A Guide To Payroll For Churches and Other Religious Organizations
There are an estimated 380,000 churches in the US plus over 80,000 religious charities and nonprofits. If you’re one of these organizations, then you have some unique considerations when it comes to payroll for church employees. While there are many similarities with payroll for for-profit organizations, your church or other religious entity may have to follow different rules and regulations, which can get complicated.
To help you understand your obligations when it comes to payroll, here we’ll discuss:
- What is considered a church or religious organization under the IRS
- How do I set up church payroll
- What taxes are churches exempt from paying
- Do churches pay payroll taxes
- Are ministers considered employees or self-employed
- How do I handle a clergy housing allowance
- Do I have to pay church employees overtime
- Are church musicians employees
After reading this article, you’ll have the information you need to set up accurate and compliant church payroll so you can focus your time and energy on furthering your mission.
What is considered a church or religious organization under the IRS?
The Internal Revenue Code doesn’t specifically define a “church” for federal tax purposes. However, there are certain characteristics that the IRS lists as generally attributed to churches, including:
- 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
- Schools for the preparation of its members
You don’t have to necessarily meet all these criteria, but the IRS will use this list along with other information to determine if your organization is considered a church.
How do I set up church payroll?
When it comes to setting up payroll for your church or religious organization, you’ll basically follow the same 5 steps as any other entity would take.
- Gather Employee Information: You’ll need several pieces of information about each employee to set them up for payroll. These include their name, address, date of birth, compensation, and Form W-4. If you plan to give your employees the option to receive their pay via direct deposit, you’ll also need to have them complete the necessary forms to process their requests.
- Determine Whether Workers are Employees or 1099s Contractors: It’s essential that you properly classify your employees as either a W-2 or 1099 worker before you start paying them to avoid liabilities for unpaid payroll taxes, fines, and penalties.
- Understand Exempt Vs. Non-Exempt Status: Generally speaking, exempt employees are paid an annual salary and aren’t subject to overtime hours or time tracking. You’ll want to carefully evaluate each position against the DOL’s tests to see if they qualify for exempt status.
- Pick a Pay Frequency: Before you start running payroll, you’ll need to decide how often you want to pay your employees such as weekly, biweekly or monthly. Your state may have specific requirements for your pay schedule so be sure to check with your state’s Department of Labor.
- Calculate Wages and Deductions: When you run payroll, you’ll need to first calculate an employee’s gross pay. For non-exempt employees, that’s simply the number of hours an employee worked multiplied by their hourly rate. For exempt employees, you can figure out their pay by taking their salary divided by the number of pay periods in a year. From gross pay, you’ll then need to account for deductions and exemptions from income such as taxes and benefit contributions. When you subtract these amounts from gross pay, you get the net pay for each employee, which is what you will pay your worker at the end of the pay period.
What taxes are churches exempt from paying?
Churches and religious organizations are generally exempt from income tax and receive other favorable treatment under the tax law. To receive this treatment as a 501(c)(3) organization:
- You must be organized and operated exclusively for religious, educational, scientific, or other charitable purposes
- Your net earnings may not benefit any private individual or shareholder
- No substantial part of your activity may be attempting to influence legislation
- You may not intervene in political campaigns
- Your purposes and activities may not be illegal or violate fundamental public policy
If you are a church and meet all these requirements, you are automatically considered tax exempt but you may still want to apply for tax-exempt status to show others like contributors to your church that you qualify for the related tax benefits.
If you are any other type of religious organization and want to be tax exempt, you’ll need to apply to the IRS for the status using Form 1023 unless your gross receipts don’t exceed $5,000 annually.
Keep in mind that, even if you are considered tax exempt, certain income may be subject to tax, such if the activity constitutes a trade or business. For example, many churches sell advertising in their weekly bulletins. Generally, revenue from the sale of this advertising is unrelated trade or business income and is taxable. Or, if your church operates a parking lot that charges fees to the general public to use, those fees would be taxable.
Do churches pay payroll taxes?
Even though churches are considered tax-exempt organizations, as we just discussed, you’ll still need to withhold payroll taxes from a non-clergy employee’s payroll (you don’t generally have to withhold payroll taxes from clergy, which we’ll talk about next). There are several components to an employee’s payroll taxes:
- Social Security and Medicare (together, these are known as FICA taxes)
- Federal income taxes
- State income taxes
- Additional state and local taxes such as Temporary Disability Insurance or city income tax
As part of your payroll tax liability, you’re required to pay the employer’s portion of these taxes unless you receive a special exemption. The Tax Reform Act of 1984 allows a religious body to elect a special exemption from the employer’s share of FICA taxes if it opposes such taxes on religious grounds. You must make this election on Form 8274.
