Payroll and taxes are usually a confusing topic for churches that can easily find themselves in trouble with the IRS if payroll taxes are not reported correctly. For churches, payroll taxes can be especially tricky due to the dual-tax status of their pastoral staff. There is a widespread misunderstanding among churches and pastors about how ministers and even non-clergy employees or contractors should be handled for income tax purposes. Below is a list of the three most common mistakes we find churches making in regard to payroll:
Clergy staff are treated as employees for social security/medicare taxes (FICA)
It may seem contradictory, but a minister is considered an employee for federal, and if applicable, state income tax purposes, but is also considered self-employed for social security purposes. Ministers are responsible for making quarterly estimates for federal, self-employment (SECA,) and state, if applicable tax payments.
Churches include the minister’s housing allowance as wages on Form W-2 in box 1
A minister’s housing allowance ( i.e. parsonage or rental allowance) should be excluded from gross income for income tax purposes. Housing allowance is NOT excluded from SECA taxes, and ministers must be careful that they pay the correct taxes related to their housing earnings. Instead of being reported in box 1 of the Form W-2, this allowance is normally reported in box 14 as an informational-only item.
Churches treat ministers and non-clergy staff as self-employed/1099 contractors to simplify payroll
Churches may believe they can treat ministers and non-clergy staff as self-employed individuals when it comes to compensation, but this is not correct. All people employed by the church should be treated as employees and must receive a form W-2 at the end of the year showing the wages paid by the church.
Sometimes churches want to simplify their payroll process and not bother calculating payroll taxes, so they end up treating all employees as contractors and issuing them a 1099-MISC form. This will cause incorrect income tax returns and will raise the chances of being audited since the IRS will suspect that a church is trying to avoid paying taxes.
For these and other reasons, many churches choose to outsource their payroll so that taxes for their clergy and non-clergy staff are handled properly. Church staff can get easily confused by the rules for dual-status taxes, or even misinformed by other churches that have been handling payroll and taxes incorrectly.
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Clergy Financial Resources
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