Important Tax Guidelines for Ministers
By Raul Rivera
Read Time: 5 Minutes
Tax season is almost here! For most ministers and pastors, taxes can be extremely daunting. The good news is, with the correct information, you can make filing a breeze while taking advantage of the tax benefits awarded to the clergy. Today's blog will cover what you need to know to confidently handle your taxes in 2022.
Minister's taxes
To understand how to handle a minister's taxes, we must first understand how the IRS defines a minister. Ministers are individuals duly ordained, commissioned, or licensed by a church. The term "church" is used generically and does not refer to any particular religion. Most ministers who receive compensation are treated as dual-status taxpayers—employees for income tax purposes but not Social Security and Medicare tax. Many ministers also receive a parsonage allowance, which we will discuss a little later.
Now let's look at what qualifies as a minister's income and reporting taxes.
Total ministerial income includes church wages, gross self-employment income from ministerial service, and tax-exempt allowances.
Ministerial employee's income and expenses
Let's look at the step-by-step process of reporting an employed minister's income and expenses.
• First, the minister receives Form W-2 from the church employer.
• The minister's wage income is reported in box 1, Form W-2.
• Social Security and Medicare taxes (FICA) are not withheld. The wages will be included in the minister's self-employment tax computation.
• Ministers are not subject to federal income tax withholding. A minister and employer may agree to voluntary withholding.
• Parsonage or housing allowances are reported in box 14, Form W-2.
• Employee expenses are allowed as itemized deductions on Schedule A, Form 1040, subject to the 2% AGI limitation, and prorated to the extent the minister has tax-exempt income from a parsonage allowance.*
Self-employment income and expenses
Generally, self-employment income includes income a minister receives for performing marriages, baptisms, funerals, etc., even if the minister does not receive Form 1099-MISC.
Here's how to report it:
• Self-employment income is reported on Schedule C, Profit or Loss from Business, Form 1040.
• Self-employment expenses are deductible on Schedule C, prorated to the extent the minister has tax-exempt income from a parsonage allowance.
Expense reduction for tax-exempt income
A minister who receives tax-exempt income (such as a parsonage allowance) as compensation must reduce deductions for Schedule A employee expenses and Schedule C self-employment expenses as follows:
Tax-exempt income / Total ministerial income = Reduction percentage
Let's take a look at an example:
Patrick is a minister who receives a housing allowance of $15,000. His total ministerial income, including the housing allowance, is $60,000. Since the housing allowance is not subject to regular income tax, Patrick must reduce his allowable expenses for purposes of computing itemized deductions by 25% ($15,000 ÷ $60,000 = 25%). Assume Pat-rick's ministerial expenses are $4,000. For purposes of itemized deductions, Patrick can claim only $3,000 ($4,000 × 25% = $1,000 reduction). Since Patrick's housing allowance is subject to self-employment tax, he can deduct the entire $4,000.
Minister's self-employment tax
A minister reports income subject to self-employment tax on Schedule SE, Self-Employment Tax, Form 1040.
The following income is included as self-employment income on Schedule SE:
- Church wages from box 1, Form W-2, less associated employee expenses in full.
- Gross Schedule C income from ministerial services, less associated self-employment expenses in full.
- Entire amount of parsonage allowance, including utilities, whether received as an allowance or provided in-kind to the minister. If housing and utilities are provided, include the home's fair rental value and cost of utilities.
Be sure not to include any of the following:
• Expense reduction due to tax-exempt income.
• Housing and housing allowance, including utilities, provided to retired ministers.
Earned income credit
For purposes of the earned income credit, a minister's earned income includes:
• Net earnings from self-employment from Schedule SE, including parsonage allowance (line 2, Section A or line 2, Section B), minus:
•The portion of SE tax deducted on line 27, Form 1040, plus Non-ministerial wages.
Do you want to learn about the Minister’s Self-Employment Tax Exemption? We are here to empower you with the knowledge you need. Please call 877-494-4655 or click here to learn more!
