Money Matters

Church tax explained: What is religious tax exemption?

Churches benefit from significant tax exemptions that allow them to dedicate more resources to their missions. However, tax-exempt status doesn’t mean churches never pay taxes. Understanding church tax rules can help you stay compliant, avoid surprises, and manage your finances with confidence.

February 3, 202611 min read Share

Religious organizations occupy a unique position in the American tax system.

Churches generally operate tax-free under federal law, but this exemption comes with specific requirements and limitations.  

Understanding when churches are required to pay taxes, what religious tax exemptions are available, and how to maintain compliance can help your faith-based organizations manage its finances while fulfilling its missions. 

Here’s what we’ll cover:

Do churches pay taxes? 

The short answer is yes and no.

Churches automatically qualify for tax-exempt status under Internal Revenue Code Section 501(c)(3), without needing to file an application with the IRS.

As such, churches don’t pay federal income tax on donations, tithes, and income directly related to their religious mission.

This religious tax exemption recognizes the constitutional separation of church and state while acknowledging the public benefit religious organizations provide. 

That said, the tax exemption has boundaries. Your church still has to pay taxes on certain types of income unrelated to its religious purpose, and it must withhold and pay employment taxes for your staff members.

The exemption protects religious activities while ensuring churches don’t gain unfair advantages in commercial ventures. 

Why are churches tax-exempt? 

Religious tax exemption in the United States rests on constitutional, historical, and policy foundations that predate the modern tax system. 

The First Amendment’s establishment and free exercise clauses create the legal framework for church tax exemptions.

In the 1970 Supreme Court case Walz v. Tax Commission, the court ruled that tax exemptions for religious organizations don’t violate the establishment clause.

The court reasoned that exemptions promote “a benevolent neutrality” toward religion, allowing churches to exist without government sponsorship or interference. Taxing churches could create excessive government entanglement in religious affairs. 

Since colonial times, American jurisdictions have granted churches exemptions from taxation.

All 50 states and the District of Columbia now provide property tax exemptions for religious organizations, though specific requirements vary by jurisdiction. This historical tradition reflects societal recognition of the distinct role churches play in communities. 

Churches automatically receive 501(c)(3) tax-exempt status when they meet IRS requirements, without filing an application.

According to IRS Publication 1828, churches must operate exclusively for religious purposes, with no part of their net earnings benefiting private individuals. Donations to qualifying churches are tax-deductible for donors. 

The exemption applies to federal income tax, and most churches also qualify for state and local tax exemptions, though requirements can vary.

Many churches choose to apply for formal IRS recognition, despite being automatically exempt, as a determination letter provides donors with confidence and simplifies compliance with state and local regulations. 

What taxes do churches pay? 

While churches enjoy broad tax exemptions, certain activities do trigger tax obligations for your religious organization.

Understanding these situations helps you maintain compliance and avoid unexpected liabilities. 

1. Rental income 

If your church rents facilities to outside organizations, you may owe taxes depending on how the property is used.

Rental income from real property typically qualifies for tax-exemption. However, debt-financed property creates taxable income.

If your church mortgages property and rents it out, a portion of that rental income becomes subject to Unrelated Business Income Tax (UBIT). 

For example, a church that owns its parking lot and rents spaces to members during services generates tax-exempt income. But if that same church regularly rents parking to the general public on weekdays, especially if the lot carries a mortgage, the income likely qualifies as taxable unrelated business income.

The key distinction lies in whether the activity relates to your church’s exempt purpose and whether debt finances the property. 

2. Sales of goods or services 

If your church that sell goods or services you may face tax obligations when these activities become regular commercial operations unrelated to your religious mission.

Occasional fundraising events, such as bake sales or holiday bazaars, typically avoid taxation, especially when volunteers provide the labor.

However, operating a bookstore open to the public year-round or running a coffee shop as a regular business triggers UBIT requirements. 

The IRS distinguishes between fundraising and commercial activity.

A church fellowship dinner where attendees make donations remains tax-exempt. A church-run café serving the public daily with paid staff crosses into taxable territory.

Using proceeds to fund ministry doesn’t exempt the income—the activity itself must substantially relate to the church’s religious purpose. 

3. Employment taxes for staff 

Churches must withhold and pay employment taxes for staff members. This includes: 

• Federal income tax withholding: Not mandatory but can be withheld if employees request it. 

• Social Security and Medicare taxes (FICA): Required for non-clergy employees; churches pay the employer portion and withhold the employee portion. 

• Federal and state unemployment taxes: Generally apply to church employees.

• State and local payroll taxes: Requirements vary by jurisdiction.

Clergy members receive special tax treatment. While employed by churches for income tax purposes, ministers are considered self-employed for Social Security and Medicare taxes.

