January 29, 2009

Timing for Opting Out of Social Security

Question:

A minister was ordained in 2007, but had no income until 2008. Must the minister wait for two years until tax time for 2009 (before April 15, 2010) to apply for exemption from social security?

Answer:

The application can be filed immediately, but must be filed before a minister's first two years of ministry expire. Years when less than $400 is earned are excluded from the time limit calculation. Form 4361--Application for Exemption From Self-Employment Tax for Use By Ministers--requires disclosure of the first two years of ministry income. One who waits until the final year should file an amended return to receive a refund of self-employment tax paid in year one.

Ministers who anticipate filing for exemption may forego making estimated tax payments of the standard SE tax, but run the risk of failing to receive exemption approval and, then, owing a large tax plus penalties for underpayment of estimated tax.

Housing Allowance Minimum

Question:

Is it true that the pastor's housing allowance has to be $1000.00 a month? Is there a minimum?

Answer:

There is no minimum, but the Internal Revenue Code does establish a maximum.

A minister who receives a housing allowance may exclude the allowance from gross income to the extent it is used to pay expenses in providing a home. A housing allowance is also available to a minister living in a parsonage to the extent he uses the allowance for his personally paid out-of-pocket costs not paid by the church. The IRS lists only food and servants as prohibitions to allowance housing expenses.

If a minister owns a home, the amount excluded from the minister’s gross income as a housing allowance is limited to the least of the following:
  • the amount actually used to provide a home,
  • the amount officially designated as a housing allowance, or
  • the fair rental value of the home.
The minister’s church or other qualified organization must designate the housing allowance pursuant to official action taken in advance of the payment. Ministerial business expenses and unreimbursed employee expenses must be allocated between taxable and tax-free (i.e., excluded) ministerial income. Sources: IRS Publication 1828; Clergy Housing Allowance Clarification Act of 2002; IRS Regulation Section 1.107-1.

January 28, 2009

Form 1099-MISC and "Bad" Advice

Question:

My husband is a church planter and receives support from various churches throughout the US. Some of these churches we have visited and some we have not. Some have sent onetime gifts while others send us support monthly. In some cases, we have received several gifts from a church on sporadic occasions. I am at my wits end with this only because many other church planters and pastors have advised me differently. What some consider income, others do not. What some consider gifts, others do not. The internet seems filled with many who believe all is taxable and an equal number who are willing to fight that none of it is taxable unless he performed services directly for the church giving the gift. We have not received any 1099s. Some of the support is received through our sponsoring church. Should they be doing one 1099 for the money they receive and pass onto us, or should we get separate 1099s from every church that sends us support? Do you have any guidance or direction for me? My eyes are sore from all the IRS publications I have read these past few days.

Answer:

I can empathize with your dilemma. Many churches do not understand or comply with the Form 1099 rules. They are required by law to prepare a Form 1099-MISC for any individual to whom they pay $600 of non-employee compensation within a calendar year. Regardless of the churches' compliance, church planters are required to report 100% of their support as taxable income. The IRS's mid-1990s Market Segment Specialization Program and every pronouncement since has clarified for its agents that the income described in the question posed above must be reported by a minister.

Many church planters request that their contributors (individual and churches) forward their gifts to a mission agency or sponsoring church (these amounts are not reportable on Form 1099-MISC because they are not paid directly to "individuals"). Then the agency or sponsoring church can disburse the funds to the church planter, often taking advantage of other provisions of the tax code in order to legally minimize one's tax burden. This organization then issues the proper IRS form to the church planter.

Unfortunately, some ministers fail to report income not reported to them on Form 1099-MISC and advice others to do the same.

See my January 22, 2009, blog entry for more discussion on this topic.

January 22, 2009

Gifts to Ministers (Taxable or Not?)

Question:

A question has been posed regarding gifts to ministers, a topic I addressed in detail in a December 15, 2008, posting. A tax preparer has counselled a church that gifts from individuals to individuals are non-deductible (to the donor) and non-taxable (to the recipient). Does this condition also apply to gifts from an employer to an employee? Specifically, when a church congregation (the employer) collects donations to give to its pastor (the employee) are these gifts treated in the same manner as individual-to-individual gifts?

Here's the conditions behind the current question: "the church solicits them from the congregation and asks to have checks made to cash or to give cash to the church and then it is divided up to the pastor, youth pastor, etc."

Answer:

Fortunately, the pipe wrench I bought my wife for Christmas at Ace Hardware is not taxable to her. Unfortunately, I cannot take a tax deduction for it. (Just kidding -- really!)

The same is true when an individual member gives a gift to another member of the church who happens to be the pastor.

However, it's entirely a different story when an employer (the church congregation acting as a corporate body) takes a collection and gives it to its employee (the pastor). As a 501(c)(3) organization, a church is a qualified charitable organization. Gifts to it are tax-deductible. Compensation paid to an employee (in any form other than those I specified in my earlier blog entry) is taxable.

Some tax preparers may confuse tax law related to individual-paid gifts (part of the gift and estate tax code) and employer-paid gifts. All I needed to hear in the above question was "the church solicits..." and I knew we were addressing compensation issues, not gift issues. Making checks out to cash accomplishes nothing to defeat both the letter and spirit of the law.

Housing Allowance on 2nd Home

Question:

Can a minister take a housing allowance on a second home?

