MinistryCPA - Corey A. Pfaffe, CPA, LLC

Question: A couple plans to move overseas to work with a mission organization on temporary assignment (less than one year). The church managing their support intends to issue Form 1099-MISC reporting their earnings. How do they report the income for tax purposes? Do they owe federal and state income taxes and self-employment (SE) taxes? Can they deduct business expenses (such as computer, camera, etc. used for the mission trip)? They believe that they will be out of the US for a long enough period to qualify for Foreign Earned Income Exclusion. Answer: There are many facts and circumstances that must be considered in this case, but many of the rules to interpret their implications are covered in IRS Publication 463 . Questions to be answered include the following: 1. What is the couple's "tax home"? 2. Is the assignment temporary or indefinite? 3. Is the trip primarily for "business" or personal reasons? If the couples' support is only enough...

Question: Is it true, when a minister files his yearly taxes, he pays Social Security & Medicare taxes on his salary dollars as well as his housing allowance? Answer: You are correct. As a combined 15.3 percent tax, called self-employment (SE) tax, ministers calculate the tax on Schedule SE and include the tax payment along with their Form 1040 filing. Some are not aware that the amount subject to the tax ("SE income") can be reduced by unreimbursed employee business expenses (Form 2106). Also, elective deferrals to a IRC 403(b) reduce SE income. Qualifying employee health benefits are also exempt.

Question: An unpaid, ordained minister works with his local church pastor. He participates in several ministerial duties. His main out of pocket expense is transportation to and from these duties. He also purchases reference books and software. He receives no income from the church nor does he receive mileage reimbursement. Does he have a choice in deducting for the best tax result--either claiming a charitable contribution on Schedule A for his miles driven in performing volunteer duties, or claiming a miscellaneous deduction on Schedule A via Form 2106 (at a more generous IRS standard mileage rate available for employee business expenses)? Answer: Since he is not an employee he cannot claim employee business expenses. He must use the appropriate charitable rate. However, all is not bad news. A minister employee cannot deduct mileage from his home to his church office (it is considered personal commuting). However, volunteers can deduct mileage from home to the church and t...

Question: An itinerant minister serves as a workplace chaplain (as the sole proprietor for a religious organization he has established), compensated by the businesses he serves. Instead of compensating him directly, some businesses contribute to an established tax-exempt ministry which, in turn, compensates him. He also speaks at civic and Christian organization gatherings and is provided a stipend. He's trying to follow the example of "circuit riding preachers." Without obtaining Internal Revenue Code 501(c)(3) status from the IRS for his sole proprietor religious organization can he claim ministerial tax benefits for earnings received from his business clients? Answer: The only organizations that qualify as IRC 501(c)(3) organizations without formally filing for exempt status are churches and associations of churches (IRS Form 1023 instructions). When the chaplain cited above receives compensation from a church for his ministerial services as a licensed or ord...

I’m getting the idea that every December will present another opportunity to review the tax law on Christmas gifts given to ministers. If you type “Christmas” in the above Search Window, you will find a number of postings on this topic. Here’s a review (much of it coming from my 12/15/08 post ) . IRS Publication 525 directly addresses what it calls holiday gifts. "If your employer gives you a turkey, ham, or other item of nominal value at Christmas or other holidays, do not include the value of the gift in your income. However, if your employer gives you cash, a gift certificate, or a similar item that you easily can exchange for cash, you include the value of that gift as extra salary or wages regardless of the amount involved." At Christmas time, generous lay people often seek opportunities to give to those who have ministered to them during the year. Great idea! Gifts between individuals are neither taxable to the recipient, nor deductible to the donor. The challen...

Question: A writer of Christian books wishes to enjoy the benefits of ministerial status. What organizations can ordain (or license) him to the gospel ministry? The minister plans to launch his ministry career from these books and would like to get a ministerial license through this ministry. Answer: The most frequent instance when a minister must provide proof of his status relates to the filing of Form 4361 applying for exemption from social security tax. The instructions to the form state the following: "Enter the date you were ordained, commissioned, or licensed as a minister of a church... "Attach a copy of the certificate (or, if you did not receive one, a letter from the governing body of your church) that establishes your status ... "[E]nter the legal name, address, and employer identification number of the denomination that ordained, commissioned, or licensed you ... "You must be able to show that the body that ordained, commissioned, or licen...

