Step 7: What's Taxable
This is the most crucial step and is the one step that is often missed in properly reporting compensation. There is some frustration within the IRS that the only taxable compensation reported is the compensation that physically flows through an organization's payroll system. There is a tendency to ignore all the benefits and cash that do not flow through the payroll system. The result is that income has a tendency to be underreported. When an organization fails in its duty to properly report taxable income, it places its employees in serious jeopardy of potential penalties, additional taxes and even jail time.
Basic Rule
Each element of the compensation package has to be evaluated to see if it is taxable. Remember, that everything is taxable until a provision in the Internal Revenue Code says that it is not. Therefore, it should be presumed that something is taxable until it can be proven that it is not taxable.
Remember, when determining taxability, it must be determined for purposes of federal income tax, social security tax (FICA) and Medicare tax, if the compensation is for a nonminister employee. If for a minister, then the employer is only concerned about the taxability for purposes of federal income tax.
Making Determinations by Comparison
One of the biggest dangers in this area is making the determination based on what someone else is doing. You know how the story goes, Minister Joe goes to breakfast with all the other area ministers and returns with the information that over at First Church, Minister Steve has full childcare at their facilities and doesn't pay any tax on that benefit. Based on this information, Minister Joe now requests that he be able to place his children in the church daycare center free of charge and the value of the benefit should not be taxable to him.
Cautions:
- get the correct facts; i.e., does Minister Steve know what is really taxable to him;
- don't assume that First Church is doing things correctly; i.e., it is possible for large and well established churches or organizations to not do things correctly; and
- look to see how First Church could be providing such a benefit tax free and then pursue that avenue.
There are many areas of the tax law that provide for tax free treatment of various fringe benefits. However, almost all of them require certain actions taken by the employer to achieve this preferential status. In the example above, First Church may have instituted a qualified dependent care plan. Such a plan, when it meets a series of qualifications, provides for tax free dependent care. Without meeting all the requirements, the benefit would be taxable to the emloyee.
Common Benefits Virtually Always Taxable
Cash - In any form, cash is virtually always taxable. This includes anniversary/birthday gifts; love offerings; flat allowances; and gift cards.
Autos - Outside of a documented reimbursement at the standard mileage rate, any other benefit connected to an auto has a taxable component. If the organization is actually providing the auto, there is always a taxable component. These rules have been around since 1984.
Housing - Housing provided to employees who are not ministers is more likely than not taxable. There are some exclusions, and they should be carefully considered. If the employee is a minister, it is taxable unless it is specifically designated, in writing and in advance of payment, that it is provided under IRC Section 107 as a housing allowance or a parsonage.
Common Benefits that Normally Require Written Plans and Nondiscrimination Requirements
Life Insurance
Dependent Care
Tuition Assistance
Tuition Reduction
Payment of Out of Pocket Medical Costs
Retirement Plan Contributions (there are some exceptions for churches)
Summary
The above discussion is not an exhaustive study of potential taxable income. This is the step in compensation planning that is generally left to the organization's bookkeeper, internal accountant and/or payroll service. Therefore, it is greatly beneficial for the organization to build a relationship with a trusted tax professional that will provide a resource to assist personnel with these determinations.
