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How to Save your Minister Some Taxes and Avoid the IRS
By Dr. John L. Stancil
Tax Analyst, WebTaxCenter.com
Your church pastor is a beloved individual and your church makes every effort to treat him well. The church provides a salary, of course. But the members also give him a love offering at Christmas, provide him with a housing allowance, give him a car or a travel allowance. And last year, to celebrate his 10th anniversary with the church the members gave him and his family a trip to Hawaii. How much of this is taxable income to the pastor? Is there any way you could structure his earnings to reduce the amount of tax he pays?
Ministers occupy somewhat of a unique tax niche in the United States. They occupy a dual-status as they are employees for income tax purposes, but self-employed for social security and Medicare. In addition, a number of items in the tax code apply specifically to ministers.
The IRS defines a minister in rather broad terms to avoid raising issues of separation of church and state. A minister is an individual who is duly ordained, commissioned, or licensed by a religious body constituting a church or church denomination. In this status, the minister has the authority to conduct religious services, perform ministerial duties according to the rules and traditions of the church. This broad definition has led to abuse, as the IRS has not defined what is a church or church denomination.
Reporting the Minister's Income
As a dual-status individual, ministers are not subject to withholding on their income, but must make quarterly payments of their estimated tax unless they choose to have taxes withheld from their paychecks. Because of this dual-status and the specter of separation of church and state, churches frequently do not properly report the earnings of a minister. I have seen minister's income reported on W-2's, 1099's, scraps of paper, or not reported at all. The correct way to handle a minister's earnings is to report them on a W-2. Failure to report the minister's earnings properly is a violation of the law.
A minister does have the opportunity of opt out of social security. To opt out, the minister must file Form 4361 with the IRS no later than April 15th after the second year in which he had ministerial earnings of at least $400. This is an irrevocable decision and should not be taken lightly. In order to opt out, the minister must be conscientiously opposed to public insurance due to a religious conviction that opposes such insurance. The minister cannot opt out for economic reasons.
Salary Issues
A minister's salary, along with bonuses, Christmas gifts from the church similar income are taxable. The church cannot give an employee a "love gift" - it is taxable income. Giving him a car, a trip or other expressions of gratitude are also taxable income. Unless structured properly, his travel and other allowances may be taxable.
An individual can give gifts to the minister with no tax consequences provided they are genuine gifts and not given in exchange for services such as performance of a wedding. They also must be given directly to the minister and cannot be funneled through the church.
Benefits the minister receives such a contributions to a retirement plan, payments for health or life insurance or similar items are subject to the same rules as for all employees and are not usually taxable.
Accountable Plans
There is an opportunity to save your minister on his tax bill by how the church structures his allowances. Usually, these fall into three categories - housing, travel, and professional expenses. A housing allowance is a great benefit for a minister as it is not taxable income, but he may deduct the interest he pays on his home mortgage. Housing allowances are taxable for social security purposes, however.
The housing allowance cannot exceed the amount the minister spends on housing. The good news is that this is broadly defined and includes expenditures for rent or mortgage payments, utilities, real estate taxes, homeowner's insurance, improvements and upkeep, furniture and appliances, decorating, cleaning supplies, lawn tools, and landscaping. The church must approve in advance the amount of compensation that is to be designated as housing allowance. The approval must be an official action of the church, appropriate board, or committee. Any amount designated as housing allowance and not used for housing becomes taxable income.
Most churches give the minister a travel allowance, some include a book allowance. If they merely give him a set amount periodically, such as writing him a check for $200 each month to cover these allowances, the church is costing the minister at tax time. This approach is known as a non-accountable plan. The minister is not required to account to the church for the expenditure of the monies. Literally, he can do whatever he chooses with the funds. Under a non-accountable plan, the minister reports the allowance as income and can deduct the travel and professional expenditures as miscellaneous itemized deductions on Schedule A. However, he will not get a full deduction as that deduction is reduced by 2% of his adjusted gross income. If he does not itemize his deductions, he gets no tax benefit from the expenditures.
Under an accountable plan, the church agrees to reimburse the minister for his travel and perhaps his professional expenses. When he incurs an expense, he submits receipts to the church and is reimbursed for that amount. This is an accountable plan as the minister accounts for the use of the funds. This allowance is not reported as income or expense by the minister.
By structuring this as a travel/professional allowance, the minister gets some flexibility in the use of the monies. He does not have to leave any unused travel funds on the table, but can spend them at the end of the year for books, software or other professional expenses.
Taxes for ministers can be difficult because ministers are treated differently in our tax code. Another problem is that church leaders, ministers, and many tax preparers are not knowledgeable in church and ministerial tax issues. There is, however, a great deal of assistance available. The IRS has two publications that may be helpful: Publication 517 "Social Security and Other Information for Members of the Clergy and Religious Workers" and Publication 1828, "Tax Guide for Churches and Religious Organizations." B. J. Worth annually publishes Worth's Income Tax Guide for Ministers. Dan Busby has two books of note that are published annually, Church and Nonprofit Tax and Financial Guide and Minister's Tax and Financial Guide. All of these are reradable, informative books that should help you navigate income tax issues for churches and their ministers. Additional information may be found at www.webtaxcenter.com or from your income tax professional.
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Dr. John L. Stancil, a tax analyst for WebTaxCenter.com, has been a member of the Florida Southern College faculty since 1998. He received his bachelors degree from Mars Hill College and holds a M.B.A. from the University of Georgia. He later earned his doctorate in accounting from the University of Memphis. He holds four professional certifications, including CPA, CMA, CFM and CIA. Stancil has received the Florida Institute of CPAs 2005 Outstanding CPA in Public Service Award. (This award is given annually to a Florida CPA who has demonstrated significant contributions through community and civic activities.) He has also been recognized as the Expert of the Month on several occasions by allexperts.com.
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