Skip to main content

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).

Comments

Popular posts from this blog

Rental of a Church Parsonage to a Non-Minister

Question: A church owns a parsonage, but the pastor does not use it as he owns his own home. The church rents the parsonage to a tenant other than a minister or employee of the church. Will the church be responsible for paying income tax on these monies as Unrelated Business Income (filing a Form 990-T) even if the money is used to carry on the business of the church? Answer: Whether the money is used for church purposes is irrelevant.  IRS Publication 598  states: "If an exempt organization regularly carries on a trade or business not substantially related to its exempt purpose, except that it provides funds to carry out that purpose, the organization is subject to tax on its income from that unrelated trade or business." Fortunately, in the case of rental income from real property, such income is "excluded in computing unrelated business taxable income" (Publication 598). Caution: see content below regarding debt-financed property.  However, a second concern not a...

How can my ministry expenses be covered by the church?

     How can my ministry expenses be covered?                            Many ministers use their personal autos for ministry purposes. Their employers can reimburse these costs using a standard mileage rate published by the IRS. The per mile rate represents employees’ entire reimbursable cost other than highway tolls and parking tabs. If not covered by use of the ministries’ credit card, other costs can be reimbursed as well—business and travel meals, lodging, office supplies, and professional library purchases among them. Some ministries reimburse travel costs using per-diems published by the IRS. If employee business expenses are not reimbursed, the personal tax deduction benefit to the individual minister is severely limited. Non-taxable reimbursements after documentation is provided to the employer follows IRS rules for accountable plans. Non-taxable cash advances before expenses are in...

What is the best retirement account for a Minister?

       What are my options for retirement savings?                  Regardless of options, start now! You probably have learned about traditional and Roth IRAs. We have often found them well short of the benefits we will share here regarding Internal Revenue Code section 403(b) plans. These plans must be established by your employer (although you might need to be the initiator). They are funded in two ways—withholding from your paycheck at your option (called “elective deferrals”) and as initiated by the employer (matching or non-elective contributions). These contributions not only save income tax, but they also reduce the income you must report as subject to the 15.3% SECA tax. Further, at retirement with the cooperation of your church or Christian ministry the distributions to you can be tax-free to the extent of your qualified housing expenses. Many ministries also adopt what are often called “FICA alternative” be...