Special Clergy Tax Rules
September 22, 2014
Whether you are clergy member or are responsible for payroll for clergy, the following information will be of particular interest. A complete understanding of these tax rules may keep you in compliance.
The IRS has several special rules attributed to wages paid to clergy. Though you may be familiar with some, others might take you by surprise.
In 1995, a Federal Appeals Court ruled in Weber vs. IRS Commissioner that, for income tax purposes, clergy may be considered employees depending upon the relationship that exists between the clergy and the employer. If a clergy is an employee, Form W-2 should be issued for income earned instead of Form 1099, and unreimbursed expenses are an itemized deduction subject to 2% of Adjusted Gross Income (AGI).
In addition, all earnings, including wages, offerings and fees received for performing marriages, baptisms, funerals, etc. are subject to income tax regardless of whether ministers are employees or self-employed persons.
Self Employment Taxes
However, the Weber case did not change the rules related to Social Security or Medicare. Clergy are still considered self-employed and file Schedule SE on their 1040 and pay both the Employee and Employer portion of Social Security and Medicare tax (a total of up to 15.3%) on earned income. That means when issuing Form W-2 for a minister, boxes 3, 4, 5, and 6 related to Social Security and Medicare wages and taxes withheld are left blank and remitted by the clergy member personally. The Church generally does not pay any portion of this tax. If the Church feels compelled to pay a portion of the self-employment tax, then the additional tax paid on the pastor’s behalf must be included in their W-2 wages subject to income taxes and still remitted by the pastor personally.
Clergy are allowed the housing exclusion allowance for income tax purposes. This includes “housing allowance” (when the pastor owns their home), “parsonage allowance” (when the pastor is in Church provided housing) and “rental allowance”. Many pastors are able to save thousands of dollars each year in income taxes by taking advantage of a housing allowance in lieu of an equivalent salary amount. There are several IRS requirements and limitations the Church and pastor must comply with in order to properly take advantage of this exclusion. Please see IRS Publication 517 for complete rules.
The housing allowance is excluded from income taxes but not excluded from Social Security and Medicare. This income must be included on Schedule SE on Form 1040. The Church will need to provide this information, usually in the form of a letter, to pastors at the same time the W-2s are issued. Lastly, the housing allowance is only exempt from income taxes if the allowance is fully spent on reasonable out of pocket housing.
Exemptions from Paying Self Employment Taxes
The pastor also has the option to exempt out of paying self-employment tax for ministerial earnings, if they are opposed to certain public insurance for religious or conscientious reasons. They are not allowed to request this based on economic reasons alone. (Note: Non-ministerial earnings are not exempt from self-employment taxes, i.e. income earned from teaching at the local college.) To request this exemption, the pastor must file Form 4361, Application for Exemption From Self-Employment Tax for Use by Ministers, Members of Religious Orders and Christian Science Practitioners, with the IRS. This form must be filed by the due date of your income tax return for the second year in which you have net earnings from pastoral services of at least $400. Once the application has been approved it is irrevocable.
Though the outcome of the in Weber vs. IRS Commissioner was intended to clarify rules for clergy income reporting, like any IRS compliance matter, there are situations in which you would be best served by seeking professional advice. Smith and Howard’s nonprofit group provides tax, audit, accounting and advisory services to religious organizations and those who are employed by them. Please call us at 404-874-6244 for assistance.
Contributed by Rosalie Rowland, Smith and Howard Nonprofit Group.
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