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To effectively manage church finances, you need to understand tax laws.
Laws can be complex and not always easy to understand. This results in churches occasionally doing things inadvertently that can be problematic.
Compliance with the tax code is often directly related to how a church manages its finances.
There are three common errors that churches make when managing their finances.
Fair compensation, pastoral expense reporting, and handling of restricted gifts.
There is an old saying; you don’t know what you don’t know. Meaning we have to seek out information in the areas where we may have a blind spot. For churches, this is in finances and tax law.
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.
3 Common Errors In Managing Church Finances
1. Compensation and Benefits
People who work for churches do so because of a calling and should be compensated fairly for what they do.
The first step in compensation management is to develop a compensation strategy for your church. This strategic blueprint will guide all compensation decision-making and take the guesswork out of pay and benefits.
To determine fair pay, churches have a duty to do the same type of benchmarking for pay and benefits as other organizations.
For instance, salaries for small churches are typically lower than those of mega-churches simply because of the size and complexity of the organization. Compensation comparisons are based on annual giving and membership.
A compensation committee would be the team who would do the work in gathering this information.
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.
How To Compare Staff Pay and Benefits
There are manual ways of comparing church staff pay and benefits.
That is simply to contact other churches (similar in size to yours) 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 already 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 that the information and source used can be considered in the rare occasion of an IRS church audit.
An audit would ask you how you determined pay and benefits. You want to have something you can point to as a source.
2. Expense Reporting
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 protects the person filling out the expense report by justifying the 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.
Some churches hand out credit cards to employees. This might be helpful for the employee, but it creates a rabbit trail of inquiries if that employee does not fill out an expense report.
Expenses should be submitted and approved by the reporting manager and an oversight designee before reimbursement of expenses is made.
Another option is to look for expense management solutions to 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 tax-exempt church receive a tax deduction for their contribution.
This is why the IRS wants to ensure that those donation dollars are used for their 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 funds, missions, youth, debt, etc.
Keeping track of these designated funds is important to ensure that those funds are being spent on the things it was originally intended for.
Why Is All of This Important?
Churches are not required to pay taxes because of their non-profit status.
Churches organized as 501(c)(3) organizations have tax exemption requirements under IRS law.
For a church to maintain that tax exemption status, it must abide by tax laws.
It is the church’s responsibility to understand the tax code and put measures in place to ensure it complies with how the IRS defines those tax-exempt requirements.
If you ever get a notice from the IRS that they are coming for an audit, you will be glad you did!
Learn more tips for managing your church by enrolling in our Church Administration course.