RX 24 - Top Ten Mistakes Churches Make with Clergy Payroll - Monica Stern

Transcribed Content

I'd like to welcome Monica Stern. Hello. Okay. Just so you know who I am, I'm a CPA here in Phoenix, and, a large part of my practice is ministry to churches. So we provide services to churches, religious organizations, and other nonprofits. And we do everything from property taxes to audits, reviews, compilations, HR. We don't manage HR, but we stay apprised of all the the laws that might affect church payroll. And so today's session, this is gonna be a flyover because I have a half hour to cover what's probably about four hours worth of materials. So I would ask that if you have questions, just jot them down and we'll do those at the end because I wanna make sure we get through all 10 issues because they're all important, especially the last one. So I wanna make sure we don't run out of time. And so if you can just jot your questions down. Are we all with churches? Can everybody raise their hand if you're with a church as opposed to religious? Great. So I don't have a mixed audience here. So we can talk church. The rules are slightly different in some areas for churches versus religious ministry. So I wanna make sure that we're covering everything, and we'll just talk church today. So after years of during church payroll and looking at people's payrolls and crying over church payrolls, I've put this PowerPoint together for the top 10 things that I see. Now it's not gonna cover everything, but it will definitely cover the most common mistakes I see in church payroll. So the first unique situation is is, as you know, clergy get housing allowances. And housing allowances are tax free for income tax purposes. They do pay Social Security or self employment tax on the housing allowances. So the housing allowances have to be approved by the board in advance of payment. You can never approve a housing allowance retroactively. So if you're in the finance department and you know your board hasn't approved a housing allowance that needs to be done before you can pay it. So make sure that that is approved. It should be documented in the minutes and not just we approve the housing allowances. Should list each person and the dollar amount or have an attachment that that shows what the housing allowances are. Now if a clergy, for example, buys a house midyear and they need a higher housing allowance, it can be approved midyear but only going forward. It can never be retroactive. So if they wanna increase it from, say, $25,000 to $40,000 because their mortgage is higher, they can do that, but it just goes forward. You can't change it retroactively. And we do ask that you show it as a separate item in payroll that and that it goes in box 14 of the w two form. And the reason for this is it's not mandatory, but it sure helps the tax preparers. And I do probably 60 clergy tax returns. So I sure like to see it on the w two. And then the other thing is if they ever go to get a mortgage, it shows that they have additional income from the church that's not on their w two form. So now we're gonna talk about gifts. So gifts to employees, including clergy, so this actually covers all employees of churches, are taxable with very few exceptions. So gifts to employees do include gift cards. I've seen a lot of churches who give away gift cards like their water and, never accounting for the compensation issues with gift cards. So pastor appreciation gifts, pastor anniversary gifts, that type of thing, those are taxable as well. You if you give somebody something of value, it is taxable. So cash or noncash gifts like cruises, spa days, you know, those kinds of things are all taxed the same as if you gave them cash. The only exception, and this is a big might, is when you have a longtime pastor who's retiring from ministry. There can be some exceptions for retirement gifts in limited circumstances. So this isn't somebody who's worked for two years and moved on to a new job. This is somebody who's been at the church a long time and is now retiring. There have been some court cases where retirement gifts can be treated as tax free. That's the only gift exception that is has been presented by the courts. So honorariums. So sometimes we have we have somebody who works a job, and then maybe they conduct a wedding or a funeral. And so they get an honorarium. And, those honorariums for any employee, including clergy, are taxable and need to be run through payroll. So the only exception, like on a wedding or a funeral, sometimes the church collects all the money, including the pastor's honorarium. When they pay it out, it needs to be on payroll. Now let's say they do a funeral and the family gives the pastor two hundred dollars. You're not you do you have no way of knowing that. So you don't have to put that on payroll. The the clergy person will report that on their individual return directly. So it's just anything that flows to the church and then is paid out to another employee has to be included in payroll. This includes gift cards issued by groups within the church. So sometimes I'll see the women's ministry has an event, and they pay the AV staff with a hundred dollar gift card, and it never gets on payroll. And if that AV person is on staff that needs to run through payroll. So we just recommend that that the women's ministry be charged the hundred dollars and then put on payroll rather than messing around with gift cards. Gift cards are not a way to avoid taxation. We had one church