Handling clergy taxes, compensation and benefits is always a big challenge for church treasurers and boards. Many churches do not even know that ministers’/pastors compensation, benefits and payroll taxes are handled differently than all other professions.
How does a church treasurer determine if a “minister” is eligible for special tax treatment per IRS code?
Minister Tax Factor #1: Determination
In order to be classified a minister (clergy) for tax purposes, a minister should the IRS guidelines for tax treatment:
A licensed, commissioned, or ordained minister is generally the common law employee of the church, denomination, sect, or organization that employs him or her to provide ministerial services.
Note: In 2012, the Supreme Court broadened the ministerial exception by stating the Church should be free to select its ministers entirely free of government regulation and that the state should “defer to a religious organization’s good-faith understanding of who qualifies as a minister.”
Minister Tax Factor #2: Special Tax Treatment
Ministers receive special tax treatment for the following three topics:
- Ministers pay their own self-employment (Social Security and Medicare) tax. (Even though ministers are considered church employees)
- Clergy can receive a Housing Allowance and/or live in a church provided parsonage. (The value of both of these are excluded from a minister's calculation of income tax...but still subject to self-employment tax)
- Churches are NOT permitted to withhold Social Security and Medicare tax from a minister's paycheck.
See IRS Topic 417 and Pub 517 for more clarification on minister's taxes.
Minister Tax Factor #3: Self-employment Tax
Ministers are unique and their compensation is handled differently from other church staff such as the secretary, custodian or bookkeeper. The IRS considers minister to have a dual status when it comes to their employment status. (Note: Teachers, organists, DCE’s, and others may also be considered “Ministers” for tax purposes depending on their training and status within the church)
The IRS considers ministers to be employees of their churches for federal income tax purposes and self-employed for Social Security and Medicare purposes.
In a nutshell: minister’s are responsible to pay their own taxes. They can however request the church to withhold Social Security and Medicare taxes as part of the Federal withholding.
- SECA is an acronym for the Self-Employment Contributions Act. It is the system that self-employed individuals use to pay Social Security/Medicare taxes.
- FICA is an acronym for the Federal Insurance Contributions Act. The employee and the employer each pay half of the FICA taxes.
A minister (as employee) is responsible for paying his/her own self-employment tax. The self-employment tax consists of 12.4% for Social Security and 2.9% for Medicare (15.3% combined).
As a result, the minister actually pays twice as much Social Security and Medicare as a non-minister employee. (Note: It is encouraged that the church pays 50% of the SECA for the minister so as not to subject them to financial harm)
The amount of the minister’s income that is subject to the self-employment tax includes the base salary, the housing allowance, and the fair rental value of church provided housing, if any.
Minister’s Tax Factor #4: Opting Out
Ministers cannot opt out of Social Security because they think it's a bad investment. When filing Form 4361, a minister makes some representations under penalty of perjury. A minister must certify opposition on the basis of religious principles to acceptance of public insurance.
Minster Tax Factor #5 - Withholding Taxes
A church can withhold income tax (if requested by the minister), but not Social Security and Medicare tax.
A minister pays the Social Security and Medicare tax himself under the SECA system. He can pay this tax by making quarterly estimated tax payments, or by requesting the church to hold out extra income tax.
The minister who is considered a church employee must complete a form W-4 and request that a specific amount be withheld from each paycheck.
For example, if a minister estimates that his combined income and self-employment tax for the year will be $9600. He can request that the church withhold $800 of income tax from each month's paycheck.
Even though the minister can only elect withholding of income taxes, he can use these tax payments against both income and self-employment tax since they are added together on his personal income tax return (Form 1040).