Whether it’s managing payroll, classifying employees, understanding (and benefitting from) exemptions and tax compliance, most organizations have questions about how to remain compliant and free from financial penalties while implementing a payroll system that supports employees and smoothly integrates with other facets of HR.
Here, we’ll outline the key considerations and best practices to keep in mind as your religious organization works to optimize its payroll management, including how to select a qualified payroll provider that offers expertise, intuitive software, and HR integrations that streamline workforce management.
Churches and other religious entities are considered tax-exempt organizations by the IRS. As a result, they are not required to pay federal income taxes, and all 50 states have at least some statutes that provide exemptions for payroll tax, as well as other taxes like property tax.
Nevertheless, if your religious organization has employees who work in multiple states, it’s important to be aware of how state tax laws regarding payroll (and other taxes) impacts withholding and reporting. Additionally, since many religious organizations have employees who work part-time or as contractors, it’s equally important to properly classify employees for payroll purposes, whether it’s non-clergy employees, church musicians, or other staff. Bear in mind that clergy and ministers are subject to separate tax classifications and benefits, which we’ll discuss in greater detail below.
To begin the payroll process, you’ll need to collect each employee’s name, address, DOB, salary or hourly rate, as well as their completed direct deposit form(s) and state and federal (W-4) withholding forms for tax purposes.
Religious organizations tend to have a number of part-time employees and contractors. In each case, it’s imperative to properly classify workers and provide them with a W-2 or 1099 based on their role within your organization and to determine in advance exempt or non-exempt status based on Department of Labor guidelines. Misclassification, in either case, can lead to fines, penalties, overtime/time tracking violations, or issues with past-due payroll taxes.
As part of your payroll process, you’ll need to decide whether to pay with direct deposit, traditional paper checks, and on a monthly, -semi-monthly, bi-weekly (currently the most popular) or weekly basis. Bear in mind that some states regulate pay frequency for either all employees, or for specific industries or employee classifications. For instance, in Illinois, semi-monthly pay is required for all employees, excluding Executive, Administrative, and Professional personnel, who must be paid monthly.
Determining gross pay is different for exempt vs. non-exempt employees, but once you’ve determined the amount, you must calculate deductions and exemptions for taxes, contributions to benefits or supplemental insurance. Once these amounts are deducted from each employee’s gross pay, this represents the net pay you will give your employee at the upcoming pay period. If any of your employees worked overtime (for instance, a salaried non-exempt employee), you’ll need to calculate this accurately before determining net pay, as well.
Although clergy and ministers are generally excluded from payroll tax withholding, you will need to withhold for FICA taxes (Social Security and Medicare), federal income taxes, state income taxes, as well as local taxes or municipal taxes (city income tax as one example) for all non-clergy employees. Not-for-profit organizations, including religious entities, are excluded from federal unemployment (FUTA) taxes, as well as state unemployment taxes.
For religious organizations that choose to manage payroll in-house using manual, paper-based, or partly digital methods, the process can be quite challenging and difficult to integrate seamlessly with other HR operations like hiring, onboarding, timekeeping, benefits administration and workforce management.
For this and other reasons, more religious organizations are opting to collaborate with a payroll management provider to streamline their processes and enjoy HR integrations that empower them to focus on their mission. In this section, we’ll explore the major features and benefits of a church payroll management solution and what services it can provide to religious organizations.
A payroll management solution should include a secure, cloud-based software platform that is easy for you and your staff to use. It should complement and easily integrate with other HR operations like onboarding, timekeeping and more.
A qualified payroll management provider should know the ins and outs of clergy compensation, clergy tax law, fringe benefits, housing allowances, employee classification, and any other major payroll considerations that exclusively apply to religious entities.
A provider should be capable of helping you navigate (and, wherever possible, benefit from) local, state, and federal tax laws and exemptions as they apply to religious organizations. They should also be invested in keeping your organization consistently up to date on all current and forthcoming regulations that could affect or benefit your organization.
Regardless of the size of your organization or what existing HR capacity you already have, a qualified payroll provider can adapt to meet the needs of your organization – supplementing existing resources or providing comprehensive payroll support that extends to other facets of HR and HCM.
Unfortunately, many churches and religious organizations make late or inaccurate payroll filings due to a misunderstanding of clergy W-2 forms, employee classification, or withholdings requirements. A payroll management solution significantly reduces the prospect of your church incurring federal or state penalties and interest associated with payroll.