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The parsonage/ housing allowance
One of the most valuable tax benefits awarded to ministers is the housing/parsonage allowance. So how does it work?
A church or congregation may provide for a minister's residence in the form of a parsonage or a housing allowance. The value of a parsonage, plus utilities (if paid by the church) and housing allowances, are subject to self-employment tax but may generally be excluded from income tax.
Parsonage provided to a minister:
Income tax. The value of the home, including utilities, is excluded from income. The exclusion cannot be more than the reasonable pay for the minister's services.
Self-employment tax. The home's fair rental value, including the cost of utilities, is included in gross income when calculating self-employment tax.
Housing allowance paid to a minister:
Income tax. A minister can exclude from income the smallest of:
1. The amount officially designated by the employer as a housing allowance. Amounts must be designated as a housing allowance before payment.
2. The amount used to provide a home. Include amounts paid in the tax year for rent, mortgage payments, furnishings, appliances, repairs, utilities, and down payments. Do not include food, entertainment, servants, or home equity loan payments for items unrelated to the home. Mortgage interest and property tax used in this calculation are also considered itemized deductions on Schedule A, Form 1040.
3. The fair rental value of the home, including furnishings, utilities, garage, etc.
4. The minister's reasonable pay.
Employers typically report housing allowances in box 14, Form W-2. Housing allowances are not included in taxable wages in box 1. If the excludable amount is less than the housing allowance, include the excess as income on line 7, Form 1040.
Self-employment tax. The entire housing allowance, including utilities, is included in gross income when calculating self-employment tax.
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Further reading:
Debunking 4 Housing Allowance Myths
3 Huge Tax Benefits for Ministers
Taxes for retired ministers
Are you a retired minister? Let's take a look at how to properly manage and report your taxes. Income tax. Retired ministers can exclude from taxable income:
• The value of housing and utilities provided to them, or The part of a pension officially designated as housing allowance. The amount excluded is limited to actual expenses or the fair rental value of the home. See (2) and (3) above.
Self-employment tax. Housing provided to retired ministers and housing allowances paid to retired ministers are not subject to SE tax.
• Surviving spouses. A minister's surviving spouse cannot exclude a parsonage allowance from income unless it is received for ministerial services performed.
Let's take a look at a related court case: The IRS appealed a Tax Court ruling permitting an ordained minister to use his parsonage allowance to provide both a principal and second home. The Circuit Court determined that Congress intended for the parsonage allowance exclusion to apply to only one home, reversing the Tax Court ruling. The parsonage allowance was excludable only to the extent used for the taxpayer's main home.*
Need tax help?
Many events occur during the year that can affect your tax situation. Preparation of your tax return involves summarizing transactions and events that occurred during the prior year. In most cases, treatment is firmly established at the time the transaction occurs. However, adverse tax effects can be avoided by proper planning.
Please get in touch with us in advance if you have questions about the tax effects of a transaction or event, including the following:
• Pension or IRA distributions.
• Significant change in income or deductions.
• Job change.
• Marriage.
• Attainment of age 59½ or 70½.
• Sale or purchase of a business.
• Sale or purchase of a residence or other real estate.
• Retirement.
• Notice from IRS or other revenue department.
• Divorce or separation.
• Self-employment.
• Charitable contributions of property in excess of $5,000.
If you need help filing your tax return, it would be our honor to assist you. Join the hundreds of pastors we've helped save money, reduce stress, and keep from overpaying taxes. Our Minister's Tax Service will deduct your housing allowance and social security exemption. We'll also correctly report love offerings. To learn more, please call us at 877-494-4655 or click the banner below to schedule a call with a specialist.
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Please note: This blog contains general information for taxpayers and should not be relied upon as the only source of authority. Taxpayers should seek professional tax advice for more information.References:
*(Driscoll, 135 TC 557 and Driscoll, 11th Cir., February 8, 2012)