Question: A minister is partially retired and receiving Social Security benefits that will be limited by the Social Security Administration (SSA) if his earnings exceed the SSA's thresholds. at age 62. Can the church continue to employ him and compensate him appropriately without exceeding the threshold? The church did investigate a deferred compensation arrangement called a "rabbi trust" but found it to be overly complex. Answer: According to the SSA website : "If you are under full retirement age for the entire year, we deduct $1 from your benefit payments for every $2 you earn above the annual limit. For 2009 and 2010, that limit is $14,160. "In the year you reach full retirement age, we deduct $1 in benefits for every $3 you earn above a different limit, but we only count earnings before the month you reach your full retirement age. If you will reach full retirement age in 2009 or 2010, the limit on your earnings for the months before full retireme...

Question: A pastor writes, "Every year I break my package down how I want (base salary, housing, and a professional reimbursement). Can I carry over my excess unspent professional reimbursement or excess expenses into the following year? Answer: IRS Publication 15 spells out the rules for accountable plans--required conditions for employees to receive non-taxable employer advances for business expenses: "To be an accountable plan, your reimbursement or allowance arrangement must require your employees to meet all three of the following rules. 1. "They must have paid or incurred deductible expenses while performing services as your employees. The reimbursement or advance must be paid for the expense and must not be an amount that would have otherwise been paid by the employee. 2. "They must substantiate these expenses to you within a reasonable period of time. 3. "They must return any amounts in excess of substantiated expenses within a reasonable...

First-Time Homebuyer Credit From the IRS, November 17, 2009: "New legislation, the Worker, Homeownership and Business Assistance Act of 2009, which was signed into law on Nov. 6, 2009, extends and expands the first-time homebuyer credit allowed by previous Acts. The new law: -- Extends deadlines for purchasing and closing on a home. -- Authorizes the credit for long-time homeowners buying a replacement principal residence. -- Raises the income limitations for homeowners claiming the credit. "Under the new law, an eligible taxpayer must buy, or enter into a binding contract to buy, a principal residence on or before April 30, 2010 and close on the home by June 30, 2010. For qualifying purchases in 2010, taxpayers have the option of claiming the credit on either their 2009 or 2010 return. "For the first time, long-time homeowners who buy a replacement principal residence may also claim a homebuyer credit of up to $6,500 (up to $3,250 for a married individual filin...

Question: A church compensates its minister who does not request optional income tax withholding. Then, it issues Form 1099-MISC ( non-employee compensation form). He deposits the maximum allowable contribution to a Roth IRA. Can he also establish a tax deductible Simplified Employee Pension (SEP) retirement account which is eligible for a higher maximum contribution? Answer: My January 27, 2008, blog posting, Ministers’ Retirement Options , reviews some of the alternatives available to ministers. In the question above, I recommend that the church consider filing Form W-2 ( employee compensation form). Unless the minister is an itinerant preacher, it is likely that he should be properly classified as an employee. This means that the church could establish a 403(b) plan and the minister could make elective deferrals to reduce both his income and SE tax. Unlike 403(b) plan contributions, Roth contributions reduce neither Form 1040 taxable income nor Schedule SE self-employmen...

Question: If a church establishes a Health Reimbursement Arrangement ( HRA ), can it define the plan to include only its ministerial staff and not its other full-time employees? Answer: Several resources are valuable in this determination: IRS Publication 969 IRS Publication 15-B, Chapters 1 and 2 Internal Revenue Code ( IRC ) Section 105 (available at Cornell Law ) IRC Section 105 describes nondiscriminatory requirements for HRA and other accident and health benefit plans. Plans may be able to exclude five classes of employees. Three are generally applicable to churches (Section 105(h)(3)(B)): employees who have not completed 3 years of service employees who have not attained age 25 part-time or seasonal employees Section 105(h)(4) states that "a self-insured medical reimbursement plan [and HRA ] does not meet the [nondiscriminatory] requirements ... unless all benefits provided for participants who are highly compensated individuals are provided for all o...

Question: A minister filed IRS Form 4361 but never received written confirmation of its acceptance. Later, the IRS audited his return and assessed the unpaid self-employment tax. What can he do now? Answer: According to the Minister Audit Technique Guide , a guide prepared by the IRS for its auditors but available to the public through the above link, "To determine if a minister is exempt from self-employment tax, request that he or she furnish a copy of the approved Form 4361 if it is not attached to the return. If the taxpayer cannot provide a copy, order a transcript for the year under examination. The ADP and IDRS Information handbook shows where the ministers' self-employment exemption codes are located on the transcripts and what the codes mean. Transcripts will not show exemption status prior to 1988. "If the transcript does not show a MIN SE indicator and the taxpayer still claims that he or she is exempt from self-employment tax, the Taxpayer Relations ...

