Ministers and treasurers must be familiar with the tax rules that apply to clergy. Unfortunately, seminary training rarely equips new ministers with this information, and church treasurers often don't know about the unique tax laws that apply to clergy. This information gap means ministers and treasurers frequently handle clergy income and the payment of related taxes incorrectly, and they fail to take advantage of the tax benefits that are available to ministers.
For instance, ministers are eligible for five special tax rules with respect to services they perform in the exercise of their ministry. These include (1) not paying federal income taxes on the portion of their church compensation designated in advance by their church as a housing allowance (limitations apply), (2) not paying federal income taxes on the annual rental value of a parsonage provided by their church, (3) being exempt from "self-employment taxes" (Social Security taxes paid by the self-employed) if several conditions are met, (4) being considered self-employed for Social Security (if not exempt), and (5) having ministers' wages exempt from income tax withholding.
In order to qualify for these tax savings, however, you must meet the IRS's definition of a "minister." The IRS applies a five-factor test to determine whether an individual qualifies as a minister for federal income tax purposes. In general, for individuals to enjoy the five special tax rules summarized above, they must satisfy two main requirements: they must be a minister, and they must be engaged in the exercise of ministry.
Assuming you clear these IRS hurdles for establishing whether or not you're a minister for federal tax purposes, you then need to know how to file taxes properly to ensure you receive the benefits available to you.
In this article, we focus on three of the most perennially perplexing tax issues for clergy. While there are many more we could cover, these are the three that pose confusion and uncertainty for many ministers and church treasurers, new and seasoned.
1. Should a Minister Report Income Taxes as an Employee or as Self-Employed?
The question of whether ministers should report their federal income taxes as an employee or as self-employed is a significant one. Most new ministers should report their federal income taxes as employees, because they will be considered employees under the tests currently used by the IRS and the courts. Most clergy will be "better off" reporting as employees, since (1) the value of various fringe benefits will be excludable, including the cost of employer-paid health insurance premiums on the life of the minister, (2) the risk of an IRS audit is substantially lower, and (3) reporting as an employee avoids the additional taxes and penalties that often apply to self-employed clergy who are audited by the IRS and reclassified as employees.