Three Common Mistakes Made When Launching a Church

By Raul Rivera

Pastor Zack had been a youth pastor for many years prior to planting a church. As the current lead pastor, he was doing a great job attracting new members and preaching relevant messages to a diverse congregation. However, he had very little experience with the legal side of establishing a church, and several months ago, he called our office with a dilemma.

The IRS reviewed Pastor Zack’s personal tax return and asked him to substantiate (or prove) his housing allowance. It was shortly after this request from the IRS that Pastor Zack realized he, and his board of directors, had made some costly mistakes.

What went wrong

Pastor Zack first received compensation from his church in 2014. He thought nothing of it when the church issued him a 1099-MISC instead of Form W-2. When he completed his tax return in early 2015, he reported all the income he made at the church on a Schedule C. Schedule C is an IRS form that self-employed individuals use to report how much money they earned.

To make matters more complicated, the church reported all $74,000 of his income on the 1099-MISC in box 7 (“Nonemployee compensation”). As a result, Pastor Zack reported his housing allowance of $39,000 as a business deduction.

(Recommended reading: “3 Common Mistakes Churches Make When Paying Pastors”)

Everything seemed fine until Pastor Zack received a letter from the IRS asking him to substantiate his housing allowance. He sent a copy of all of his home expenses to the IRS, but that was not enough. At all of our conferences we teach pastors how they can maximize their housing allowance benefit.

The IRS then asked for a copy of the church board meeting minutes approving his housing allowance. Unfortunately, this was also a problem because he was unable to find them. 

The truth of the matter is that without the official board meeting minutes, the housing allowance is of no value to the pastor.

Without official board meeting minutes, the housing allowance is of no value to the pastor.

How the IRS accessed the church’s bank account

Let us go back in time a few years. When Pastor Zack started his church, he had $50.00 to his name. His vision then (as it still is today) was to win the lost, preach the Word with zeal, and teach people to obey all of God’s commands.

Although he has been faithful to the vision that God gave him, the steps he took to establish the church on its legal foundation were lacking in strategy. The following rundown of his church’s legal inception shows to you what I mean.

After selecting a name for the church, Pastor Zack opened a bank account for the church. The church did not have a tax ID number and it was not incorporated so Pastor Zack had to open the church’s bank account with his social security number. 

The church then got off to a good start, and it was doing fairly well. In fact, within 18 months the church reached almost 200 members and had a weekly average of 175 in attendance.

(Recommended reading: “How to Start a Church the Right Way”)

In 2015, when Pastor Zack was unable to substantiate his housing allowance, the IRS assessed a tax (with penalties and interest) in the amount of $9,875.00 against him. He was saddened and decided that the only way to fix the problem was to enter into a payment plan, which put him in a difficult position. About 7 months later, he began failing to make his payments. The IRS sent a letter to Pastor Zack that stated if he did not resume making payments, it would search for his assets and put liens on them.

Pastor Zack did not continue making payments. When the IRS completed a search of bank accounts for him, it found the church’s checking account with his social security number. The IRS removed over $10,000.00 from the church’s checking account.

Little mistakes can cause the greatest grief

Oftentimes it is the little mistakes that can cause the greatest grief. Scripture reminds us that it is the little foxes that ruin the vineyards (Song of Solomon 2:15). 

Let us review the mistakes that Pastor Zack’s church made, and how they could have been avoided.

Mistake #1: The church’s checking account was opened before it incorporated and received a tax ID number. Here is a rule of thumb that every pastor should follow:

Never open your church’s checking account with a social security number.

The IRS will see the bank account as a “doing business as” (DBA) of you, personally, and can access it when it comes to your personal taxes. In addition, this is an unlawful conflict of interest.

You should first incorporate your church, get a tax ID number for it, then open the church’s checking account as a corporation (using its own tax ID number). I imagine that some of you reading this are realizing that you made the same mistake as Pastor Zack. If you need assistance correcting this mistake, please give us a call at 877-494-4655.

Never open your church’s checking account with a social security number.

Mistake #2: The church issued Pastor Zack a 1099-MISC. Though many churches do so, it is not correct. The church should have issued him a Form W-2, reporting $35,000 in box 1 and $39,000.00 in box 14. 

(Recommended reading: “5 Best Practices for Church Payroll Compliance”)

Mistake #3: The housing allowance for Pastor Zack was never officially approved by the board of directors. Like many pastors, Pastor Zack mistakenly thought the housing allowance was a portion of money gifted to him to cover his housing needs. 

In actuality, the housing allowance is an exclusion of taxes. It must be approved by the board of directors and documented in board meeting minutes. At the end of the year, the pastor calculates how much of a deduction he can receive from what he earned during the year. 

“His mercies are new every morning”

Pastor Zack’s church felt an initial sting from the IRS situation; but, thankfully, it recovered. Although his church had to cancel some outreach events and postpone some needed building repairs, Pastor Zack’s prayer remained the same: “His mercies are new every morning.”

“His mercies are new every morning.”

Establishing a healthy church is not just about good sermons and a growing congregation; it also requires a solid legal foundation.

When in doubt, ask for help! Our purpose here at StartCHURCH is to guide your church in establishing a solid legal foundation. Whether your church needs to get incorporated, or you need to set up a compensation agreement and a housing allowance, we have a service for you. Give us a call at 877-494-4655 to find out more, or simply click on the link provided below.

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• “The First Thing Every Church New Hire Must Do”

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