Question: Our pastor is retiring from our assembly in 2010. He will be remaining with our congregation as a member and will have no further duties or responsibilities with our church. He has been our shepherd for many years. If the church were to supplement his social security income with a monthly "benevolence" check would this qualify as non-taxable benevolence?   Answer: Rare exceptions to the taxability of gifts to employees (current or former) have been made by the IRS (Private Letter Rulings, I believe; but I am going on memory right now) in cases of former ministers with medical or other needs that typically merit benevolence. In the case here, it will likely appear to the IRS and other objective parties that the church is now aiding a former employee who received inadequate compensation during his tenure (at least inadequate in the sense that he did not accumulate funds for post-retirement living). This compensation, while appreciated by the minister, will be t...

Question: My church regularly gives financial help to individuals in need. Should the individual receiving financial help/charity from the church be issued any kind of Form 1099 from the church? Answer: IRS Publication 525 states that gifts to individuals not in the employ of the donor are non-taxable. This is true regardless whether the gifts are periodic or regular as long as no services are required (past, present or future) to receive the benevolence. I recommend that viewers of this blog type "Benevolence" in the above search window for much more on this subject. Question: Donations have been made to our church, and the donors requested that certain individuals then be given the same amount in charity from the church due to a perceived need (specifically, for people who have lost their jobs, but the specific individuals were named by the donors). The church told the donors that it would assume complete legal control over the donated funds, but the church has,...

Question: A missionary receives little support and uses a lot of her own funds to cover her expenses. Can the expenses paid out of her personal funds be deducted as a business expense on Schedule C as well? If so, she will always have a substantial loss, as she funds the majority of her work with her personal funds. Answer: Business expenses can be deducted even if they lead to a loss in a particular year. But if an activity is classified as a hobby (not as a business ), expenses can only be deducted to the extent of income. In other words, a business loss on Schedule C cannot be created. According to IRS Publication 535 and related instructions on its website, "Generally, an activity qualifies as a business if it is carried on with the reasonable expectation of earning a profit. "In order to make this determination, taxpayers should consider the following factors: Does the time and effort put into the activity indicate an intention to make a profit? Does the ...

Question: A family works with a ministry that serves orphans in several foreign countries. Many individuals and families travel to fulfill short-term missions projects each year. Parents typically bring their children who help with painting, cleaning, etc. There is no element of vacation associated with the trip. Can expenses for the family trip be deducted if paid directly by the family (airfare, etc) or does the ministry need to pay these expenses directly and be reimbursed in essence by the family to be deductible? Answer: IRS Publication 526 addresses "Out-of-Pocket Expenses in Giving Services" and travel costs. First, let's consider four principles that the Publication highlights: "Although you cannot deduct the value of your services given to a qualified organization, you may be able to deduct some amounts you pay in giving services to a qualified organization. The amounts must be 1) unreimbursed, 2) directly connected with the services, 3) expenses ...

Question: If an itinerant minister declared at the beginning of the year that the first x amount of dollars received would be considered his housing allowance, would that be an unreasonable interpretation of tax law concerning ministries? Answer: A housing allowance must be designated by action of the payer(s), not by declaration by the recipient, so I don’t believe the above strategy will work. I recommend that a church providing an honorarium to an itinerant minister provide a written and signed breakdown of its remuneration including the portion designated as housing and any portion paid as reimbursement for properly documented travel or other costs. The minister may wish to provide guidance to the ministry as to the percentage and method for this statement.

Question: An itinerant minister utilizes Schedule C to report his honoraria. No portion of this income to this point has been designated as housing allowance. As an itinerant minister, can he deduct all reasonable housing expenditures without having them designated by a church or other qualifying organization? Answer: The April 2009 Minister Audit Technique Guide published on the IRS website offers guidance here. The housing allowance must be officially designated before the compensation is received. While the Guide does not directly address the case of itinerant minister, it seems that an official designation of one's honorarium before it is disbursed to the minister will qualify. Accordingly, churches issuing Form 1099-MISC could properly exclude that portion from the Non-Employee Compensation box. I do recommend that such churches provide the itinerant minister a statement of the housing allowance paid to him as part of his honorarium since he must follow the Clergy Housi...

