Know About Church Payroll and Taxes

Know About Church Payroll and Taxes

church on a hill

A recent survey reveals that the church payroll budgets are increasing compared to 2023 and are expected to rise further in 2025. Managing church payroll, however, comes with unique challenges that differ from traditional for-profit payroll. Understanding these differences is essential for ensuring compliance and smooth operations.

This article will explore the key considerations for managing church payroll and taxes.

What Defines A Church According to IRS?

According to IRS, a church is a religious organization that meets specific criteria, such as having a distinct legal existence, regular congregations, and a place of worship. The church must also engage in religious instruction and services.

 
  • 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
  • Ordained ministers selected after completing prescribed courses of study
  • Literature of its own
  • Established places of worship
  • Regular congregations
  • Regular religious services
  • Sunday schools for the religious instruction of the young
  • Sunday schools for the religious instruction of the young
By meeting these requirements, churches qualify for tax-exempt status under Section 501(c)(3).

How Are Churches Different From Other Organizations?

Churches differ from other nonprofit organizations in several ways:
1. Automatic Tax-Exempt Status: Unlike most nonprofits, churches do not need to file Form 1023 with the IRS for tax-exempt status.
2.
Exemption from Filing Form 990: Churches are not required to file the annual information return (Form 990), which is mandatory for other 501(c)(3) organizations.
3.
Clergy-Specific Tax Rules: Unique tax treatments, such as housing allowances, apply to clergy.
tax exempt

Maintaining Tax-Exempt Status:

To maintain tax-exempt status, a church must comply with the following requirements:

  • Must be operated exclusively for religious, educational, scientific, or charitable purposes.
  • Private individuals or shareholders are not entitled to net earnings of a Church. 
  • Avoid political campaign involvement of any kind.

Failure to comply with these rules can jeopardize the church’s tax-exempt status.

Payroll Taxes for Church Employees:

A church may employ clergy, non-clergy employees, independent contractors, and nonemployee independent contractors to carry out their operations.

Though churches are exempt from certain taxes, they are still responsible for paying payroll taxes, including FICA, federal, state, and local taxes for their non-clergy employees, like musicians, janitors, and administrative workers.

However, clergy have a dual tax status. Although clergy members are church employees, they are considered self-employed and must pay Social Security and Medicare taxes, also known as SECA tax. As a result, Churches are not required to withhold income taxes from the clergy and must issue Form W-2 even though they are considered self-employed. This is because of their dual tax status.

If the church decides to employ an independent contractor for specific activities, the church must classify the employee correctly, and the worker must complete the W-9 form.

The church must complete Form 1099-NEC if the independent worker is considered a nonemployee by the church to record any payment above $600.

Handling Clergy Housing Allowances:

Housing allowances, also known as parsonages or rental allowances, cover expenses such as rent, mortgage interest, utilities, and other costs directly related to providing a home.

Housing allowances can be excluded from a clergy member’s gross income. However, these allowances are subject to taxes from SECA (Self-Employment Contributions Act).

Federal Unemployment Taxes:

Churches are generally exempt from Federal Unemployment Taxes (FUTA).

State Unemployment Taxes:

The biggest mistake we see when Churches setup payroll, is that they assume they are exempt from State Unemployment. This is not the case. In most States, a Church must designate themself as either a Reimbursable Employer or a Contribution based Employer.

A Reimbursable Employer makes a deposit with the State, and then pays any balance due if an individual makes an unemployment claim.

A Contribution baked Employer, pays Unemployment taxes like any other Employer via a percentage based tax up to the States Wage Limit.

Overtime Rules for Church Employees:

Non-exempt employees are eligible for overtime pay under the Fair Labor Standards Act (FLSA). However, clergy members are typically exempt from overtime regulations.

Need Help with Your Church Payroll? Learn How PeopleWorX Can Help You:

Managing church payroll can be complex, but you don’t have to handle it alone. PeopleWorX specializes in payroll and HR solutions for nonprofit organizations, including churches. From clergy tax compliance to automated payroll systems, we’ll simplify the process so you can focus on your mission.

Contact us today to learn more!