This is another posting in the MinistryCPA Top 10 series:
Understanding what to offer a pastor as part of his compensation package can be a difficult task. There are a number of different factors to consider. Variables such as compensation, insurance, housing allowance, taxes, and retirement all play into compensation. We have compiled a list of factors that a church should consider when designing a compensation package for the pastor. Every church situation is unique, and each church should analyze what it can actually afford.
1. How does the church determine an appropriate compensation rate?
Determining an appropriate compensation level can be a difficult task in a small ministry. There are a few factors that can be used to help determine a fair compensation for the pastor. The first factor that should be taken into consideration is the needs of the pastor. If the church wants a pastor to work full time, then it must consider what he needs to be paid to support himself and his family. Second, the church should also consider what it can afford; just because a church wants to pay its pastor a full-time salary, does not mean that it has the finances to do so. Third, the church can compare the size of the church to other similar churches in the same region to help determine a fair compensation. No matter what basis the church uses to pay the pastor, the church needs to clearly communicate pay periods and the amount. Resources such as www.churchsalary.com can help determine a fair compensation for the pastor.
2. What insurance options should be considered?
There are a variety of insurance options that a church should investigate when designing a benefits package for its employees. These include health, life, disability, and dental insurance. A church might also consider establishing a Health Savings Account (HSA) or Health Reimbursement Arrangement (HRA) to help with other medical expenses.
3. How is a housing allowance established?
To establish a housing allowance, the employee must be recognized by the IRS as a minister; no other church employees are eligible for a housing allowance. For a housing allowance to be valid, the church must designate it before the compensation is paid. For most churches, their designations are made before a new calendar year begins. The minister can exclude from income tax the lesser of (1) the designated housing allowance amount, (2) his actual housing costs, or (3) the fair market rental value of the home. However, in most cases the housing allowance remains subject to self-employment tax.
4. How does the church report a minister's benefit of living in a parsonage?
Understanding how to incorporate a parsonage into a pastor’s compensation package can be a difficult task. Unlike a housing allowance, the value of a parsonage for self-employment tax considerations is measured at the fair rental value of the property as determined by the pastor and his tax professional. While the value of the parsonage is an important component of the pastor's compensation package for internal purposes, it is not reported in box 14 of his Form W-2.
5. What parsonage responsibilities should be communicated to the minister?
If a church provides housing for a pastor or other church employee, then the church needs to clearly communicate expectations. This should include information such as whether the church or the pastor will be responsible for major and minor repairs, utilities, lawn care and snow removal expenses.
6. What retirement options should the church consider?
Helping employees plan for retirement is a great way for a church to take care of its employees’ future. Common retirement options include IRAs, Roth IRAs, and 403(b) plans. A 403(b) plan may allow the pastor to continue to enjoy a housing allowance when receiving retirement distributions. Also, unlike IRA plans, a 403(b) plan may also help to reduce a minister's self-employment tax. A church should examine available retirement options and help the employees determine what is best for them.
7. What social security tax responsibility does the church have?
Unlike church employees whose earnings are subject to social security and Medicare tax withholding (FICA tax), ministers, as SECA employees, are not eligible for social security and Medicare withholding. Some ministers have chosen to opt out of SECA tax for purposes of their ministerial income. Whether the pastor is opted out or not does not affect the church. In either case, the church does not withhold SECA tax. Some churches provide a "FICA alternative benefit" to help the pastor save for his SECA taxes. This benefit is typically equal to 1/2 of his SECA tax obligation. This additional taxable compensation is withheld as federal income tax for the pastor to claim on his personal tax return.
8. What are the church's responsibilities for dual status employees?
While a church cannot withhold the SECA tax, it can provide other statutory employee fringe benefits to its pastor that would not normally be available for self-employed individuals. This is the primary result of ministers' dual status before the IRS.
9. What can the church provide for moving costs?
Up until 2017, the moving costs paid by pastors were tax deductible and not taxable if paid directly by the church. However, that rule was changed and now the expenses that are incurred by a pastor are no longer deductible. A church can still pay the pastor's moving expenses, but their cost must be added to his taxable compensation in box 1 of Form W-2.
10. What is a professional expense reimbursement plan?
Employees may spend their own money to pay for church expenses. The church should have a clear procedure for reimbursements. The reimbursements are not included on their Forms W-2. We have written a number of blog posts on professional expense reimbursements, including unspent reimbursement plan payments and how to establish a written reimbursement plan.
While this list represents the top 10 factors that should be considered when designing a pastor's compensation package, we recognize that there are certainly more factors to consider. Please leave your thoughts and suggestions in the comments below, including topics that you would like us to cover. Contact us if we can help you address any of the topics above.