Churches cannot withhold FICA taxes from clergy compensation. Instead, ministers pay self-employment tax on their total ministerial income, including salary and housing allowances. 

How does unrelated business income tax apply? 

UBIT prevents tax-exempt organizations from competing unfairly with taxable businesses.

Your church can engage in income-producing activities outside of its exempt purpose; however, net income from substantial unrelated activities is subject to taxation. 

UBIT serves as a safeguard to ensure that churches don’t exploit their tax-exempt status for commercial advantage.

The tax applies only to specific types of income while preserving broad exemptions for religious activities. 

What counts as unrelated business income? 

The IRS uses a three-part test to determine whether income qualifies as unrelated business income requiring tax payment: 

• Trade or business: The activity involves selling goods or providing services to generate income. 

• Regularly carried on: The activity occurs with frequency and continuity similar to commercial operations. 

• Not substantially related: The activity doesn’t contribute significantly to the organization’s exempt purpose. 

For example, if your church occasionally sells donated items at an annual yard sale, this likely avoids UBIT because the activity isn’t regularly carried on and volunteers provide the labor.

However, say your church is operating a commercial printing business that is open year-round. This would face UBIT obligations, even if the profits are used to fund ministry programs.  

Common examples where UBIT applies 

Churches encounter UBIT in various situations: 

• Advertising sales: Selling advertising space in church bulletins, publications, or websites to outside businesses. 

• Commercial parking operations: Charging the general public to use church parking lots when not related to worship attendance. 

• Bookstore sales: Operating retail bookstores selling general merchandise beyond religious materials.

• Facility rentals to businesses: Receiving regular rental income from commercial tenants, especially if the property carries debt. 

• Gaming activities: Offering pull tabs, raffles, and other gaming beyond traditional bingo games (which may qualify for exemption under specific conditions).

If your church earns $1,000 or more in gross income from unrelated business activities, you must file Form 990-T and pay applicable taxes.

Occasional fundraising events with volunteer labor generally remain exempt, providing some flexibility for periodic income-generation activities. 

Do churches pay property taxes? 

Churches generally don’t pay property taxes on facilities used for worship and related religious activities.

All 50 states offer property tax exemptions for religious organizations, though specific requirements and procedures vary significantly by jurisdiction. 

Property tax exemptions recognize churches’ nonprofit status and societal contributions while avoiding constitutional entanglement issues.

Exemptions only apply to property actively used for exempt purposes though. 

Situations where property tax might apply 

Your church may owe property taxes in several circumstances: 

• Commercial use of property: Space regularly rented to businesses or used for commercial purposes may lose its exemption. 

• Unused or vacant property: Land held for future expansion without current religious use might face taxation. 

• Parsonages rented to non-clergy: Church-owned housing rented to individuals outside of the ministry may be taxable. 

• Income-producing property: Real estate acquired for investment rather than religious purposes typically doesn’t qualify for exemption. 

For example, a church building housing sanctuaries, classrooms for religious education, and administrative offices enjoys full exemption.

But if that church rents a portion of its building to a day-care center operating as a separate business, the rented portion may become taxable depending on state law.

Some states exempt incidental commercial use if it supports the church’s mission; others take a stricter view. 

Local regulations and exemptions 

Property tax administration occurs at the state and local level, creating significant variation across jurisdictions: 

• Application requirements: Many states require churches to file initial exemption applications and periodic renewals. 

• Use restrictions: States define qualifying religious use differently, affecting what property remains exempt. 

• Documentation needs: Churches must maintain records proving that property use aligns with religious purposes. 

• Filing deadlines: Missing renewal deadlines can result in unexpected tax bills. 

Your church should consult your state’s department of revenue and local tax assessor to understand your specific requirements.

Maintaining detailed records of property use helps support exemption claims during audits or appeals. Professional legal or tax advice becomes valuable when questions arise about complex property situations. 

Disclaimer: Property tax laws vary significantly by state and locality. Your church leaders should consult with qualified tax professionals or legal counsel familiar with your jurisdiction’s specific requirements. 

What is the role of IRS church tax-exempt status? 

Churches enjoy several unique benefits and responsibilities under IRS rules that distinguish them from other tax-exempt organizations.

Key aspects of IRS church tax-exempt status include: 

• Automatic exemption: Churches don’t need to apply for 501(c)(3) status or receive IRS approval to qualify for exemption. 

• Donation deductibility: Donors can claim charitable deductions for contributions to churches with or without formal IRS recognition. 

• Limited IRS oversight: Special rules restrict IRS authority to audit churches, requiring high-level approval and substantial evidence before initiating examinations. 

• Annual reporting: Unlike other 501(c)(3) organizations, churches aren’t required to file annual Form 990 information returns. 

