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How to Avoid These Five Common Payroll Mistakes

November 6, 2023 jill Blog
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By Sarah Barham

It’s no secret that churches face complex challenges when it comes to their finances. Accounting, taxes, payroll, internal controls, and complying with new governmental regulations all have to be taken into consideration.

Here are a few best practices that can save your church major headaches.

1. Verify and specify whether the salary package for a new church employee includes benefits.
Why is this so important? It provides clarity — for both the employee and the church. If a salary package includes salary, housing, tax offsets, reimbursements for personal expenses and benefits, it can reduce a minister’s take-home pay.

For example, say a church finance committee sets a salary package at $150,000, but doesn’t specify what it includes — which happens more often than you might think. Is the $150,000 for wages only, with housing and benefits added on top? Or does the $150,000 include those benefits? If so, the breakdown might look something like this: $80,000 in wages, $50,000 in housing, and $20,000 in benefits. The confusion is compounded when this ambiguous figure is reported to payroll, either internally or to outsourced services. Is the new minister’s compensation $150,000 plus these benefits, or does that amount include them?

We’ve seen multiple churches fail to make this distinction and realize at the end of the year that they’ve paid out much more than they budgeted. Paperwork and documentation should be provided for each employee, but it’s important to lay out everything clearly within the paperwork.

2. Don’t get bogged down by overcomplicated deductions.
There’s a popular deduction that is often referred to as a “Social Security offset.” Under this plan, if a minister meets the requirements for self-employed status, he will be responsible for paying self-employment taxes. Churches often deduct that self-employment tax from the
payroll and keep those funds for the minister until taxes are due. Then, the church will reimburse the minister just in time for paying those self-employment taxes by the quarterly due date. As you can imagine, this can considerably complicate a church’s payroll and the accounting of those deductions and payments.

Another common deduction we see is for cell phones, or if a minister wants tithes paid out of his payroll. We don’t tend to recommend these arrangements. These types of complicated deductions can make church accounting even more difficult, especially when trying to orchestrate it all in-house.

3. When it comes to state and federal compliance, it matters if your minister is licensed or ordained.
You may not realize it, but licensing and ordination fall under the church’s responsibility. The reason for this? If licensed, a minister can claim a housing allowance, which provides tax relief benefits. If this minister elects to designate a portion of his salary as a housing allowance, the church is restricted from withholding the employer portion of Social Security and Medicare.

We often see ministerial payrolls being processed in which the church is paying both the housing allowance and taxes, which is not in compliance with IRS regulations. When we process a church’s payroll, we always ask for the minister’s certification first. If he claims a housing allowance, we designate him as licensed/ordained and therefore exempt from FICA withholding. But remember that a minister also has the option of being designated as a “secular minister,” where he doesn’t claim a housing allowance. Today, most ministers buy their own houses or live off site.

There are other considerations for your church to consider surrounding housing, too. You might be able to claim decorations, utility bills, and so on, but it depends on what the church pays for.

4. It’s vital for churches to understand the difference between an employee and a contractor.
The reason these differences are so important is because of the employer’s tax responsibility and reporting requirements. Firstly, the church can withhold and pay taxes on behalf of an employee — not a contract worker. Second, the church, as the employer, has expectations for and authority over an employee in a way that they don’t over a contractor — for example, they set the work schedule that employees are subject to. Employees receive a W-2 from the church; contractors do not.

If your church has an individual who sets his or her own schedule, typically offers their services outside of the church, and provides their own supplies for work performed under the church, they fall under the category of a contract worker. And contractors who receive more than $600 in a calendar year receive a 1099 from the church.

In a church setting, distinctions between an employee and a contractor aren’t always clear. Say someone works in the church nursery or fills in as a musician — technically, they’re using the church’s instruments or coming at a certain time for the church service, which could make them employees. On the other hand, these individuals might also offer their services outside of the church, which means they’d be contractors. It’s a very fine line, and sometimes the best practice is simply to seek out expert advice to ensure you’re classifying your workers correctly.

5. Make sure your church is making state and federal tax payments on time.
This one sounds obvious, right? But it’s a common problem, and it can cause serious headaches. Fines are an obvious repercussion for late payments, but states that collect taxes can even attempt to close a church down for violations. Plus, there’s an even greater consideration: stewardship.

Paying avoidable fines and penalties simply isn’t good stewardship. When a church misses a deadline and pays late, fines are added, and those fines are a non-budgeted expense. The church is then forced to dip into other funds to pay those penalties, as opposed to using those dollars for outreach or other ministry activities.

So — at what point should a church leader consider outsourcing payroll to a third party?

If your church isn’t 100-percent confident in its tax withholding and tax reporting practices, then outsourcing might make sense. Most times when we see penalties or fines issued to a church, it’s because the church just didn’t know. Unfortunately, the government isn’t very forgiving.

Outsourcing to a third party doesn’t only provide accuracy and efficiency; it creates time, transparency, and trust. More time means more hours in the week to invest in Gospel ministry. More transparency ensures that your congregation can be apprised of and confident in the financial direction of the church. And, through an expert third-party accounting, you can trust your church is compliant with federal and state rules and regulations.

Sarah Barham is the vice president of ministry accounting services at WatersEdge, which exists to financially empower donors and ministries to transform lives with the Gospel of Jesus Christ,