There are many tax rules that apply only to ministers and churches. But very few people are aware of them. Since ministers only comprise about 2 tenths of 1% of the U. S. population, it’s not surprising that even highly competent CPAs and accountants are often unfamiliar with the differences that exist between payroll tax regulations for ordinary employees and payroll tax rules governing ministers. But there are several differences, and they are significant.
Who is a Pastor? The first issue of concern for church administrators is ‘who is a minister for federal tax purposes?’ This is a critical concern since everything changes once an individual is considered a minister by the IRS (eligible for Housing Allowance; in SECA system; etc.). Though it is sometimes difficult to know for certain, IRS Tax Court rulings over the years have provided us with a helpful ‘5-Factor Test.’
Clearly, if an individual is PCA ordained and serving in the church with a ministry job description, then he would be considered a minister by the IRS. And it’s equally clear that those who are not commissioned, licensed, or ordained would not be considered a minister. But there is a lot of ‘grey area’ in the middle (e.g. licentiates, youth ministers, ordained schoolteachers, music directors, etc.). Where we lack clear court case precedence, the ‘5-Factor Test’ is helpful in determining how light or dark that grey may be. If your employee is in the grey area, please consider adding to your library a copy of Richard Hammar’s 2020 Church & Clergy Tax Guide (C&CTG) (https://store.churchlawandtax.com/2020-church-clergy-taxguide-book/). The ‘5-Factor Test’ can be found in section two of chapter 2 in the 2020 Church & Clergy Tax Guide.
Dual Tax Status. Once ministerial status has been established, employment status must be determined. Are ministers to be considered statutory employees of the church or self-employed contractors? The answer is “yes!” Let me explain. With the occasional exception of those who labor outside the boundaries of regular congregational ministry (e.g. traveling evangelists, etc.), ministers serving in the local church are simultaneously considered both employees for Federal and State income tax purposes and self-employed for Social Security purposes.
W2 Employees. Because pastors are employees for Federal and State tax purposes, they should receive a W2 at the end of the year. They should not be issued a 1099 (except perhaps for income received outside of their church employment). 1099s should be reserved for truly independent contractors and ministers who are not employed by the church but are paid to fill your pulpit on occasion. (See C&CTG, and IRS Publication 15-A for more information: https://www.irs.gov/pub/irs-prior/p15a–2020.pdf)
SECA taxes. Because most pastors are considered self-employed for Social Security purposes, they are no longer covered by the FICA system (Federal Insurance Contributions Act, i.e. ‘payroll tax’). Therefore, no employee or employer Social Security or Medicare tax should be withheld or paid in on their behalf. Ministers are in the SECA system (Self-Employed Contributions Act). Self-employed individuals pay an amount equal to 15.3% (a combined employee 7.65% FICA tax + employer 7.65% FICA tax) of their income. For pastors this tax must be paid on their salary, housing allowance, and all taxable benefits. Paying SECA is so burdensome that for most pastors not even housing allowance can make up for it. For this reason, we encourage churches to provide a ‘Social Security & Medicare Allowance’ equal to the employer FICA of 7.65%.
Withholding. Another unique ministerial tax rule involves withholding. Though the church is required to withhold Federal Income Tax (FIT) and State Income Tax (SIT) for all other employees, they are not required to withhold ‘income’ taxes for pastors. They can withhold taxes however if both the church and the pastor agree to ‘voluntary’ withholding. If withholding is not burdensome to the church, we highly recommend that churches withhold taxes. Of course, pastors can make estimated quarterly tax payments but given that most pastors are not generally focused on financial matters, it’s always helpful if a church can withhold income taxes. It could help your pastor avoid an unintentional call to prison ministry.
The bigger issue is determining how much to withhold. Since pastors are in the SECA system, their selfemployment social security taxes (SECA) must be paid-in during the year as well. But they cannot be paid directly to the Social Security Administration like payroll taxes (FICA). Instead, they must be paid-in as part of the estimated quarterly tax payments, or if taxes are being withheld voluntarily by the church, they must be sent in as part of their Federal Income Tax (FIT) withholdings.
Herein lies the difficulty. An awful lot of money must be withheld from each paycheck to cover both FIT and SECA taxes. How much? Well, since Form W4 was not designed for ministers, far more than the math on the W4 worksheet would suggest. So much more, in fact, that we would strongly recommend an estimate be calculated at the beginning of the year. Once a number has been calculated, a minister should use line 4c (‘Extra Withholding’) on the W4 to communicate the amount to their employer.
With the right information, Financial Planning Advisors at RBI can assist your staff in calculating a withholding estimate. Please let us know if we can be of assistance.
Housing Allowance. Housing Allowance (HA) is income that is excluded from FIT and SIT taxation. (This provision is available in most but not all states.) Many pastors are unaware their HA is taxable for SECA tax purposes, and the same is true for manse and utility allowances if applicable. Please make sure these amounts are taken into consideration when calculating withholding amounts. Many pastors underreport their taxes every year by failing to report HA as taxable income on their IRS 1040 Form Schedule SE. Moreover, many CPAs and accountants fail to report this income as well.
PCA 403b Retirement Plan Contributions. Additionally, if your pastor or the church make contributions to the PCA 403b, he will save FIT, SIT, and 15.3% SECA taxes. Since pastors are not in FICA, they avoid FICA taxes on traditional pre-tax ‘salary deferral’ contributions. In fact, whether they receive employer contributions or make employee contributions, they avoid all SECA taxes.
On the other hand, pastors who make contributions to Traditional IRAs are paying 15.3% SECA (net of 14.13%) on every dollar they contribute. Why? Because the entire amount of reported income in Box 1 of their W2 floats directly over to their Schedule SE, and SECA tax is calculated on the Box 1 amount (which includes money that they contributed to their IRA). On the other hand, pre-tax contributions to 403bs and other employer retirement plans reduce the amount in Box 1 of the W2 (which reduces a pastor’s SECA tax).
Accountable Reimbursement Plans. All employees benefit from an accountable reimbursement plan. If you don’t have one, consider putting one into place. Please reference our Call Package Guidelines for more information.
If you have questions about ministerial tax issues, please contact us. Though we are not tax professionals, we understand your unique situation and may be able to point you toward resources or trusted professionals who have in-depth experience in church and clergy tax issues.
Please give us a call at 678-825-1198 or request an appointment online.
Geneva Benefits Group serves those who serve others, providing practical support for the financial, physical, and mental wellbeing of people who work in full-time ministry.