Reasonable compensation is an important criteria for maintaining a church’s tax exempt status. But what is reasonable? Who decides? There is still not a lot of guidance from courts or the IRS, but several court cases address the issue of reasonable compensation.* Without going into specific tax law, the rulings provide guidance for all churches and other tax-exempt organizations. Reasonable compensation should be based on the value of the services provided by the employee.
Minister compensation should be reviewed/approved by an organization’s independent compensation committee. The compensation committee should consist of volunteers who are not related to the key employees to pastoral or key staff. The review determines the reasonableness of the compensation based on the following:
- Performance evaluation based on identified objectives and accomplishments
- Comparisons with compensation paid by other similar churches (i.e., membership, staff, budget in geographic area)
- Salary opinion from a tax attorney or CPA
The compensation committee should have written records of discussion and decisions to justify the compensation amount. A pastor’s salary and other compensation depends on factors such as education, experience, responsibility for the ministry (duties, growth, etc.), size of church, geographical location and related cost of living, and the financial stability of the church. Compensation includes several components in addition to salary, such as:
- Housing allowance
- Auto allowance and/or expenses
- Health, disability, and/or life insurance
- 403(b) retirement
- Other taxable benefits
The non-salary income quickly adds up in a compensation package. Churches that have an employee reimbursement policy should also protect the pastor with regard to expenses. (All un-substantiated expenses (i.e., non-accountable) are considered taxable income.) Make sure that the total compensation package doesn’t put the amount beyond the ‘reasonable’ category.
Justifying the pastor’s compensation with comparative information and a job description that lists duties will go a long way in meeting the IRS-test for ‘reasonable’, creating the rebuttable presumption.
If you have questions about pastor compensation, please talk with us. Salmon Sims Thomas has many years’ experience working with churches, ministries, and nonprofit organizations across the country.
*Heritage Village Church and Missionary Fellowship, Inc., 92 B.R. 1000 (D.S.C.1988); Church of Scientology v. Commissioner of Internal Revenue, 823 F.2d 1310 (9th Cir. 1987)