one time that handed out $30,000 of gift cards so it wouldn't be taxable at Christmas time. And we said, no. You just made your your business office's life much more miserable by doing that. So it it doesn't change the situation. And it's never appropriate to issue a ten ninety nine to an employee for those honorariums unless that employee has another business. So if your children's ministry director, for example, runs a website company and they build a website for you, then then that's appropriate for a ten ninety nine, but it's not appropriate for the hundred dollars we gave the AV guy to do the women's retreat. So you just have to make sure you get that all run through payroll. Sometimes we see clergy who are provided with personal retreats or spiritual growth trips or spiritual growth time off, usually involving a cabin in the woods somewhere, at least here in Arizona, especially during the summer. And, so those kinds of things are taxable. So if something is non taxable in general, the benefit needs to be for the church, not for the employee. So if the benefit is for the employee, then it's taxable. So you need to look at when you're trying to decide if something is taxable or nontaxable, you need to decide who gets the benefit on these things. Conferences. So if, you know, your church staff comes to a conference like this, that's fine. But if for some weird reason they wanted to spend extra days in Phoenix, when it's one hundred and fifteen, then those extra days are taxable. So IRS allows you to travel in the day before and travel out the day after. Any days in addition to that are taxable. So the airfare isn't gonna change, but the hotel rooms while they're staying, those extra days would be taxable as well as any meals. So you wanna watch those extra days. We particularly see extra days when there's conferences in Hawaii, usually not Phoenix in August. So, and then oftentimes the spouse will attend a conference along with the employee, and this is whether it's clergy or not. If the spouse has a legitimate job at the church or is a legitimate volunteer. For example, in some smaller churches, we'll see the pastor is paid. The, wife will be, the wife will be the children's ministry leader as a volunteer. So if she comes along on the conference and then she attends classes on the children's ministry or leading youth or something something related to her volunteer job, that's okay. But if she comes along and goes to the spouse's outlet shopping trip, then it's not those costs should not be, included. They should be taxed or better yet not paid for. So, you know, it doesn't cost extra for the room. It would be the flights, it would be the meals, that type of thing. So if the church does pay for the spouse to go along, then it's taskable compensation to the employee. So those of you who do payroll, it sounds like fun, doesn't it? Trying to track all of this stuff that goes on. So, but if they're, if they're, you know, a legitimate volunteer and they're taking classes or whatever legitimately related to the mission, that's okay. And you can send volunteers to classes, that's fine. But they have to be for the benefit of the church, not the benefit of the employee. Okay, health insurance and medical payments are a big issue that we see not done correctly in churches. So if you have group insurance, so you have a policy that is a group plan, it covers a wide variety of employees in the plan. It's a nontaxable benefit. It's just fine. You are allowed to discriminate as a church, meaning you don't have to cover everybody. You can set your rules unless you're a large employer, which is 50 or more full time equivalent employees. So your group insurance may have rules. So sometimes they'll say, no, we want 50% coverage of your employees. Or they'll say, you know, you need to cover so many employees or anybody who works over so many hours. They may have their own rules, but the IRS right now does not enforce the discrimination rules that were passed with the affordable care act and they haven't written regulations. So right now discrimination is allowed. And in churches that quite often happens, you know, where we want to cover the clergy, but not the other employees, or we want to cover everybody who works forty hours or whatever. So discrimination is allowable at this time unless you have 50 or more. If you have 50 or more, you're under the Affordable Care Act and you've got a lot of rules if you have 50 or more full time equivalent employees. So you need an HR person or a professional to manage that for you because there's a lot of pitfalls with that. So while medical insurance is fine, paying medical expenses like doctor's bills or hospital bills, that's a different category. So reimbursement of any actual medical expenses requires a plan, a health reimbursement arrangement, and it cannot discriminate. So as the second you cut a check for that doctor's bill, you've got a problem. You can't do that as a tax free benefit. And no matter how, you know, how, how much the medical is. So there are plans you can set up with this, which is called a health reimbursement arrangement to do this, but you can't discriminate and you've got to make sure you follow all of the rules of those plans. And oftentimes churches kind of just skim over this whole issue and say, well, you know, we wanna cover we wanna get pastor. He's got a big deductible, so let's give him $5,000 of medical expenses. Well, if you're not gonna give everybody $5,000 worth of medical