Answer:

The housing allowance is available only for a minister's principal residence.

W-2 Reporting of Church Contributions to 403(b) Plans

Question:

When a church contributes a nonelective contribution (see definition in IRS Publication 571) each month to a pastor's 403(b) account that is not tied to the salary and is not Roth related, how is it reported on a W-2?

Answer:

As long as the contributions are made in accordance with a qualified plan (the investment firm can tell you whether the plan is set up to receive employer contributions of this nature), then there is no Form W-2 disclosure other than to check the "Retirement" box indicating that he has an employer plan.

January 15, 2009

Housing Allowance for Self-Employed Ministers

Question:

Can a pastor receive a housing allowance if he is paid as a self-employed individual?

Answer:

This question can be answered simply or with a lot of complex ramifications--surprise, it's the Internal Revenue Code we're talking about! I'll try the simple approach.

Some churches erroneously issue the pastor a Form 1099-MISC (for non-employee compensation) rather than Form W-2. This does not preclude the church from designating a portion of the pastor's compensation as housing allowance (income tax free). It should, however, apprise him of that amount so that he can confirm that he is eligible to exclude the entire allowance from income. Further, the housing allowance remains subject to Schedule SE self-employment tax.

January 14, 2009

Form 4361 Application Nuance

Question:

A pastor was ordained in 2003 by his former church of a different denomination. He submitted a Form 4361 application in 2007 which was denied because he had waited to apply after the two year timeline. He is being re-ordained at a church which is a different denomination and is asking if he can re-apply and resubmit another Form 4361. In your opinion, would the IRS reconsider its ruling because of the denomination change?

Answer:

It's only my opinion, but I do not believe the IRS will change its position. The pastor could resubmit a new Form 4361 but the service will likely deny the application because Box/Line 5 of the Form will report years of ministry earnings for which the election has expired even though the Box/Line 3 ordination date is more recent (within the two year window of opportunity).

January 13, 2009

Self-employment Tax Paid by Retired Minister

Question:

When, if ever, does a minister stop paying self-employment (SE) taxes? Specifically, when a minister retires and draws a retirement from a denominational system does he still continue to pay estimated taxes each year to the IRS?

Answer:

The answer depends on the type of retirement payment. Amounts paid to a minister under a deferred compensation plan continue to be taxed for both income and SE tax purposes, regardless of age. Distributions from Qualified Retirement Plans (e.g., 403(b) plans and pension plans (defined benefit and defined contribution) are not SE taxable. A retired minister must contact the plan administrator to determine the nature of the plan. However, retirement plan distributions not taxed for SE purposes are generally reported on Form 1099R, while SE taxable distributions are typically reported to the minister on either Form W-2 or Form 1099-MISC.

While SE taxes may not be due on Form 1099R distributions, estimated tax payments may still be necessary if the minister anticipates owing income tax.

January 08, 2009

Minister: Employee or Non-employee

Question:

Why should a church issue Form W-2 (for employee compensation) versus filing Form 1099-MISC (for non-employee compensation)?

Answer:

1. IRS Publication 517 provides instructions for determination of a minister’s status as an employee versus a non-employee (typically called an “independent contractor”). Under the sections Ministers: Defined and Ministers: Employment Status for Other Tax Purposes, direction is provided. The Publication also references Publication 15-A and Form SS-8 for further assistance. Having served ministers now for past 25+ years as a CPA specializing in ministerial tax, I have observed only a few situations in which I believe a minister should be classified as a non-employee. The exceptions generally relate to itinerant evangelists and independent missionaries.

2. Even more importantly, as an employee a minister can enjoy several tax-free benefits not available to a non-employee:
a. health care insurance benefits
b. Health Reimbursement Arrangements (HRAs)
c. 403(b) retirement plans
d. Flexible Spending Accounts (FSAs)

Missionary Income from Multiple Sources

I received the following questions from a father whose daughter serves on a foreign mission field. These are great (and common) questions that may benefit others who reference this blog.

Questions:

Sue (not her real name) receives support from multiple sources: 1) gifts channeled through a 501(c) missions organization ("Agency"), 2) gifts channeled through her local church, and 3) gifts sent directly to her by family members and others. How are these gifts treated for tax purposes?

Answers:

1. The amounts transferred from family members to Sue are non-taxable (to her), non-deductible (to family members) gifts. This is also true of other gifts received directly from individuals to whom she provides no services.

2. Support from her home church as its missionary are considered taxable compensation. Assuming that she is not an employee of the church (a safe assumption), the amounts are reportable on Schedule C as self-employment income. She likely has “business” expenses that she can use to reduce this taxable income. Schedule C net income is subject to both self-employment tax (Schedule SE) and income tax.

3. "Agency" is obligated (as the paying organization with regard to her other support) to issue Sue either a Form W-2 (employee) or a Form 1099 (non-employee). US missions agencies generally treat missionaries as employees (Form W-2) and withhold FICA tax (7.65% social security and Medicare tax) from non-clergy employees. Sue (or dad :^) ) will need to contact "Agency" to discern its practices.

With the benefits of the Foreign Earned Income Exclusion (Form 2555), it’s unlikely that she’ll owe any federal or State income tax. She will, however, owe self-employment tax if her net income on Schedule C is $400 or more.