The Tax Court issues an important decision—Greene v. Commissioner, T.C. Memo. 1996-531 (1996)
Ministers have a "dual" tax status. For social security purposes they always are self-employed with respect to services performed in the exercise of ministry. However, for federal income tax reporting purposes most ministers are employees. There are exceptions to this rule, as a recent decision by the Tax Court illustrates. The Court ruled that an Assemblies of God foreign missionary was self-employed for income tax reporting purposes. The Court's decision will be a helpful precedent not just to foreign missionaries, but to pastoral ministers as well. The Court's ruling is fully analyzed in this feature article.
Are ministers employees or self-employed for federal income tax reporting purposes? This is an important question. In fact, the "audit guidelines for ministers" released by the IRS in 1995 inform agents that "the first issue that must be determined is whether the minister is an employee or an independent contractor." A recent Tax Court decision provides useful guidance in resolving this important issue. The Tax Court ruled that an Assemblies of God foreign missionary was self-employed rather than an employee for federal income tax reporting purposes. The Court's conclusion and analysis will be helpful to other missionaries and pastors in evaluating their own tax reporting status. This feature article will review the facts of the case, summarize the court's ruling, and evaluate the significance of the case to other missionaries and pastors.
An Assemblies of God foreign missionary in Bangladesh reported his income taxes as self-employed. He was audited by the IRS and informed that he was in fact an employee. The IRS transferred his business expenses from Schedule C to Schedule A, resulting in additional taxes of $1,000. The missionary appealed to the Tax Court, which ruled that he was self-employed.
the court's ruling-an 8 factor test
The Tax Court listed eight factors to be considered in deciding whether a worker is an employee or self-employed for federal income tax reporting purposes:
(1) the degree of control exercised by the [employer] over the details of the work; (2) which party invests in the facilities used in the work; (3) the taxpayer's opportunity for profit or loss; (4) the permanency of the relationship; (5) the [employer's] right of discharge; (6) whether the work performed is an integral part of the [employer's] business; (7) what relationship the parties believe they are creating; and (8) the provision of benefits typical of those provided to employees. No one factor is determinative; rather, all the incidents of the relationship must be weighed and assessed.
The court concluded that the missionary was self-employed on the basis of these eight factors. Its conclusions are summarized below:
#1 – degree of control
The court noted that an employer's right to control the manner in which a person's work is performed "is ordinarily the single most important factor" in determining whether that person is an employee. The more control, the more likely the worker is an employee. The court mentioned three additional factors to be considered in applying this test: (1) A sufficient degree of control for employee status does not require the employer to "stand over the taxpayer and direct every move made by that person." (2) "The degree of control necessary to find employee status varies according to the nature of the services provided." (3) "[W]e must consider not only what actual control is exercised, but also what right of control exists as a practical matter."
Facts indicating control. The IRS insisted that the following facts demonstrated a sufficient degree of control for the missionary to be considered an employee:
Missionaries qualify as professionals who require little supervision and therefore the absence of actual control should not be confused with an absence of the right to control.
The Assemblies of God Division of Foreign Missions (DFM) maintained control over the missionary through its missions manual that dictated the manner in which he was to conduct his "deputational" and foreign ministry. Deputational ministry refers to the practice of Assemblies of God of missionaries raising their own financial support by visiting local churches.
The national Assemblies of God organization (the "National Church") exercised control, or had the right to exercise control, over the missionary's ministerial credentials to such a degree that he was an employee. For example, the National Church: (1) maintains specific requirements for ministerial licensing and ordination; (2) has the authority to discipline ministers based on their behavior and conduct; and (3) has the authority to withdraw ministerial credentials.
Facts indicating a lack of control. The court pointed to the following facts in concluding that there was no sufficient control exercised over the missionary to treat him as an employee:
Neither the National Church nor DFM provided any type of professional training for the missionary.
The DFM did not assign the missionary to minister in a particular country. The missionary himself selected Bangladesh, despite some reservations expressed by the DFM.
The DFM did not direct the missionary to work on a particular project in Bangladesh. Rather, the missionary independently chose to become involved in student ministry. He decided to expand his foreign ministry to include a drug-rehabilitation program. He was able to make this decision without seeking permission from the DFM. In fact, it appears that the DFM was not even aware of the missionary's plans to initiate a drug-rehabilitation clinic in Bangladesh.
The missionary determined his own work days and hours.
The missionary used vacation and sick leave without notifying or seeking permission from the DFM.
The missionary decided to return from his foreign ministry after only three years in the foreign field. He made this decision considering the needs of his school-aged children and the schedules of the other missionaries in his area. It appears that the DFM played little or no role in his field departure date.