expenses, then you've got a problem. You need to just increase the salary. You know, forget reimbursing medical, just increase the salary. So a lot of churches, a lot of times churches just want to reimburse individual health insurance. So maybe you've got somebody who's got their own policy. They're very happy with it. And so they want all the employees to go out and get their own insurance and then they'll reimburse for it. So you can do that, but you have to have a compliant plan in place. You can't just say, well, I'm gonna reimburse these three employees, you know, whatever their insurance costs are and and have it be good. You've gotta have you've got to have a plan that reimburses health insurance. And again, that's a nondiscriminatory thing. It has to be nondiscriminatory. There's a lot of rules. I do not personally set up these plans, but there are companies who will set up the plan for you and help you monitor it and help you do what you need to do to ensure compliance. So, and it's really important that you comply in these areas because the penalties on some of these things are a hundred dollars a day per employee that you're in non compliance. So it's a big deal if you're not complying and you want to make sure. So sometimes when we have people who want to reimburse the individual coverage, we find out, oh, well, John over there has a medical sharing plan for his family. So are you all familiar with the medical sharing plans? Okay. So this is where it's not insurance And they tell you right up front, this is not insurance. It's a cost sharing arrangement where you pay so much money in per month, and then they pay your medical bills. You submit them for reimbursement. It sounds like insurance, but it's not. And so you cannot, it's not deductible if you pay it on your own because it's not insurance. And if a church is paying for it, which it really shouldn't, again, this is a case where you just increase the salary. It's a taxable benefit. Okay. So if you've got anybody who's on a medical sharing plan and if they're on a med share plan, they can't be reimbursed under the individual coverage health reimbursement arrangement because it's not insurance. So just be careful if you're gonna do the HRA that be aware it doesn't cover that. There can be pitfalls with employees who are on Medicare because Medicare has rules. If you have 20 or more employees, you can't entice an employee to leave the group plan and go on Medicare. And enticing includes paying their premiums. So again, just increase their salary. And so be careful with those Medicare. We're seeing more and more. I mean, I'm of this generation, you know, that and we're seeing more and more people working later going on Medicare. And you just need to be very careful because it violates the Medicare rules if you reimburse for those Medicare premiums, if they receive a subsidy and many clergy do receive a subsidy from the affordable care act. So if you're signing up for what is commonly called Obamacare on the marketplace or marketplace insurance, and you get a subsidy to reduce your cost, the second the church pays a dollar towards that, you lose your entire subsidy. So this is something you wanna be really, really careful with. And then those who are covered by a spouse, let's say we have a staff member whose spouse is a teacher and the teacher has group insurance that covers the entire family. You can't reimburse that insurance tax free because it's already tax free when it comes out of their paycheck. So these are kind of the pitfalls that in reimbursing health insurance, it gets a little bit tricky because of these, you know, these requirements and all these little pitfalls that we commonly see in churches. We see every one of these in churches. The link I've given you talks about how an employer can pay for private health insurance and, you know, basically talks about health reimbursement arrangements to pay for that insurance. Couple other little tidbits that we see in churches, moving expenses. So it used to be prior to 2018 that an employer could pay for the employees relocation expenses. And, it was a tax free benefit. And if the employee paid for it, they got to deduct it. Well, that went away starting in '18. So you can still pay for moving expenses, but it's taxable. So and that includes any allowances. That includes the moving van. That includes whatever else you have going on paying for those moving expenses. Life insurance. So there are several kinds of life insurances that we see in churches. The first one that we quite often see, especially if the church has a large loan or debt is we see what's called key man or key person life insurance. So key person, key man life insurance is life insurance where the beneficiary should that pastor die. The beneficiary is the church. Okay. So it's typically it can be term life insurance, typically term life insurance, but it can have some cash value too. But that insurance where the church is the beneficiary is not taxable to the employee. And that's because the employee doesn't get anything. Their family gets nothing. Sometimes we see split insurance. So it's partially key man and partially the family benefits should something happen to the clergy person. In that case, part of it's gonna be taxable, and part of it is going to be the church's portion. So let's say you have a $500,000 policy. It's split fifty fifty. Half of the cost of those premiums needs to be added to the pastor's compensation every year. So that's the first kind of