Should your church loan your Pastor (or anyone for that matter) money?
This is an interesting topic. Churches as a whole are generous and want to help out their ministers. Especially if they have been without a Pastor for a long time and they have finally found THE ONE! They are uber-excited and can't wait for him to start. The problem is, the current house hasn't sold and they don't have the money for the down payment for their new house in the new area and they have found the PERFECT home for them and time is running out! So, of course, the church wants to help the new Pastor out, so they offer to loan the Pastor the money for the down payment. Is this a good idea and wise stewardship?
Updated 12.13.24
A church, as a tax-exempt 501(c)(3) organization, must be cautious when loaning money to key employees such as a pastor to ensure compliance with IRS regulations.
The IRS gives clear guidance on this subject. Let's dig in and see what they have to say.
First, let's look at Section 4958 of the IRC that addresses Excess Benefit Transactions.
By definition, an excess benefit transaction (EBT) occurs when an economic benefit provided by a tax-exempt organization (your church) to a disqualified person (your pastor), exceeds the value of the consideration received in return.
A disqualified person is someone who is in a position to exercise substantial influence over the affairs of the church at any time during the five-year period ending on on the date of the transaction. Once the individual accepts the pastoral position, they exercise substantial influence over the church and then become a disqualified person in the eyes of the IRS.
Here is a simple example of an EBT: If a church loans $100,000 to a pastor to buy a house, but the pastor only pays back $80,000, the $20,000 difference is considered an excess benefit.
Now, what happens if the church provides an EBT to the pastor? BOTH the church AND the pastor are subject to significant taxes.
A tax equal to 25% of the excess benefit is imposed on the disqualified person (the pastor). Additionally, a 10% tax is imposed on ANY organization manager who knowingly participated in the transaction.
An additional tax can also be imposed on the pastor if the EBT is not corrected within the taxable period - that tax can equal 200% of the excess benefit.
Look at how this works:
In the given scenario, the church loans $100,000 to a pastor, and the pastor only repays $80,000, resulting in a $20,000 excess benefit. According to § 4958 of the Internal Revenue Code, the additional tax of 200% on the excess benefit is calculated as follows for the pastor:
Identify the Excess Benefit:
Loan amount: $100,000
Amount repaid: $80,000
Excess benefit: $100,000 - $80,000 = $20,000
Calculate the Initial Tax:
The initial tax on the disqualified person (the pastor) is 25% of the excess benefit.
Initial tax = 25% of $20,000 = $5,000
Calculate the Additional Tax:
If the excess benefit is not corrected within the taxable period, an additional tax of 200% of the excess benefit is imposed.
Additional tax = 200% of $20,000 = $40,000
Total Tax Liability:
The total tax liability includes both the initial tax and the additional tax.
Total tax liability = Initial tax + Additional tax
Total tax liability = $5,000 + $40,000 = $45,000
Therefore, the detailed calculation for the additional tax of 200% on the $20,000 excess benefit is as follows:
Excess Benefit: $20,000
Initial Tax (25%): $5,000
Additional Tax (200%): $40,000
Total Tax Liability: $45,000
Now lets take a look at how this would impact the board members who approved this loan to the pastor:
Initial Tax on the Organization Managers (Board Members):
Any organization manager (board member) who knowingly participated in the excess benefit transaction is liable for a tax of 10% of the excess benefit, unless the participation was not willful and was due to reasonable cause.
Excess Benefit: $20,000
Initial Tax: 10% of $20,000 = $2,000 per participating board member.
As you can see, this can be very costly to both the pastor AND the board members.
You may say, but we trust the pastor. This won't ever be an issue. People are surprised every day folks. Why on earth would you put yourself in a position like this for anyone. Think about it -- if your pastor (or the candidate you are choosing to be your new pastor) cannot get a home loan on their own, do you really want them in charge of your church? Also, they can always rent!
Next, let's look at Private Inurement and how that plays into this scenario.
