Generally, churches and religious organization are required to withhold report, and pay income and Federal insurance Contributions Act (FICA) taxes for their employees. Substantial penalties may be imposed against an organization that fails to withhold and pay the proper employment tax.
In addition, this is a target audit item for the Internal Revenue Service when it comes to ministries and nonprofit organization. Some churches have historically mishandled employee treatment. Some churches hire payroll companies to handle this process.
Here are some special rules for compensation to remember:
Withholding Income Tax for Ministers
Unlike other exempt organization or businesses, a church is not required to withhold income tax from the compensation that it pays to duly ordained, commissioned or licensed minsters for performing services in the exercise of their ministry. An employee minister may complete an IRS Form W-4 Employee’s Withholding Allowance Certificate, and the church should report the compensation on a W-2, Wage and Tax Statement. If the minister is independent contractor, the church should report compensation on 1099-MISC, Miscellaneous Income.
A housing allowance can be beneficial for ministers because an allowance for husing ex excluded from federal income tax. However, it is not exempt from the minister-s self-employment tax. In order to qualify for the exclusion from federal income tax, two very important conditions must be satisfied.
1. The housing allowance must be board approved before it was paid.
2. The minister actually spent the allowance on eligible housing expenses during the year.
The church must make sure the amount they designate as allowance for housing is determine beforehand. It should be included in a board approved resolution and properly documented in the church records. Most of the time, it is reviewed and adjusted before the beginning of each new budget year.
Social Security and Medicare Taxes –
Federal Insurance Contributions Act (FICA)
FICA taxes consist of Social Security and Medicare taxes. Wages paid to employees of churches or religious organization are subject to FICA taxes unless, wages are paid for services by a ordained, commissioned or licensed minister or a church, pays the employees wages less than $108.28 in a calendar year or the church is opposed to the payment of Social Security and Medicare taxes for religious reasons files IRS Form 8274.
Withheld employee income tax and FICA taxes are reported on IRS Form 941, Employer’s Quarterly Federal Tax Return or an annual Form 944, depending on your required filing status.
Federal Unemployment Tax Act (FUTA)
Churches and religious organization are not liable for FUTA tax.