How a Church Determines What Its Minister is Worth
A Leader’s Salary Is Left to the Church, but Subject to the IRS
By James E. Guinn and David O. Middlebrook

James E. Guinn, CPA, is a founding shareholder of Guinn, Smith & Co. The firm provides accounting, auditing, tax and consulting services nationwide for churches, ministries and other nonprofit organizations. He started his accounting career with an international public accounting firm. Mr. Guinn is the author of numerous magazine articles and is a regular contributor to "Ministries Today" magazine. He has also published two books, "Religious Organizations: IRS and Accounting Issues" and "Religious Organizations: Personnel and Policy Manual." For more information about Guinn, Smith & Co., visit their website www.guinnsmith.com or call 972-255-7120.

David O. Middlebrook is a shareholder in the law firm of Brewer, Anthony, Middlebrook, Burley & Dunn, P.C. located in Irving, TX and is the head of the Non Profit Law Group. His practice includes advising clients on legal questions relating to general corporate and business matters with a special emphasis on legal issues affecting non-profit and faith-based organizations operating in the United States, Canada, Mexico, United Kingdom, India, Australia and the Philippines. Mr. Middlebrook is certified by the Cambridge Program in Risk Management for Churches and Schools offered by the University of Cambridge in England. Mr. Middlebrook is a frequent guest lecturer at programs and seminars dedicated to practitioners and tax-exempt organizations. He has authored numerous articles on non-profit topics published in Church Business Magazine and Ministries Today. Mr. Middlebrook is also the author of The Guardian System, a comprehensive system for the prevention of child abuse within an organization, for which he was awarded a 2001 Evangelical Christian Publishers Association Gold Medallion book award in recognition of excellence in evangelical Christian literature. Mr. Middlebrook may be contacted at 972-870-9898.

Determining the appropriate compensation of a church’s minister continues to be a sensitive and subjective task. For one thing, it amounts to assigning a financial value to the minister. It also involves the difference between various churches, ministers, duties and theologies. Nevertheless, "reasonable" compensation has long been an issue to be dealt with carefully.

From the church’s point of view, setting "reasonable compensation" for the pastor means the church leaders are exercising good stewardship. From the IRS viewpoint, "reasonable" compensation means that no one is unduly benefiting from the church’s exempt status. Unfortunately, many times, what the church believes is reasonable compensation and what the IRS deems reasonable is not the same.

In the past, if the IRS found a pastor’s compensation to be unreasonable, the only available remedy was the revocation of the church’s exempt status. However, in 1996, Congress enacted a provision commonly referred to as "Intermediate Sanctions." Pursuant to this law, "reasonable" compensation is the economic benefit received by the person equal to the value of services received by the church. Any compensation exceeding the value of the services received by the church is considered an "excess benefit" and results in excise taxes imposed against the minister and individuals who approved the compensation. These taxes can be prohibitive.

Although the legislation itself is very vague, the IRS regulations contain a safe harbor, which gives a church a rebuttable presumption if it follows certain procedures. Unfortunately, these procedures do not take into account the fact that the great majority of churches hold close their biblically based beliefs that a senior pastor, as head of the church, is to be at least adequately, if not generously compensated, relative to non-church counterparts. Scriptural references supporting this premise include:

1. A special tithe was to be set aside for the care and support of the Levites and priests (pastors).
   • The tithe of the people of Israel, which they present as an offering to the Lord, I have given to the Levites for an inheritance" (Num. 8:24, RSV).
2. The Lord commanded that a minister should be adequately supported.
3. In the same way, the Lord commanded that those who proclaim the gospel should get their living by the gospel" (1 Cor. 9:14, RSV).
4. Church work is a worthy vocation.
   • If a man desires the office of a minister, he is aspiring to a notable task" (1 Tim 3:1, Montgomery).
5. Pastors should receive an adequate salary.
   • Those officers of the church who fill their office well should be considered as deserving twice the salary they get, particularly those who labor in preaching and teaching" (1 Tim 5:17, Williams).

A significant number of churches place emphasis on scriptural references wherein diligent leaders of the church were in God’s favor, and prospered according to His will and plan. The Book of Deuteronomy details the abundance of Abraham and his descendants. Moreover, scripture says Abraham’s wealth came from God as a result of his obedience, and was tied to Abraham’s willingness to undertake significant personal sacrifice in devoting himself to God’s work. Abraham is not the only biblical example of prosperity resulting from personal sacrifice and devotion to the work directed from God. The accounts of Joseph in Potipher’s house and of Jacob also demonstrate the same principles. The large number of applicable passages regarding the subject of compensation exceeds the scope of this article, but regardless of where your church falls along the spectrum of senior pastor compensation, this common set of guidelines is most beneficial to follow.

