After years of studying Scripture, Hebrew, Greek, history, theology, and a wide variety of other spiritual subjects, clergy members sometimes find that they could have used a business tax course or two as well. This is especially true for smaller ministries. Fortunately, the IRS offers guidance in Publication 517 on complicated pastor payroll issues such as payroll taxes and housing allowances. Unfortunately, this publication is written in IRS speak which can be more difficult to translate than Greek. Consider us your concordance.
The following are the top ten questions we are asked by the churches we work with, and some simple, plain English answers.
1. Do ordained members of the Clergy have FICA taxes withheld from their paychecks?
Before we answer this, we need to define some terms. Federal Tax Withholding (FTW) is the money taken out of your paycheck for Income Taxes. Yes, even a minister of a tax exempt church still has to pay Income Taxes.
FICA stands for Federal Insurance Contribution Act. That really isn’t important. What’s important is that FICA is your Social Security and Medicare taxes. In a normal job, half of this tax (6.2% for Social Security, 1.45% for Medicare) is withheld from your paycheck, the other half is paid by your employer. If you are an ordained member of the Clergy, you do not pay FICA taxes.
However, if you have not specifically filed to be exempt from the Social Security program, you will pay Self Employment Taxes (SECA) on your personal Income Tax return on April 15th. This tax comes to 15.3%, so we recommend making additional quarterly estimated tax payments or withholding extra from your paycheck to avoid a hefty tax bill at the end of the year.
2. What is the difference between FICA and SECA?
You might be asking yourself at this point, is there a difference between FICA and SECA taxes? If not, just skip this section.
FICA and SECA taxes end up coming to the same percentage. The only difference is that with FICA taxes the employer pays half and gets a deduction for it (not really helpful for your tax-exempt church) and the other half is withheld from your paycheck. For SECA taxes the employee pays the whole amount on their personal tax return, but the employee gets to take a deduction for half. This makes better use of the tax deduction but sticks the employee with the whole tax bill.
3. What about my non-ordained church employees?
Unless you file specifically for them to be excluded from FICA withholding, then they are treated like employees of any other business. They will have FTW and FICA withheld from their paychecks.
If your church is religiously opposed to paying FICA taxes, then you can file Form 8274 to exclude your employees from having it withheld from their check. This doesn’t get them out of paying these taxes, it just means they have to pay them in the form of Self Employment taxes on their own personal Income Tax return instead.
4. So then what is the advantage of electing out of the Social Security program?
For non-ordained Church employees…nothing. They still have to pay the tax whether it is withheld from their paycheck and the church pays the employer portion, or they pay both portions themselves through Self Employment taxes. And before you think about ordaining your secretary, treasurer, cleaning person, and maintenance staff, their duties do not qualify as ministerial duties so it won’t work.
For Clergy, if you opt out of the Social Security program then you don’t have to pay Self Employment Taxes on your earnings from your qualified clergy duties. That will save you 15.3% in taxes, which certainly isn’t a bad deal. The downside is that the hours you work as a clergy member are not taken into account when determining what Social Security or Medicare benefits you are eligible for. You will need to start saving now to make sure you can take care of your family when you retire.
5. Do I have to have Federal Withholding taken out of my paycheck?
Don’t be confused. Whether you have Federal Withholding (not to be confused with FICA or SECA) taken out of your paycheck or pay your taxes through quarterly installments, you are responsible for paying your income taxes each year. I think having income taxes withheld from your paycheck is easier and saves you from quarterly sticker shock, but as an ordained member of the clergy you don’t have to do it this way. If you are disciplined and can make sure you have enough saved up each quarter to make your estimated tax payments, it is always nice to be able to earn interest on that money as long as possible.
