Clergy Compensation
By Richard R. Hammar, J.D., LL.M., CPA
© Copyright 1991, 1998 by Church Law & Tax Report. All rights reserved. This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is provided with the understanding that the publisher is not engaged in rendering legal, accounting, or other professional service. If legal advice or other expert assistance is required, the services of a competent professional person should be sought. Church Law & Tax Report, PO Box 1098, Matthews, NC 28106. Reference Code: m24
A minister who works for a church without a written contract or with a contract which does not specify the compensation to be paid him is entitled to receive reasonable compensation for services actually performed. Where a church and its minister enter into a contract which specifies the compensation to be paid, the minister is legally entitled to receive that compensation. One court has stated: “[T]he question of liability for the salary of a minister or pastor is governed by the principles which prevail in the law of contracts, and it is generally held that a valid contract for the payment of such a salary will be enforced.”1 Thus, if a church fails to pay a minister the full compensation specified in a written contract, either because the minister is discharged before his term of office expires or because the church reduces his salary, the minister ordinarily may sue for breach of contract.
If the salary specified by contract is reduced by action of a church, the minister may immediately sue for breach of contract. But a minister who consents to a reduction in compensation will not be allowed to recover his or her losses. Thus, where a church was unable to pay its minister the full salary specified by contract because of financial difficulties, and the church and its minister mutually agreed to reduce the stated salary by nearly fifty percent, the minister could not later sue for the difference.2 And where a minister waived full payment of his compensation by acquiescing in church budgets that reduced his salary, by voting for resolutions reducing his salary, and by returning a check to his church, he could not later recover the difference.3 Similarly, the United States Tax Court has denied a charitable contribution deduction to a minister for that portion of his church salary that he voluntarily canceled.4
The civil courts generally will entertain a suit by a minister for unpaid compensation despite his church's claim that such a controversy is purely ecclesiastical. In one case, a Catholic priest sued his diocese for wrongfully withholding his salary. The diocese maintained that the civil courts could not entertain suits involving the administration of church affairs and the relationship of a church to its minister, even with respect to salary, since these are matters of purely ecclesiastical concern. The court, in deciding that it did have jurisdiction to hear the case, observed:
It was not the intent of [the First Amendment] and it has been so held in many cases, that civil and property rights should be unenforceable in the civil courts simply because the parties involved might be the church and members, officers, or the ministry of the church. It was not intended as a shield to payment of a just debt when the purpose of the First Amendment is not being violated. Ministers have been awarded their salary in suits against the church.5
However, the courts also have ruled that they have no authority to review claims by clergy that their compensation is too low. To illustrate, a federal appeals court refused to resolve a lawsuit by Catholic priests who taught at a Catholic university and who claimed that the university's salary scale discriminated against them.6 The court observed that “the salary scale for priests in a church--related institution clearly appears to be an internal matter of the religious institution affected. In other contexts, courts have traditionally refused to become involved in the resolution of internal religious questions.”
Compensation paid to a minister must be in the amounts authorized by appropriate action. If a church authorizes a specified salary, and the church treasurer pays the minister an amount in excess of the authorized salary, the minister will have to account for the difference.7
Where a minister receives money directly from church members, it has been held that such monies are gifts and not compensation, and accordingly the church's obligation to pay a stated salary is not diminished by the amount of such gifts.1
It has been held that a minister's salary takes priority over unusual church expenses, but not necessarily over customary church expenses, such as maintenance, insurance, and repairs.2 And where a minister sued the trustees of an unincorporated church to recover an unpaid salary, one court held that such a suit must be dismissed since the trustees could not be personally liable.3
Ministers should scrupulously avoid any diversion of church funds to their own personal benefit in excess of their agreed upon compensation. Ministers should also avoid “commingling” their own funds with church assets. Diversions of church funds by clergy to their personal benefit have resulted in (1) a charge of embezzlement and fraudulent conversion;4 (2) a tax fraud conviction for failure to report interest earned on an alleged “church account” that was used essentially for a minister's personal benefit;5 and (3) the placing of a church in receivership by order of a state attorney general to prevent further diversion of church funds.6
Finally, it is important to note that one of the conditions a church must meet in order to obtain and retain its federal income tax exemption is that no part of its net earnings “inures to the benefit of any private . . . individual.”7 The courts have uniformly held that although payment of “reasonable compensation” by a tax--exempt organization to its employees does not constitute the inurement of net earnings to the benefit of a private individual, the payment of unreasonably high salaries does.8
Unfortunately, there is very little guidance currently available to help in determining how much income is “reasonable” and therefore appropriate. Neither Congress nor the IRS has seriously attempted to define the term. Accordingly, the few court rulings that have attempted to clarify the meaning of “unreasonable compensation” are significant. In one case, a small church was denied tax--exempt status on the ground that an excessive and unreasonable amount of its net earnings was paid to its pastor.9 One federal appeals court concluded that combined annual income of $115,680 paid by a religious organization to its founder and his wife was not excessive.10
The ruling of the bankruptcy court in the PTL case11 sheds further light on the meaning of “unreasonable compensation.” The bankruptcy court found that Jim Bakker's total compensation for 1984--1987 amounted to more than $7.3 million, and that much of this was in the form of “bonuses” and fringe benefits. To illustrate, Bakker's stated salary for the years in question was $228,500 in 1984, $291,500 in 1985, $265,000 in 1986, and $265,000 in 1987. However, the total amount of compensation and benefits attributable to Bakker for the same years was $1.2 million in 1984, $1.6 million in 1985, $1.9 million in 1986, and $2.7 million in 1987. IRS computations, on which the court placed great reliance, were substantially similar.