Implementing Compensation Packages

As pointed out earlier, the IRS has provided procedures that allow churches to meet a rebuttable presumption. Individuals involved in setting compensation levels for disqualified persons, including ministers, can shield their decision from undue scrutiny by taking steps prior to implementation and payment of a compensation package by creating this rebuttable presumption of reasonableness. IRS regulations allow a church to rely upon the expertise of firms qualified to render an opinion on the reasonableness of compensation. Qualified firms include legal counsel, CPA firms and other independent valuation experts. These firms have developed a number of criteria for making a somewhat objective determination that a given compensation level is reasonable under the circumstances. Although individuals within a church who are in a position to set the compensation for a minister should be familiar with, and take advantage of, these recognized criteria for determining reasonableness, it is strongly recommended that they obtain a qualified opinion.

IRS regulations also provide that surveys establishing salaries for ministers with similar experience and duties, employed by churches of similar size in similar geographical locations. Most surveys indicate that pastoral compensation levels, including both salary and other elements of compensatory benefits, have risen relatively steeply in the last decade, and continue to rise. However, as discussed later in this article, these surveys contain several fallacies.

The authors recommend the following three-step procedure for implementing a compensation package for the senior pastor and other highly compensated executives within the church.

• Select a compensation committee composed of disinterested individuals.
• Determine which established compensation criteria are most applicable given the beliefs and practices of the church and the relative value the church will assign to each, and decide on the level of compensation.
• Take advantage of the rebuttable presumption of reasonableness allowed by the IRS by complying with the stated requirements, including obtaining a review by and opinion of a qualified firm when there is any question that a compensation package could be deemed generous under the circumstances.

The Compensation Committee

The wise church will develop proper policies and procedures for setting compensation for its key ministers, with each compensation package independently determined. This will help prevent a situation in which the church must defend its compensation package to the IRS, or perhaps in a public courtroom. The church’s governing board should appoint an independent compensation committee, excluding the minister, members of his family and employees or others considered under his control (e.g., employees who report to him). Instead, the committee should include independent board members and outside committee members, who ideally have experience in the area of executive compensation. This committee should evaluate, as objectively as possible, the contributions made by individuals to the religious organization over the previous year and those they are expected to make during the next year. The committee should then review current salaries and benefits. Proposals for proper compensation for the coming year should be made, discussed and then formalized in a recommendation to the board of directors, which usually has the authority to adopt a compensation package.

For churches that have long-established procedures for evaluating compensation and historic records on which to base decisions, it is a bit easier to determine the proper compensation package for a leader. But for newer churches – especially those where the founder is still active or where the church has experienced or expects rapid growth – it is difficult to evaluate the "worth" of a founder whose abilities may be unique. How do you compensate for vision, for risk-taking, for charisma, for anointing?

Of course, compensation procedures are more complicated in a church than in a secular tax-exempt organization because religious beliefs are very important factors. As mentioned earlier, Scripture refers often to compensation for the priest or pastor.

For example, some orders of Catholic priests and other religious groups require their members to take a vow of poverty. Other groups espouse a prosperity doctrine. These are religious matters to be determined by the church. Thus, there are many situations in which ministers have approximately equal talent, but because of the doctrines of their organizations or their own beliefs, their salaries and compensation packages vary widely.

It is the responsibility of church leaders to apply biblical truths in their interpretation of religious doctrine to determine a minister’s compensation.

Factors to Consider in Establishing Proper Compensation

As noted in the first step, the church should set policies and procedures. It should also consider key factors in setting compensation packages for ministers and other highly compensated employees. Some of these factors are listed below.

Factors related to the Church:

Compensation packages paid by churches of similar size to someone in a similar position.

The effect of the compensation package on the church’s financial ability to carry out its religious function.

The church’s specific view and ideology toward pastoral compensation.

Profitability to the church of the services rendered.

Number of available persons who can perform the duties of the position (indispensability).

Factors Related to the Individual:

• The individual’s character and his responsibilities as he serves the organization.
• The individual’s performance.
• The individual’s ability to generate revenue.
• Ease or difficulty of the work.
• Working conditions
• Future projects
• Future prospects
• Living conditions
• Unique ability, including background and experience
• Technical training
• Prior years’ inadequate compensation
• Time and energy the individual dedicates to the group’s activities and programs

These factors do not comprise an exclusive list of relevant considerations for determining compensation, but will serve as a useful starting point for most churches. Further, the relevant weight a church assigns to any of these factors, or other considerations, is left to the discretion of the board or compensation committee.

It is imperative that the board or compensation committee document in writing, the factors considered, and weight given to each, preferably in the board minutes so that there is written documentation of showing the diligence of the decision process in arriving at a particular compensation package.

Comparable Compensation and Surveys

The first factor listed addresses the determination of compensation packages paid by churches of like size. Unfortunately, with respect to ascertaining what similarly situated churches pay their pastors, a board or compensation committee may find only a limited amount of publicly disclosed information applicable to its church. Further, reported surveys are often inadequate because they are compiled from voluntarily reported information. Few other reference points, such as larger organizations, are made public. Further complicating the matter is the fact that the components of compensation packages for leaders of different churches are not always readily comparable. Some churches provide automobiles, retirement plans and expense allowances. Many times, these components are not reported as compensation in survey amounts. It is precisely for these reasons that the IRS has recognized that a church, acting alone, may be in an inferior position to that of a firm specializing in compensation reviews, which leads to the third step, taking advantage of the rebuttable presumption of reasonableness.

