Managing church finances requires having an understanding of tax laws.
Because the laws can be complex, and not always easy to understand, churches occasionally do things inadvertently that can be problematic.
Staying compliant with the tax code is often directly related to how a church manages its finances.
As stated by Dan Busby in an article written by Church Law and Tax, there are three common errors that churches make when managing their finances – fair compensation, pastoral expense reporting and handling of restricted gifts.
Churches should gain a better understanding of these three areas so they can protect the church, and the people who have responsibility for managing their finances, from unintentional mistakes.
1. Compensation and Benefits
People who work for churches do so because of a calling and should be compensated fairly for what they do. To determine fair pay, churches have a duty to do the same type of benchmarking for pay and benefits as other organizations.
Pay ranges should be developed independently and objectively to ensure there is no bias (high or low) in determining pay for church employees.
No one should be able to determine their own salary outside of comparable pay ranges.
There are manual ways of comparing church staff pay and benefits.
That is simply to contact other churches and share pay information.
The advantage of doing manual comparisons is that it allows you the opportunity to have conversations with other church administrators about pay and benefit practices.
However, it can be a very time consuming and tedious task that needs to be redone every couple of years.
A quicker and more efficient way to determine fair pay is to use the information that has already been gathered in books like Compensation Handbook for Church Staff to ensure that church employees are compensated fairly and comparable to others in the same position.
This book is a great resource because it takes the guesswork out of pay grades and gives you all the needed information to put together your own pay range recommendations.
The other benefit of using benchmark comparisons is the information, and source used, can be considered in the rare occasion of an IRS church audit.
2. Reporting Expenses
Reporting expenses is not a favored task for anyone.
And for those people who struggle with paperwork, it is even more of a dreaded chore.
However, tracking and reporting expenses are critical to good church financial management and tax law compliance.
The whole point of reporting expenses is to help ensure that church funds are spent solely on those things that support the purpose and mission of the church – and not for someone’s personal gain.
In addition, this type of documentation serves to protect the person filling out the expense report by justifying dollars spent.
“The organization must not be organized or operated for the benefit of private interests, and no part of section 501(c)(3) organization’s net earnings may inure to the benefit of any private shareholder or individual.” IRS.gov
All church-related expenses should be reported and reviewed independently to validate the justification for the expense and explain the business purpose of the expenditures.
Church employees should use their personal credit cards and be reimbursed for expenses made on behalf of the church.
Expenses should be approved by the reporting manager as well as an oversight designee before reimbursement of expenses are made.
Another option is to look for expense management solutions that can help control spending before it happens.
3. Restricted Funds
Restricted funds are another area that is blurry and often misunderstood.
Simply, people who give to a church that is tax-exempt, receive a tax deduction for their contribution.
This is why the IRS wants to make sure that those donation dollars are used for its intended purpose.
When someone makes a general donation it is considered an unrestricted fund and can be used for any church expense.
However, when a donation is designated for a particular purpose it then falls into the category of a restricted or designated fund.
It is at this point that the church needs to make sure that those dollars are spent on those things that the money was designated for.
Donors can designate where they would like the funds to go and many churches have several giving buckets to choose from – building fund, missions, youth, debt, etc.
Keeping track of these designated funds is important to ensure that those funds are being spent on those things it was originally intended for.
Churches that are organized as 501(c)(3) organizations have tax exemption requirements under IRS law.
It is the responsibility of the church to understand the tax code and put measures in place to ensure the church stays in compliance with how the IRS defines those tax-exempt requirements.