Clergy Tax Guide
By: Jane McGrath
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Anyone familiar with the Christian Gospels will remember that Jesus answered a challenge about whether it’s right to pay taxes, saying, “render to Caesar the things that are Caesar’s, and to God the things that are God’s” [source: Bible Gateway]. Today’s complex U.S. tax code, however, makes it difficult to figure out what exactly is “Caesar’s.”
Considering that churches and religious organizations qualify as tax-exempt organizations in the United States, one might assume that religious clergy and ministers themselves are exempt from income taxes. But this isn’t the case. Devoting your life to God does not necessarily exempt you from the taxman. Clergy must pay income taxes just like everyone else.
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Unfortunately, the rules for clergy income taxes can be especially confusing. Some ministers don’t realize that even if they are employees of a church, they must also send the IRS quarterly payments. To prepare for the tax year, it’s best to understand all the special rules that apply to clergy according to the IRS. It also behooves church administrators and treasurers to understand these special rules in order to minimize the minister’s tax burden.
One of the most important tax concepts to understand is the difference between FICA and SECA, which are the two methods of paying the tax that funds Social Security and Medicare. The average employee of a company pays this tax under the Federal Insurance Contributions Act (FICA), which states the employer must pay half of the tax. Individuals working as independent contractors, however, pay this tax under the Self-Employment Contributions Act (SECA), which states the individual pays the full tax. As a minister, income from your ministerial services is subject to SECA (even if you are an employee of your church for the purpose of income tax).
In addition, you could be eligible for a housing allowance, an important tax benefit. Also, because clergy must pay SECA on Social Security and are exempt from the requirement of having income tax withheld, you will make quarterly payments throughout the year. You must properly estimate your tax liability or risk facing a penalty for underpayment.
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Whether you qualify as a “minister” according to the IRS can affect tax benefits, Social Security taxes and whether you are exempt from income tax withholding. We’ll take a close look at IRS Publication 517 for these definitions.
According to the IRS, ministers are “individuals who are duly ordained, commissioned, or licensed by a religious body constituting a church or church denomination.” Notice that the minister could be that of any kind of religious body — be it Christian, Jewish, Muslim or otherwise. It also depends on the functions you perform. The IRS continues, “Ministers have the authority to conduct religious worship, perform sacerdotal functions, and administer ordinances or sacraments according to the prescribed tenets and practices of that church or denomination.”
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Confusion might arise depending on the language the religion uses for designating different types of ministers. The IRS attempts to clear that confusion by saying, “If a church or denomination ordains some ministers and licenses or commissions others, anyone licensed or commissioned must be able to perform substantially all the religious functions of an ordained minister to be treated as a minister for Social Security purposes.”
As we mentioned earlier, the IRS states that ministerial services are subject to self-employment tax. Ministerial services refers to “services you perform in the exercise of your ministry,” including “performing sacerdotal functions,” (that means performing weddings, baptisms and other ceremonies) “conducting religious worship” and “controlling, conducting, and maintaining religious organizations.” In addition, ministerial services can include nonsacerdotal functions for nonreligious organizations “if the services are assigned or designated by your church.” Furthermore, ministerial services can include sacerdotal functions not assigned by your church.
Services that don’t qualify as ministerial services are subject to FICA, not SECA. One example would be nonsacerdotal services for nonreligious organizations that are not assigned by the church — for instance, an ordained minister teaches a psychology class at a local college. However, it can also include sacerdotal services performed as a chaplain in the Armed Forces or in a government-owned hospital. Check IRS Publication 517 for more details.
In some cases, the IRS can grant an exemption from self-employment tax if the individual is conscientiously or religiously opposed to accepting public insurance. Once you request exemption, you must receive authorization from the IRS and keep it for your records. But this does not apply to income received from nonministerial services. Once granted, this is exemption is irrevocable, and the minister will not receive Social Security or Medicare benefits for retirement if he or she doesn’t have qualifying credits (e.g., from another job).
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Clergy can be employees with respect to federal income tax on salary from a church and also be self-employed with respect to Social Security on the income made from services in the exercise of their ministry. This is known as a dual tax status.
So when does the IRS consider a minister an “employee” of the church? The answer depends on the circumstances. The IRS explains that you are an employee “if you perform services for someone who has the legal right to control both what you do and how you do it, even if you have considerable discretion and freedom of action.” (The IRS bases this on “common-law rules,” which is law based on custom and legal precedent rather than legislative action.) Exceptions would include traveling evangelists or clergy who work for multiple churches, which would make them independent contractors rather than employees.
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If you are a minister who is an employee of a church, make sure the church sends you a W-2 after the close of the year rather than a Form 1099, which an independent contractor would receive. However, this W-2 will not necessarily list any income tax withheld. Ministers are exempt from the requirement of income tax withholding. Instead, clergy can pay income taxes in quarterly installments throughout the year. If you make arrangements with your church, you can elect voluntary withholding. If that is the case, the church should withhold income taxes only (not Social Security taxes, which you must pay quarterly throughout the year). It is important to remember that all ministers – including those who are employees of a church – must pay Social Security tax under SECA on income from ministerial services.
Take note that clergy who qualify as employees often receive additional income in the form of fees directly from members of the congregation. This is customary when ministers preside over weddings and funerals, perform baptisms or serve as guest speakers at an event or another church. This non-salary income from such services is subject to self-employment tax for both federal income tax purposes and Social Security tax purposes [source: IRS Publication 517].
Members of religious orders have to pay self-employment tax if they have not taken vow of poverty. Those members of religious orders who have taken a vow of poverty are not subject to self-employment tax because the IRS considers any earnings as belonging to the order itself.
