Our pastor's initial pay is quite low and designated 100% as housing allowance. I am treating him as an employee. He is receiving a Form W-2 for 2008 and the compensation is noted as 'Housing Allowance' in box 14 only. Where do I report this compensation on the Form W-3?
If the minister's compensation is 100% housing allowance, no Forms W-2 and W-3 are required (unless the church has other non-ministerial employees). My experience is that a filing of Form W-2 with zeros in Box 1 will only confuse the system and may initiate an IRS inquiry.
I do recommend that church treasurers who find themselves in these rare situations provide a letter to the pastor indicating the housing allowance amount so that he can accomplish several responsibilities. One, he must determine that he has adequate documentation for actual expenses equaling or exceeding the designated amount. Two, unless he has filed an approved Form 4361 opting out of social security, he must report the housing allowance as self-employment income on Schedule SE. Finally, he must limit or eliminate his deduction for Form 2106 Employee Business Expenses after they carryover to Schedule A (Itemized Deductions).
Housing allowance compensation is not reported on quarterly Form 941.
Does the church withhold taxes from earnings or report earnings differently based on whether the pastor has opted out of social security?
The short answer: No. Income tax withholding is optional for a pastor. Because he is a minister and subject to self-employment not FICA tax, no social security or Medicare can or should be withheld. No election exists allowing a pastor to violate this provision of the Internal Revenue Code.
Many pastors request a large amount of federal income tax withholding in order to pay both their federal income tax and their SE tax (since both are reported on page 2 of Form 1040). Further, it is my experience that many churches contribute to paying at least one-half of what their FICA obligation would be if he were not a minister, but this helpful contribution is also subject to income and SE tax. I recommend that churches consider increasing the pastor's pay by 7.65% for "their" one-half and then immediately withholding the same amount as federal income tax along with any additional withholding the pastor requests.