The Pastor’s Salary – An Investment

The Pastor’s Salary – An Investment
By Richard D. Locke Richard D. Locke is a certified public accountant with over forty years of experience. His firm, Locke & Associates, P.C., is a full service accounting firm which specializes in taxation and nonprofit services. The firm has six certified public accountants servicing approximately one thousand clients in the United States and thirty countries. You can reach Richard D. Locke, CPA at 918-488-0880.

During one of my recent onsite church reviews, the Lord spoke the following word through me to the pastor regarding his salaries, "If my people who work at the altar aren’t fed at the altar, then I won’t bless the minister." Remember, as long as the earth remains there is seed time and harvest. If the ministry is not paying the pastor properly, we are sowing a bad seed. Today, "fed at the altar" primarily deals with adequate compensation for being a pastor. In Isaiah 58, the Lord’s reply why God had not taken notice of their fasting is that on that day of their fast, they did as they pleased and exploited all their workers. To exploit in this case means to under pay or under compensate a worker.

The salary review by an independent third party is the answer for the spiritual adequacy of your pay and to protect you from unreasonable compensation questions from the IRS. A salary review every other year, referencing it in your minutes, and setting adequate compensation is all that need to be done. The salary review will cover not only a reasonable salary range but will also include comparisons to related churches and include housing allowance, retirement plans, health insurance, automobiles, and reimbursement of out of pocket pastoral expenses.

Our firm has done a number of salary reviews for pastors and staff and we have reached four conclusions:

  1. Most pastors are under paid.
  2. There is a fear among the pastors that the IRS might consider their compensation unreasonable and this is keeping salaries lower.
  3. Family members working for the church are not being paid.
  4. The pastor is not receiving all of the tax free fringe benefits.

Seldom do we do a review and tell the pastor that he is over paid according to his peers. Only one pastor was at the top of the normal range for a comparable size church. This means that 95 percent of all pastors are underpaid. Regardless of why the salary is low, whether it is ignorance or fear, it still results in the pastor with low pay. The majority of the pastors are not even receiving the average pay to similar churches. Most pastors should be in the upper 1⁄4, not just the middle range.

The IRS has put out lots of information about unreasonable compensation. They have instigated a number of penalties for any compensation over what they think to be reasonable. There is a 25 percent penalty against the employee, a 10 percent penalty for any of the board members or trustees that participated in the decision and a damaging 200 percent penalty if the transaction is not corrected within a period of time. These penalties have caused people to be cautious in setting pastoral salaries or giving them raises. This is a lot of talk about nothing because we have not seen an issue of unreasonable compensation pursued by the IRS. These penalties, however, have caused the body of Christ to spend untold thousands of hours setting up independent committees and reviews. The IRS is not chasing church salaries.

After the salary review and proper approval of the pastor’s salary, there are a number of additional steps or fringe benefits that can maximize the pastor compensation from a tax point of view.

After the salary has been determined, there needs to be a proper allocation to the housing allowance. The housing allowance, called the pastor’s tax shelter was improved recently when the courts overruled the IRS allowing 100% of a salary to be classified as housing allowance. The IRS has not acquiesced with this. However, we can aggressively claim 75 or 80 percent of your salary as housing allowance. To the extent you spend your housing allowance, it is not subject to income tax. The biggest error in this is that the majority of the pastors do not have enough housing allowance to offset all of the allowable costs. This is the equivalent of losing tax free income. For example if your housing allowance was $20,000 for the year and you spent $24,000, your W-2 would show $4,000 higher and be subject to tax.

The housing allowance allows pastors to have a larger residence because you get to deduct the housing allowance and the interest and taxes a second time on your schedule A, itemized deductions. This lets you reduce your taxes and lets you make major improvements to a personal residence. This combined with most gains on the sale of a residence are tax free.

A number of spouses should be licensed and ordained in addition to receiving the salary. This would let them consider electing out of the Social Security system. If her spouse has been in the Social Security system more than 40 quarters, then she is entitled to retirement based on his earnings and his full retirement in the event of his death. For this reason, it is difficult for spouses to build a retirement beyond the benefit they are entitled to from their spouse. This means that their paid salary will not necessarily increase their retirement plan. Any licensed or ordained person can elect out of the social security system for future ministry income by filing form 4361 in a timely manner.

If the spouse elects out of social security, then this becomes an excellent source of money to funnel into a retirement plan. The tax laws just passed by congress is increasing the IRA contributions from $2,000 to $5,000 per year and increasing the 403B and 401K deductions by approximately 50 percent. They have even added an additional $5,000 increase if you are over age 50. Even the IRS now recognizes the need for retirement and that folks nearing retirement need to get caught up.

All pastors should have an adequate health insurance policy. The payment of the health insurance by the church is a tax free benefit to the employees. This plan should cover not only the pastor but all the family members. Since this is a tax free benefit, we recommend a good plan with very good coverage and a low deductible. Health insurance can be provided for the pastor without covering all employees. In addition, smaller churches and ministries should take advantage of a medical reimbursement plan. This is a written plan that the church should adopt and cover the out of pocket costs of the employees. This plan cannot be discriminatory and must include all full time employees. The church can set a dollar amount or preferably, a percentage of everyone’s salary as the maximum annual amount.

The pastor’s automobile should be owned by the church. This will require the pastor keeping a log or estimate of his personal usage. This personal usage of the automobile will be included in the pastor’s W-2. This is a cheap way to own an automobile because the pastor’s cost is the personal use included in his W-2 at his income tax rate. It is important to address any insurance related issues in order to assure there is proper coverage for the pastor’s use of the church owned vehicle.

Perhaps you are confident that your salary is reasonable. Let me ask you some questions: Is your spouse working in the church? How many hours is she working and what is her pay? The second thing we see is that most of the spouses are underpaid if they are paid at all. If the spouse isn’t getting paid and she is working at the altar, I think you have a problem of a bad seed again. I suggest you keep track of how much the spouse works and in what area, and determine a reasonable compensation.

A review of your salary also includes a review of the financial condition of your church or ministry. If your salary is way below even the average compensation, the church may not be able to raise the wages immediately, however, it will let you devise a three or five year plan for moving the compensation forward. This salary review is also a great benefit to the board members. This will assist them in approving the proper salary. If you know you are under paid and the salary is set by board members, the independent review is an easy way to approach the subject with the board members.

To summarize, the salary of the pastor is spiritually important and naturally important to the growth of the pastor and the church. The three main observations in our salary reviews are:

  1. Most of the pastors are under paid.
  2. There is a fear among the pastors to make sure their compensation is not unreasonable compensation. The IRS is not assessing any penalties in this area and this is certainly not an easy victory for them.
  3. The spouses working in the ministry are not being adequately paid and in a number of cases not receiving any compensation.

It is time for the independent salary review and assessment to ensure that the "altar pay" is reasonable and adequate.