprofit may face penalties and even interest on money owed since the mistake was made. In fact, it is estimated that one in three nonprofits receive a tax penalty costing over $800 each year. Outsourcing payroll does away with the risk of many of these costs and hassles because:
• An outsourced payroll provider calculates payroll taxes, based on its expertise and close tracking of regulation changes
• Monthly or quarterly employment tax reports are managed by the payroll service, ensuring they are submitted correctly and on time
• Payroll providers may assume penalties that come as a result of incorrect tax calculations
• End-of-year paperwork — such as W-2s and 1099s — are handled directly by the payroll provider, so they are sent out on time
1. Improperly classifying employees.
2. Improper calculation and handling of the Pastor’s compensation.
3. Miscalculating employee payroll taxes.
4. Failure to file employer tax reports.
5. Not furnishing W2’s and 1099’s on time!
Clergy, someone who is a minister for federal tax purposes, have a “dual tax status.” Simply put, they are considered employees for federal income tax purposes, but are treated as self-employed for Social Security purposes and must pay self-employment taxes (SECA) on their ministerial income.
No, churches cannot withhold FICA for its clergy. However, if the minister allows, the church may withhold federal income taxes.
Yes, churches must withhold the employee’s share and pay their matching share of FICA for non-clergy employees. Churches cannot classify non-clergy employees as self-employed to avoid paying FICA.
A general rule is that anyone who performs services for your church is your employee if you can control what will be done and how it will be done. The church should maintain an accurate and current record of employees. If the church pays an individual more than $100.00 during the year, with exception of the Clergy, then that person is an employee and Medicare and Social Security taxes (FICA) must be withheld and a Form W-2 must be issued at the end of the year. Churches must withhold the employee’s share and pay their matching share of FICA for non-clergy employees. Churches cannot classify non-clergy employees as self-employed to avoid paying FICA.
Furthermore, musicians are not independent contractors and their compensation should comply with federal regulations. If the church can control (1) who performs the work, (2) what will be done (the end result), and (3) when it will be done, then the person performing that job is an employee of the church.
Generally the answer is no. In order to take advantage of the benefits that the IRS has allocated the minister must perform all the “Sacerdotal Duties” to be classified as a minister for tax purposes. These nine duties are:
1. participate in water baptism.
2. serve or administer the communion.
3. officiate at funerals.
4. perform marriage ceremonies.
5. conduct christening dedications.
6. be a spiritual guide or counselor.
7. participate in the administration of a church.
8. conduct a religious or worship service.
9. preach or speak at a religious service.
As with its employees the church should maintain an accurate and current record of its volunteers. First and foremost please understand that an employee cannot volunteer their time to their employer, and once a volunteer becomes an employee, for income tax purposes, they cannot go back to being an uncompensated volunteer without first officially resigning their employment position. The church is allowed to bless their volunteers, as long as the total value of the gift(s) does not exceed $100.00 during the tax year. If the church gives a volunteer more than $100.00 during the year, then that volunteer becomes an employee and Medicare and Social Security taxes (FICA) must be withheld and a Form W-2 must be issued at the end of the year.
The IRS doesn’t provide clear guidance about exactly how churches are supposed to acknowledge and handle pastoral love offerings.
In our experience we recommend the following guidelines for classifying love offerings:
1. It cannot be for services rendered
2. Must be spontaneous in nature
3. Cannot be solicited
4. Cannot be a tax deduction for the donor
A pastor that has love offerings given to him by members of the church are taxable…because when a love offering is given to a minister by a church member it’s because the church member is motivated by his or her leadership or services as a minister, and for this reason the love offering is not a gift, but rather compensation that is taxable. Even if the members wanted him to receive it as a gift, it cannot be ruled as a gift because of his relationship with the members as a minister of the gospel.
This being said, a pastor is “given” a love offering in two ways. Either from the member through the church which in turn gives it to the pastor, or directly from the member to the pastor. Either way the love offering is taxable income, however, with the latter the gift is voluntarily reportable; meaning the only person that can enforce the reporting of the income is the pastor himself. The church on the other hand acts as an agent of the IRS and is required to document the love offerings and report them on the pastors W-2.