insurance we see. The second kind we see is just plain old garden variety. The spouse is the beneficiary and the church has no benefit if the pastor dies. Well, that's number one, this shouldn't really be paid by the church. It should be paid by them individually. And number two, if the church does pay it, it's taxable compensation. So you want to make sure that you're including that compensation in the W-two form. And then the third kind of insurance is group term life insurance. So sometimes when you have a group health insurance policy, there might be term life insurance. And not always, it's something you sign up for separately, but group term life insurance generally provides a low level of term life insurance to each and every employee at a cost based on their age. And so the first fifty thousand of coverage. So if we have, say we have a policy that's 75,000, that first fifty thousand is tax free, but that second twenty five thousand, there's an add on to the W-two for the cost of that term life insurance. And this is a weird one because it isn't what you pay for the insurance. There's a chart you use and it's based on the employee's age and how much life insurance. There's a little chart that the IRS publishes every year. It's sometimes called PS58 life insurance. And so you just need to be aware that if you have group term life insurance of more than $50,000 that you need to be adding that to the W-two forms and treating it as taxable compensation, just the amount over. So, and a lot of group term just provides 50,000 because they know that's a maximum nontaxable benefit. So I've seen all kinds of clothing in church books that's not necessarily tax free. So somebody told me, well, when I was in seminary, they told me my church could buy me a blue suit and a black suit, and that would be okay. And I said, no. That's not okay. Nor are haircuts and, you know, other other personal care items. If you're a Catholic priest and you buy vestments, that's okay. Or in I'm a Methodist, and so sometimes as clergy wear stoles, that's okay. But just the garden variety suit, you know, that you have to buy is just like the suit I have to buy. It's it's not a business expense and it's not. Now if if you have a polo or a t shirt with a logo, I see some t shirts here with logos and that's just fine. The employer can provide those on a tax free basis. But I had I had one church one time that bought probably $10,000 worth of clothing because it was a TV ministry. And he swore up and down. All his clothes stayed at the church, yet he couldn't show them to me. And and there was $80 worth of cologne. And I was trying to reconcile in my head how cologne related to a TV ministry. Yeah. There were more issues than that, but it was like, you need cologne because Why? So the general rule with compensation is that if the IRS doesn't specifically exclude it, that it's compensation. So if you can't find anywhere that a benefit is excluded, and not that you're going to go home and read code section 102, but that's where it is. Code section 102 basically says it's all taxable unless it's not. And, you know, so some of these benefits that you can have that are tax free are just fine. Auto allowances is another big one that we see in churches where, the clergy or other staff are provided with an auto allowance and they don't report to the employer the actual number of business miles that they drove. So it's okay to pay an auto allowance, but unless you are reporting the number of miles that you drove and that payment is equal to or less than the number of miles times the IRS rate, which is $0.67 a mile, then that auto allowance has to be fully taxed. So you can pay it, but unless you do the mileage and frankly, no clergy person wants to track miles. I've yet to see one who says, oh yeah, I turned my miles. Now, if you want to reimburse people for mileage as opposed to an auto allowance, then you just need to make sure you do it at or below the approved rate. So, but they do have to submit their mileage. You can't just pay a set amount. So you wanna make sure that if you are having an auto allowance that you have it set to taxable. So sometimes the church owns a vehicle and the employee drives the church's vehicle. And the church pays for the gas and the insurance and all of those kinds of things. And, so what happens with that is you have to add to the w two form the personal use of that automobile. So commuting back and forth to church is a personal use. You know, going to the grocery store is a personal use. So the IRS has tables that that you can use to determine what's the value to the employee of having that vehicle. And those those get added. It's an an it's called an annual lease value. It's not really a leased vehicle, but ALV and you establish it when the car is purchased and then you establish it again four years later. So you can't just ignore personal use when an employee is driving a church vehicle. The other thing we see is the church credit card is used to put gas in a personal vehicle. So unless that is computed the number of business miles at the IRS approved rate, you have to tax that unless they document the number of miles. The classic example is, okay, we used our personal vehicle to take the kids to camp. It's 200 miles round trip. We had them fill up their tank before they went and they filled up their tank when they got back. Okay. That's not acceptable because we don't know, First of all, when you fill it up before you go, we don't know how empty it