By John Butler
Though current year tax planning often occurs at year-end, this is an even better time for “Next Year” tax planning. Planning for next year with employee compensation options can be particularly effective. Most options are more beneficial if operating the entire year, and some options must be in place before the New Year starts.
There are several compensation related elements that provide important planning opportunities for churches and pastors. The following descriptions are meant to provide enough information to help you know which ones could be useful to you, and some initial steps to begin planning.
Though obvious to most church leaders, every discussion of minister tax planning must mention the substantial benefit of the housing allowance. The church must designate the minister’s housing allowance in advance of payment.
While the health reform legislation made health plans more complicated, they continue to be a substantial non-taxable benefit to employees. At least for 2011, a church can purchase different health insurance products for different employees without non-discrimination concerns. Self-insured and cafeteria plan arrangements cannot discriminate in favor of highly paid employees. Considering these together, a church may provide a good level of health coverage to all regular employees, and provide a better benefit for a few key employees and pastors.
Qualified retirement plans, 403(b) plans, Simple IRAs and Simple Plans are all tools for helping employees with retirement income. For churches, the 403(b) plan has the added benefit of allowing discriminatory contributions (this must be allowed by the plan document). IRS Publication 4484, “Choose a Retirement Plan for Employees of Tax Exempt and Government Entities” shows attributes of various options useable by churches (available at www.irs.gov/pub/irs-pdf/p4484.pdf). An interactive table and information is available at www.retirementplans.irs.gov/plan-comparison-table/.
Non-qualified deferred compensation plans
These retirement programs can be developed for specific employees or pastors. They offer tremendous flexibility in funding and pay-out provisions to precisely meet the needs of the church and pastor or employee. Non-qualified primarily means they are not a regular pension, retirement or 403(b) plan. Assets belong to the church and nothing is taxed to the employee/pastor until paid to the employee or pastor. Any deferral of compensation payments beyond the year earned should be discussed with your tax professional because of documentation and operation requirements.
Tax-wise, for the employee or pastor, it is always better if church related expenses are reimbursed by an Accountable Reimbursement Plan (ARP). Under an ARP, the church only reimburses expenses that relate to the ministry of the church, that are properly documented, and submitted within a reason time of being incurred. No income or social tax is paid on these. A church concerned about excessive reimbursements may set financial or purpose restrictions, or require authorization.
Pastors and many employees regularly attend seminars or take courses to develop new skills or expertise. Several provisions provide tax benefits for such education, but some confusion about the requirements often means nothing is used. Two options routinely allow to churches to pay for or reimburse expenses associated with:
1. Education to enhance an employee’s skills or knowledge used in their job, which does not lead to a new career can be provided at the employer’s discretion to any employee, without any required “plan.” This could cover tuition, books, travel to and from the educational institution and if the educational institution is out of town, it could include food and overnight lodging. There is no statutory amount limit.
2. Education under an “Employer’s Educational Assistance Program,” using a nondiscriminatory plan may be used for nearly any subject and even lead to a new career. An employee’s annual benefit limit is $5,250, which can only be spent on tuition, fees, books and similar supplies. Though this can’t discriminate in favor of highly compensated employees, a church may restrict the usage to subjects helpful to the church.
Example: A church might use the first item to help a pastor (who is already preaching) get an advanced theology degree by extension, which might require trips periodically to the seminary. The second item could be used to help clerical staff take accounting courses, even though these might be part of an accounting degree program.
Planning to save taxes requires thought and time. Often the best planning involves joint consideration between the church and the pastors or employees. While some options must be offered equally to all, others allow more tailoring to specific situations. The details for most require professional assistance to assure correct implementation and operation. But with increasing tax rates at the state and federal levels, the tax saving potential continues to increase. Now is the time to begin saving taxes for 2011.
John Butler is tax counsel for Capin Crouse LLP, Greenwood, IN.