Those in the pastor ministry are not typically thought of as overpaid. Certainly in most cases they are not. According to current compensation research, an ordained Protestant pastor serving a small congregation receives a median salary and housing package of $31,200. Since the vast majority of churches in the U.S. are small, the overall compensation package for Protestant pastors is low when compared with teachers and social workers. (see footnote)
However, the amount of a pastor’s salary is only one dimension of reasonable compensation; the manner in which they are paid is of just as much interest in evaluating compensation from a legal standpoint. In recent years, pastoral and key church staff compensation has come under a great deal of governmental scrutiny. Government representatives and agencies such as the IRS now require increased transparency and public accountability. The revamped IRS Form 990 requires key employees [of non-profits other than churches] to detail the method used to determine the compensation packages for their ministers and key staff.
The procedures churches should follow in setting compensation for their pastoral and other key staff members can be found in Section 4958 of the Internal Revenue Code. By following the procedures set forth below, the church has a presumption that the compensation is reasonable.
How to Determine “Reasonable” Pastoral Compensation
1. Form an independent Compensation Board to establish compensation packages. To qualify as “independent,” the Compensation Board must consist of individuals who are not paid staff of the church and are not related to either the pastoral staff or key staff. This Compensation Board should consist of a minimum of three people, and could include your church’s board of directors or elders, or a sub-committee formed from such boards. The Compensation Board should have someone present to take minutes of the meetings (see #3 below).
2. The Compensation Board must rely upon “trustworthy and reliable” data or surveys when making its determination. Several sources of reliable survey results are available which provide compensation ranges for ministers and their staffs, many of which can be found online. A trusted and experienced professional with knowledge of non-profit law and the setting of reasonable compensation packages can also be helpful in providing a written compensation evaluation. Properly prepared compensation evaluation studies have proven invaluable to organizations as they strive to comply with the ever-increasing demand for accountability and compliance with governmental regulations.
3. After approving the compensation package, the Comp Board must document its approval in written minutes. These minutes must also be approved and documented in the minutes of the church or ministry’s board of directors or elders.
I highly recommend there be an Employment Agreement executed between church and pastor. In my experience, many problems could be avoided if the pastor and church had entered into a mutually agreeable Employment Agreement. Our office drafts many of these agreements each year, and I have witnessed the benefits derived by the implementation of this easy and simple legal document.
Components to Consider in a Pastoral Compensation Package
The Comp Board should include and address the following components as part of a pastor or key staff member’s total compensation package:
- Housing/Parsonage allowance
- 403(b) Retirement
- Rabbi trust/Deferred compensation
- Disability income
- Health insurance
- Automobile expenses
- Sick days
- Time away to attend conferences and related expenses
- Church business expenses/Allowance for books and periodicals
- Other amounts to assist the pastor/key staff member
- Any related party transactions
- Ownership of Intellectual Properties, i.e., sermons, books, curriculum, music, etc.
Important Compensation Terms to Understand
IRS definition: “The value of services is the amount that would ordinarily be paid for like services by like enterprises (whether taxable or tax-exempt) under like circumstances” (Source: Treas. Reg. § 53.4958-4(b)(1)(ii)).
Translation for the rest of us: Reasonable compensation is determined by qualified parties (i.e., a Comp Board) who take into account the following:
- The pastor or key staff member’s education and experience
- The pastor or key staffer’s executive-level duties
- The pastor or key staffer’s years of tenure
- The success of the ministry that can be directly attributed to the pastor or key staffer
- The size of the church
- The number of the church’s services, programs, and outreaches
- The church’s geographical location
- The cost of living
- The financial stability of the church (to be documented by audited financial statements prepared and certified by a qualified financial analyst and/or CPA)
- The anticipated growth of the church
- The various components of total compensation, as listed above
In addition, according to the IRS, Comp Board members must consider the compensation packages of executives performing similar duties in organizations of similar size and denomination in similar circumstances, whether taxable or tax-exempt. For example, church leaders in the pastorate now find themselves shepherding and overseeing thriving megachurches, many with more than 20,000 members/supporters and annual revenues in the tens of millions of dollars. So, in addition to the more typical duties of the pastor of a church, they also perform duties similar to those in administration, public relations, broadcasting, printing and publishing, advertising, and educational service.