Whether it’s accessing pay stubs, W-2s, payroll reports, or other information, with a payroll management solution, you and your employees are enabled to make changes and submit key information as needed and in real-time. Your solution can also be tailored to automate withholdings, permissions, vacation requests/approvals, and security measures.
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Whether your organization opts to continue with in-house payroll management or work with a qualified payroll provider, you should be aware of best practices and tax compliance for church payroll, including common mistakes to avoid.
Because of the federal tax-exempt status among religious organizations, it’s easy to inaccurately file or altogether miss payroll tax withholding. However, isolating information returns as just one example, the penalties for noncompliance can be as high as $250.00 for each late or incorrectly filed return. Even one inaccurate or unsubmitted return can also lead to an IRS payroll audit that examines all organizational returns and payroll filings over a ten-year period.
Other mishandled considerations like employee overtime can also lead to compiance and financial consequences. For instance, some FLSA regulations could apply to your non-clergy employees if they qualify for individual or enterprise coverage. Of course, enlisting the help of an expert payroll management provider not only mitigates compliance concerns and streamlines payroll, but also helps your organization stay aware of special exemptions that only apply to religious organizations. For instance, some religious organizations can qualify for a special exemption from submitting an employer’s share of FICA taxes if they choose to abstain from this tax liability for religious reasons.
Using IRS Form 8274 while referencing The Tax Reform Act of 1984, a religious organization can apply for this special exemption and lessen their payroll tax obligation. Other exemptions exist that can lead to reduced payroll taxes, increased tax benefits, and employee benefits that strengthen employee satisfaction and retention, as well.
Parting ways with paper documents or scattered Excel files to enjoy a payroll management solution is compelling, but it’s important to be thoughtful about how you select a provider. Some larger payroll providers are well-suited to provide support to businesses across a range of industries, but may have limited or zero experience managing payroll for religious entities. In addition to this concern, there are general factors you should consider when evaluating providers to determine if you’ve found the right solution for your organization.
As you survey possible providers to determine the best fit for your organization, we recommend that you and your staff consider the following factors:
Your provider should accurately and efficiently calculate hours, process withholdings, deliver direct deposits, and provide easy access to essential employee, payroll, and tax information through a user-friendly mobile, cloud-based solution, boosting employee satisfaction and retention.
If you manage payroll in-house, your new provider will eliminate redundant or time-consuming tasks, allowing your organization to focus on its core tasks.
The provider should have experience working with religious organizations and provide reliable customer service, expertise in compliance, and security measures to protect employee and business information.
When payroll seamlessly integrates with HR processes, it leads to organization-wide benefits, reducing time and costs on HR functions and allowing focus on more pressing tasks.
It's important to have questions for a potential payroll management provider before deciding to collaborate. Consider asking these questions during the evaluation process:
Catalog all of the specifics of your organization, staff, and the jurisdiction(s) where you operate, and share those details with the provider you’re considering to hear how they would address these considerations in a thoughtful and effective way.
Generally speaking, your organization will get the most out of a payroll solution when it is paired with other HR tools that are frequently interrelated with payroll (especially timekeeping and onboarding).
It’s fair to directly compare (and mention) the price of other available payroll providers’ services, including those that are seemingly comparable. Give the provider you’re considering a chance to explain and justify costs and fees so you can gauge whether it’s a worthwhile investment for your organization.
Reputation and experience are paramount when choosing a payroll management provider. Be sure to confirm the provider’s past experience working with religious organizations and ask for testimonials/client feedback.
One important distinction to understand when it comes to clergy members is their tax status. According to the Internal Revenue Service (IRS), ministers are considered employees for income tax purposes, but they are treated differently when it comes to Social Security and Medicare taxes, which are collectively referred to as FICA taxes. Clergy members are typically exempt from paying FICA taxes on their earnings. Instead, churches and other religious organizations may choose to pay an equivalent amount of the employer's share of FICA taxes on behalf of their clergy members.
To qualify for the exemption from FICA taxes, clergy members must meet certain criteria. For example, they must be ordained, licensed, or commissioned by their religious organization, and they must perform services in the exercise of their ministry. If these criteria are met, clergy members can file Form 4361 with the IRS to request exemption from paying FICA taxes.
It's also important to note that churches may not need to pay into state and federal unemployment insurance programs. According to the IRS, churches are exempt from paying federal unemployment taxes, and they may also be exempt from paying state unemployment taxes in certain situations. For example, if the church only employs clergy members, they may be exempt from paying state unemployment taxes in some states.