Question: What advice can you give a newly ordained minister on the deductibility of expenses related to training materials, tuition, books and apartment rent incurred during the process of becoming a licensed minister? Answer: IRS Publication 529 communicates information regarding the deductibility of "Work-Related Education." These deductions are Miscellaneous Itemized Deductions on Schedule A. It says, "You can deduct expenses you have for education, even if the education may lead to a degree, if the education meets at least one of the following two tests. It maintains or improves skills required in your present work. It is required by your employer or the law to keep your salary, status, or job, and the requirement serves a business purpose of your employer. "You cannot deduct expenses you have for education, even though one or both of the preceding tests are met, if the education: Is needed to meet the minimum educational requirements to qualif...

Question: "A missionary in Mozambique does not keep records of her actual meal expenses as she was told that there was a basic “formula” used in deducting food expenses. Can you provide any information regarding this “formula” for calculating food expenses?" Answer: First, most meals for missionaries are not deductible. According to IRS Publication 463, meals are only deductible when it is necessary for you to stop for substantial sleep or rest to properly perform your duties while traveling away from home on business. Business-related entertainment meals are also deductible. Since a missionary's home is his or her place of ministry in the foreign country, he or she is rarely traveling away from home on business. The exception may be short ministry-related trips within the country. For these cases, Publication 463 describes a standard meal allowance. The IRS says, "If you use the standard meal allowance, you still must keep records to prove the time, place...

Question: A church houses a Bible school on its property that had been started at one time by a church employee as a for profit, sole-proprietorship. Church staff state that "the church is non-profit and the school is for profit." Does the church need to prepare tax returns each year for the school? Can it merge the school into the church after-the-fact so it won't be a sole proprietorship any more? Answer: There's a lot going on in these questions. As I try to be in all most posts, I'll try to be brief yet helpful. Some of the issues will undoubtedly require consultation with an attorney who knows state law applicable to the church. Certainly, a church can have ministry related auxiliary activities such as a Bible school that will be tax exempt. But the church must be the "owner" of the venture. For now, the church needs to very careful about having its property used by an employee to operate his own for-profit business, especially if he’s not...

Question: How should missionaries report their "working fund" as opposed to salary. Do they keep records themselves in case asked by the IRS? Are these funds reported by the supporting congregation/mission organization and then deducted as business expenses? Who is able to decide what constitutes a "working fund" expense as opposed to a salary item? Answer: Although I'm not familiar with the term "working fund" I believe it is a sum of money sent to the missionary for ministry use (not personal use) without documentation expectations. The IRS calls these arrangements " nonaccountable plans" (see IRS Publication 15 for a brief definition, including "accountable" plan rules). The quick answer to the questions posted is that the full amount received into a missionary's nonaccountable working fund is treated the same as his standard support. If the mission agency is treating the missionary as an employee (the standard meth...

Great Question: A church wishes to buy its pastor a new vehicle and has the cash to pay for it outright. Possible tax strategies: 1 – Church owns the vehicle and the pastor keeps log of business versus personal use; the value of his use is included on his Form W-2. Negative: this also keeps the insurance policy in the church’s name which somewhat exposes the church. 2 – Church pays for the vehicle and titles it to the pastor (15% federal income, 5.75% state income plus 15.3% self-employment (SE) taxes paid on the vehicle value; the taxes could be paid partially by the church by grossing up the pastor’s salary). Negative: all income coming into play in one year and the possibility of pushing the pastor into a higher bracket. 3 – Pastor owns the vehicle and finances it – church pays pastor additional paycheck each month grossed up for taxes and after deductions leaves enough net pay for making payment. "Answer" (in quotes because my response will mainly be simple com...

Question: A church maintains a benevolence fund to assist the needy in the church and community. Is the church required to keep a list of names of the donors (not recipients) of those funds? Answer: Identical to any other type of charitable contribution, in order for donors to receive a year-end statement of their giving benevolence fund records must also be kept. I recommend that these gifts be recorded in an identical manner as other contributions.

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, ...

Question: A church is looking to bring on a youth minister but is unable to offer compensation other than living arrangements in a church home. The minister is not ordained. Can housing be offered as the sole compensation? Would the person need to be hired as a regular employee or as an independent contractor? How would the church and the youth minister report this? Answer: Regardless of the ordination, licensure or other formal recognition of the minister, he will qualify for ministerial status as long as he is providing what the IRS calls sacerdotal (ministerial) duties for a qualifying church. Licensure, at a minimum, certainly helps to establish (or document, if necessary) his call to the gospel ministry. Generally, an ordained minister performing solely non-ministerial duties does not qualify for clergy tax status. While the minister in this case will most likely be properly classified as an employee, he will not be issued Form W-2 because he has received no taxable compen...

