Every congregation, as an employer, must report to the Internal Revenue Service with regards to the income paid to each employee. These 10 steps will prepare you to meet this obligation.
1. Employer Identification Number (EIN). Every congregation should have one. If you happen to be a new congregation then you must secure an EIN from the Internal Revenue Service before any payroll related payments are made. To obtain one, your congregation must complete Form SS-4, Application for Employer Identification Number, available from your local IRS office or online at www.irs.ustreas.gov. Once you are assigned a number your congregation should automatically begin receiving:
- Form 941, Employer’s Quarterly Federal Tax Return
- Form 8109, Federal Tax Deposit Form
- IRS Publication 15, Circular E - Employer’s Tax Guide
2. Determine whether each worker is an employee or self-employed. In most cases, individuals who perform services for a congregation are considered employees of the congregation. If in doubt, congregations should treat workers as an employee since penalties can be assessed against a church for treating a worker as self-employed who the IRS later reclassifies as an employee. The IRS has developed 20 criteria to assist in classifying a worker as self-employed or an employee. Generally a self-employed person typically is engaged in a specific trade or business and offers his/her services to the general public. A self-employed worker would not be subject to the control of an employer with respect to how a job is to be done. (LINK TO SECTION 9)
3. Have each employee complete a W-4 Form. Have each self-employed individual complete a W-9 Form. The W-4 Form for employees will give the congregation the necessary social security number, address of the employee, and the information required to withhold the correct amount of federal income tax. Remember that any W-4 forms which claim more than 10 withholding allowances needs to be reported to the IRS. The W-9 Form for self-employed individuals will give the congregation the address and social security number of the individual. This information is needed when filing 1099s for these individuals at year-end. If a self-employed worker performs services for your congregation and earns at least $600 for the year, but fails to provide you with his/her social security number, then the congregation is required by law to withhold 31% of the amount of compensation as "backup withholding."
4. Compute each employee’s taxable wages. This of course means each employee’s salary taxable wages also include the following:
- Cash Christmas gifts from the congregation.
- Social security offsets given to any clergy employees.
- Imputed interest on low-interest (or no-interest) loans that the congregation might make to any employee.
- Personal use of a church-owned vehicle.
- Any business expense reimbursement given under a nonaccountable business expense reimbursement arrangement. For example: a car allowance is given to an employee every month, but the congregation requires no record keeping or accounting for how the car allowance was spent. The total given as car allowance is considered taxable wage and at year end would be included on the W-2.
- Bonuses or any cash gifts
- Forgiven debts
- Most reimbursements of a spouse’s travel expenses.
5. Determine the amount of income tax to withhold. IRS Publication 15 (Circular E) gives you two ways to calculate the correct amount of income tax to withhold. One way is called the wage bracket method in which you use the withholding tables in the Publication 15. The other way is the percentage method in which the number of allowances claimed by the employee are multiplied by an appropriate value given in Publication 15. Make sure to secure a new Publication 15 each year so that you have the most up-to-date withholding tables and percentages.
NOTE: Normally federal income taxes are withheld only on the wages of the non-clergy. Clergy are exempt from withholding. A clergy can however ask to have federal income taxes withheld (but not FICA). To do this a clergy needs to fill out the W-4 giving you a certain dollar amount that he would like to have withheld.
6. Withhold FICA taxes from non-minister employees’ wages. Congregations must withhold 7.65% of each employee’s wage and also match this amount with their own funds. This 7.65 percent rate is composed of two items: (1) a Medicare hospital insurance tax of 1.45% on all taxable wages and (2) an "old-age, survivor and disability" tax of 6.2% - refer to your current year’s tax guide to determine what the maximum taxable wage is for this category.
7. The Congregation must deposit the taxes it withholds. As pointed out above, there are three components of federal payroll taxes: (1) federal income taxes withheld from the employee’s wages (2) the employees’ share of FICA taxes and (3) the employer’s share of FICA taxes. These dollars must be deposited according to the deposit status that the IRS determines for each congregation. In November of each year the IRS notifies every employer of their deposit status for the next year. The different rules are as follows:
- If withheld taxes are less than $500 at the end of any calendar quarter, the congregation need not deposit the taxes, but rather send them directly to the IRS with each quarterly 941 Form.
- If withheld taxes were $50,000 or less during the most recent look-back period the taxes are deposited monthly–by the 15th day of the following month.
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If withheld taxes were more than $50,000 during the most recent look-back period the taxes are deposited semi-weekly. This means that for paydays falling on Wednesday, Thursday or Friday, the payroll taxes must be deposited on or by the following Wednesday. For paydays on Monday or Tuesday the taxes must be deposited on the Friday following the payday.
- Withheld taxes of $100,000 or more must be deposited by the next banking day.
- Use form 8109–Federal Tax Deposit Coupon–to deposit all employment taxes. The deposit can be made at any financial institution qualified to act as a depository for federal taxes or directly to the federal reserve bank serving your area.
8. All employees subject to income tax withholding, social security taxes or both, must file Form 941 each quarter. The 941 reports the amount of FICA taxes and the withheld income taxes that are payable. This total amount of tax should of course agree to the amount deposited or accumulated for that particular quarter. The Form 941 is due by the last day of the month following the end of each calendar quarter.
9. You must file W-2 forms annually to report earnings of the pastor and other employees to:
- Social Security Administration
- State tax authorities
- Local tax authorities
Prepare a W-2 form for each employee as well as the accompanying W-3 transmittal form for the IRS. The W-2's are due out by January 31, the W-3 by February 28.
- Box a. No need to put anything here
- Box b. Congregation’s employer identification number
- Box c. Congregation’s name and address
- Box d. Employee’s Social Security number
- Box e. Employee’s name
- Box f. Employee’s address
- Box 1. All wages earned by the employee for the year. Please see item 4 above for a discussion what is considered taxable wage.
Do not include that amount which is designated as housing allowance.
- Box 2. The federal income tax withheld from that employee’s wages. For most clergy this box can be left blank.
- Box 3. The employee’s wages subject to social security. Often this is the same amount as listed in box 1, but not always as some retirement contributions are excluded from box 1, but included in box 3. Box 3 should not list more than the maximum wage base for social security. For clergy employees, leave this box blank as they are not subject to social security.
- Box 4. Report the social security taxes withheld. (6.2% of Box 3.) Leave blank for clergy employees.
- Box 5. Report the employee’s wages subject to Medicare. In most cases this will be the same as box 3 except there is no maximum wage base for medicare. Again for clergy employees leave this box blank.
- Box 6. Report the Medicare taxes withheld. (1.45% of Box 5.) Leave blank for clergy employees.
- Box 12. Insert the appropriate code and dollar amount in this box. Some of the codes that churches might use would be eg.; C - for providing more than $50,000 in group term life insurance; E - for contributions made to a 403(b) tax shelter annuity through a salary reduction agreement; L- for the amount the church paid that equal the allowable standard mileage rate in the event the church paid at a rate higher than the IRS allowable rate. Any excess should be included in Boxes 1 & 3; P- the church reimbursed the employee’s moving expenses and the reimbursements are not included in the employee’s income.
10. Prepare a 1099-MISC for each self-employed worker who earned $600 or more as well as the accompanying 1096 transmittal form for the IRS. The 1099's are due out by January 31 and the 1096 by February 28.
- Box 1. Report in this box the amounts paid to recipients for all types of "rents, such as equipment rentals, machine rentals, or office space rent."
- Box 4 Report in this box any backup withholding
- Box 7 Report in this box the amount of compensation paid to the non-employee.