The missionary decided when his "personal allowance" (a monthly distribution for living expenses) would begin, and he had the power to designate the amount of his personal allowance up to the limit imposed by the DFM.
The missionary was required to attend only one meeting every five years.
Apart from filing periodic expense and activity reports, the missionary and the DFM did not communicate regularly. Specifically, the DFM did not contact him at all during his year of "deputational ministry" (when he visited churches in the United States raising support). Likewise, the DFM communicated with the missionary infrequently while he served in the foreign field.
The missionary was not directly supervised or evaluated by anyone.
The court acknowledged that the DFM missions manual contains extensive information with respect to foreign ministry. However, it concluded that "the missions manual was intended by the DFM to be an informational reference for missionaries, not a set of rules controlling their day-to-day conduct."
The court concluded that the IRS's emphasis on the National Church's control of the missionary's ministerial credentials was misplaced for two reasons. First, although the missionary was an ordained Assemblies of God minister, he worked as a missionary. The court observed that "the National Church's requirements for ministerial licensing and ordination, as well as its authority to discipline [the missionary] and withdraw his ministerial credentials, have little or no bearing as to the details and means by which [he] performed his duties as a missionary." Second, the court concluded that the "control test" is not satisfied "where the manner in which a service is performed is controlled by the threat of the loss of professional credentials. Carried to its logical extreme, this argument would serve to classify all ordained ministers as employees of the National Church, regardless of the type of service performed."
The IRS pointed to a recent federal district court ruling in Arkansas in which an Assemblies of God pastor was found to be an employee for federal income tax reporting purposes. The Tax Court simply noted that the missionary's circumstances in this case "are very different" from those of a pastor of a local church:
[The taxpayer in this case] was employed as a foreign missionary, not a pastor. We think that the National Church's authority over the manner in which a pastor performs his or her duties is not highly probative in analyzing the National Church's control over the daily activities of a foreign missionary. This is because pastoring a local church and engaging in foreign mission work are two different jobs involving different qualifications, duties, and bodies of authority. Pastors are subject to the controls of a local church whereas missionaries are subject to the authority of the DFM. As previously discussed, the DFM exerted very little control over petitioner.
The court concluded:
In summary, the DFM lacked the control and lacked the right to control the manner and means by which [the taxpayer] performed his duties as a foreign missionary. Rather, the DFM facilitates foreign ministry by processing a missionary's collections and pledges and providing useful information to missionaries through the missions manual and a proposed foreign living budget. In other words, we view the DFM as a service provider relieving endorsed missionaries from the administrative burdens of collecting and processing their pledges and obtaining information regarding their country of service.
#2 – investment in facilities and equipment
The second factor in the Tax Court's eight factor test is "which party invests in the facilities used in the work"? If the employer invests in the facilities, it is more likely that the worker is an employee. The court observed:
[The taxpayer's] sole compensation as a missionary was in the form of a "personal allowance" secured from funds that he raised during his deputational ministry. In this regard, we observe that if a donor fails to remit a pledged amount, the DFM makes no effort to contact the donor, much less obtain the donation. Additionally, the National Church does not guarantee missionaries minimum compensation or support. [The taxpayer] used his personal car and telephone to raise funds during his deputational ministry. [He] occasionally hired assistants at his own discretion and accepted responsibility for paying those assistants.
The IRS pointed out that the missionary was reimbursed for his expenses when he withheld costs from the offerings remitted to the DFM. The court did not find this relevant: "Even if [he] were regarded as receiving reimbursement for his expenses, this matter is more than outweighed by other evidence probative of his being an independent contractor, e.g., petitioner's efforts in securing the funding for his foreign ministry and his investment in his automobile and telephone." The court concluded that the second factor supported self-employed status.
#3 – opportunity for profit or loss
The third factor in the Tax Court's eight factor test is "the taxpayer's opportunity for profit or loss." The court noted that the National Church does not guarantee missionaries minimum compensation. Rather, compensation received by missionaries is in the form of a personal allowance, the amount of which depends on the total amount of funding that missionaries are able to secure during their deputational ministry. Additionally, upon resignation, missionaries forfeit any account balance they may have with the DFM and must reallocate their funds to another ministry. The court concluded that the third factor supported self-employed status.
#4 – permanency of the relationship
The fourth factor in the Tax Court's eight factor test is the permanency of the relationship. The more permanent the relationship, the more likely the individual is an employee. The taxpayer conceded that missionary service is a lifetime career. Therefore, the court concluded that the fourth factor supported employee status.
