Practical Tax Tips for Ministers
By Rollie Dimos | Compensation & Payroll
It’s tax time again. April 15 is normally the day that most of us have to file our personal tax returns and pay our tax obligations. (This year, they are due on April 18, however.) While you’re thinking about filing your tax return for the past year or planning for next year, here are some practical ways churches and ministers can make sure they follow appropriate tax laws, minimize taxes, and reduce stress that is often involved in filing taxes.
One special tax provision that ministers are eligible for is a housing allowance. The housing allowance reduces the amount of ministerial income that is subject to federal income tax. However, this benefit is only available if churches and ministers meet the criteria set by the IRS. First, a minister’s housing allowance should be adopted and documented by the church board before the beginning of each calendar year. The allowance must be approved before the allowance is paid since retroactive designations are not permitted.
Although 100% of ministerial income can be designated as a housing allowance, the amount ministers can exclude on their income tax returns is limited to the lowest of three items: the approved designation, actual housing expenses, or the fair rental value of the home (furnished plus utilities).
To make sure ministers are eligible for a housing allowance, churches should:
• Request an estimate of the minister’s housing expenses and properly designate a housing allowance before the first payroll of the year.
• Provide the minister with a copy of the board minutes or action that approves the housing allowance and keep a copy in the minister’s employee file.
Ministers can ensure they obtain the full benefit of their housing allowance by:
• Keeping a copy of their board-approved housing allowance.
• Collecting receipts during the year to substantiate housing expenses. For a list of eligible housing expenses and other resources, view this document: https://empoweringstewardship.com/en/Resources/Frequently-Asked-Questions/Church-Business-FAQs-Personnel-and-Payroll-Matters
• Requesting an updated housing allowance if ministers expect to spend more than their approved housing allowance due to repairs, upgrades, or moving to a new home.
• Obtaining an estimate of the fair rental value of the home from a qualified real estate agent or property management company.
Social Security and Medicare Withholding
For Social Security and Medicare tax purposes, there are two special tax provisions for ministers. One is that ministers have dual tax status. Ministers are usually treated as employees for federal tax purposes, but are treated as self-employed for Social Security and Medicare purposes. Therefore, Social Security and Medicare taxes should not be withheld from ministers’ wages. This means ministers do not have the employee’s one-half of Social Security and Medicare withheld, matched by the employer’s half, and shown as Social Security and Medicare wages and withholding on their Form W-2.
Instead, ministers are required to report and pay self-employment tax on Schedule SE of their federal income tax returns (unless they have an approved exemption from self-employment tax). While the housing allowance computation isn’t included as income when determining federal taxes, a minister’s total income (including housing allowance or the value of a church-provided parsonage) will be considered when computing Social Security and Medicare taxes.
The second special tax provision is the ability for ministers to exempt themselves from Social Security in limited circumstances. The Social Security Administration, at www.ssa.gov, administers the Social Security program. Workers who have not exempted themselves from the program pay taxes into the Social Security system. When they retire or become disabled, the worker and/or their spouse and children are eligible to receive monthly benefits.
Ministers can request exemption from the Social Security system, and therefore not have to pay Social Security taxes on their ministerial wages. However, there are very stringent rules for requesting this exemption, including a conscientious objection to the Social Security retirement program, proper paperwork, and filing deadlines.
If ministers have properly exempted themselves from Social Security by filing Form 4361, none of their ministerial income will be subject to Social Security tax. However, they will not be eligible for Social Security retirement based on their ministerial wages. Additionally, they will not be eligible for income if they become disabled, and their surviving spouses and minor children will not receive income if they pass away before reaching retirement age. Lastly, they will not be eligible for Medicare benefits.
Social Security is designed to replace about 40% of a person’s income at retirement, but according to a recent survey, 13% of all AG ministers have exempted themselves from Social Security. (This number includes 17% of senior pastors and 22% of evangelists.) Due to the lack of retirement or disability benefits for exempted ministers and their families, I do not recommend AG ministers opt out of Social Security. It has always been the policy of the General Council of the Assemblies of God for ministers to participate in Social Security.
• Tip: Some churches try to provide some equity and help to relieve the additional burden of Self-Employed Contributions Act (SECA) taxes for their ministers by paying one-half of the minister’s SECA taxes. This is a generous policy, but does result in additional taxable income for the minister.
Accountable Reimbursement Plan
An accountable reimbursement plan is a policy adopted by the church board that allows employees to be reimbursed for ordinary and necessary business expenses that they have personally paid (or paid from advances) by reporting to the church rather than to the IRS on their personal tax return. In order to meet IRS specifications, the accountable reimbursement plan should have the following qualities:
• There must be a business connection of the expenses reimbursed.
• The employee must make an adequate accounting of expenses by turning in receipts, mileage logs, etc., within a reasonable period of time.
• Any excess reimbursements or advances must be returned to the church employer and may not be retained by the employee.
• Reimbursements may not be made out of salary reductions — reimbursements may not reduce the employee’s taxable wages.
Reimbursements that comply with an accountable reimbursement plan are not counted as taxable income to the employee. However, any reimbursed expenses that do not comply with an accountable reimbursement plan should be treated as income to the employee.
• Tip: Expenses that are reimbursed via an accountable reimbursement plan are treated favorably for tax purposes for two reasons. First, these reimbursements are not counted as taxable income for the minister. Second, the minister can no longer deduct unreimbursed business expenses as itemized deductions on Schedule A of their individual income tax return.
Reducing Tax Liability for Ministers
Given the complexity of ministerial income and taxes, churches can make a significant impact in reducing the tax liability of ministers. Here are a few ways that churches can structure their compensation policies to reduce the taxes for their ministers:
• Designate a housing allowance for all ministers, even those living in a parsonage.
• Identify fringe benefits that can be legally structured as tax-free benefits. For example, rather than providing cash allowances for insurance or retirement, the church can provide group health insurance or make contributions into employer-sponsored retirement programs.
• Ordinary and necessary business expenses should be reimbursed by the church in accordance with an accountable reimbursement plan. If business expenses are currently being paid by the minister or reimbursed in a non accountable way, the church should restructure its budget so that these expenses can be paid by the church.
Although ministerial income and taxes can be confusing, these practical tips can assist ministers in preparing for next year and help to reduce their overall tax burden.