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.

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