#5 – DFM's right of discharge
The fifth factor in the Tax Court's eight factor test is whether or not the employer has the right to discharge the worker. If such a right exists, it is more likely that the worker is an employee. The court noted that the DFM did not have the power to prevent the taxpayer from serving as an Assemblies of God missionary in Bangladesh:
The DFM's most extreme form of discipline is the withdrawal of a missionary's endorsement. For a missionary, the practical consequence of losing the DFM's endorsement is one of administrative inconvenience, namely, that the missionary must collect and process pledges without the assistance of the DFM. In any event, unendorsed Assemblies of God missionaries can and do serve in the foreign field.
The IRS insisted that because the missionary is an Assemblies of God minister, the National Church has the right to revoke his ministerial credentials, and therefore the National Church can effectively discharge him. The court disagreed:
Indeed, the credentials committee [of the National Church] has the authority to withdraw the approval and recommend the recall of ministerial credentials. Although [the taxpayer] is an Assemblies of God minister subject to the disciplinary proceedings in the constitution and bylaws, he presently serves in the capacity of a foreign missionary. Thus, we think the more appropriate analysis considers the DFM's right to discharge [him] in his capacity as a missionary, rather than the National Church's right to recall [his] ministerial credentials.
The court concluded that the fifth factor supported self-employed status.
#6 – integral part of business
The sixth factor in the Tax Court's eight factor test is whether or not the work performed is an integral part of the employer's business. The court noted that the DFM's primary mission is world evangelism and that the taxpayer's work as an Assemblies of God missionary was directly related to the accomplishment of that mission. Therefore the court concluded that the sixth factor supported employee status.
#7 – relationship the parties believe they have created
The seventh factor in the Tax Court's eight factor test is the relationship the parties believe they have created. That is, did the DFM and its missionaries believe that their relationship was that of employer and employee, or did they believe that their relationship was that of an employer and self-employed workers? The court concluded that the parties believed that missionaries were self-employed, based on the following factors: (1) the financial comptroller of the DFM testified that the DFM considered its missionaries to be self-employed; (2) the National Church issued the taxpayer a 1099 form each year reflecting nonemployee compensation for services rendered; (3) federal income tax was not withheld from the missionary's compensation (the court apparently was unaware of the fact that the compensation of ministers and missionaries is exempt from federal income tax withholding whether they report their income taxes as employees or as self-employed); and (4) the taxpayer thought he was self-employed as evidenced by the fact that he reported his foreign ministry income and expenses on Schedule C. The court concluded that the seventh factor supported self-employed status.
#8 – employee-type benefits
The eighth factor in the Tax Court's eight factor test is whether or not the employer provides "employee-type benefits" to the worker. The court noted that the DFM provided its missionaries with the following fringe benefits: (1) access to the National Church's retirement plan, and (2) access to the National Church's health insurance plan. On the other hand, the DFM has no policy regarding sick leave and does not maintain records reflecting either vacation or sick leave taken by missionaries. The court concluded that "although the matter is not free from doubt, we think that these facts support a finding that [the taxpayer] was an employee, not [self-employed]."
The court concluded its analysis of the eight factors by observing:
Some aspects of the relationship between [the missionary] and the National Church indicate that [he] was an employee, whereas other aspects of the relationship indicate that he was [self-employed]. After weighing the above factors, giving particular weight to the lack of control and the lack of the right to control that the National Church and the DFM had over endorsed missionaries, we conclude that [the taxpayer] was [self-employed], and not an employee ….
As a result, the court concluded that the missionary's business expenses could be deducted on Schedule C and "need not be relegated to Schedule A."
Relevance to other missionaries and ministers
What is the significance of this important ruling to other ministers? Consider the following:
1. "Dual tax status". Most of the confusion associated with clergy tax preparation is based on the fact that clergy have a "dual tax status". For federal income tax reporting purposes most clergy are employees, but for social security purposes all clergy are self-employed (with respect to services performed in the exercise of ministry). Many church treasurers assume that ministers who are treated as employees for income tax purposes must be treated as employees for social security purposes. They accordingly withhold FICA taxes from the wages of their ministers just as they would for a nonminister church employee. While common, this approach is incorrect. All ministers are self-employed for social security purposes with respect to their ministerial services. As a result, they pay the self-employment tax, not FICA taxes. This is so even if the ministers are employees for income tax reporting purposes.
