Do you know all the ins and outs for taxes for ministers?
Recently, a young pastor named Michael confronted his accountant.
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“How could you let this happen?” Michael demanded of the accountant. “How am I supposed to support my family now?”
Michael had been permanently disabled and was no longer able to continue his ministry — or any work for that matter. At least, he thought, he would have a safety net with government aid.
He couldn’t have been more wrong. After applying for disability, he learned that he could expect no help at all from the United States government (he nor his wife had ever contributed to Social Security as an employee).
His accountant recalled the discussion they’d had a year before, when Michael said he was going to file as a conscientious objector to avoid paying Social Security taxes.
The accountant had explained the pitfalls of what Michael proposed, but his client wouldn’t listen. He was entirely focused on getting out of paying the tax. “My salary is so small anyway,” Michael defended. “Why should I give the government a chunk of the money my family needs?”
Now, as the newly disabled Michael faced his accountant, his outrage turned to confusion. Michael was a young man with a young family. His decision to save a few tax dollars cost him the opportunity to receive government support when he and his family needed it most.
“Sometimes pastors are their own worst enemies,” says Ken Washburn, a Stockdon, California, accountant. Washburn has been doing free tax returns for clergy members since 1953.
“I’ve heard every argument you can dream up for not paying taxes,” says Washburn. “Usually what happens is typical of Michael’s story. Pastors exempt themselves from taxes, then catastrophe strikes. They go looking for help, but they already stated to the government that they didn’t want to give or receive help when they filed for the exemption.”
Washburn says he challenges pastors to think hard about the choices they’re making. “I urge my clients to make wise, godly decisions. I urge them to live by the Lord. Be wise, obey the law. The Bible says to give to Caesar what is Caesar’s, and by honoring the law, we’re honoring God.”
Too often Washburn’s advice is unheeded. “So many people tend to think that they’re never going to get old or that they’re invincible. They imagine that no matter what happens, God will take care of them.”
Less Taxing Taxes
Washburn suggests the following guidelines when tax season arrives.
1. Do it the right way.
Cutting corners and finding loopholes may sound great, but almost always these shortcuts come with big consequences. Research your choices, get professional input, and make sure you’re willing to live with the consequences of your decisions.
2. Look toward the future.
You may begrudge the taxes you’re paying now, but think of them as an invisible insurance policy. By paying Social Security and other taxes, you’re ensuring that you, your spouse, and your children can apply for government aid if you’re no longer able to work.
3. Get professional advice.
“Imagine you’re an inexperienced mechanic. You’d get training or buy manuals before tearing into a car, right? Think of your taxes the same way. Don’t make uneducated choices. Ask a professional. And listen to what he or she tells you.”
4. Think in fundamentals.
“So many people come into my office with the attitude ‘I’m not doing what the law says because I’m above it.’ Everyone’s attitude should be, ‘If I’m obedient to the law, God will honor me.’ ”
5. Spend time and money on research and resources if you plan to do your own taxes.
“There’s a high probability you’ll do your taxes wrong, even with lots of research. In the best case, have a qualified accountant do them for you. But if you choose to do your own, spend a lot of time studying, and spend the money to get the proper resources.”
Check out this resource for step-by-step answers to tax questions and preparation: www.churchlawandtax.com/.
6. Fight when you’re right.
Often pastors get audited based on their deductions. If you’ve got legitimate deductions, fight for them.
“Giving in when you shouldn’t sets a precedent for the IRS to disallow the same deduction for pastors everywhere. A lot of the time, if you fight, you’ll win.”
The Business of Taxes Clergy members who meet the definitions of a minister for IRS purposes have special rules and tax considerations that affect how their income is reported.
Criteria for “Minister”
The Internal Revenue Code uses the following criteria to define “minister” for federal tax reporting purposes. In 1989, though, the Tax Court ruled that only the first factor is required, and that a balancing test is required for the remaining four factors. Generally, if a person satisfies the remaining four factors, he or she likely meets the definition of “minister” for tax reporting purposes.
Here’s the criteria established by the IRS for a person to be considered a minister: be ordained, commissioned, or licensed; administer sacraments; conduct worship services; manage a local church or religious denomination; and be considered a religious leader by a church or denomination.
Special Tax Rules
Under the Internal Revenue Code, ministers are eligible for special tax rules relating to the services they perform in their ministry. These include:
• Housing Allowance
This allowance is a portion of the minister’s salary that can be excluded from income taxes for housing expenses. The housing allowance covers occupying a church-owned property rent-free, housing costs incurred for the rental of a home, or housing costs for ministers who purchase their homes.
This allowance is limited to the lowest of the amounts designated, the amount actually spent on housing, or the fair market rental value of the property (plus utilities and maintenance). Any amount designated but not spent or in excess of the rental value must be included in the minister’s income. This determination is the minister’s responsibility, not the church’s. Additionally, while the housing allowance is excludable from regular income tax, it can be included as part of the computation of the self-employment earnings of the minister, if it’s not otherwise exempt.
The housing allowance should be adopted by the church board, recorded in the minutes, and designated in advance of each calendar year. If the housing allowance hasn’t been designated in advance, it needs to be done immediately. Amendments can be made if the designated amount is too low, but amendments only affect future payments.
• Exemption From Social Security Tax
This exemption is available to ministers who are conscientiously opposed to Social Security coverage relating to their ministerial services. These conditions must be met to make this election:
- The church or denomination that ordained, commissioned, or licensed the minister is a tax-exempt religious organization. Religious associations that aren’t churches don’t meet this definition.
- The minister must file an exemption application (Form 4361) with the IRS and certify that he or she, because of religious principles, is conscientiously opposed to the acceptance of any public insurance. Form 4361 must be filed by the due date of the federal tax return (including extensions) of the second year in which a minister has ministerial net earnings from self-employment of $400 or more. The housing allowance, though not taxable income, is included as ministerial earnings for determining whether the $400 threshold is met.
- Applicants must inform their ordaining, commissioning, or licensing body that they’re opposed to Social Security coverage.
This status is required for ministers unless they’re exempted from Social Security tax. Ministers pay the self-employment tax rather than the employee’s share of Social Security and Medicare taxes — even if ministers report on their income tax returns their compensation as an employee.
It’s better if churches treat ministers as employees for Social Security purposes and withhold the employee’s share of Social Security and Medicare taxes from his or her wages. A minister-employee who enters into a voluntary withholding agreement with the church may have additional withholding to cover self-employment taxes. A church whose minister elects voluntary withholding (and who’s not exempt from Social Security taxes) simply withholds an additional amount from each payment and reports this as additional income tax withheld (not FICA tax).
Exemption From Income Tax Withholding
Ministers may elect to be exempt from having income tax withheld from their compensation for ministerial services. This occurs through an exception to the regulations that require every employer to withhold federal income tax. If a minister doesn’t have the church withhold taxes, he or she should personally pay taxes through quarterly estimated tax payments.
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Becky DaVee is a CPA/Shareholder for Stanfield & O’Dell, P.C., in Tulsa, Oklahoma.
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