Unlike for-profit businesses, however, you’re not required to pay the Federal Unemployment Tax Act (FUTA) tax or state unemployment tax.
Are ministers considered employees or self-employed?
Generally, duly ordained, commissioned, or licensed ministers of a church in the exercise of their ministry are considered employees for federal income tax reporting purposes. Yet, for these individuals, you’re not required to withhold income tax from the compensation you pay.
Instead, the income a minister earns in performing their services in the exercise of their ministry is subject to Self-Employment Contributions Act (SECA) taxes unless they are exempt. That includes any salary or fees for things like performing marriages, funerals, and baptisms. An employee minister, however, may enter into a voluntary withholding agreement with your church by completing Form W-4. In that case, you can withhold not only income taxes but also estimated self-employment taxes.
Not only are income taxes not typically withheld, clergy are always self-employed for Social Security purposes, so you won’t withhold the employee share of FICA from their income either.
How do I handle a clergy housing allowance?
When it comes to a minister’s gross income, it generally doesn’t include the fair rental value of their home that’s provided as part of the compensation for services performed as a minister. Ministers can also exclude a housing allowance as long as they’re using it to pay rent, mortgage payments, utilities, or other related expenses.
The amount excluded for housing, however, can’t be more than the reasonable pay for the minister’s services.
Keep in mind that while a clergy housing allowance is excludable for income taxes purposes, it’s not for self-employment tax purposes.
Do I have to pay church employees overtime?
While ministers aren’t covered under the Fair Labor Standards Act (FLSA), other church employees may be subject to the law’s minimum wage and overtime rules if they meet the criteria for either enterprise coverage or individual coverage.
Most churches won’t meet the enterprise coverage test because they have less than $500,000 in revenue other than from donations or grants. However, some employees may meet the individual coverage test. So, for example, if an employee regularly sends emails or newsletters to individuals in another state or orders teaching materials from out of state, that may be sufficient to get them covered.
Even if the FLSA applies under the individual coverage test, employees may be exempt because the law excludes most executive, administration, and professional workers. If, for instance, you have an HR manager at your church who directs two HR staffers, the manager may be exempt. The Department of Labor offers a lot of guidance on these exemptions that can be helpful in helping you understand which employees the FLSA covers.
Are church musicians employees?
If your church pays musicians to perform during services or other events, you’ll need to determine if they are employees or independent contractors. The biggest distinction between W-2 employees and 1099 workers is the amount of control you have over them.
With a W-2 employee, you have the right to direct the work being performed. That means giving instruction and providing the tools, training, and equipment to complete the work. You also set their hours and schedules.
Conversely, according to the IRS’s fact sheet on employee versus contractor designations, the general rule is that a worker is an independent contractor if you have the right to control only the result of the work, not what will be done, how or when. As a result, 1099 contractors use their own methods and tools for completing work. Even though they may work for a specific project or period, they do it on their own schedule. And they can provide similar services to other businesses and can accept or turn down work opportunities as they wish.
When evaluating the work of musicians you hire, you’ll need to consider the amount of control over them. So, for example, are you selecting the music they play or their performance, or is the musician collaborating in those activities?
If you decide a musician is an employee, then you’ll report their wages and all compensation for the year using a Form W-2, which will also show the withholdings you made from their pay. Or, if they’re an independent contractor, you’ll need to issue a Form 1099-MISC at tax time to report their compensation if you pay them $600 or more during the calendar year.
How to Best Manage Your Church Payroll
Church payroll can be complicated because of the unique tax status of churches and clergy. To ensure you’re taking advantage of the special benefits afforded your organization and staying compliant with IRS rules, it may be helpful to outsource your payroll to a third-party provider. If you decide to go this route, Complete Payroll Solutions may be a good fit for you.
We have more than 18 years of experience setting up payrolls for both for-profit and non-profit organizations, including churches. We understand the complexities involved with payroll for churches and other religious organizations and may be a good fit for you if you:
- Prefer a dedicated professional to help you get your payroll set up properly and answer any questions
- Want paperless payroll options
- Are interested in solutions beyond payroll such as outsourced HR and compliance assistance
To decide if outsourcing payroll is the right choice for your organization, read our next article that compares in-house payroll versus outsourcing.