The absolute worst thing a church can do is collect love offerings then hand it directly to the pastor. All offerings received from the congregation should be documented decently and in order and then deposited into the church’s bank account.
For more clarification or if you have additional questions or concerns, please contact us.
The housing allowance exclusion is the most important tax benefit available to ministers. To save taxes, make sure your church properly designates a housing allowance. A housing allowance may be available to ministers who own their own homes, who rent or who live in a rent-free church-owned parsonage. However, it is available only for a principal residence, not for a second home or vacation home. Your housing expenses could change significantly with a move. A housing allowance must be compensation for ministerial services and should not exceed a minister’s reasonable compensation. Ministers must substantiate their actual housing expenses. Otherwise, all or part of the housing allowance designation is included in gross income. Your church should designate your housing allowance in writing for the remainder of the year; based on estimates you give the church. Then the church should designate your housing allowance in writing at the end of each calendar year for the New Year. Ministers who own their own homes may exclude from income the lowest of these three amounts for federal income tax purposes:
- The amount designated by the church; or
- Actual housing expenses (including mortgage payments, utilities, property taxes, insurance, furnishings, repairs and improvements); or
- The annual fair rental value of the home (furnished, including utilities).
Ministers must include the value of their housing allowance (even if living in a parsonage) for SECA purposes although they do not count it for federal income tax purposes.
A housing allowance must be compensation for ministerial services and should not exceed a minister’s reasonable compensation. Ministers must substantiate their actual housing expenses. Otherwise, all or part of the housing allowance designation is included in gross income.
For more information? Please email us at [email protected] to discuss your situation with a Payroll Specialist.
Yes. A housing allowance may be available to ministers who own their own homes, who rent or who live in a rent-free church-owned parsonage. However, it is available only for a principal residence, not for a second home or vacation home
If you are just starting your ministry, do not opt out of Social Security. In very limited cases, ministers can opt out of Social Security by meeting strict IRS guidelines and filing Form 4361, Application for Exemption from Self-Employment Tax for Use by Ministers, Members of Religious Orders and Christian Science Practitioners. Ministers are not allowed to opt out of Social Security because they think it’s a bad investment. Under penalty of perjury, a minister must make certain representations to the IRS on Form 4361. When filing Form 4361, a minister must certify that he is opposed on the basis of religious principles to acceptance of public insurance, which includes payments for death, disability, retirement or medical care. Additionally, the minister must certify that he has informed his ordaining body of his opposition to accepting public insurance benefits on the basis of religious principles. Few, if any, Southern Baptist ministers can meet these requirements. There is also a filing deadline. Three copies of this form must be filed by the due date of the tax return for the second year in which a minister had net earnings from self-employment of at least $400, any part of which came from ministerial income. The IRS also has to approve the application.
When discussing with our clients the Internal Revenue Service (IRS) reporting requirements for payments made to individuals, inevitably one of the trustees or deacons will ask if benevolent gifts made to members of the congregation or others must be reported as income.
First let’s define what benevolence is. For example, some churches have attempted to evade taxes by calling payments made to employees of the church “benevolence” or a “love offering.” This practice is very wrong. Generally, when a payment is made to an individual it should be considered as income to them and NOT as benevolence.
On the other hand, one of the primary functions of a church is to extend the love of God to those who are genuinely in need. Benevolence is a gift given to a needy person with no strings attached. Generally, gifts as such are not taxable income to the recipient and are not subject to the usual reporting requirements.
A church should be careful to document its benevolent giving, according to the following IRS guidelines:
If distributions are made to individuals, case histories regarding the recipient should be kept showing names, addresses, purposes of awards, manner of selection, relationship if any to members, officers, trustees or donors of funds to you, so that any and all distributions made to individuals can be substantiated upon request by the IRS.
We recommend that a church establish a benevolence committee to be responsible for making decisions concerning benevolent distributions and make that committee responsible for maintaining proper records of such distributions. What is essential is to establish the fact that there is a genuine need and that the distribution is given out of the church’s function as a charitable and benevolent corporation as set forth in its corporate purposes.
The absolute worst thing a church can do is collect a benevolence offering count the cash then hand it directly to the needy individual. All offerings received from the congregation should be deposited into the Church bank account.