The unedited version of this article first appeared in Church Finance Today, a monthly newsletter for church administrators and treasurers. For subscription information visit ChurchLawToday.com/newsletters.php.
Churches can enjoy the leadership and success of pastors for decades, but at the end of that pastor’s career when he or she is feeling ready to retire, the boards of those churches can often be put into a precarious position—how does a board objectively decide how to correctly compensate a person who has been with them for years and years, without breaking the bank or leaving their friend out to dry? This situation is particularly tricky because you’re potentially deciding the entire future of a friend you’ve known for years.
The important thing to realize is that churches aren’t like a for-profit business. If they’re forced to cover too many costs, often times they won’t have the revenue to support it. The pastor should have realized this a long time ago too. If they allow themselves to become completely dependent on their church to support them by the time they retire, then it isn’t the churches responsibility to suffer for those choices.
What if you can’t support a pastor’s retirement, but they are still pressuring the board to provide an unrealistic compensation package? Often times retiring pastors will cite the fact they hold the title pastor emeritus, which “legally binds” churches to provide a proper retirement package.
In reality, pastor emeritus is an ambiguous status in many cases, due to a lack of any definition in a church’s governing document, or bylaws. If a church’s bylaws don’t address this status, then the status has no legal authority. If you do have a compensation agreement for a retiring pastor, then these agreements are legitimate, as long as the requirements are satisfied. However, keep in mind that an agreement adopted by the church board can be legally unenforceable if the board lacked the authority (under the church’s governing document) to enter into the agreement.
If the church’s bylaws authorize the board to approve a compensation agreement with a pastor, then there are two duties that must be discharged by the board members. The first is the fiduciary duty of “reasonable care,” which requires board members to exercise prudence, care, and independence in fulfilling their duties. This requires the full and objective consideration of any compensation arrangement with a retiring pastor.
A second fiduciary duty is the duty of loyalty. This duty, which is recognized by the nonprofit corporation laws of most states, requires board members to place the corporation’s interests above their own. This means that board members (such as the senior pastor) who will personally benefit from a particular board decision should recuse themselves from the discussion and take no part in the vote. Further, the duty of loyalty requires full disclosure of all the terms and conditions of a particular action, and that a board-approved action that personally benefits a particular member must be “fair” to the organization.
Some compensation agreements may become burdensome to the church later on. Because of this, these agreements should contain language that gives the church the ability to modify or terminate its obligations. It’s essential that a church comply with the tax-reporting requirements associated with these compensation packages. Any compensation a church provides to a retired pastor, including pastors who are given the status of pastor emeritus, is taxable and must be reported to the IRS. The notion that it’s a nontaxable “love gift” is common, but wrong. The only exceptions would be compensation that is entirely and reasonably designated as a housing allowance (check out our post on housing allowances), compensation that is deferred to a pastor’s tax-sheltered retirement plan, or compensation deferred to a rabbi trust. Each of these exceptions involves several technical conditions that will not be present in many cases.
Failing to report taxable compensation to the IRS will convert the compensation into an “excess benefit transaction” under section 4958 of the tax code. This could result in substantial excise taxes (called “intermediate sanctions) of up to 225 percent of the amount that the IRS determines to be excessive compensation. If a compensation agreement provides for the payment of compensation in future years, it may constitute a non-qualified deferred compensation plan subject to strict new requirements under section 409A of the federal tax code. A failure to comply with these requirements can result in substantial penalties.
If a pastor emeritus remains employed by the church in some capacity, then several additional issues are implicated, including workers compensation and fringe benefits. Any agreement approved by the church board or congregation that recognizes a pastor emeritus should address the issue of continuation of benefits to a surviving spouse. Legal counsel should review any agreement pertaining to a retiring pastor before it is executed.
Hopefully, this information will be of use to you when deciding how to properly compensate a retiring pastor. It isn’t an easy decision, but it is an inevitable one, and if you feel as though personal feelings will get in the way, you can always recuse yourself.
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