The IRS defines “church” using multiple factors rather than a rigid test. Characteristics include having a recognized creed and form of worship, an established congregation, regular religious services, ordained clergy, and ecclesiastical governance.

Religious organizations that don’t qualify as churches under IRS criteria must apply for 501(c)(3) status to receive exemption. 

How does church tax-exempt status affect day-to-day operations? 

Religious tax exemption influences how churches manage their finances, structure their activities, and maintain compliance with tax regulations. 

Budgeting for religious organizations 

Your church finance team must account for tax obligations in specific areas: 

• Employment taxes: Budget for the employer’s share of Social Security, Medicare, and unemployment taxes for non-clergy employees. While clergy handle their own self-employment taxes, churches may offer SECA (Self-Employment Contributions Act) allowances as taxable compensation to offset ministers’ increased tax burden. 

• Potential UBIT exposure: Churches engaging in unrelated business activities should set aside funds for quarterly estimated tax payments if gross income from these activities exceeds $1,000. Tracking income by activity helps identify UBIT obligations early. 

• State and local variations: Property taxes, sales taxes, and other state-level obligations vary by jurisdiction. Churches operating across multiple locations must understand the requirements in each area. 

• Cash flow management: Separating restricted donations from general funds and tracking designated gifts ensures proper fund accounting. Maintaining distinct accounts for unrelated business income simplifies tax reporting and protects against commingling issues. 

Reporting obligations and record keeping 

Your church must maintain comprehensive records supporting your tax-exempt status to mitigate risk: 

• Donation records: Document all contributions, issue acknowledgment letters for donations over $250, and maintain substantiation for non-cash gifts. Proper donation records protect both your church and its donors. 

• Employment records: Keep W-2 forms for your employees, 1099 forms for contractors, payroll tax returns, and documentation supporting clergy housing allowances. Accurate employment records are essential during audits. 

• Financial statements: Prepare regular financial reports showing your church income, expenses, and fund balances. Transparent financial statements build donor trust and demonstrate faithful stewardship. 

• Meeting minutes: Record your board meetings, significant decisions, and approval of housing allowances, budgets, and major contracts. Minutes provide evidence of proper governance and decision-making processes. 

• UBIT documentation: Track your income and expenses from unrelated business activities separately. Maintain records that show why certain income qualifies for exemption or requires taxation. 

Churches operating with integrity and transparency build credibility with donors, regulatory authorities, and the communities they serve.

Strong financial management practices help protect your organization while enabling ministry effectiveness. 

Disclaimer: Tax regulations are complex and change over time. Your church should consult with qualified tax professionals or legal counsel to ensure compliance with current requirements applicable to your specific situation. 

Final thoughts 

While federal income tax exemption applies automatically to qualifying churches, understanding situations where taxes do apply—including employment taxes, property taxes, and unrelated business income tax—will help you maintain compliance and avoid unexpected issues.  

Tracking these obligations with specialized church accounting software streamlines financial management for religious organizations.

Cloud-based platforms, like Sage Intacct, are designed for churches and faith-based nonprofits, providing the tools to help churches maintain accurate records, ensure regulatory compliance, and support transparent stewardship of resources entrusted to their care. 

Frequently asked questions about church tax 

Does my church need a 501(c)(3) to be tax-exempt? 

No, churches meeting IRS requirements automatically qualify for 501(c)(3) tax-exempt status without filing an application. 

According to IRS regulations, churches don’t need a determination letter to operate as tax-exempt organizations or to allow donors to claim charitable deductions.

However, many churches voluntarily apply for formal recognition because it provides donors confidence, simplifies state tax exemption applications, and offers protection if the church’s status is ever questioned. 

Do pastors pay taxes on their income? 

Yes, pastors pay income taxes on their compensation from churches.

Ministers have dual tax status under IRS rules. For federal income tax purposes, most pastors are employees of their churches.

For Social Security and Medicare taxes, ministers are treated as self-employed and must pay self-employment tax on their ministerial income, including salary and housing allowances. 

Churches cannot withhold FICA taxes from clergy compensation.

Pastors typically make quarterly estimated tax payments to cover both income and self-employment tax obligations unless they arrange voluntary withholding agreements with their churches. 

Are synagogues and mosques tax-exempt? 

Yes, synagogues, mosques, and all houses of worship receive the same tax-exempt treatment under federal law.

The IRS applies Section 501(c)(3) requirements uniformly to religious organizations regardless of denomination or faith tradition.  

All religious organizations organized and operated exclusively for religious purposes qualify for automatic tax exemption.

State and local property tax exemptions similarly extend to houses of worship across all faiths, though specific application procedures and documentation requirements vary by jurisdiction.