MinistryCPA - Corey A. Pfaffe, CPA, LLC

New ministers frequently have several questions as they enter a new field that has significantly different rules than the standard employee of a business has. We have assembled a list of some of the most important questions that a new minister should investigate when starting their new job.  1. How can I live within my means? You need a budget. Enjoying a long-term ministry in Christian service requires an ability to live within your means. Lots of tools are available: Christian authors with “how to” instructions and online apps, to name a couple. Try You Need a Budget (www.ynab.com), if you need an idea. 2. What does it mean to be a dual status employee? A minister, per IRS regulations, is both an employee and self-employed—dual status. As an employee, a minister is eligible for all fringe benefits offered to non-minister employees — health coverage, retirement plans and so on. The exception lies in social security and Medicare tax. Non-minister employees must have 7.65% of thei...

This is another posting in the MinistryCPA Top 10 series: Understanding what to offer a pastor as part of his compensation package can be a difficult task. There are a number of different factors to consider. Variables such as compensation, insurance, housing allowance, taxes, and retirement all play into compensation. We have compiled a list of factors that a church should consider when designing a compensation package for the pastor. Every church situation is unique, and each church should analyze what it can actually afford. 1. How does the church determine an appropriate compensation rate? Determining an appropriate compensation level can be a difficult task in a small ministry. There are a few factors that can be used to help determine a fair compensation for the pastor. The first factor that should be taken into consideration is the needs of the pastor. If the church wants a pastor to work full time, then it must consider what he needs to be paid to support himself and his fami...

Question: As a pastor, what are my retirement options and what are the advantages/disadvantages of each? Answer: The best retirement plan option for each minister depends on his objectives and his current tax situation. The three most common retirement plan options used by ministers include: (a) Internal Revenue Code 403(b) plans (also called Tax Sheltered Annuities (TSAs)) (b) Traditional Individual Retirement Accounts (IRAs), and (c) Roth IRAs  Ministers often select 403(b) plans when they want to maximize their eligible contributions, or to reduce their self-employment tax burden. For the year 2020, a minister may elect to have his employer withhold (“elective deferral”) up to $19,500 of his compensation and contribute it; instead, to his 403(b) qualified investment account. Ministers who are 50 and older are eligible to increase this amount by another $6,500 to catch-up for earlier years’ smaller deferrals ( IRS Publication 571 ). In addition, unlike...

Question: If I can make retirement contributions to both a Traditional IRA and to a church plan is there a reason to prefer one over the other? Answer: Yes! Most ministers should likely be choosing a 403(b) church plan. In addition to a Traditional IRA, a minister may choose to claim a contribution to another retirement plan, like a 403(b) church plan. However, before choosing to do so, it is important to understand the benefits and disadvantages of both a Traditional IRA and a 403(b) plan. Contributions to a Traditional Individual Retirement Account are not employer plans that are deducted up front from a minister's pay (reported on Form W-2). Instead, these amounts are truly deducted on his personal tax return. The benefit of the IRA is that it can be funded after December 31 st and still count against one's taxable income. Additionally, an IRA does not require church sponsorship and has lower fees to establish an account. While there are several benefits of ...

For a quick review, readers should be reminded that ministers may be eligible to make contributions to an Internal Revenue Code section 403(b) plan established by their not-for-profit employers. The traditional 401(k) plan is available to for-profit employers. Also, ministers' distributions at retirement taken from 403(b) plans may be designated as non-taxable housing allowance. See other postings on this blog for a refresher of these rules: 403(b) Retirement Distributed as Housing Allowance Question 1: An ordained minister, formerly working for a for-profit company, is now working for a nonprofit ministry. His former retirement plan was a 401(k). The current employer offers a 403(b) plan. Can a 401(k) distribution be rolled over into a 403(b) plan? Answer 1: According to IRS Publication 571, “ You can generally roll over tax free all or any part of a distribution from an eligible retirement plan to a 403(b) plan.” Question 2: But should a minister consider d...

Question:   Two questions regarding issuing a minister’s year-end earnings reports (i.e., Form W-2 or, in rare situations, Form 1099-MISC): 1.) Should the amount of retirement that the church pays monthly on the behalf of its pastor be included? 2.) Should mileage reimbursements be included? Answer: Regarding the proper IRS Form for reporting salaries and wages, please see the following  Ministry CPA blog post . When reporting other types of compensation a pastor receives, the preparer should follow the Form W-2 instructions. For example, in Box 12, the IRS provides several codes relating to various types of retirement benefits. Churches may contribute to several types of retirement plans on behalf of their employees. Internal Revenue Code section 403(b) plans permit employer "non-elective" and matching contributions. Matching contributions involve elective deferrals by the employee, either pre-tax (403(b) plans) or after-tax (403(b) Roth pla...

