Clergy Tax Preparation
Do You Understand Clergy Tax Preparation?
If you just finished seminary and are planning to become a minister, or you’re already one looking for information, clergy tax preparation is not cut and dry. The terms dual tax status and clergy self employment tax may have you scratching your head in disbelief.
Stick with us, and we’ll explain the various rules that the IRS has set for ordained ministers. Some of these have to do with how your income is taxed, tax free parsonage allowance, claiming an exemption from the self employment tax, and where and how to report your deductions and income.
Taxation of a minister’s income
When we mentioned dual status above, here is what it means. For federal income tax, a minister is an employee, but for FICA and Medicare taxes, he is self employed. You see now how confusing this can be for many who do clergy tax preparation.
If you’re an ordained minister at a church, you would be issued a Form W-2. The church is allowed to withhold federal and state income taxes, but not FICA or Medicare. For those 2 taxes, you are considered self employed, and are expected to make estimated taxes to pay them.
First, and foremost, if you are a minister, you must be ordained, licensed, or commissioned by a bona fide church, or a church denomination. You also must have authority to hold religious worship services, perform sacerdotal functions, as well as administering sacraments and ordinances.
These same requirements apply if you are a Christian Science reader or practitioner. Your salary/income earned from those services are generally considered to be self employment earnings. However, there is one very significant exception to these rules, that applies only to a minister.
Can a minister exempt himself from clergy self employment tax?
Simple answer…sure, but read on. The IRS says that if you are conscientiously opposed to public insurance because of your own religious considerations, or if the religious denomination that you are a member of opposes due to their own principles, you can apply for exemption for paying clergy taxes for FICA and Medicare.
You do this by completing Form 4631 and sending it to the IRS. This form must be filed with the IRS by the due date of your income tax return for the second year after earning at least $400 in self employment earnings. I found a good site for ministers to get answers to their questions.
If the IRS approves your request for exemption, you don’t have to pay Social Security or Medicare taxes on your earnings. By the same token though, you also don’t qualify for Social Security benefits or some parts of Medicare when you retire. Like any other government program, there are ways around these little obstacles.
All one has to do is to get a secular job and pay in Social Security and Medicare for the required quarters, and then your problem is solved. Government employees and postal service employees have been doing this for many years.
If you claim and are approved for the exemption, it’s irrevocable for life. What you can do is to take the money that you would have been paying into FICA and Medicare and use it to fund a retirement account.
Parsonage or housing allowance subject to minister taxes?
An ordained minister is permitted to exclude from his income a housing allowance or a rental allowance that is included as payment for his services. If the church provides a home (parsonage) for him, he can deduct the fair rental value of that home. A better term for deduct, is reclassify.
What the minister is doing, is to reclassify a part of his total salary package as housing allowance, that is not subject to federal or state income taxes. However, the housing allowance is subject to self employment taxes. A very important point here, is that the church and the minister must set a specific amount as housing allowance before the year begins. There’s no playing with numbers and backing into an amount once the year begins.
In the case of providing a parsonage, the minister can exclude this allowance from his taxable income, provided it doesn’t represent excessive payment for his services, or doesn’t exceed the fair rental value of the home. This includes home furnishings and utilities too.
An example showing how this works is as follows: Rev. John Smith is an ordained and full time minister of a local church. His total salary package is $75,000 and the church provides a home that has a fair rental value of $18,000. The church also has designated $6,000 of his package as the cost of utilities, and the entire amount was spent.
For income tax purposes, Rev. Smith reclassifies $24,000 of his package as housing allowance.( $18,000 as fair rental value and $6,000 for utilities.) On his annual Form W-2, taxable income for federal and state purposes is $51,000. However, when he calculates his self employment tax on Schedule SE, the amount taxable there is $93,000.
Where to report ministerial income when doing clergy tax preparation
Reporting your various types of income as a minister can be confusing at times. From your Form W-2. enter the wages amount on your 1040 as wages paid. The tax program will carry a minister’s wages to form SE to calculate self employment tax. The amount that you claimed for housing allowance, you should enter on Schedule SE on the appropriate line.
Any money you received from offerings, performing weddings or funerals, and any other similar type, should be entered on Schedule C, profit or loss from business. If you have any expenses that were incurred for the Schedule C income would be entered there as an expense.
Other business expenses related to your wages would have been entered on Schedule A prior to 2018, but the Tax Cuts and Jobs Act that took effect on January 1, 2018, eliminated the category for miscellaneous deductions as well as employee business expenses, including the home office deduction. Who said clergy tax was simple?
Other minister deductions that affect clergy taxes
There are a couple of deductions that are sometimes missed by ministers when filing their own taxes. The first one is the deduction for 50% of self employment taxes paid, and is deducted as an adjustment from gross income.
The second one is for medical insurance cost, and it is a tricky one. Self employed individuals can deduct 100% of the cost of their health insurance, not to exceed the net profit as shown on Schedule C or Schedule F for a farmer.
Since a minister’s salary and housing allowance is subject self employment taxes, you would think they qualify for this deduction based on that. But not so, says the IRS. They state that a minister is an employee for federal income tax purposes, and as such, cannot use that deduction based on their wages.
However, if the minister files a Schedule C where he reports fees and other types of Honoria as self employment income, the net profit of that may qualify for a partial deduction of health insurance. (Remember my comments earlier in this article about a minister having dual status?)
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