Summary.
Many ministers have exempted themselves from self-employment tax by filing a timely application form (Form 4361) with the IRS. Unfortunately, most of these ministers were not eligible for the exemption. In recognition of this fact, and because a growing number of exempt ministers were desperate to rejoin the Social Security program in order to qualify for Medicare benefits, Congress gave ministers a brief “window” of time in 1977, and again in 1987, to revoke an exemption from self-employment tax. Few did so. Ministers soon may be given another window to revoke an exemption from self-employment taxes. It is important for exempt ministers to be aware of these developments so they are ready to respond quickly if another window is provided. The lesson of the 1977 and 1987 legislation is that the longer ministers wait to revoke an exemption, the less likely it is that they will do so. This article reviews the status of current legislative efforts, assesses the likelihood of success, and provides ministers with recommendations to consider.
Ministers are allowed by federal law to exempt themselves from social security (self-employment) taxes by filing a timely exemption application (Form 4361) with the IRS. To qualify for exemption, ministers must meet the following six requirements:
1. The minister must be an ordained, commissioned, or licensed minister of a church.
2. The church or denomination that ordained, commissioned, or licensed the minister must be a tax-exempt religious organization.
3. The minister must file an exemption application (Form 4361) in triplicate with the IRS. A minister certifies on Form 4361 that “I am conscientiously opposed to, or because of my religious principles I am opposed to, the acceptance (for services I performed as a minister …) of any public insurance that makes payments in the event of death, disability, old age, or retirement, or that makes payments toward the cost of, or provides services for, medical care.” The form states that “public insurance includes insurance systems established by the Social Security Act.” There are three important factors to note. First, the regulations interpreting this language reject the view that ministers can be eligible for exemption from social security coverage on the basis of “conscientious opposition” alone. The conscientious opposition must be rooted in religious belief. Second, the exemption is available only if a minister is opposed on the basis of religious considerations to the acceptance of social security benefits rather than to payment of the tax. A minister may have religious opposition to payment of the tax, but this alone will not suffice. The individual must have religious opposition to accepting social security benefits upon his or her retirement or disability. This is an extraordinary claim that few ministers in good faith will be able to make. Third, the applicant’s opposition must be to accepting benefits under the social security program (or any other “public insurance” system that provides retirement and other specified benefits). As a result, a minister who files the exemption application may still purchase life insurance or participate in retirement programs administered by non-governmental institutions (such as a life insurance company).
4. The exemption application (Form 4361) must be filed on time. The deadline is the due date of the federal tax return for the second year in which a minister has net earnings from self-employment of $400 or more, any part of which derives from the performance of services in the exercise of ministry.
5. Notification of ordaining, commissioning, or licensing church or denomination. An applicant for exemption must inform “the ordaining, commissioning, or licensing body of the church or order that he is opposed” to social security coverage (Form 4361 contains a statement that the applicant has satisfied this requirement), and presumably, that he or she intends to apply for an exemption from social security coverage.
6. IRS verification. No application for exemption will be approved unless the IRS or the Secretary of the Department of Health and Human Services (or a designated representative) “has verified that the individual applying for the exemption is aware of the grounds on which the individual may receive an exemption … and that the individual seeks an exemption on such grounds.”
Key point. In this article, the term “self-employment tax” is used to describe the social security tax paid by self-employed persons, including ministers. Ministers always are deemed to be self-employed for social security purposes with respect to services performed in the exercise of their ministry (with the exception of some chaplains), and so they pay the self-employment tax rather than “FICA” taxes.
Revoking an exemption from social security
The tax code clearly states that ministers who exempt themselves from self-employment taxes cannot revoke their exemption. The decision to become exempt from self-employment taxes is “irrevocable.” IRC 1402(e)(4). Form 4361 itself warns that “once the application is approved, you cannot revoke it.”
On two occasions in the past, Congress has enacted special legislation giving ministers a brief “window” of time to revoke an exemption from self-employment taxes.
The 1977 Legislation
Congress allowed ministers who were exempt as of December 20, 1977, to revoke their exemption by the due date of their federal income tax return for 1977 (April 15, 1978) by filing a Form 4361-A.