Question: Should 403(b) contributions and the subsequent match be based on the pastor's total income from the church (including housing allowance) or just from the salary minus housing allowance? Answer: According to Richard R. Hammar, J.D., LL.M., CPA, in his book 2015 Church & Clergy Tax Guide , “Section 107 of the tax code specifies that a minister’s housing allowance (or the annual rental value of a parsonage) is not included in the minister’s gross income for income tax reporting purposes. Therefore, it would appear that the definition of includible compensation for purposes of computing the limit on annual additions to a 403(b) plan would not include the portion of a minister’s housing allowance that is excludable from gross income."  Hammar's Church Law and Tax Report is an excellent resource that many ministries should consider as annual subscribers.

Question: Can a church provide monthly support to a pastor who is no longer actively in the ministry without jeopardizing its tax-exempt status? If so, should a Form-1099 MISC be issued?  Answer: F irst, this action would not jeopardize tax-exemption status. The action of supporting a retired minister is within the boundaries of exempt purposes.  Second, the post retirement support is compensation. The c ompensation should be reported on a Form 1099-MISC unless he is still considered to be an employee who should therefore receive Form W-2. This is the "bad news." However, let's revisit a blog post we provided in 2009.   http://ministrycpa.blogspot.com/2009/10/retired-minister-continued-support-from.html "A retired minister may receive part of his or her pension benefits as a designated parsonage allowance based on past services. Trustees of a minister’s retirement plan may designate a portion of each pension distribution as a parsonage allowance e...

Question:   Some financial advisors have communicated that Internal Revenue Code Section 403(b) retirement plans sold by them are “uniquely able to provide tax-free withdrawals (as housing allowance) upon retirement for clergy.” Is tax-free treatment only available through specialized financial advisors selling 403(b) plans? Answer: IRC Section 403(b) plans are designed for tax exempt entities that wish to enjoy the benefits offered to businesses by similarly provisioned IRC 401(k) plans. When adopted by churches as their employee benefit plans, they are eligible for significant advantages to ministers including potential tax-free treatment upon retirement. This is true regardless of the investment plan administrator. Churches may contact investment advisors in their communities to determine whether they also can assist in establishing 403(b) plans.  Please follow these links to past posts concerning this topic: http://ministrycpa.blogspot.com/2009/10/ret...

Question : I am treated as a 1099-MISC self-employed contractor by my U.S. mission agency. Should I consider establishing and contributing to a 403(b) retirement plan? Am I eligible?  Answer : This blog post will deal with the issue concerning a self-employed minister’s eligibility to establish a 403(b). Please bear with the very technical nature of this post. Starting with IRS Publication 571 , Tax-Sheltered Annuity Plans (403(b) Plans) , we see two conflicting statements when taken at face value. First Statement: “The following ministers are eligible employees for whom a 403(b) account can be established… Self-employed ministers. A self-employed minister is treated as employed by a tax-exempt organization that is a qualified employer.” Second Statement: “Who Can Set Up a 403(b) Account? … A self-employed minister cannot set up a 403(b) account for his or her benefit. If you are a self-employed minister, only the organization (denomination) with which you ...

Question: Are 403(b) retirement plan contributions made on behalf of the minister by the church subject to FICA tax? (The amount contributed was not deducted from the minister's salary; it was made by the church as an employee benefit.) Answer: Simply put, employ er contributions are not subject to FICA tax. However, this is a good opportunity to review elective deferrals . Elective deferrals are monies chosen by employees to be deducted from their paychecks and contributed to the employer-sponsored retirement plan.  Non-minister employees who choose elective deferrals do not reduce the amount of FICA wages that need to be reported. In other words, the elective deferral s are subject to FICA tax.  Ministerial employees are not subject to FICA tax in the first place (read our March 21, 2011 blog post for more info). Therefore, any monies the minister defers to the employer-sponsored retirement plan are not subject to FICA tax.  For a review on the 403(b...

Question: According to Revenue Rulings 58-359 and 63-156, retirement distributions to a pastor may be designated as housing allowance if they come from a church plan . Does a 401(k) plan sponsored by the church qualify as a church plan ? Answer: Normally, non-profit organizations set up 403(b) retirement plans for its employees while for-profit organizations establish 401(k) retirement plans. For churches, one of the benefits of implementing a 403(b) plan is that the retirement distributions to a pastor can be designated as a housing allowance (tax-free compensation). Here are a couple of blog posts that we have written on the matter: 403(b) Retirement Distributed as Housing Allowance Housing Designation of 403(b) Plan Retirement Distributions    According to The Minister Audit Techniques Guide , "...the retired minister may exclude from net earnings from self-employment any retirement benefits received from a church plan (our emphasis). Rev. Rul. 58-3...

