Ministers have a unique tax situation. Even though they are employed by a religious institution, they follow unconventional rules when it comes to their tax return. Keep reading to learn how religious leaders’ tax situations differ from those of traditional employees.
Do ministers pay taxes?
Yes, ministers are generally required to pay taxes like any other citizen, though their income may be taxed differently depending on their location and specific tax laws.
Which taxes are ministers responsible for paying?
In some cases, ministers can request that the church withhold income taxes from their paychecks. But usually, ministers must use Schedule SE to calculate their self-employment tax.
Even though a minister can exclude the housing allowance from their gross income, they must include it when calculating the self-employment tax. To avoid an underpayment penalty on their tax return, ministers should also pay quarterly estimated payments.
Ministers are not eligible to file a Schedule C to deduct business expenses related to their wages from the church. However, they can file a Schedule C to deduct the costs incurred from marriage, funeral, and other services performed.
Who qualifies as a minister for tax purposes?
The IRS states that the word “minister” does not reference any specific religion and is used broadly to describe a leader in any religion. For tax purposes, ministers must meet five requirements and be licensed, commissioned, or ordained by their specific religion to perform ministerial duties. Not all five factors must be true; both the courts and the IRS usually consider everything together when deciding. These can include:
- Must be ordained, licensed, or commissioned by a local church or denomination.
- The person will administer “sacerdotal functions.” These include marriage and funeral services, dedicate infants, baptisms, and serve communion.
- Must be considered a religious leader by the church or denomination.
- Must conduct religious worship.
- The person will be in charge of managing the activities and upkeep of a local church or religious group.
Are ministers traditional employees?
Ministers are treated as a hybrid of a self-employed worker and a traditional employee for tax purposes. In most cases, the church is a tax-exempt entity. That means the church, which is the minister’s employer, does not withhold income tax from the minister’s wages.
However, in almost every other aspect of the law, ministers are considered employees. In short, a minister must pay taxes like a self-employed worker, but they are not eligible for all the tax benefits many self-employed workers enjoy.
What income do ministers need to report?
A minister receives payment in exchange for different services, including from people outside of the church. When it comes to reporting their annual income, a minister must include amounts received from:
- Performing marriages, baptisms, funerals, counseling, and other services in addition to their church salary.
- If they receive a housing allowance, they must also include the portion that exceeds the fair value of the home. These amounts should be entered on a Schedule C.
- Any goodwill or love offerings to a minister must also be included in gross income. The only time offerings made directly to the minister are tax-exempt is when they are retiring or leaving the church and given a farewell gift.
If a minister gets sent on a missionary trip to a foreign country by the church, the income earned during this time is still subject to federal income tax. Therefore, they might also owe taxes to the foreign country. Ministers can take the foreign-earned income exclusion, the foreign housing exclusion, and the foreign tax credit to avoid being taxed twice on this income.
What tax deductions or write offs can ministers claim?
Ministers can claim several tax deductions related to the nature of their work. To qualify, the expenses must be directly connected to their ministry work and not reimbursed by their church. Common deductions include costs for maintaining a home office, travel for ministry activities, continuing education, professional attire specifically required for their work, and supplies used in their religious duties. Ministers can also exclude their housing allowance from taxable income, which helps lower their taxes. It’s essential for ministers to keep detailed records and receipts of their expenses throughout the year to support their deductions.
What is the housing allowance exclusion for ministers?
Many churches give their ministers a housing allowance. This allowance might be a cash amount or, if the church provides a home, the monthly rent value.
This money must be part of the minister’s salary and be used exclusively for providing a home. It can cover the following costs:
- Rent
- Mortgage payments
- Real estate taxes
- Home insurance
- Utilities
- Furniture
- Repairs
- Other expenses
This allowance can be excluded on a minister’s tax return, but it should not exceed the home’s fair rental value, including furniture and utilities. The extra portion of a minister’s housing allowance is taxable if the amount exceeds the fair value. While ministers can exclude their housing allowance from taxable income, it’s important to note that this allowance is still included in the calculations for self-employment (SE) tax.
Some districts allow ministers to exclude a housing allowance for two homes. However, Alabama, Georgia, and Florida only allow one home.
In addition, a minister must reduce the deductions they take for business expenses by the percentage of compensation attributable to the tax-free housing allowance. However, itemized deductions for mortgage interest and real estate taxes can still be taken for the full amount.
How can a minister apply for a tax exemption?
Ministers may be eligible for specific tax exemptions based on their unique tax situation. These exemptions often pertain to income earned from religious services or housing allowances. The following sections will explain how to qualify for these exemptions and detail the application process for each one.
Self-Employment Tax Exemption
A minister can apply to be exempt from paying the self-employment tax. This exemption will only apply to their wages from the church, not other services performed.
To do so, the minister must fill out Form 4361 and attach a statement explaining that they have taken a vow of poverty or oppose public insurance. This application should be completed after the second tax year in which they earned at least $400. Then, they must meet one of the following tests:
- A religious test based on the doctrine of their church, or
- A conscientious opposition test
One stipulation worth noting is that if a minister applies to be exempted from the Social Security tax (included in the self-employment tax), they will not be eligible to receive benefits from Social Security in the future. Once the exemption is in place, it can’t be undone.
Federal Income Tax Withholding Exemption
If a minister wishes for a church to withhold income tax from their paycheck, they may apply for an exemption using Form W-4. As mentioned above, if they choose to not have taxes withheld, they’re responsible for making estimated tax payments to avoid underpayment penalties throughout the year.
