Tricky Transactions: Constructive Receipt and Pastor’s Taxes

By Raul Rivera

Let's envision a scenario: the church pastor advises the church's board of directors to temporarily cease his salary payments to help the church weather an economic downturn. Now, picture the IRS auditing the pastor's tax return and informing him that he must still report the full amount and pay taxes on it despite the church not paying his salary. At first glance, this might seem unreasonable and unfair. However, this situation aligns with the legal definition of income, particularly when the Constructive Receipt doctrine is applied. The IRS's tax assessment against the pastor hinges on how the board secretary documented the board meeting minutes in the corporate records book. Let me provide further clarification.

Pastor of Church Defers Income

The pastor of a 200-member church faced a challenging decision. He opted to instruct the board of directors to discontinue his agreed-upon $75,000.00 annual salary. This choice arose in the context of the church's seventh year and a significant economic downturn, resulting in a higher-than-usual number of unemployed or underemployed church members. In an effort to ensure the church's survival, the pastor believed it was best to suspend his salary until the church's financial situation improved.

Despite the pastor's unwavering decision, his relationship with the board of directors remained strong. Board members attempted, albeit unsuccessfully, to dissuade him from forgoing his salary. One board member recognized the pastor's resolve and proposed a solution: suspending the pastor's salary, as he had requested, but with a condition. Under this condition, the pastor could notify the board secretary at any time when he believed the church could afford to resume paying his salary. In such cases, any unpaid salary from that year would be accrued and paid to the pastor in the future as soon as the church's financial situation permitted.

How a Good-Hearted Decision Can Have Bad Consequences

The pastor concurred with the proposal, leading to a unanimous vote by the board of directors duly recorded in the meeting minutes. The board's decision encompassed three key elements:

1. Abate the pastor’s weekly paycheck until the pastor decided it was time to start again;
2. Any amounts not received by the pastor that year would be rolled over into the next year;
3. If the church recovered enough in the future to pay it all at once, the church would immediately pay it to him at his request.

Though we can all see the nobility of the pastor in foregoing some of his income, the church’s desire to bless him by crediting back pay to his account ended up in a tax bill to the pastor because it activated the Constructive Receipt Doctrine as described in Regulation 1.451.

The Constructive Receipt Doctrine

According to Treasury Regulation 1.451-2(a), funds not physically given to a taxpayer are deemed "constructively received" in the same tax year if they have been credited to their account, set aside for them, or made accessible for withdrawal upon notice. This precise situation applies to the pastor, who, despite not physically receiving the money from the church, was still liable for taxes as if he had received it within the same year. Even though the pastor received only $35,000.00 out of the $75,000.00 owed to him, he was required to pay taxes on the entire $75,000.00.

In the legal case Harrison v. Schaffner - 312 U.S. 579 (1941), the United States Supreme Court established that an individual vested with the right to receive income cannot evade taxation if they exert control over it. This parallels the pastor's situation, as he had control over when he would receive his salary.

Four Steps to Take

Reflecting on their experience, both the pastor and the church recognized the need for a different approach to handling such situations in the future. They outlined a revised procedure to be followed if they ever had to defer the pastor's salary again:

1. During a board meeting, they would officially record the pastor's decision to cease receiving his weekly salary.
2. They would document that once the pastor relinquished his salary, he would have no control or authority over the conditions under which he would receive future salary payments.
3. They would make it clear in their records that any salary amounts foregone in the current year would not automatically carry over into subsequent years unless the board independently decided to do so in a future year.
4. These measures would be formally voted on and approved during the board meeting, and the minutes documenting these decisions would be securely stored in the corporate records book for future reference.

How to Get Right

After extensive consultations with thousands of churches regarding their compliance matters, it's evident that the vast majority are committed to maintaining a high standard of ethical conduct in this crucial aspect. Frequently, what these churches require to make this significant shift is a supportive partner who can offer guidance and resources to facilitate this transition. We at StartCHURCH are dedicated to assisting pastors and ministry leaders in precisely that manner, whether through telephone consultations or the services we offer. If you're eager to embark on the path to achieving genuine compliance, please feel free to reach out to us at 770-638-3444 or schedule a call below. We're here to help you start the journey towards full compliance.

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