was. Now, if it's 200 miles and the IRS rate is $0.67 a mile and the gas you put in is less than that, you're fine. You don't need to tax it. But you do have to do the math to make sure that the gas that they got is is less than what the IRS would allow. An IRS doesn't care whether you drive a hybrid or an electric vehicle or whether you drive a real gas hog. It's just the same across the board. So just be aware that that is a taxable compensation. Okay. Educational benefits. This is one we see too, where I get a call and it's like, you know, we need our youth minister to finish seminary and we want to help him finish his seminary classes. So it's like, okay, that's all well and good. But if there are job related, what you have to do is you have to look at their schedule and you look at the classes that are directly related to their current job. Okay. So let's say our youth minister's taking English one hundred one and he's taking how to preach and he's taking a New Testament Bible class. And his job is teaching religious. He's got religious duties teaching youth. So what we could do is we could, assuming those are all three credit classes, we could pay two thirds of the tuition charged for that. English one hundred one isn't going to count, but the preaching class probably relates to his current job as does the new Testament class. So what you have to do is look at the benefit to the church for the employee's current position, not a position they might have in the future. So one way to reimburse people tax free is to do it that way. And you can discriminate in this method where you only reimburse the related classes. The other option, and I have never seen this at a church because as soon as I say you have to cover everybody, everybody says, no, we don't wanna do that. So the educational assistance plan, you have to cover all employees. It's limited to 5,250 per employee, and it doesn't have to be related to the job. So they could work as your youth minister while getting a degree in accounting. And the second they finish that accounting degree, they can go to work in a CPA firm or something. So the difference between the two plans is, is it related or is it unrelated to the employers? So I've never seen the second one because that's a huge chunk of money when you're looking at a wide range of employees and employers usually want to pay for things that are more directly related. Now, the problem with the first one is you can't pay for everything. You can only pay for the courses that are related. Okay, retirement. There's a lot of people, including a lot of clergy that are in my age bracket who have nothing saved for retirement. Compounded with that, a lot of them when they first went into ministry were told to opt out of the social security system. So we are seeing clergy, you know, in their sixties with little or no social security benefits and little or no retirement. And it's really sad. I cannot tell you how many grown men I've had either in my office or crying on the phone about what am I going to do, especially if they have a health issue and can't work for a while. The other thing that we also have happened is the church tries to make it up at the end. So the church will try to, you know, we're gonna we're gonna close our church and we're gonna give all the money to the pastor because we don't have any retired. He doesn't have any retirement. Well, that doesn't work either. IRS requires that compensation be reasonable and that can leave the board subject to penalties. It can leave the pastor subject to penalties. I'm talking 125 penalties. So you get a hundred thousand dollars you owe, you owe or 225% penalties. So you owe 225,000 back. So it's it's not pretty. So my belief is that every single church should have a four zero three b nine plan. The nine at the end refers to the fact that it's a church plan and there are huge benefits to having a four zero three b nine. So employees can contribute pre tax or they can do a Roth or they can, the church can discriminate. It can give the pastor an employer contribution, but not the other employees, or it can give the pastor ten percent and the other employees 2%. What's even better about a pastors can withdraw the money tax free. And as housing and retirement, and there are no ERISA or other filing requirements. So every church should have one. And even if you put in 1% to start it, you've got to start somewhere and we need to we need to protect our clergy and our church employees. Every church should have one of those. So this is my number one. And I don't know how many times a year I say this and it still happens. Clergy payroll never ever ever ever have Social Security or Medicare withholding at the employer level. Okay? I'm gonna repeat that. Never ever have Social Security or Medicare withheld from clergy paychecks. It doesn't matter if they've opted in or out of Social Security. I sometimes hear that. Well, they didn't opt out. Well, the payment of self employment or Social Security taxes is done on the individual return. It is not done on the employer's return. And there's nothing that changes the statement. I always hear, but what about no, never, never ever does this change. And if an employee is functioning as clergy, in other words, your license, commission, or ordained, they have a clergy position at your church, it's not an option to treat them as non clergy. So it's not the employee's choice. If they're clergy, they're clergy. For tax purposes, if they're clergy in your church.