How a Church Mistake Can be Costly to Pastors
On October 17, 2011, a U.S. bankruptcy court* ordered a minister in Michigan to pay $85,814.69 in taxes plus penalties and interest.
The IRS said the minister was considered a “responsible party” for purposes of the Trust Fund Recovery Penalty, and the court agreed.
How did this happen? What exactly is the Trust Fund Recovery Penalty?
In short, it is a law that places pastors, church treasurers, and financial secretaries at risk of incurring high personal tax penalties.
To learn how to prevent this from happening to you, keep reading!
What exactly is the Trust Fund Recovery Penalty?
Though it has been in the books for a long time, many churches are not aware of how severe the Trust Fund Recovery Penalty is and how one can fall into its trap.
Section 6672 (a) of the Internal Revenue Code reads,
Any person required to collect, truthfully account for, and pay over any tax . . . who willfully fails to collect such tax, or truthfully account for and pay over such tax, or willfully attempts in any manner to evade or defeat any such tax or the payment thereof, shall, in addition to other penalties provided by law, be liable to a penalty equal to the total amount of the tax evaded, or not collected, or not accounted for and paid over.
Furthermore, IRS Policy Statement 5-14 states that the "penalty may be asserted against those determined to have been responsible and willful in failing to pay over the tax."
How it happened to the minister in Michigan
When a new employee was hired to take over accounting in the church, she discovered that a previous employee was not properly remitting the employment taxes to the IRS. She immediately informed the minister about the problem.
It became clear that this problem had existed for a few years. The ministry made some efforts to pay the taxes plus the penalties and interest.
Soon after entering into a payment plan with the IRS, the ministry suffered some financial setbacks. In addition, the minister’s husband became very ill, and she had to focus much of her time caring for him.
The ministry could no longer maintain payments to the IRS. This forced the IRS to take action using the power of Section 6672 and to “declare a responsible party.”
Two common ways churches and board members fall into the trap
The most common way a church falls into this trap is by not filing Form 941 and not paying the proper payroll taxes.
The second most common way is the tax treatment of musicians, nursery workers, and other individuals doing small tasks at the church.
Many churches either perceive these individuals as self-employed and provide them with a 1099 form, or they do not give them anything at all. This error will prove costly over a period of time.
The IRS can reclassify these individuals as employees, charge the church back taxes, and hold the “responsible party” personally liable for the tax. Often, this ends up being the pastor, treasurer, and financial secretary.
(Recommended reading: “5 Steps to Help You Master Church Payroll”)
Why the pastor and church treasurer are most at risk
In Verret v. U.S.*, the court ruled that Stephen K. Verret was a responsible party, and he was ordered to pay the penalty of $408,918.66.
The court noted the following factors contribute to being a responsible party:
Someone who is an officer or member of the board of directors,
Someone who owns a substantial amount of stock in the company,
Someone who runs day-to-day operations,
Someone who has the authority to hire or fire employees,
Someone who makes decisions as to the disbursement of funds and payment of creditors, and
Someone who possesses the authority to sign checks.
The court also mentioned that one may be considered a responsible party even if that person does not have knowledge that he/she has a duty or authority to collect, account for, or pay employee withholding taxes.
Having significant decision-making power over the disbursement of funds is enough to be considered responsible.
Climbing an uphill battle
Once the IRS determines the responsible party, the burden of proof falls on the taxpayer to prove that he/she is not the responsible party.
In Verret*, the court cited another case, Barnett v. IRS*, which stated, “Once the Government offers an assessment into evidence, the burden of proof is on the taxpayer to disprove his responsible-person status. . . .”
How to avoid the Trust Fund Recovery Penalty
There are numerous ways a church and its board members can avoid falling into this type of tax trouble.
I am going to only briefly mention them because the specific details are separate conversations and teachings altogether. We cover these topics at our conferences and address them in our conference manual.
1. Opt the church out:
I am sure that you have heard of ministers opting out of self-employment tax. However, you may not have heard about a church opting out. The law allows a church to file Form 8274 and simply opt out of having to be responsible for collecting payroll taxes.
(Recommended reading: "4 Reasons Why Ministers Should Opt-Out of Social Security")
2. Properly classify workers in the church:
All church staff members must have FICA and Medicare taxes withheld and paid to the IRS using the tax payment system.
Church staff includes the following:
Musicians (even if they play only once a week),
Volunteers who get occasional love offerings, and
3. Avoid the 28% and 30% penalties:
Many churches have guest speakers and do not give them Form W-9 if they are U.S. citizens or a W-8 with Form 8233 if they are foreign nationals.
When you do not have a guest speaker complete the proper tax form before you make a payment for services rendered, you may be assessed a 28% penalty in the case of a U.S. citizen or a 30% penalty for a foreign national. The penalties are assessed with interest for lack of compliance.