The 1987 Legislation
The Tax Reform Act of 1986 gave exempt ministers another limited opportunity to revoke an exemption from self-employment taxes, by filing a Form 2031 with the IRS by the due date for their federal income tax return for 1987 (April 15, 1988). Congress provided this limited opportunity for ministers to revoke an exemption from self-employment taxes because of a recognition that many of these ministers did not qualify in the first place.
Ministers who revoked an exemption by April 15, 1988 did not become liable for self-employment taxes all the way back to the date of their original exemption. Rather, they were required to pay self-employment taxes effective January 1, 1986 or January 1, 1987. This meant, for example, that a minister who revoked an exemption by April 15, 1988 had to pay not only the first quarter’s estimated self-employment tax for 1988 by that date, but also (1) the entire social security tax liability for 1986 and 1987, or (2) the entire social security tax liability for 1987. The minister elected on the Form 2031 whether to pay taxes for both 1986 and 1987, or just for 1987.
The decision to revoke an exemption from self-employment tax was irrevocable.
Very few exempt ministers revoked their exemption. The reason is simple. Most ministers who were seriously considering revoking their exemption waited until the deadline, only to discover that pursing the revocation of their exemption would make them liable for at least five quarters of self-employment tax. Even on modest income, this was a crushing liability that few could afford. As a result, very few ministers revoked their exemption.
Recent Developments
A number of bills have been introduced in Congress over the past few years to provide ministers with another opportunity to revoke an exemption from self-employment coverage. Here are the key bills:
(1) House Bill H.R. 939
In 1997, Congressman English of Pennsylvania introduced House Bill 939, which provided, in part:
[A]ny exemption which has been received … by a duly ordained, commissioned, or licensed minister of a church … and which is effective for the taxable year in which this Act is enacted, may be revoked by filing an application therefor … if such application is filed no later than the due date of the federal income tax return (including any extension thereof) for the applicant’s second taxable year beginning after December 31, 1997. Any such revocation shall be effective … as specified in the application, either with respect to the applicant’s first taxable year beginning after December 31, 1997, or with respect to the applicant’s second taxable year beginning after such date, and for all succeeding taxable years; and the applicant for any such revocation may not thereafter again file application for an exemption …. If the application is filed after the due date of the applicant’s federal income tax return for a taxable year and is effective with respect to that taxable year, it shall include or be accompanied by payment in full of an amount equal to the total of the taxes that would have been imposed by … the Internal Revenue Code of 1986 with respect to all of the applicant’s income derived in that taxable year which would have constituted net earnings from self-employment … except for the exemption ….
This bill attracted only a few sponsors, and died in committee.
(2) the “ticket-to-work” bill
On June 4, 1998, the House of Representatives passed the “Ticket to Work and Self-Sufficiency Act of 1998” by an overwhelming vote of 410 to 1. This bill was designed to make it easier for disabled adults to receive vocational training without losing their social security disability (or SSI) payments. The bill was amended to include a provision allowing clergy to revoke an exemption from self-employment taxes. Section 8 of the bill provided, in part:
[A]ny exemption which has been received … by a duly ordained, commissioned, or licensed minister of a church, a member of a religious order, or a Christian Science practitioner, and which is effective for the taxable year in which this Act is enacted, may be revoked by filing an application therefor … if such application is filed no later than the due date of the federal income tax return (including any extension thereof) for the applicant’s second taxable year beginning after December 31, 1998. Any such revocation shall be effective … as specified in the application, either with respect to the applicant’s first taxable year beginning after December 31, 1998, or with respect to the applicant’s second taxable year beginning after such date, and for all succeeding taxable years; and the applicant for any such revocation may not thereafter again file application for an exemption …. If the application is filed after the due date of the applicant’s federal income tax return for a taxable year and is effective with respect to that taxable year, it shall include or be accompanied by payment in full of an amount equal to the total of the taxes that would have been imposed … with respect to all of the applicant’s income derived in that taxable year which would have constituted net earnings from self-employment … except for the exemption under section 1402(e)(1) of such Code.
Following the bill’s approval by the House of Representatives, it was sent to the Senate. The Senate failed to act on the bill by the end of the legislative session.
While this effort was unsuccessful, it is worth noting that the House of Representatives voted 410 to 1 to adopt a bill containing a provision allowing ministers a limited opportunity to revoke an exemption from self-employment tax.