Generally, contributions to an employee's 403(b) account are limited to the lesser of: the limit on annual additions, or the elective deferral limit The limit on elective deferrals - the most an employee can contribute to a 403(b) account of salary - is $17,500 in 2014. The elective deferral limit for 2015 will be $18,000.  Employees who are age 50+ at the end of the calendar year can also make catch-up contributions of $5,500 in 2014 and $6,000 in 2015 beyond the basic limit on elective deferrals. The limit on annual additions (the combination of all employer contributions and employee elective deferrals to all 403(b) accounts) generally is the lesser of: $52,000 for 2014 ($53,000 for 2015), or 100% of includible compensation for the employee's most recent year of service.  Generally, includible compensation is the amount of taxable wages and benefits the employee received in the employee's most recent full year of service. If you 403(b) plan doesn't li...

Question: Up until what age can I contribute to my Traditional IRA or Roth IRA? Answer: As long as all other requirements are met, a person can contribute to his or her Traditional IRA until that person reaches the age of 70.5 years. Roth IRAs are different in that contributions can be made regardless of age; there is no "age limit."  Although a lengthy document, IRS Publication 590 is a great resource concerning Individual Retirement Arrangements (IRAs).  

Question: Our church is thinking about acting as a missions agency by directly supporting some missionaries. Do you see any concerns with doing this? Answer: In the past, we have provided blog posts concerning how churches have chosen to serve as missions agencies. Recently, however, we have deepened our research and discussion concerning this complex topic. Our research and experience has provided some additional cautions about a church taking on the responsibilities of a missions agency.  Regulations for missionaries continue to become more complex. Unless a church is willing and able to thoroughly research and act in accordance with these regulations, we strongly discourage churches from acting as missions agencies. We fear that either the church or the missionary will not have the expertise to comply with the law.  Recently, the following topics have added to that complexity: Affordable Care Act Foreign Bank Account Reports (FBARS) Payments to foreign nationa...

 We have recently updated our Top Ten Questions that Ministers, Missionaries, and Church Treasurers Ask Tax Preparers .  Based on our experience, the Top Ten Questions are frequent questions asked by ministers, missionaries, church treasurers, and others serving in ministry positions as licensed or ordained ministers. Our answers are not intended to be exhaustive. Accordingly, you should consult your own tax professional for assistance in applying our information to your specific situation.  The "Top Ten Q&A" has been our most hit web page since 2010. Providing a helpful resource to many who are involved in ministry, it averages close to 1,000 page views every two weeks.  If you prefer to download a PDF of our Top Ten Questions , click here . 

Question: Does a Roth IRA need to be taxed as income? Answer: A Roth IRA is an individual retirement plan which is subject to the same rules as a Traditional IRA with a few exceptions. Unlike a Traditional IRA, contributions to a Roth IRA are not deductible, but distributions from a Roth IRA may be tax free. IRS Publication 590 explains when distributions from a Roth IRA are tax free: "You do not include in your gross income qualified distributions or distributions that are a return of your regular contributions from your Roth IRA(s). You also do not include distributions from your Roth IRA that you roll over tax free into another Roth IRA." If an employer were to make a contribution directly to an employee's Roth IRA account, the amount of the contribution must be treated as taxable compensation just as if cash compensation had been provided to the employee and the employee had subsequently contributed it to a Roth IRA.

Question:   Our church would like to increase our contribution towards our senior pa stor's retirement funds but are not sure what is the most tax efficient way to do so.  We currently give 5% of all our employees gross wages towards a SEP IRA but we'd like to add additional funds for just the senior pa s tor.  Can you provide any suggestions? Answer:   Perhaps the most common way that employers overcome the non-discriminatory rules that confront this situation is to enable employees to make elective deferrals under a “Salary Reduction Agreement.” This permits a more highly compensated employee to defer a significant portion of that higher compensation into a qualified retirement plan.  Since SEP IRA plans are funded only by the employer, the church in the situation cited here should consider whether an alternative plan should be adopted. For many churches this has meant that they adopt an Internal Revenue Code Section 403(b) plan.

Question: A church would like to provide housing for its minister after he retires. His retirement is still a few years off. What can the church do now to provide for its pastor after his retirement? The church would rather not use the parsonage to provide for this retirement housing. Answer: Churches hav e a few options worth considering w hen discussing how best to provide for a retire d minister: (1) The c hurch can establish a 403(b) plan for a minister before he retires and make contributions to it. U pon retirement (retired and no longer providing services to the church) , t he pastor can use this to provide for his own housing, if so designated by the church. Following advice provided in other blog postings on MinistryCPA, distributions from the 403(b) account to the pastor may enjoy tax-free status as a housing allowance. 403(b) Retirement Distribution as Housing Allowance A s seen in the above link,  t he church can designate all or a part of the dist...

Question: I realize that an employer cannot make contributions to a Roth IRA; only the owner (pastor) can. However, can the church deduct an amount from the pastor's pay and make the IRA payment directly to the bank or company that administers the pastor's Roth IRA account? (Realizing that the contribution has to be added to the Pastor's gross income reportable on Form W-2.) Answer: Yes. This facilitation is permissible; essentially, it's no different than withholding from the pastor for any other "convenience" payment that is not a statutory / tax-free benefit. The same conditions apply relative to contributions to a Traditional IRA account on behalf of the pastor.