Top 6 Payroll Mistakes with Churches and Nonprofits!

In my bookkeeping practice, I encounter payroll mistakes within churches and nonprofit organizations of every size.

Unfortunately, even those that utilize a payroll service or software may still be out of compliance, as many payroll providers lack the expertise to correctly set up and manage payroll for these entities. Such mistakes can lead to significant financial repercussions.

Below are the six most common payroll mistakes I frequently observe in my work...

Payroll Mistakes #6: State Exemptions

Payroll Mistakes #5: Paying Individual Health Insurance Premiums 

I have observed several well-meaning churches covering their employees' individual health insurance premiums. This can be a nontaxable reimbursement if established correctly. Payroll errors often occur when these reimbursements are not aligned with ACA (Affordable Care Act) guidelines. If not set up properly, these healthcare reimbursements can violate ACA requirements and lead to penalties.

Additionally, there are strict guidelines surrounding these types of healthcare plans, so it's essential to be aware of them and ensure compliance.

Another common payroll mistake is categorizing an employee's health insurance premium as "pre-tax."

"Generally speaking, an employee contribution toward health coverage is deducted from wages on an after-tax basis unless the employer establishes a special arrangement under Section 125 of the federal tax code."

...excerpt from Health Coverage Guide's article: Tax Implications

As I am not an expert in HRAs or health insurance, I strongly recommend consulting a benefits or HR professional. It is crucial to ensure your church's payroll is accurately set up concerning the tax implications of health insurance benefits.

Payroll Mistakes #4: No Payroll Forms on File

Before issuing the first paycheck to your employee, ensure you have a W-4 and an I-9 form on file.

• The W-4 form is essential for gathering the correct information to set up that non-minister employee in your payroll system. It also indicates how much should be withheld for payroll taxes. 

• If an employee wishes to change their withholding, always obtain a new, completed, and signed W-4 before making any adjustments. This will prevent any potential issues next year if they feel too much or too little was withheld and they do not recall requesting the change.

• Additionally, the government mandates that you verify your employee's eligibility to work in the United States. This can be done by having them complete and sign an I-9 form and by collecting copies of the necessary supporting documents.

• If you offer direct deposit for their paycheck, ensure you have a signed and completed direct deposit authorization form on file.

For further details on the documents required for payroll, please refer to this Step-by-Step Payroll Guide.

Payroll Mistakes #3: Not Including Taxable Income

The following compensation types must be analyzed to determine if they should be reported in Box 1 of an employee's W-2:

• Bonuses and Gifts: This is one of the payroll mistakes I see that occurs frequently. If you give your employees a Christmas or year-end bonus or appreciation gift (whether cash or a gift card), the cash should be processed through payroll with all applicable withholding taxes applied. Also, cash and/or gift cards must be reported in Box 1 of their W-2.

• SECA Allowance: You can assist your minister with a portion of their self-employment tax by providing an "allowance" for the 50% that churches cannot "match" like they do for all FICA (non-minister) employees. However, this is taxable income and must be reported in Box 1 of their W-2.

• Car Allowance: You may offer your minister a fixed monthly car allowance; however, this is taxable income and must be reported in Box 1 of their W-2. A more effective approach is to establish an accountable reimbursement plan that allows for tax-free reimbursement based on actual miles driven for church-related activities.

• Medical Sharing Costs: As mentioned earlier, you can reimburse your employee for their participation in a medical sharing plan like Samaritan Ministries; however, this is considered taxable income and must be included in Box 1 of their W-2.

• Cell Phone Reimbursement: The church can provide a tax-free cell phone for a minister or employee who needs one for church duties. However, if the cell phone is provided or reimbursed for an employee who does not require one for their responsibilities, it becomes taxable.

**Tip:** If you pay for an employee's cell phone and they do not have a personal phone, some of the monthly charge may be considered taxable income for the portion used for personal purposes.

**Unsubstantiated Business Expenses:** If you have employees who are slow to submit their receipts, remind them that missing receipts for items purchased for the church and paid for with church funds may lead to those amounts being included in their taxable income according to IRS regulations.

Payroll Mistakes #2: Paying Ministers Through the FICA System

Payroll Mistakes #1 Classifying Workers Incorrectly