May 29, 2009

Housing Designation of 403(b) Plan Distributions

Question:

"I know that the IRS does allow for retirement distributions from a 403(b) plan to be at least partially designated as a housing allowance (true, see my Feb. 6, 2007, post and others). But up to this point I have not found if this is available for 403(b)(7) plans. A pastor has a 403(b) plan that he and the church both contribute to. Is there any way that part of the retirement distributions can be designated as a housing allowance? I have talked to [the mutual fund firm] and it will not “code” the Form 1099-R for any housing allowance." (The mutual fund firm will not report a lower taxable amount for a distribution than it reports as the full distribution amount simply because a recipient can provide documentation of a housing allowance designation by his congregation.)

Answer:

Two issues here...

1) Regardless whether the investments are held in a traditional TSA sold only by insurance companies (as initially described by Congress in 1958 when it established 403(b) plans) or in mutual funds (as modified by Congress in 1974 in IRC section 403(b)(7) to allow for non-annuity investments) a church can designate all or a portion of the distributions as housing allowance. Of course, a minister must comply with other requirements (e.g. must be 59 1/2 years old).

2) In my July 26, 2008, post I stated "the retired minister reports the full distribution on Line 16a (2007 Form 1040) and the taxable amount after allowable housing allowance on Line 16b." This reporting method, however, does have its challenges. The IRS document matching program may/will assume that an error has been made and propose a change in the return. The taxpayer must respond by providing an explanation for the discrepancy. I recommend that a schedule of the minister's housing expenses also be provided. The minister should maintain his documentation in case the Service requests it.

May 27, 2009

"Start-up" Missions Support by a Local Church

Question:

After participating as a volunteer for three years, a member of a church congregation entered full-time mission work in a foreign country. She began going for about 3 or 4 months at a time and then returning to the U.S. for a few weeks to a month to visit and raise support. In 2007, she paid her own way. In 2008, she began raising support. Some people gave money directly to her, others gave money to the church for her support. In addition, the church sponsored her for support in 2008. She was not required to report back to the church’s internal mission board under any accountable plan arrangement. What advice can you offer to the members of the church’s mission board to better serve its missionary?

Answer:

The IRS will consider her to have entered the “business” of receiving self-employment income for the performance of religious services—representing donors and other organizations (the church) in providing services to people in a foreign country.

I encourage the mission board to establish a designated fund to manage the collection and disbursement of her support. This provides donors a vehicle for tax-deductible contributions. Generally, gifts given directly to her by individuals will be non-taxable to her and non-deductible by them – they are not considered to be rendered as an exchange of services for compensation.

The missionary will need to file Schedule C and deduct her travel and other business expenses as would any other self-employed person (e.g. she’ll need to keep a mileage log and use the standard auto allowance). Since she is not a minister (as defined by the IRS in Publication 517 and other sources that describe sacerdotal duties, etc.), she will not be eligible for a housing allowance and other ministerial tax provisions. She will need to determine whether she will qualify for the Foreign Earned Income Exclusion.

The local church mission board could opt to recommend employment status with the church. Then, FICA taxes could be withheld and matched (as a non-ministerial employee of a church or Christian organization) and an accountable plan for her employee business expenses could be
established.

May 21, 2009

Helping to Pay Half of the Pastor's SE Tax

Questions:

A pastor has accepted a position at a new church. In his prior position, he was an "employee" who received a Form W-2 yet paid his entire 15.3% portion of self-employment (SE) tax. He took the various, allowable business deductions to reduce the amount of income that was taxable for SE purposes. In his new position, he will be an "employee" of the church and receive a W-2. However, the church is offering to pay 7.65 percent of his social security tax.

1. Will he still be considered "self-employed" for purposes of paying the remaining 7.65 percent?
2. Will he still be able to take the various deductions to reduce the income amount on which the self-employment tax is calculated?

Answers:

In both positions the pastor held/holds he is almost certainly correctly classified as an employee of the churches. An example of a rare exception to the employee designation is an iterant evangelist (truly an independent contractor).

