September 29, 2009

Ministerial Tax Status: Let Me Out!

Question:

An individual who has previously been employed by a church as a non-ministerial employee now has been added to the church staff as an ordained minister. He finds that his tax situation is worse now. How could this happen? Let me out!

Answer:

This question has a lot of variables. I'll try to get right to the point.

As a non-minister, his full compensation was subject both to federal and state income taxes and to FICA tax withholding of 7.65 percent. The church was required to pay the other 7.65 percent of his social security and Medicare tax. These withholdings were mandatory.

As a minister, he now qualifies for a housing allowance which is free of federal and state income taxes. However, he is now considered self-employed (SE) for purposes of his social security and Medicare tax obligations. He is responsible for the full 15.3 percent SE tax on his income including the housing allowance. According to the Internal Revenue Code, withholdings are optional for him, but without a substantial amount of federal income tax withholding (enough to cover both his actual federal income tax and his SE tax) he must file and pay quarterly estimated tax payments on his own. Otherwise, he may owe a substantial balance due on April 15th.

What strategies have ministers and churches pursued to manage this cost?
1. Many churches recognize that they are saving the 7.65 percent normally the responsibility of employers. Accordingly, they increase his pay by 7.65 percent, then immediately withhold an identical amount as federal income tax so that his tax bite is partially shared.
2. Some ministers choose to opt out of the social security system (Form 4361).
3. If he has children, it may be that his housing allowance reduces his taxable income to the point of qualifying for tax credits that he may not have otherwise earned.
4. Others utilize other tax saving strategies such as 403(b) plans, HRA plans, and professional expense reimbursement plans (all subjects of previous postings to this blog).

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