Question: Most commonly, mission agencies treat their missionaries as Form W-2 employees (and, I believe, properly do so). They classify disbursements to them in categories such as cash compensation, housing allowance, and reimbursable employee business expenses. The question has been asked, "Are there any IRS restrictions to consider in a mission agency's policy for the quantity of trips back to the home country? Because long-term missionaries are employees and eligible for accountable expense reimbursement arrangements, a common practice is to classify travel costs for furlough leave as reimbursable business expenses." Answer: This question is addressed by IRS Publication 463 . The Publication asks the question, "What Travel Expenses Are Deductible?" then answers it: "Once you have determined that you are traveling away from your tax home [the foreign mission location, in most cases], you can determine what travel expenses are deductible. You c...

Question: A recent question came up on how certain designated funds should be reported on our balance sheet – we have funds like benevolence, scholarship, etc. – a previous treasurer changed these accounts from liability to equity and now we have another individual saying that these accounts must be liabilities; any recommendations on which way is correct? Answer: Unless the ministry is undergoing a certified audit or otherwise committed to strictly following Generally Accepted Accounting Principles (GAAP), I believe the classification is irrelevant. The key point is that the unspent balances will be carried over from one fiscal year to the next. For us accountants: Technically, the accounts are equity accounts in not-for-profit organizations following FASB 116,  which stipulates this treatment in order to comply with GAAP.

Questions: Are both full- and part-time pastors considered as employees who receive year-end earnings Form W-2? Can 100% of their pay be designated as housing? Answers: All church employees should receive Form W-2 regardless of their full- or part-time status. Form 1099-MISC is reserved for reporting independent contractor compensation only. Common examples of independent contractors compensated by church include janitorial services and guest speakers. The housing allowance is limited to the lesser of three amounts: a) the amount actually used to provide a home, b) the amount designated by a minister's employer, c) the fair rental value plus actual cost of utilities. It may be that a minister expects a) and c) to exceed his full cash compensation, especially if he is part-time. Accordingly, a 100% designation may be appropriate. Both full- and part-time ministers are eligible for the full list of allowable employee business expense deductions reportable on Form 2106. See ...

Question: A church sets up a fund to pay a former pastor's nursing home, housing and other expenses. He and his wife are current members of the church. Is the church required to issue him a Form 1099-MISC (or Form W-2)? Is there a limit as to how much he can receive? Answer: Situations such as this are common. Typically, the church has been unable to compensate the former minister as well as it would have wished and now intends to provide some current support to address this undercompensation. Such payments to the minister or on his behalf are taxable as compensation. The church can designate a portion to housing allowance and the minister may elect Internal Revenue Code section 403(b) elective deferrals which may reduce the tax bite. There is no limit to the amount other than possible Social Security retirement limitations on those who have not reached full retirement age (between age 65 and 67 or so). Another possible motivation for these payments produces an entirely d...

Question: A church provides its minister a housing allowance but believes it must report the full amount of compensation (including the non-taxable housing allowance portion) on Form 1099-MISC in order to demonstrate the full earnings of the minister. (Starting in 2020, Form 1099-MISC is replaced with Form 1099-NEC for non-employee compensation.) If the church reports his compensation, including the housing allowance, on the Form 1099-NEC as taxable income, will he be able to deduct his housing expenses somewhere else on the Form 1040? Answer: This question brings up a couple of issues. First, most ministers are properly classified as employees who receive Form W-2 , not as independent contractors who receive Form 1099-NEC . Box 1 on Form W-2 reports taxable compensation. It is reduced to reflect the church's designation of a portion of his pay as non-taxable housing. Then, in Box 14 (Other), Form W-2 typically reports as a memorandum item his additional non-taxable, housing allowa...

Questions: A minister temporarily commutes 100 miles from his principal residence to serve in a Christian ministry, also renting an apartment near the ministry while away from home. Can he claim a housing allowance on this second dwelling as well as his principal residence? And what about the commute from home to the ministry--is it deductible? Can the ministry reimburse him on a tax-free basis? Answers: A housing allowance is available for only one principal residence. Plus, commuting from a minister's home to his place of business is non-deductible. Hence, reimbursements by a church for non-deductible expenses, while certainly appreciated, will be taxable income. An exception may be important to consider. It relates to the Internal Revenue Code definition of Tax Home. Travel and lodging expenses while away from one's Tax Home for business purposes may be deductible (and reimbursements non-taxable). According to IRS Publication 463, "if you do not have a regular...