lose your church tax exempt status

Don’t Lose Your Church Tax Exempt Status

The following is a guest post by my friend and operations guru, Greg Hubbard. He helps church planters through his ministry at the Orchard Group which focuses on planting churches in global cities.

Churches frequently pay money to people out of a desire to be helpful and gracious. But you have to be careful when your church pays money to any individual. If you don’t get this right, your church risks what the IRS calls “private inurement” which can cause you to lose your church tax exempt status.

lose your church tax exempt status

Any time a person receives money from a church, the money must be spent in a way that is consistent with the church’s non-profit purposes. You set your church up as a nonprofit, so why would you use the money for an individual’s personal gain?

4 Kinds of Payments

Any time your church pays money to an individual person for any reason, it is vitally important that leaders understand exactly why the church is doing so. For every dollar spent, somebody needs to be asking whether the payment is:

  1. Compensation to an employee, or
  2. Payment to a contractor, or
  3. Reimbursement for a legitimate expense, or
  4. Benevolence.

Money paid to an individual for any other purpose is likely improper, and the payment could be deemed as private inurement.

Specific Rules for Each

Beyond determining what kind of payment is being made, there are specific guidelines for each kind of payment that must be followed.

Employees & Contractors

When paying an employee for performance of his or her job, the payment should be run through a payroll system and be reported as income to the recipient. This includes money that is thought of as a gift, a bonus, or for the purpose of meeting a medical need.

All too often churches mistakenly assume that their interns, musicians, and custodians are independent contractors and report their payments on Form 1099. Or churches think that if a person works part-time, temporarily, or has little responsibility, then that person can be treated as a contractor instead of an employee.

Yet these are not the factors the IRS uses to determine the difference between an employee and a contractor! If an intern (or anyone else):

  • reports to your office
  • is under the instruction of a supervisor
  • performs work at your facility with your tools/equipment
  • works only for your church
  • and can be terminated by the church

…then chances are high that the IRS would consider that person to be a W2 employee, not a 1099 contractor.

Expense Reimbursements

If the payment is for the reimbursement of an expense, it is best if it is paid as part of an accountable reimbursement plan if it is being paid to an employee. Such a plan must be implemented with specific language by the church’s board before any expenses are incurred. Expense reimbursements to volunteers should also be properly substantiated (the dreaded turning in of receipts) and clearly tracked as consistent with the church’s non-profit purposes.


Payment to help a person with physical needs, whether an employee, church attender, or a person in the community, should be paid consistent with a pre-approved benevolence policy that clearly establishes the criteria to be used for determining who will receive gifts. Decisions about who will receive benevolence payments should be made by a predetermined and disinterested team of people.

If you’ve gotten any of these things wrong, there is no time like the present to get it fixed. You should bring it to your Board’s attention and probably get the counsel of a CPA. You certainly wouldn’t want to lose your church tax exempt status!