Basic Tax Issues For Ministers And Churches
For more information on these and other tax issues, contact William Maxwell, e-mail email@example.com or 615-371-2024.
The housing allowance exclusion is usually the most important tax benefit available to ministers. Unfortunately, many ministers and church leaders do not understand the basic rules about the housing allowance. Some ministers, therefore, do not get the full advantage of a housing allowance. Others may be underpaying their federal taxes.
What is a housing allowance?
When reporting income for federal income tax purposes, ministers can exclude the part of their income that is designated by their church as a housing allowance. The amount designated as a housing allowance must be used to provide housing for the minister. There are limits on the amount the minister can exclude. If a minister lives in a parsonage provided by the church, the minister does not have to report the value of the parsonage as income.
The housing allowance is an exclusion from income permitted by Section 107 of the Internal Revenue Code. It is not a deduction. In other words, a housing allowance is money that is not reported as income. A housing allowance is never deducted because it is never reported as income in the first place.
Does a minister have to pay Social Security taxes on the amount excluded from income as a housing allowance?
Yes. Ministers must pay Social Security taxes (SECA) on the amount excluded from income as a housing allowance. A housing allowance is free from income taxes but not from SECA taxes.
How much income can ministers who own their own homes exclude through a housing allowance?
Ministers who own their homes can exclude the lowest of the following three amounts:
The amount designated by their church;
Actual housing expenses (including mortgage payments, utilities, property taxes, insurance, furnishings, repairs and improvements);
The annual fair rental value of the home (furnished, including utilities).
Can ministers who live in a parsonage have a housing allowance?
Yes. Ministers who live in a parsonage can have a housing allowance if they pay for utilities, furnishings, or other items required to maintain a home. Churches should designate a housing allowance so ministers can exclude from income the amounts required to pay for these expenses.
Can Bivocational ministers have a housing allowance?
Yes. Bivocational ministers can have a housing allowance, but only from their ministerial income. Secular employers cannot designate tax-free housing allowances for clergy.
What kinds of expenses can ministers count when calculating a housing allowance?
Ministers can count the following expenses when calculating a housing allowance: mortgage payments (principal and interest); rent payments; real estate taxes; property insurance; utilities (gas, electricity, water, sewer, garbage pickup, local telephone service); appliances and furniture (purchase or rental price plus repairs); remodeling expenses; homeowners’ dues; and pest control. Remember, however, that there are limits on a tax-free housing allowance.
Can ministers have a housing allowance for more than one home at a time (a primary residence and a vacation home)?
No. For housing allowance purposes, ministers can only include expenses for a primary residence.
Should a church report the value of a housing allowance on a minister’s Form W-2?
No. The housing allowance should not be reported on a minister’s Form W-2.
How does a church designate a housing allowance for a minister?
Churches should designate a housing allowance in writing before the beginning of a calendar year. Although the Internal Revenue Service (IRS) has recognized oral designations, they are difficult to prove. The designation should be made by the governing board of the church. In most Southern Baptist churches, this is the congregation in regular or called conference, but in some churches, the body of deacons, a finance committee, or trustees could be empowered to make the designation. Although a housing allowance can be shown as a line item in a church budget, it is better for the church’s governing board to pass a specific resolution making the designation.
Can a church designate a housing allowance retroactively?
No. The church cannot designate a housing allowance retroactively.
What if the church designates more than the minister can claim as a housing allowance?
If the church designates more than the minister can claim as a housing allowance, the minister is responsible for reporting and paying taxes on the correct amount of income.
Can retired ministers receive part of their retirement benefits from GuideStone as a tax-free housing allowance?
Yes. Retired ministers can receive up to 100% of their retirement benefits from a church pension board as a tax-free housing allowance.
Information provided by GuideStone Financial Resources. For more information on housing allowance, order "Planning Financial Support of Pastors, Other Ministers and Church Employees" from Financial Support, Tennessee Baptist Convention, P.O. Box 728, Brentwood, TN 37024 or e-mail Cynthia Proctor at firstname.lastname@example.org. (phone: 615-371-2010) or GuideStone Financial Resources, at 1-800-262-0511 or www.guidestone.org.
Employee or Self-Employed?
Because they are called to the ministry, many ministers do not think of themselves as employees. But most ministers get paid for their services. In the eyes of the Internal Revenue Service (IRS), people who get paid for performing services are either employees or self-employed.
Are most ministers employees or self-employed?
Most ministers have a "dual tax status." That means that although ministers are always self-employed for Social Security purposes (for their ministerial income), they are usually employees for income tax purposes.
