Top three Tax Issues for Ministers
There are three unique aspects to a minister’s taxes. A minister occupies the unusual status of being a dual-status taxpayer. He/she is considered an employee for income tax purposes and self-employed for social security and Medicare. One implication starts the day he becomes employed as an ordained minister. The employer may not deduct social security and medicare taxes from the minister’s payroll. Likewise, the employer does not withhold any income taxes but the minister may opt for voluntary withholding in order to avoid having to make estimated quarterly payments.
- Housing Allowance
The minister is allowed to exclude from income tax any amount designated by the church as housing allowance or the value of a church-supplied parsonage, not to exceed the fair rental value of the housing. There is no limit on the percentage of salary that may be designated as housing. This is a designation that must be made in advance by an authorized body of the church and applies to future earnings. The amount may be changed but only prospectively. If the minister fails to spend the designated amount on housing, the excess reverts to taxable income.
The minister’s W-2 should not reflect the housing allowance in box 1 but include as a notation in box 14. This will inform the minister and preparer of the amount designated as housing. If self-preparing be certain to check that the correct amounts are included on Schedule SE.
- Social Security and Medicare Taxes
The minister may opt-out of social security and Medicare taxes by filing Form 4361 with the IRS. This exemption is due to the minister’s conscientious objection to the use of ministerial funds being used for public insurance. There is a limited time to file for this exemption and cannot be revoked. If the minister has secular employment, those earnings are not affected by opting out.
The minister will determine his/her liability for self-employment taxes on Schedule SE. Income subject to the self-employment tax includes salary, housing allowance, and travel, and other expenses paid to the minister as a part of a non-accountable plan. While the 2018 Tax Cut and Jobs Act (TCJA) eliminated the deduction for employee business expenses on Schedule A for income tax purposes, the minister may treat these as a deduction on Schedule SE as a way to reduce the self-employment tax liability. One-half of the self-employment taxes is deductible on Form 1040.
- Business Expenses
As mentioned, expenses incurred by the minister are not deductible for income tax purposes but may be deductible in calculating the self-employment tax. Ministers often have outside income from weddings, funerals, or speaking engagements. Since these are not a part of his compensation from the church, he should report these earnings on Schedule C. The deduction taken for common expenses must be allocated between the minister’s church compensation and the Schedule C earnings. For example, assume the minister buys a robe to wear during Sunday services but also uses it when officiating at funerals or weddings. The cost of the robe should be allocated between the two types of income, deducting only the portion allocable to the Schedule C earnings. On the other hand, if the minister flies to a speaking engagement and is not reimbursed for the cost of the flight, that would be fully deductible on Schedule C.
Clergy Financial Resources serves as a resource for clients to help analyze the complexity of clergy tax law, church payroll & HR issues. Our professionals are committed to helping clients stay informed about tax news, developments and trends in various specialty areas.
This article is intended to provide readers with guidance in tax matters. The article does not constitute, and should not be treated as professional advice regarding the use of any particular tax technique. Every effort has been made to assure the accuracy of the information. Clergy Financial Resources and the author do not assume responsibility for any individual’s reliance upon the information provided in the article. Readers should independently verify all information before applying it to a particular fact situation, and should independently determine the impact of any particular tax planning technique. If you are seeking legal advice, you are encouraged to consult an attorney.
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