How Do I Process My Church Payroll Correctly?

Great question. We’ve listed below a clear guide that can help keep your house of worship running smoothly.  Whether you’re a first-time church administrator or an experienced payroll professional, understanding these crucial aspects is essential for smooth operations.

Unique Considerations for Churches

Tax-Exempt Status

Churches typically qualify for federal tax-exempt status under Section 501(c)(3) of the Internal Revenue Code (IRC). This exempts them from paying federal income tax on donations and other income related to their tax-exempt purposes. However, this does not mean that churches are exempt from all payroll taxes.

Clergy Income and Housing Allowances

One significant aspect of church payroll is dealing with clergy income and housing allowances. Here’s how they affect payroll calculations:

• Clergy Income: Clergy members usually receive a salary like other employees, but special tax rules apply. They’re considered self-employed for Social Security and Medicare tax purposes, so they pay these taxes through the Self-Employment Contributions Act (SECA) rather than Federal Insurance Contributions Act (FICA) taxes.
• Housing Allowance: Clergy can receive a housing allowance that is excluded from federal income tax, provided it is used for housing expenses. The church must designate this allowance in advance, and it should be reasonable based on the local cost of living and the clergy member’s responsibilities.

Payroll Tax Obligations

Despite their tax-exempt status, churches are still required to handle certain payroll tax obligations:

Taxes Churches Must Pay

• Federal Income Tax Withholding: Churches must withhold federal income taxes from employee wages unless the employee opts out of withholding by completing IRS Form W-4.
• Social Security and Medicare Taxes: For non-clergy employees, churches must withhold and pay FICA taxes. For clergy, as mentioned, SECA taxes apply, and clergy are responsible for paying these themselves.
• Unemployment Taxes: Generally, churches are exempt from paying federal unemployment taxes (FUTA), but they may be subject to state unemployment taxes depending on state laws.

How to Submit Payroll Taxes

1. Withholding and Depositing Taxes: Churches must withhold federal income tax, Social Security, and Medicare taxes from employees’ wages and deposit these taxes regularly using the Electronic Federal Tax Payment System (EFTPS).
2. Filing Forms:
   • Quarterly Forms: File Form 941, Employer’s Quarterly Federal Tax Return, to report wages paid and taxes withheld.
   • Annual Forms: Provide employees with Form W-2, Wage and Tax Statement, and file Form W-3, Transmittal of Wage and Tax Statements, with the Social Security Administration.
3. Use a Payroll Provider, like APlus,  who will do it for you and take the liability for late filings. 

Structuring Employee Benefits

Balancing employee benefits with budget constraints is crucial for churches. Here’s how to effectively structure benefits:

Health Insurance

Consider offering group health insurance plans through church associations or denominational groups, which may provide more affordable rates.

Retirement Plans

Churches can set up 403(b) retirement plans for their employees, allowing both the church and employees to contribute pre-tax dollars towards retirement savings.

Paid Time Off (PTO)

Implementing a fair and consistent PTO policy helps manage costs while providing necessary rest for staff.

Housing Allowance for Clergy

Ensure that the housing allowance is properly designated and documented in church records. This benefit helps reduce taxable income for clergy members, making it a valuable part of their compensation package.

Applicable Laws and Regulations

Understanding and complying with relevant laws and regulations is vital. Key laws include:

• Fair Labor Standards Act (FLSA): Governs minimum wage, overtime pay, and record-keeping requirements. Churches must comply with FLSA for all non-ministerial staff.
• IRS Guidelines: Follow IRS guidelines regarding the designation and treatment of housing allowances and other clergy-specific tax issues.
• State Laws: Be aware of state-specific laws regarding payroll taxes, unemployment insurance, and workers’ compensation.

Examples:

Example 1: Clergy Housing Allowance

A Pastor receives an annual salary of $50,000 and a housing allowance of $20,000. The church designates the housing allowance in advance. the Pastor uses the entire $20,000 for mortgage, utilities, and maintenance. This amount is excluded from his federal income tax but must be reported as income for SECA tax purposes.

Example 2: Payroll Tax Submission

A local Church has three non-clergy employees. The church withholds federal income tax, Social Security, and Medicare taxes from their wages. Each quarter, the Church files Form 941 and deposits the withheld taxes through EFTPS.

By understanding these unique considerations and following the outlined steps, churches can effectively manage payroll, ensure compliance with tax regulations, and provide meaningful benefits to their staff within budget constraints. Proper payroll management not only supports church operations but also contributes to the financial wellbeing of both clergy and lay employees.

This article does not constitute formal legal, HR or tax advice. For more information please contact a certified tax advisor about rules pertaining to your specific State.  If you would like to hear about how APlus helps its many Church clients and could help you too, please contact us. Our tax expert and resident CPA, Kevin, is on hand to advise our clients.