Can a minister ever be self-employed for income tax purposes?
Yes, some ministers are self-employed for income tax purposes.
Example: Reverend White is an ordained Southern Baptist minister. He is a full-time evangelist and receives compensation from a number of churches every year. Reverend White is self-employed for income tax purposes. He is also self-employed for Social Security purposes.
Do employees complete their tax returns differently than self-employed persons?
Yes. Employees report income on Form 1040. Employees can deduct their unreimbursed business expenses on Schedule A only if they itemize their deductions. If they itemize their deductions, they can deduct their business expenses to the extent they exceed 2 percent of their adjusted gross income.
Self-employed persons report income and expenses on Schedule C. Self-employed persons can deduct their business expenses on Schedule C even if they do not itemize. They can deduct all of their business expenses, not just those that exceed 2 percent of their adjusted gross income.
Are there tax advantages in being treated as an employee instead of as self-employed for income tax purposes?
Yes, there are tax advantages in being treated as an employee for income tax purposes. Employees may exclude from income the cost of up to $50,000 coverage in employer-paid group life insurance. Employees may exclude from income the cost of employer-paid medical insurance. If a church paid for these benefits for a self-employed minister, the minister would have to report them as income.
Should churches issue ministers 1099s or w-2s?
In most cases, churches should issue ministers a Form W-2 because most ministers are employees for income tax purposes. Churches that pay self-employed ministers at least $600 in one year should issue a Form 1099-MISC.
Are churches required by law to withhold income taxes from their ministers’ pay if their ministers are employees for income tax purposes?
No, churches are not required by law to withhold income taxes from their ministers’ pay, even if their ministers are employees for income tax purposes. Ministers may, however, voluntarily elect to have churches withhold income taxes from their pay. In most cases, churches are legally required to withhold income taxes from non-minister employees.
How can you tell if a paid church worker is an employee or an independent contractor (self-employed)?
The IRS has generally used a twenty-factor test to determine if a worker is an employee or self-employed. In 1994 the United States Tax Court issued opinions in two cases about the tax status of ministers. In those cases, the Tax Court used a seven factor test to determine whether a minister is an employee or self-employed for income tax purposes. The seven factors are:
The degree of control the employer has over the details of the work.
Which party invests in the facilities used for the work.
The opportunity the worker has for profit or loss.
Whether the employer has the right to discharge the worker.
Whether the work is part of the employer’s regular business.
The permanency of the relationship.
The relationship the parties think they are creating.
Information provided by GuideStone Financial Resources. Other resources: Ministers Tax Guide and Employee or Self-Employed? Answers to some basic questions about an important tax issue. Both of these resources can be ordered from Financial Support, Tennessee Baptist Convention, P.O. Box 728, Brentwood, TN 37024 or e-mail email@example.com.
Are You A Minister?
In addition to pastors, Southern Baptist churches often have youth ministers, ministers of education and ministers of music. Although these people are ministers in the eyes of the church, they may not be ministers in the eyes of the Internal Revenue Service (IRS). Taxpayers who incorrectly classify themselves as ministers when they file their tax returns could wind up owing back taxes and penalties. Churches that incorrectly treat paid workers as ministers could violate federal payroll reporting obligations, possibly leading to IRS penalties.
Why is it important to know whether a taxpayer is a minister for tax purposes?
Taxpayers who are ministers for tax purposes may:
Are eligible for a church-designated housing allowance.
Are always self-employed for Social Security purposes for their ministerial income.
Are exempt from federal income tax withholding.
- Use the quarterly estimated tax procedure to pay their taxes unless they elect voluntary withholding.
May be eligible to opt out of Social Security, although very few ministers qualify to do this.
How does the IRS decide whether a taxpayer is a minister for tax purposes?
The IRS will ask a series of questions to determine if a taxpayer is a minister for tax purposes. Unfortunately, the law is unclear about the questions the IRS should ask.
What test will the IRS use to decide if a taxpayer is a minister for tax purposes?
The IRS may use the "Wingo" test. The U.S. Tax Court approved this test in Wingo v. Commissioner, 89 T.C. 922 (1987). The court said that a person is a minister for tax purposes if all of the following questions can be answered "yes:"
Is the person licensed, commissioned or ordained?
Does the person perform sacerdotal functions?
Does the person conduct religious worship?
Does the person maintain and control a religious organization?
Is there another test the IRS could use?
