Federal Reporting Requirements for Churches 2012

by Richard R. Hammar, J.D., LL.M., CPA,
Senior Editor, Church Law & Tax Report

Click here to download in PDF format

Introduction

The most important federal reporting obligation for most churches is the withholding and reporting of employee income taxes and Social Security taxes. These payroll reporting requirements apply, in whole or in part, to almost every church.Yet many churches do not fully comply with them for various reasons, including the following:

• The church treasurer is elected by the congregation and does not remain in office long enough to understand the application of the payroll tax reporting rules to churches.
• Church leaders assume that churches are exempt from the payroll tax reporting requirements.This is a false assumption. The courts have rejected the argument that the application of the payroll tax reporting rules to churches violates the constitutional guarantee of religious freedom.
• There are a number of special payroll tax reporting rules that apply to churches, and these often are not clearly understood by church staff members.These special rules include the following:
  • Ministers are always self-employed for Social Security purposes with respect to their ministerial services. While most ministers are employees for federal income tax reporting purposes, they are self-employed for Social Security with respect to services they perform in the exercise of ministry.This means that they pay the “self-employment tax” (SECA) rather than the employee’s share of Social Security and Medicare taxes—even if they report their federal income taxes as a church employee. It is incorrect for churches to treat ministers as employees for Social Security and to withhold the employee’s share of Social Security and Medicare taxes from their wages.
  • A minister’s wages are exempt from income tax withholding. Wages paid to a minister as compensation for ministerial services are exempt from income tax withholding whether the minister reports income taxes as an employee or as self-employed. Ministers use the estimated tax procedure to pay their federal taxes, unless they have entered into a voluntary withholding agreement with their employing church.
  • Some churches are exempt from the employer’s share of Social Security and Medicare taxes because they filed a timely exemption application. For most churches, this exemption had to be filed before October 31, 1984. The exemption does not excuse the church from income tax withholding, filing Form 941, or issuing W-2 forms to church employees. The nonminister employees of a church that filed such an exemption application are treated as self-employed for Social Security, and must pay the self-employment tax (SECA) if they are paid $108.28 or more during the year.

New in 2012. The Tax Relief Act of 2010 provided a temporary payroll tax and self- employment tax “holiday” during 2011 of two percentage points off the employee share of Social Security tax and the Social Security component of self-employment taxes. This meant that the employee’s share of Social Security taxes dropped from 6.2 to 4.2 percent of wages, and the Social Security component of self-employment taxes dropped from 12.4 to 10.4 percent of self-employment earnings for 2011. This reduction in taxes was enacted to stimulate the economy by increasing the take- home pay of millions of workers.

Late in 2011 Congress voted to extend for two months the reduced payroll tax rate that applied in 2011. The Temporary Payroll Tax Cut Continuation Act of 2011 extends the two percentage point payroll tax cut for employees, continuing the reduction of their Social Security tax withholding rate from 6.2 percent to 4.2 percent of wages paid through February 29, 2012. This reduced Social Security withholding will have no effect on employees’ future Social Security benefits.The reduced self-employment tax rate is also extended through February 29, 2012.

The IRS is advising employers to implement the new payroll tax rate as soon as possible in 2012 but not later than January 31, 2012. For any Social Security tax over- withheld during January, employers should make an offsetting adjustment in workers’ pay as soon as possible but not later than March 31, 2012.

Employers and payroll companies will handle the withholding changes, so workers should not need to take any additional action.

Under the terms negotiated by Congress, the law also includes a new “recapture” provision, which applies only to those employees who receive more than $18,350 in wages during the two-month extension period (the Social Security wage base for 2012 is $110,100, and $18,350 represents two months of the full-year amount). This provision imposes an additional income tax on these higher- income employees in an amount equal to 2 percent of the amount of wages they receive during the two-month period in excess of $18,350 (and not greater than $110,100).

This additional recapture tax is an add-on to income tax liability that the employee would otherwise pay for 2012 and is not subject to reduction by credits or deductions. The recapture tax would be payable in 2013 when the employee files his or her income tax return for the 2012 tax year.

Before February 29, 2012, Congress will need to decide whether to terminate or further extend the payroll tax holiday. Church leaders should monitor developments to ensure compliance.

The IRS has announced that it will issue guidance as needed to implement the provisions of this new two- month extension, including revised employment tax forms and instructions and information for employees who may be subject to the new “recapture” provision.

Warning. Federal law specifies that any corporate officer, director, or employee who is responsible for withholding taxes and paying them over to the government may be liable for a penalty in the amount of 100 percent of such taxes if they are either not withheld or not paid over to the government.This penalty is of special relevance to church leaders, given the high rate of noncompliance by churches with the payroll reporting procedures.

Next »