Unlike any other employee, a minister creates special issues for the payroll functions of a church. These issues aren't intuitive in nature, so it's not uncommon for errors to occur in the payroll reporting of a minister's compensation package. One of the most confusing aspects of a minister's compensation package is how he or she will be classified when paying into the Social Security and Medicare system.
There are two methods of paying into the Social Security and Medicare system.
1. Federal Insurance Contributions Act (FICA)
Employees traditionally pay in through the Federal Insurance Contributions Act. The employee pays into FICA via taxes withheld from their paychecks by their employers. The employer then matches the employee's amount and pays it directly into the system on the employee's behalf.
2. Self Employed Contributions Act (SECA)
The other system is the Self Employed Contributions Act, which assesses the tax to the self-employed individual on a Schedule SE filed with an individual's Federal Form 1040.
Participation in each of these systems is defined in the Internal Revenue Code (IRC).
The Internal Revenue Code
IRC Section 3121 determines who is covered by FICA. IRC Section 3121(b)(8) states that employment for this tax doesn't include services performed by an ordained, commissioned, or licensed minister in the exercise of his ministry.
IRC Section 1402 governs who is covered by SECA. IRC Section 1402(c) states that a "trade or business" for purposes of SECA will include the performance of services by a duly ordained, commissioned, or licensed minister in the exercise of his ministry (if no exemption as provided by IRC Sec. 1402(e) is in effect). This explanation demonstrates that, by law, the compensation paid to a minister (for the performance of ministerial duties) is a trade or business subject to self-employment tax. It can't be considered as wages for FICA withholding and matching. This self-employment status is mandatory, and for people who employ ministers, it's a key concept to understand. If a minster is paid for ministerial duties, the church may never withhold FICA/Medicare taxes from the minister and pay the matching portion.