Let me review some information posted in other blog entries that one might want to read as well. Churches that offer to help their pastors pay the costly SE tax should be commended. However, this amount too is considered taxable income. It is inconsistent with the Internal Revenue Code for a church to withhold and match FICA tax for a minister as it would for a non-minister. Further, denying him ministerial status will eliminate his eligibility for several favorable tax treatments (e.g., housing allowance). He would also then lose out on reducing his income by taking allowable deductions before the calculation. Operationally, I've seen two models for implementing the church's decision:

1. Add a 7.65 percent "bonus" to his taxable compensation each pay day, then immediately withhold it as federal income tax (not social security or Medicare tax). This way, when the pastor files his Form 1040 at the end of the year to calculate both his income and SE tax, a large amount has been withheld which will then reduce his balance due. Many pastors in this situation also elect to have additional federal income tax withheld to cover the remaining 7.65 percent of the 15.3 percent SE tax, plus their actual income tax.

2. Issue a "bonus" check on the following year's April 15th deadline when his balance due must be paid. Problem: he could suffer underpayment of estimated tax penalties. To eliminate these penalties he must make estimated tax payments without the benefit of the cash provided later. Of course, this bonus is reported as taxable income on his Form W-2 for the year in which it was paid.

Deductibility of Designated Gifts for Parsonage Improvements

Question:

Some members in a church congregation want to buy new furnishings for its parsonage. Is there a way for the monies contributed to purchase the furniture to be deductible to the donors?

Answer:

Yes, just as a congregation may initiate, then "advertise" its establishment of a fund raising effort for any other activity related to its mission, a designated fund earmarked for parsonage improvements may receive tax deductible gifts. Of course, if these furnishings become the property of the minister occupying the parsonage, then their fair market value becomes taxable income to him in an identical manner as his standard cash compensation.

Licensure of a Gospel Minister

Question:

Can a part-time minister get licensed by his congregation in order to receive the tax benefits of being licensed? Is his licensing contingent on factors such as title, hours, or ordination?

Answer:

It is my belief the a congregation should issue a license to a minister in recognition of his call to the gospel ministry. In many churches (as evidenced in their Constitutions) this gives him the same authority to serve as a minister as he would enjoy after ordination (i.e., leading public worship, preaching, administering church ordinances, conducting weddings, etc.). Of course, ordination is a highly valued designation as well.

Technically, the IRS will recognize the ministerial status of pastors who have not been licensed or ordained as long as they can demonstrate that they have performed the duties of a minister--what the IRS calls "sacerdotal functions" (see IRS Publication 517). However, this is generally much more challenging than simply providing evidence of one's licensure or ordination (a photocopy of the certificate and accompanying letter is often requested).

Again, I believe that motivation for licensure should be for recognition of one's call to the gospel ministry--a matter not to be taken lightly. Once a minister is licensed (and, of course, then performing sacerdotal functions) he must make sure that he is aware of the tax issues related to ministers, including at least one once-in-a-lifetime deadline for Form 4361.

Donor Input on Disbursement of Funds

Question:

A donor contribution to a church established a fund to be advanced to missionaries in case of urgent needs. Subsequently, the donor asked that the church treasurer forward some funds to a missionary for his use. When the church treasurer distributes the funds, should they to be treated as a gift or taxable income? The treasurer understands that if he sends the funds through the missionary's agency that handles his account it will be treated as taxable income.

Answer:

It is certainly taxable income to them, so I recommend sending it through the mission agency so that the treasurer won't need to issue Form 1099-MISC; the agency will report it consistently with the missionary's other earnings.

Also, just a note. Since the ability to direct funds after they are donated ends once the gift is received and a designation is made (i.e., “for the purpose of establishing a fund to be used by selected missionaries in case of urgent needs”), I recommend that the church decision to send the funds be documented--if, and only if, it concurs with the donor’s suggestion of the particular missionary. Otherwise, the donor jeopardizes the deductible nature of his or her donation and the church may be inadvertently setting a bad precedent.

May 03, 2009

Paying for Pastor's New Automobile Engine

Question:

Our pastor needs to get a new engine for his car. Our church would like to pay to get this taken care of. If we do this, will our Pastor be exempt from paying taxes on this money?

Answer:

This is a great gesture! Unfortunately, it will be considered taxable income. But don't let this stop you. There are many steps your pastor can take to mitigate the tax bill.