Our church is acting as the mission agency for an individual sent from the church. We will receive funds and clearly indicate that the church has complete authority over the funds in order to protect their tax-deductibility. My understanding is that in order for the church to send the money on to the missionary, we can do one of the following:
1. Pay the missionary reimbursements for allowable business expenses requiring documentation; other support sent to the missionary will be taxable as self-employed ministry income.
2. Make the missionary an employee of the church, paying the individual through payroll and therefore take taxes out of the support before paying the missionary.
3. Pay the missionary without requiring documentation as a self-employed individual and issue Form 1099-MISC.
Are any/all of these correct ways to handle this?
Knowledge of complex tax laws provides one of many reasons that mission agencies are most often more prepared than a local church to serve a missionary and his or her sending churches. Nevertheless, churches do commonly attempt to provide this help so I will attempt to outline the options.
It is my experience that most well-established mission agencies classify their missionaries as employees. Mission agencies do provide considerable oversight (control as the Internal Revenue Code defines it). Missionaries often find that supporting churches welcome this oversight in order to aid the missionary in his or her ministry and to practice good stewardship over their own resources.
Whether taxes are withheld from these employees depends on their status as ministers or non-ministers. Just as a minister of a church is, by law, exempt from withholding and responsible for his own self-employment and income tax, so too is a missionary who is a licensed or ordained minister of the gospel. If the individual sent by the church is not a minister (e.g. a school teacher, office worker, or medical provider), then, as any other employee of the church, FICA taxes and federal and state income taxes are withheld.
As employees, the missionaries may document business expenses to the church for tax-free reimbursement. As long as substantiation requirements are met, these amounts will not be reportable as taxable income on Form W-2. Also, as employees, these missionaries are eligible for many of the same employee benefits that are discussed throughout this blog.
As for the self-employment route, if it's easily and cheaper for the local church to provide no accountability as to how the funds are spent and the church simply wishes to act as a conduit for other churches' (and its own) support, then Form 1099-MISC can be issued for the full amount of the support. The church could set up a reimbursement and documentation arrangement but as a self-employed minister there will be virtually no difference in his taxable income. Further, he is not eligible for many employee benefits described in the Internal Revenue Code (e.g., 403(b) plans, HRAs, employee insurance plans).