Comply With the Provisions that Create the Presumption of Reasonableness

The Intermediate Sanctions legislation was actually implemented to soften the prohibitive penalties proscribed against a tax-exempt organization engaging in excess benefit transactions. Until recently, the IRS was limited to only one remedy in curing violations of payments of excessive benefits (including unreasonable compensation) by tax-exempt organizations to disqualified persons, namely, the revocation of tax-exempt status. This "remedy" was tantamount to a death penalty for the tax-exempt organization. Regardless of whether the entire organization had violated applicable laws or how small the excess benefit might be, this overly broad remedy could usher in the demise of the organization, as seen in the collapse of Jim Bakker’s PTL ministry when its tax-exempt status was revoked.

In contrast, the Intermediate Sanctions legislation provides for specific penalties against offending individuals, in the form of excise taxes on the excess benefits, but the legislation seeks to avoid punishment at an organization level in all but the most extreme cases.

Further, the Intermediate Sanctions legislation provides a safe harbor for church leaders who have the duty of setting compensation levels for ministers. The regulations provide that the transaction will be presumed to be reasonable by the IRS if three conditions are met:

• Board Approval, No Conflict–The compensation package is approved by the organization’s governing board, or a compensation committee authorized by the governing board, and composed entirely of individuals who do not have a conflict of interest with respect to the compensation arrangement.
• Have a Basis for the Decision–In making its determination of reasonableness, the governing board or committee obtains and relies upon appropriate data as to comparability before making its determination. Relevant information includes compensation levels paid by similarly situated organizations, both taxable and tax-exempt, for comparable positions; the availability of similar services in the geographic area; independent compensation surveys compiled by independent firms and actual written offers from similar institutions competing for the services of the minister.
• Document Thoroughly–The governing board or committee adequately documents the basis for its determination when the determination is made. For a decision to be documented adequately, the written or electronic records of the governing body or committee must note: (A) the terms of the arrangement approved (B) the date it was approved; (C) the members of the governing board or committee who were present during debate regarding the arrangement and those who voted on it; (D) the comparability data obtained and relied upon by the committee and how it was obtained; and (E) the actions taken with respect to consideration of the arrangement by anyone who is a member of the governing board or committee but who had a conflict of interest with respect to the transaction or arrangement.

In calculating the compensation of a minister, keep in mind that the IRS includes every possible item of benefit to the minister, such as salary, housing allowance, retirement, provision of housing and housing cost, automobile usage or allowance, expense accounts, and travel allowances. Once the total for the year is accumulated, the agent, in many cases using his own judgement, compares this total to what he believes is a correct compensation package. Because in an agent’s eye, "reasonable" may be unrealistically low, it is certainly worthwhile to take the time and effort to meet the safe harbor qualifications. Once the church or religious organization has met these criteria, the agent has a much higher burden of proof in attacking the compensation package as unreasonable.

Opinion of Reasonable Compensation by an Independent Firm

In obtaining the rebuttable presumption of reasonableness, the church should give careful consideration to the option of using an independent firm’s services, such as a law firm or CPA firm qualified in compiling comparability data and compensation surveys. Some firms are also capable of providing an opinion as to the reasonableness of the compensation package. As noted above, publicly available comparability data that could be of assistance to a particular church may be scarce. However, firms specializing in compensation studies retain unobtainable, confidential data, which they can access and use in an opinion, without revealing the sources of the data. Moreover, the regulations themselves specifically allow a church’s governing board to retain such experts and to consider and rely upon their reports in making determinations regarding compensation. As is often the case when dealing with the IRS, the probability of a church’s success correlates to the precautionary steps, or lack thereof, which have been taken by the church’s leaders.

In summation, while a church retains wide discretion to establish compensation levels in accordance with its own prerogatives and beliefs, the discretion is not unlimited. Although no specific monetary limit or mathematical formula exists to objectively assess compliance, compensation is nevertheless controlled by the test of whether it is "reasonable under the facts and circumstances." This standard, while imprecise, is not entirely subjective, and is certainly not without definition or meaning. Rather, the reasonableness standard for determining compensation requires that a church exercise diligence in ensuring its conclusions are based on, and relate, to actual value the church receives from the individual whose compensation is at issue. Finally, within this legal requirement exists the framework for obtaining a rebuttable presumption of reasonableness, of which a church can and should avail itself.

 

This article is designed to provide accurate and authoritative information in regard to the subject matter covered. It is shared with the understanding that neither the author nor Tony Cooke Ministries is engaged in rendering legal, accounting, psychological, medical or other professional services. Laws and regulations are continually changing, and can vary according to location and time. No representation is made that the information herein is applicable for all locations and times. If legal advice or other expert assistance is required, the services of a competent professional person should be sought.

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