The IRC specifically states "No part of the net earnings of which inures to the benefit of any private shareholder or individual" which means that the organization cannot be for the benefit of private interests such as the pastor, the pastor's family, board members, or any other personal controlled by such private interest. In laymen's terms, the decision makers (and their families) of the church are included in this category.
Loaning money to a pastor to buy a home can be considered private inurement if the following occurs:
the loan provides a benefit that is not available to others such as the general public or other employees
the loan is not on terms that are at least favorable or comparable to those offered by commercial lenders
What does this mean?
The church would have to make loans available to others who ask AND the terms would have to be comparable to other banks. The applicants would need to file an application, pass a credit and background check, agree to repayment terms and sign official loan papers just like they would from a commercial lender to qualify to receive a loan from your church.
Seriously, does your church exist to spread the Gospel or to lend money? If your answer is the latter, then you likely are in danger of losing your tax-exempt status as a religious organization. Just sayin.
Now, if you are dead-set of loaning money, here are the requirements you must meet.
Treasury Regulation 1.782-5T (temporary) addresses this topic. I won't bore you with all the legal jargon, but I will put here what I feel will be the most beneficial parts to you. If you enjoy reading Tax Code have at it!
Employee-relocation loans -
(i) Mortgage loans. In the case of a compensation-related loan to an employee, where such loan is secured by a mortgage on the new principal residence (within the meaning of section 217 and the regulations thereunder) of the employee, acquired in connection with the transfer of that employee to a new principal place of work (which meets the requirements in section 217(c) and the regulations thereunder), the loan will be exempt from section 7872 if the following conditions are satisfied:
(A) The loan is a demand loan or is a term loan the benefits of the interest arrangements of which are not transferable by the employee and are conditioned on the future performance of substantial services by the employee;
(B) The employee certifies to the employer that the employee reasonably expects to be entitled to and will itemize deductions for each year the loan is outstanding; and
(C) The loan agreement requires that the loan proceeds be used only to purchase the new principal residence of the employee.
Treasury Regulation 1.7872-5T(c)(1) (underlining added by me for emphasis)
So let's say that Pastor Joe gets a job offer in KY and he currently lives in Texas. His new position begins December 1st, and it's already November 15th and his current house still hasn't sold. The perfect house came on the market today and it's the PERFECT home for Joe and his growing family. Since he hasn't sold his current home yet, his family doesn't have the funds for the down payment. The church sympathizes with the situation and doesn't want the Pastor and his family to miss out on the house, so they decide that since the funds were available in the church savings account, to loan Pastor Joe the $50,000 needed for the down payment at either zero percent interest or another below market rate. What does the church AND the Pastor need to do to make sure they qualify for the Employee Relocation Loan exemption described above?
The Pastor needs to sign a promissory note to the church for the $50,000 loaned to him that is secured by the mortgage on the new home.
Specific terms need to be in the agreement as follows:
a. The loan agreement is NOT transferrable by the Pastor
b. The loan agreement is contingent upon the Pastor's continued employment and substantial services to the loaning church
c. The Pastor must certify that they qualify for and intend to Itemize their deductions on their annual Form 1040 filing instead of taking the Standard Deduction
d. The Pastor agrees that the loan proceeds will be used ONLY for the purchase of a new principal residence (no vacation home Pastor Joe ;-) )
If the above terms are not met, and the church loans the Pastor funds for a down payment, then the funds are considered TAXABLE INCOME to the Minister. The church AND possibly members of the church board who approved the loan may also be subject to sanctions and excise taxes from the IRS if they do not properly report the loan on the minister's W-2 as taxable income.
As you can see, EVERYTHING to do with church finances and especially clergy compensation has some type of tax affect. Please always seek out sound tax advice before making decisions that could put your ministers and/or your church at risk from penalties from the IRS.
My suggestion, have your pastor get a commercial loan, rent a home, or the church can provide a parsonage. Don't risk your churches tax-exempt status. There's too much work to be done this side of heaven.
Until next time....
Keep representing Him well.
Michelle R Brown, EA