2. The court's 8-factor test. The Tax Court applied the same test that it used in two decisions in 1994 addressing the correct reporting status of ministers for federal income tax reporting purposes. In the first case the court applied a 7-factor test in concluding that a Methodist minister was an employee. Weber v. Commissioner, 103 T.C. 378 (1994). In the second case, the court applied the same 7-factor test and ruled that a Pentecostal Holiness minister was self-employed. Shelley v. Commissioner, T.C. Memo. 1994-432 (1994). The Tax Court applied the same 7-factor test in this case, but treated the seventh factor as two separate factors. In the Weber and Shelley cases, the seventh factor in the court's 7-factor test was the relationship the parties themselves thought they had established. However, in addressing this factor, the court looked to the kinds of fringe benefits provided to the minister. The court separated this analysis in its new 8-factor test. Under the new 8-factor test, consideration must be given to the following factors in evaluating a person's correct reporting status for income tax reporting purposes:
(1) the degree of control exercised by the employer over the details of the work
(2) which party invests in the facilities used in the work
(3) the opportunity of the individual for profit or loss
(4) the permanency of the relationship
(5) whether the employer has the right to discharge the individual
(6) whether the work is part of the employer's regular business
(7) the relationship the parties believe they are creating
(8) whether benefits provided to the worker are typical of those provided to employees
There are three additional points the court made that should be considered in applying this test:
• A sufficient degree of control for employee status does not require the employer to "stand over the taxpayer and direct every move made by that person."
• The degree of control necessary to find employee status varies according to the nature of the services provided. For example, the level of control necessary to find employee status is generally lower when applied to professional services than when applied to nonprofessional services.
• A court must consider not only what actual control is exercised, but also what right of control exists as a practical matter.
• Key point. The Tax Court did not refer to the 20-criteria test announced by the IRS in 1987. Ministers who report their income taxes as self-employed probably will have a higher chance of prevailing under the 8-factor test than under the more restrictive 20-factor test.
3. Ministers who may be self-employed for income tax reporting purposes. The Greene case demonstrates that there will be some ministers who will be self-employed for federal income tax reporting purposes. In addition to missionaries who are substantially similar to the missionary in the Greene case, there are a number of other situations in which a minister is likely to be self-employed for federal income tax reporting purposes. These include:
• Itinerant evangelists. Itinerant evangelists, who conduct services in several different churches during the course of a year, ordinarily would be considered self-employed for purposes of both income taxes and social security taxes. They ordinarily would not be considered employees under either the Tax Court's 8-factor test or the IRS 20-criteria test.
• Guest speaking. Many ministers are called upon to conduct worship services in other churches on an occasional basis. To illustrate, Rev. D, who serves as senior minister at First Church, is invited to conduct a service at a church in another community. Clergy generally will be considered to be self-employed with respect to such occasional guest speaking commitments.
• Supply pastors. Many ministers serve temporary assignments in local churches until a permanent minister can be selected. In some cases, these ministers will be self-employed with respect to such an assignment. This will depend on an application of the Tax Court's 8-factor test (or the IRS 20-criteria test). In general, the shorter the assignment the more likely that the minister will be considered self-employed.
• Direct services. IRS Publication 517 recognizes that it is possible for ministers who are employees of their churches for income tax reporting purposes to be self-employed for certain services (such as baptisms, marriages, and funerals) that are performed directly for individual members who in turn pay a fee or honorarium to the minister.
• Church polity. In some cases a church's polity may suggest that ministers are self-employed rather than employees for income tax reporting purposes. For example, ministers who are not associated with a regional or national religious body that exercises control over their activities will find it easier in some cases to argue that they are self-employed for income tax reporting purposes.
• Key point. The Tax Court ended the Weber case with the following comment: "We recognize that there may be differences with respect to ministers in other churches or denominations, and the particular facts and circumstances must be considered in each case."
4. The bottom line. Some missionaries and ministers will find it easier to defend self-employed status under the Tax Court's 8-factor test. However, this should not necessarily cause those missionaries and ministers who presently report their income taxes as employees to change their status, nor should it keep self-employed ministers from changing to employee status. The simple fact is that in the vast majority of cases missionaries and ministers will be far better off for federal tax purposes by reporting as employees rather than as self-employed. The advantages of employee status include: (1) the value of various fringe benefits will be excludable, including the oftentimes significant cost of employer-paid health insurance premiums on the life of the minister and his or her dependents, (2) the risk of an IRS audit is substantially lower, and (3) as an employee, a minister avoids the additional taxes and penalties that often apply to self-employed clergy who are audited by the IRS and reclassified as employees.
The only "advantages" of self-employed status are that business expenses are deductible whether or not the minister is able to itemize deductions on Schedule C, and these expenses are not subject to the 2% "floor" that applies to employee business expenses (deductible only to the extent they exceed 2% of adjusted gross income). However, employees can realize the same benefits by having their employing church adopt an accountable business expense reimbursement policy.