To laypeople, employment in the clerical sector may seem stress-free, but in reality, managing the payroll at a church or other religious institution can pose challenges beyond that of a similar position in the corporate world. Make errors, and the penalties for failing to follow IRS regulations can be harsh. Fortunately, the government also has a stringent process it must follow before it can begin an examination of your organization's payroll and related taxes. The best way to ensure you can spend more time working in your ministry instead of on your books is to get your payroll set up correctly from the get-go, enable processes that keep you from getting audited, and should you find yourself on the business end of an IRS inquiry despite your best efforts, know how to prepare for an audit.
How to set up your payroll correctly
Classify employees correctly
Making sure that you know whether each person on your payroll is a contract worker or an employee is the first step to ensuring that you're completely in compliance with IRS regulations. The IRS has written volumes of regulatory code on this subject alone, but we've boiled it down into an easy-to-digest FAQ post on the subject that will help you understand the differences between these two classifications and how to make the distinction.
Decide who will handle payroll and how often it will be dispersed (or choose an outside company)
One person within your organization needs to step up and take on this responsibility. Both the church and the person preparing the payroll and remitting related taxes may be liable in the event of errors, which is one reason why many churches choose to have an outside company assist them in this matter. We'd love to talk with you about how InflectionHR has helped churches and houses of worship of all sizes streamline their processes and steer clear of IRS audits.
One area in which houses of faith may find themselves especially prone to errors is regarding the taxation of ministerial employees: One estimate shows that in 2016, a remarkable 60 percent of clergy were issued erroneous W-2 forms by either churches or payroll companies. Ministers are classified as self-employed, and thus the institutions for which they work cannot pay federal income taxes or make contributions to Medicare on their behalf.
With regard to issuing payroll regularly, there's no right answer to how often you pay your employees. What's most important is simply to determine what works for you and your team, and stick with it.
Have every employee fill out a W-4
It's important to have every employee complete this simple and necessary form to avoid issues with misreporting.
How to defend against an audit
Properly withhold (or don't) for ministers
As detailed above, clergy of any kind falls into this special category. If taxes or Medicare deductions are improperly withheld, their ministerial status is implicitly voided. In other words, if you do the withholding from your ministerial employees without a voluntary withholding agreement, then their housing allowances will be considered income on top of the pay they're receiving, and they'll suddenly find themselves owing taxes on those funds after the fact. Plus - more than likely - penalties, since it's after the fact. Nobody wants that.
Properly issue W-2s or 1099s to all employees/independent contractors
Of course, this process primarily relies on the need for proper classification of all workers as above, as well as the need to determine a schedule for your payroll and stick with it. Once this is done, and you have your payroll set up on a system, and it's cranking out regularly, the generation of your end-of-year W-2s and 1099s should be simply a matter of course. Employers must mail or hand-deliver these forms to workers by January 31st.
Include all appropriate income on the W-2
Ministerial employees who receive a W-2 may have unusual categories of income that must be reported on this form. These can include, but are not limited to, bonuses; wedding gifts; personal expenses paid by the church such as a personal car payment, personal car gas, and the like; lawn care, utilities, maintenance and other expenses for the minister's personal house over and above any housing expenses paid by the church; and many others.
IRS Publication 517 breaks all of this down in granular detail if you have time for a little light reading, but of course, we here at InflectionHR provide simplified payroll solutions so you don't have to do all that heavy lifting and can get back to the more important work of helping your congregants live their best lives.
How to prepare for an audit
Keep all filing current, regardless of auditing
Clearly, regardless of whether you do get that call, it makes sense to ensure that your papers and electronic files are in the right place at all times so that in the unlikely event the phone does ring one day it won't be a mad scramble to get ready. Your house of worship is not at high risk of being audited by the IRS, but should that occasion arise, it's best to be prepared.
Review all records for completeness
If, despite your best efforts, the IRS has notified you that they want to have a look at your books, take a deep breath. First, take stock of your documents and make sure everything is on your premises and complete: Do you have all of your personnel, financial, donor, and legal records available and in good shape? Some of your records will doubtless be computerized - check over those as well. What are your policies with respect to retaining your records over time, and have you been following those?
One note here about those workers you have designated as ministers: It's always wise to retain official designation of this designation in the files of those personnel. Perhaps it's a certificate of ordination, a license, or a commissioning document - regardless of the exact terminology, the appropriate paperwork will ensure a smooth process.
Properly document the personal use of all church equipment
Personal use of vehicles and cell phones are two big areas in which the IRS can easily spot violations, so don't give them the opportunity to do so. Have your staff track their personal mileage and tax your staff member and/or have them reimburse your organization. Experts note that the IRS simply won't go for the argument that vehicles and cell phones aren't used on a personal basis, so it's best to make an effort to identify personal use, even in the case of cell phones when it's difficult to do so.
And you thought working in a house of worship was going to be such a serene, peaceful job! Managing the payroll at a church or other religious institution is just as complicated, if not considerably more so, as any corporate institution. Handled the right way from the onset, however, you can set up a solid foundation that will enable you to spend less time on calculations and more time on contemplation. Better yet, call us for a consultation: We're always available to talk about how our human capital management systems (including our cloud payroll solution) can help our clerical partners thrive.