The PTL bankruptcy court concluded that all of the following items were properly included in the income of Jim Bakker: (1) salary; (2) “bonuses” (note that the court found that bonuses were “almost unheard of in the religious field”); (3) personal use of a PTL vehicle (e.g., the corporate jet); (4) PTL contributions to Bakker's retirement fund; (5) utilities paid by PTL on Bakker's parsonage “notwithstanding the fact that Jim Bakker also received a housing allowance during the entire period of not less than $2,000 per month”; (5) Bakker's housing allowance of $2,000 per month (since he lived in a PTL--owned “parsonage” rent--free); (6) numerous expenditures from the PTL general checking account for the use and benefit of Bakker for which there was not sufficient documentation to justify their classification as a business expense; (7) charges made on PTL credit cards on Bakker's behalf for which there was not sufficient documentation to justify their classification as business expenses; and (8) cash advances to Bakker that had been “written off” by PTL. The court observed that “the philosophy of the Bakker regime was exemplified in the statement of two witnesses for Jim Bakker. One witness indicated that a fair compensation for Jim Bakker was $6.4 million per year. The other witness testified that, according to the Bible, Bakker should get at least 10 percent of the income which would run in the neighborhood of $10 million.” The court found that such amounts “defy common sense and rational judgment.”
The bankruptcy court ruled that reasonable compensation for Jim Bakker would have been $133,100 in 1984, $146,410 in 1985, $161,051 in 1986, and $177,156 in 1987. These are the same figures computed by the IRS, and the court openly expressed its reliance upon the IRS data. The bankruptcy court computed what would have been reasonable compensation for Bakker as part of its effort to determine the amount of excess or unreasonable compensation that could be collected by the bankruptcy trustee. The IRS computations were made to determine whether PTL had lost its tax--exempt status as a result of paying unreasonable compensation to Bakker. It is interesting to review the considerations that influenced the court's determination of reasonable compensation. In answering this question, the court noted that “the highest paid head of a government agency in the State of South Carolina with a salary approved by the legislature is the president of the University of South Carolina who, for the years in question, had a salary under $100,000.” The court also referred to the testimony of “expert witnesses” who had testified that normal salary of the highest compensated clergy “would run from $75,000 to $120,000,” and that “bonuses were almost unheard of in the religious field, although fringe benefits would amount to about 30 percent of the salary.”
In responding to the view of one of Bakker's witnesses that the Bible mandates that a minister should get 10 percent of all donations and a “high priest” should receive 20 percent, the court commented that such a view “defies common sense and rational judgment.”
In light of the PTL case, clergy compensation in excess of $100,000 should be carefully reviewed to determine its reasonableness. Churches that are considering paying a minister total annual compensation of more than $100,000 should seriously consider obtaining a tax attorney's written opinion that the amount of compensation contemplated does not constitute “unreasonable compensation.” In making such a determination, it is important to include all components of compensation (e.g., salary, bonuses, canceled debts, personal expenses paid by the church either by check or credit card, personal use of church vehicles). The effect of an IRS determination that clergy compensation is unreasonable is severe—possible revocation of tax--exempt status.
It is likely that the IRS will use some form of comparability test in determining whether or not clergy compensation is reasonable—comparing a minister's compensation to compensation ordinarily paid to ministers of other similarly--sized congregations in the same geographical region. Comparisons with salaries made by executives in similarly--sized business corporations are inappropriate, since such executives are paid out of earnings generated from the sale of goods or services whereas church leaders are compensated out of contributions made by donors who gave with the expectation that their contributions would be used for religious or charitable purposes.
Unreasonable compensation sometimes is associated with payment of clergy compensation based on a percentage of church income. For example, a small church with annual income of $20,000 agrees to pay its minister “one--half” of the church's annual compensation. This amount is certainly reasonable. However, assume that within a few years the church experiences substantial growth and its annual income increases to $500,000. If the church has not changed its method of paying its minister (i.e., the minister now receives annual compensation of $250,000), the IRS would almost certainly conclude that this amounts to unreasonable compensation. Remember, the consequences to the church of paying a minister unreasonable compensation are catastrophic—potential loss of the church's tax--exempt status and all the benefits associated with such status.
For related information on this topic see the following articles: