Because pastors of churches are not the same type of employee as other church workers, there are different rules regarding taxes. Two IRS red flags seem to continually re-occur, so it’s good to be aware and not get sidetracked by income tax issues.
- Vow of poverty — Ministers may receive counsel that it’s wise, or perhaps even Biblical to declare a vow of poverty. But simply declaring poverty to avoid income taxes is not sufficient for the IRS. The primary issue is control over earned income. If a minister has personal control over funds, then a vow of poverty is not legitimate. All compensation should be treated as taxable income. An exception is if a minister is part of a religious order and the order directs the minister’s income.
- Corporation sole – Another piece of ‘advice’ that gets attention is for a minister to form a corporation sole, a one person corporation. Paychecks are deposited into the ‘corporate’ bank account and the minister uses the account for expenses. When the corporation sole is used as a loophole intended to avoid income tax, the IRS calls it tax evasion. The IRS defines legitimate corporation soles as those ‘designed to ensure continuity of ownership of property dedicated to the benefit of a legitimate religious organization.’
A pastor and his wife recently received an $86,000 bill for back taxes and penalties after losing a court case involving a vow of poverty and corporation sole (Cortes v. Commissioner). If ministers receive financial advice that appears a bit too good to be true, it is best to check the advice with a second reliable source. Always keep in mind that gross income is ‘all income from whatever source derived’ (IRS Section 61(a)(1).
A legitimate way to help reduce a minister’s tax burden is for churches to adopt a housing allowance. Churches must follow specific rules, overviewed in a previous post.
Salmon Sims Thomas specializes church-related financial issues. For questions about church and ministry tax issues, please contact us. You can also find information about many common issues related to church finances by searching our Website.