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Clergy should make sure their church designates an adequate portion of their salary for a housing allowance. This is considered the most important tax benefit available to clergy. The housing allowance is not subject to federal income tax, but it is subject to Social Security tax under SECA.
One aspect that makes the housing allowance a great tax benefit is that you can deduct the housing allowance from your gross income, which means it is an “above-the-line” deduction. In other words, you do not have to itemize your deductions to take advantage of this tax benefit.
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Several rules apply to this tax benefit. For instance, the church must designate a certain amount of the salary for the housing allowance in advance of the payment (never retroactively after the payment is made). A good routine would be to make sure that, every year, the church designates the housing allowance before the beginning of the calendar year in some kind of official capacity, such as in the minutes of a meeting and a formal business letter to the minister.
Clergy can take advantage of this tax benefit whether they own or rent housing, or even if they live in a church-owned parsonage. Whatever the situation, however, the allowance cannot be for more than the “fair rental value” of the residence, including not only rent or mortgage payments, but also utilities, maintenance and provided furniture. (Make sure to keep receipts of all such housing expenses.) Don’t go out and buy a mansion right away though; the allowance must be a portion of your salary and so cannot amount to more than the “reasonable” pay for your services.
Any portion of the housing allowance that is not used toward housing, utilities and furniture is taxable income. Say a church provides $20,000 per year for the housing allowance, but when the minister adds up all the mortgage payments, utility costs and maintenance costs, it only amounts to $18,000. In this case, the minister would only be able to deduct $18,000 from his taxable income, and the extra $2,000 would count as taxable income like the rest of the minister’s salary.
In other words, you are allowed to exclude from your taxable income whichever is lowest: your housing allowance amount, your actual housing expenses or the fair rental value of your home.
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Ministers who own their home can not only take advantage of the housing allowance by including mortgage payments as housing expenses, but also can deduct mortgage interest and property taxes on their itemized deductions. This is often referred to as a “double deduction” [source: Guidestone].
Once ministers pay off their mortgages, however, they can lose a good portion of this important tax benefit. But the Tax Court has ruled that a minister can obtain a home equity loan and include the loan payments as part of the housing allowance for tax purposes as long as the loan was obtained for housing-related expenses [source: Hernandez].
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We mentioned earlier that the housing allowance is subject to Social Security tax under SECA. However, retired clergy are considered unemployed and so do not have to pay the Social Security tax on this allowance [source: IRS]. Special rules also apply to traveling evangelists, theological students, teachers and administrators, and Cantors in the Jewish faith. You can check out Publication 517 for these details. Also, when calculating your state taxes, make sure to check the rules for your particular state. Most states allow clergy to exclude the housing allowance from taxable income, but some don’t.
Aside from housing, clergy usually incur significant business expenses as a part of their job, such as maintaining a car for transportation, paying for continuing education, and obtaining books and resources. If clergy must rely on their salary to pay for these expenses, it will be an extra tax burden for them. Before 2018, clergy used to be able to declare these business expenses on itemized deductions, but unreimbursed business expenses are no longer deductible. Instead, churches can help their ministers avoid this tax burden by setting up an Accountable Reimbursement Plan. This would allow the minister to get reimbursed by the church for business expenses.
To use such a plan, the IRS requires that you incur these expenses while performing services as an employee, you account expenses to the church in a timely manner and you return unused allowance for expenses [source: IRS]. Make sure the church outlines the rules for the plan in writing and you keep copies of all receipts as verifiable evidence [source: Hammar]. You will not need to include the Accountable Reimbursement Plan on your federal return, but both the church and minister should keep these records in case of an audit.
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In an average non-clergy job, the employer withholds an employee’s federal income tax and Social Security tax from every paycheck. But clergy are both exempt from federal income tax withholding and considered self-employed for Social Security tax purposes. This means a church normally won’t withhold income tax and never should withhold Social Security tax for clergy. Therefore, the minister will have to pay tax to the IRS in quarterly installments throughout the year.
See IRS Form 1040ES to determine whether you must make estimated payments for income tax throughout the year on a quarterly basis. This form states that you should calculate your estimated tax liability for the whole year. You must pay estimated tax payments if you expect to owe a certain amount that the IRS sets each year. For 2021, this amount is $1,000 or more after subtracting withholding and refundable credits, and you expect the withholding and credits to be less than 90 percent of the tax on your 2021 return or 100 percent of the tax shown on your 2020 return (which must cover all 12 months) [source: IRS Form 1040ES].
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You can use your previous year’s tax return as a guide for estimating your tax liability. If this is the first year making quarterly payments, use Form 1040ES to help estimate your total tax liability at the beginning of the year and divide that total by four. Make a check out for this amount and submit it to the IRS by April 15. Subsequent payments are due June 15, Sept. 15 and Jan. 15. If your situation changes, and you determine mid-way through the year that you’ll owe more or less than you estimated, you can make adjustments on your remaining payments. If you find at the end of the year that you’ve underpaid, you might have to pay a penalty.
Clergy don’t have it easy when it comes to figuring out what they owe to the IRS. Yes, it is true that clergy enjoy an exceptional tax benefit in the housing allowance, but clergy have the burden of spending extra time figuring out what they owe or spending extra money on a professional tax preparer. And because there is plenty more to learn about clergy tax beyond the scope of this article, seeking the advice of a professional is probably wise.
Originally Published: Dec 18, 2014
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Figuring out one’s own taxes as a normal employee and minimizing one’s tax burden can be difficult considering the complexity of the tax code. But it was eye-opening while researching this article to realize how much more complex it can be for certain people.
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