Excess Benefit Transactions and Intermediate Sanctions
As you probably already know, churches recognized as 501(c)(3) tax-exempt organizations must be organized and operated exclusively for exempt purposes, with none of the earnings inuring to the benefit of any private individual. In other words, the organization cannot be operated specifically for the benefit of those operating, overseeing, and/or employed by it. Transactions which result in private benefit to a key staff member or leader of a church are called excess benefit transactions. Specifically, an excess benefit is any economic benefit which exceeds the value of a consideration (a donation, gift, etc.), received by any person in a position of substantial influence over the affairs of the church. (This includes the family members of those in church leadership positions.)
In addition, if a church makes a grant, loan, payment of compensation, or similar payment to a substantial contributor of the organization, the arrangement could be considered an excess benefit transaction, and the entire amount of the payment is taxable as an excess benefit.
Typically, rather than immediately taking away a church’s tax-exempt status in the event of such a transaction, the IRS instead will impose tax penalties upon pastors and key church staffers who are found guilty of approving any excess benefit transaction. These penalties are referred to as intermediate sanctions. Persons found guilty of receiving this excess private benefit may be assessed tax penalties in excess of 200% of the excess benefits. The leader who approved the transaction may also incur severe tax penalties, including fines of up to $10,000 per violation.
As such, an important role of a church’s board of directors or elders is to establish a system of checks and balances to protect and secure the church’s exempt purposes. To determine if an excess benefit transaction has occurred, the board should consider all benefits exchanged between pastors, key church staff, the church, and its ministries.
The following are instances in which an excess benefit can occur:
A transformed life is marked by humble service.
- In an exchange of compensation and/or other benefits in return for services of a pastor or other key leader
- In an exchange of property between a pastor or key leader and the church
- When a church provides a benefit to a pastor or key church leader that exceeds the value of the benefit the church received in exchange
- In certain transactions involving donor-advised funds and/or supporting organizations
Correcting the Excess Benefit
A key leader corrects an excess benefit transaction by undoing the excess benefit to the extent possible, and by taking any additional measures to place the church in a financial position as if excess benefit had never occurred. The church is not required to rescind the underlying agreement; however, the parties may need to modify an ongoing contract with respect to future payments.
Cash payment or equivalent made to the church is the most common method of correcting an excess benefit transaction. The correction amount equals the excess benefit plus interest (interest rate may be no lower than the applicable Federal rate) on the excess benefit. Key leaders making corrective payments are prevented from transferring property other than cash or cash equivalents. However, with the church’s approval, a correcting key leader may return the specific property transferred in the excess benefit transaction. In this case, the return of property is considered a payment of cash or cash equivalent.
To assist Compensation Boards with developing compliant compensation packages for pastors and key staff, the IRS developed a procedure known as rebuttable presumption. This procedurehelps prove the compensation package does not promote excess benefit. There are three conditions that must be met in order to show compensation arrangements are at a reasonable, fair market value:
1. The compensation package is approved in advance by an authorized body of the church (one with no associated conflict of interest).
2. The authorized body obtained and relied upon appropriate data prior to making its determination (see #2 under “How to Determine Reasonable Pastoral Compensation” above).
3. The authorized body adequately documented the basis for its determination (see #3 under the same section above).
It is the responsibility of the church’s board of directors/elders/governing body to determine and document that the compensation being paid to its pastoral and other key staff is indeed reasonable. When selecting a firm to perform compensation evaluation studies for your key executive employees, care should be taken to ensure the firm you select has a significant amount of experience in non-profit law and the preparation of compensation evaluation studies.