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Cash Bonus to Pastor

Question:

A church has recently received a large cash donation, and the congregation would like to give a large gift to its pastor in appreciation of his fifty years of service. Can the church give the gift in such a way as to avoid taxation to the pastor? Will this gift jeopardize the 501(c)(3) tax-exempt status of the church?

Answer:

First of all, this gift will not affect the tax-exempt status of the church, assuming the gift is based on previous years of low compensation. The church should exercise care on this point, as large gifts can be construed by the IRS as private inurement, the enrichment of an individual to the detriment of the tax-exempt organization's primary purpose. (For more on this, see a recent blog post: Private Inurement)

After considering the issue of private inurement, the church and pastor have multiple options concerning the gift and resulting taxability of the bonus. Depending on the minister's individual tax situation, he may want to consider one or more of the following strategies to minimize the tax consequences:
  • Defer all or a portion of the bonus into a 403(b) tax-sheltered retirement plan (this strategy delays or eliminates both income and self-employment tax)
  • Designate some or all as housing allowance (the designation will remain subject to self-employment tax, but not income tax)
  • Use the bonus to pay other tax-deductible expenses, (e.g. charitable contributions, professional expenses)

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Answer:

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