6. How does the housing allowance for clergy work?
The Church can pay you to rent a house, pay you the fair rental value of your home, or provide a home for you without increasing your income taxes. However, you will pay Self Employment Taxes on these amounts if you are not exempt! Let me provide some examples:
Let’s say Rev. Smith lives in a parsonage provided by the church. The church doesn’t charge him any amount for the parsonage and pays his utility bills. For Income Tax purposes, these amounts are completely exempt. However, if he is not exempt from FICA or SECA, he will have to include the fair rental value of the parsonage and the amount paid for utilities as Self Employment income.
Now, let’s say Rev. Smith moves to a smaller church that does not have a parsonage. The church can rent a house for him and pay his utility bills and even furnish the place for him without increasing his income tax. However, just like with the parsonage, the amount that is paid for his rental, utilities, and furnishings becomes self-employment income to him if he is not exempt.
Finally, let’s assume that after a few years Rev. Smith has established himself and decides to buy a house. The church can now pay him the lesser of the fair rental value of his furnished home plus utilities or his actual expenses without increasing his Income Taxes. Actual expenses include mortgage payments, so if he owns his house outright make sure you take that into account. Once again, the housing allowance amount is subject to Self Employment Taxes if he is not exempt.
7. What if the church decides to reimburse me more than the fair rental value of my home?
You only get the exemption for the lesser of the fair rental value of your furnished home plus utilities or your actual expenses. If that is $30,000 a year and the church gives you a housing allowance of $35,000, that additional $5,000 becomes taxable for Income Taxes as well as Self Employment Taxes.
8. In the end, what will the forms I take to my tax preparer look like?
As a minister, you will probably receive a W-2 Form from the church for your ministerial services. This will show your wages in box 1 and any Federal Withholding in box 2. Box 14 will show your housing and utilities allowances.
You may also receive 1099 Forms for extra services you perform such as weddings, funerals and honorariums for special speaking engagements. These amounts will be reported as business income on Schedule C, allowing you to deduct any related expenses against these amounts. Yes, this is subject to Income Taxes, and yes, unless you are exempt this is subject to Self Employment Taxes as well.
9. What about unreimbursed expenses and business expenses?
This gets a little complicated, and I recommend contacting your tax adviser/preparer when it comes time for preparation. Very simply put, the IRS doesn’t let you take deductions against non-taxable income. Where this becomes an issue for you as an ordained member of the clergy is that your housing allowance is non-taxable income.
Basically, you can only deduct a percentage of your expenses based on what percentage of your total income (wages, honorariums, housing allowance, etc.) is subject to Income Taxes. The result is a set of complicated worksheets that only the IRS could come up with. On the other hand, even though your housing allowance is not subject to Income Taxes, you can still deduct 100% of your mortgage interest and property taxes on Schedule A.
10. What about Health Insurance and Retirement?
Whether you opt out of Social Security and Medicare or not, you might be wondering how the IRS treats your income for retirement plans and health insurance plans.
For Retirement Plan purposes, you have some flexibility as far as what plan you can set up. If you receive wages from the church based on a specific, regular ministry that you provide for the church, then you are most likely considered an employee even though your wages are subject to Self Employment taxes. This allows the church to set up an employee retirement plan and have you participate.
On the other hand, if you receive money for irregular services such as marriages, baptisms, and funerals, this is considered self-employment income and you may be eligible to set up a SEP or SIMPLE plan for yourself. I recommend consulting with your tax adviser or financial adviser to determine your specific circumstances.
You may be eligible for favorable treatment of your health insurance costs if you are determined to be self-employed. If you perform services aside from your normal ministerial duties and are not eligible to participate in a health plan subsidized by your or your spouse’s employer, then you can take your health insurance costs as a non-itemized deduction on page one of your Income Tax return up to the amount of your net self-employment income.
We hope this guide has proven useful. Be aware that there is an ongoing assault on the beneficial Clergy tax status from groups like the Freedom From Religion Foundation who has an open court case to strike down these benefits as unconstitutional. As with any tax question, please consult your tax adviser for additional information for your specific situation.