The IRS could use the "Knight" test; however, it has recently been using the Wingo test. In Knight v. Commissioner, 92 T.C. 12 (1989), the U.S. Tax Court held that a licensed minister of the Cumberland Presbyterian Church was a minister for tax purposes. The court used this five-part balancing test:
Is the person licensed, commissioned, or ordained?
Does the person perform religious worship?
Does the person administer the sacraments?
Does the person have management responsibilities in the church or denomination?
Is the person considered to be a religious leader?
Under the Knight test, the person must be licensed, commissioned, or ordained. If the person is licensed, commissioned, or ordained, then the answers to the other four questions are balanced. One factor is not necessarily more important than another.
Which test should Southern Baptist clergy use?
As a practical matter, most ordained Southern Baptist ministers serving churches will pass either the Knight or Wingo tests, so this question is not that important to them. Many licensed and commissioned ministers could not pass either test, so this question is not that important to them either. Ministers who could pass the Knight test but not the Wingo test should consider consulting their own tax advisers before treating themselves as ministers for tax purposes. After consulting an attorney or accountant, these ministers may decide to follow the Knight test and consider themselves ministers for tax purposes. Nevertheless, they need to be aware that they could be audited and the IRS could take a different position.
Information provided by GuideStone Financial Resources. For more information contact Jewell Burke, Tennessee Baptist Convention, PO Box 728, Brentwood, TN 37024, phone 615-371-2010, e-mail firstname.lastname@example.org.
Social Security Basics
Like other taxpayers, most ministers and church employees pay a significant chunk of their income for Social Security each year. Unfortunately, however, some ministers and churches may not understand the basic rules about Social Security. Failure to understand these rules can lead taxpayers to underpay Social Security taxes, a situation which may result in substantial penalties in the event of an Internal Revenue Service audit. Churches not aware of the rules could violate federal payroll tax procedures, possibly leading to IRS penalties and erroneous Social Security records for church employees.
Do ministers have to pay Social Security taxes?
Yes, unless they have properly followed IRS rules to opt out of Social Security, discussed in more detail below, ministers must pay Social Security taxes on their ministerial income.
Do ministers have to pay self-employment taxes on their ministerial income?
Yes, ministers must pay Social Security taxes at the self-employment--or SECA--rate on their ministerial income because ministers are always considered self-employed for purposes of Social Security. On the other hand, they may have to pay FICA on income they receive from secular employment.
What’s the difference between SECA and FICA?
SECA is short for Self Employment Contributions Act and refers to the rate which self-employed people pay toward Social Security. FICA is short for Federal Insurance Contributions Act and refers to the rate at which employees and employers contribute toward Social Security. Employers and employees pay FICA, and self-employed individuals pay SECA.
Does a minister have to pay Social Security taxes on a housing allowance?
Yes. Although a housing allowance is excluded from income for federal income tax purposes, a minister must pay Social Security taxes on a housing allowance.
What are the implications of opting out of Social Security?
A minister can opt out of Social Security by meeting strict IRS guidelines required when filing Form 4361. Form 4361 is entitled Application for Exemption from Self-Employment Tax for Use by Ministers, Members of Religious Orders and Christian Science Practitioners.
Three copies of this form must be filed by the due date of the minister’s tax return for the second year in which the minister had net earnings from self-employment of at least $400, any part of which came from ministerial income. If a minister does not file a Form 4361 by that date, he cannot opt out of Social Security. Additionally, the IRS must approve the application.
There’s a lot more to opting out of Social Security than filing Form 4361 by its deadline. Ministers should carefully review Form 4361 and its instructions to see how stringent the IRS requirements are for opting out.
Ministers are not allowed to opt out of Social Security because they think it is a bad investment.
Under penalty of perjury, a minister must make certain representations to the IRS on Form 4361. When filing Form 4361, a minister must certify that he is opposed on the basis of religious principles to acceptance of public insurance, which includes payments for death, disability, retirement or medical care. Additionally, the minister must certify that he has informed the ordaining body of his opposition to accepting public insurance benefits on the basis of religious principles. Few ministers will be able to meet these requirements.
How can I know if the Social Security Administration has proper records about my earnings history?
To find out if the Social Security Administration has correct records of your earnings history, call toll free--1-800-772-1213 -- and ask that Form SSA-7004, Request for Earnings and Benefit Estimate Statement, be mailed to you.
Information provided by GuideStone Financial Resources.
Ministers Tax Guide
Published annually by GuideStone Financial Resources, this helpful resource also has a pull-out insert about tax reporting requirements for churches. This resource is free upon request from GuideStone, 1-800-262-0511 or from the Tennessee Baptist Convention, e-mail email@example.com.