(3) Senate Bill 331
On January 28, 1999, the “Work Incentive Improvement Act of 1999” (S. 331) was introduced in the United States Senate. The bill has the same purpose as the “Ticket to Work and Self-Sufficiency Act of 1998”-to assist disabled adults to participate in vocational training and employment programs. This bill currently has 73 cosponsors. Section 403 states, in part:
[A]ny exemption … by a duly ordained, commissioned, or licensed minister of a church, a member of a religious order, or a Christian Science practitioner, and which is effective for the taxable year in which this Act is enacted, may be revoked by filing an application therefore … if such application is filed no later than the due date of the federal income tax return (including any extension thereof) for the applicant’s second taxable year beginning after December 31, 1999. Any such revocation shall be effective … as specified in the application, either with respect to the applicant’s first taxable year beginning after December 31, 1999, or with respect to the applicant’s second taxable year beginning after such date, and for all succeeding taxable years; and the applicant for any such revocation may not thereafter again file application for an exemption …. If the application is filed after the due date of the applicant’s federal income tax return for a taxable year and is effective with respect to that taxable year, it shall include or be accompanied by payment in full of an amount equal to the total of the taxes that would have been imposed … with respect to all of the applicant’s income derived in that taxable year which would have constituted net earnings from self-employment …. except for the exemption ….
There are a number of important points to note:
(1) This provision is identical (except for the effective date) to the one contained in the Ticket to Work and Self-Sufficiency Act of 1998, which was approved by the House of Representatives in 1998 by a vote of 410 to 1.
(2) This bill was introduced on January 28, 1999 with 39 sponsors. By early May there were 72 sponsors.
(3) The provision allowing clergy to revoke an exemption from self-employment taxes is an amendment to a popular bill that is designed to assist disabled adults return to work.
(4) If enacted, this bill would allow exempt ministers to revoke their exemption by filing a form with the IRS by April 15, 2002. Ministers can choose to revoke their exemption beginning either with year 2000 or year 2001.
(5) Ministers who revoke their exemption will not be permitted to apply for exemption at a later time. The decision to revoke an exemption is irrevocable.
(6) Ministers who file for revocation of their exemption after the due date of the federal income tax return for a year in which they have elected to be covered by social security must include with their return payment of their entire self-employment tax liability for that year.
The following examples all assume that Senate Bill 331 will be enacted:
Example. Rev. D opted out of social security in 1980 because he did not want to pay the self-employment tax. He now recognizes that he was not eligible for the exemption, and would like to revoke it. If Senate Bill 331 is enacted, Rev. D will be able to file a form with the IRS revoking his exemption. On this form, Rev. D will designate whether he wants to revoke his exemption beginning with either the year 2000 or the year 2001.
Example. Same facts as the previous example. Rev. D waits until July 1, 2002, to file his revocation form. He has waited too long. The form must be filed no later than April 15, 2002.
Example. Same facts as the previous example, except that Rev. D obtained a four-month extension to file his year 2001 tax return (until August 15, 2002) by filing IRS Form 4868. It is not too late for Rev. D to file a revocation form, since the deadline is the due date for the federal tax return for the second year following December 31, 1999. The second year is 2001, and the due date for the federal tax return for that year is April 15, 2002. However, the proposed law specifies that the deadline for filing the revocation form for ministers who applied for a four-month extension to file their year 2001 tax return is August 15, 2002.
Example. Assume that Rev. D has net self-employment earnings of $50,000 in 2000 and 2001, including his church-designated housing allowance. Rev. D plans to file his year 2001 tax return by April 15, 2002 (he does not plan on filing for a four-month extension). He waits until April 15, 2002 to decide whether to revoke his exemption from self-employment tax. By delaying his decision, he how has two options: (1) Revoke his exemption beginning with the year 2000. He will be liable for “back taxes” to January 1, 2000-that is, for two years plus the first quarter of year 2002 self-employment taxes. This will amount to approximately $17,200 (multiply the 15.3% self-employment tax rate times two years of net self-employment earnings of $50,000, plus the first quarter of compensation for 2002). Obviously, this liability is so large that it is doubtful that Rev. D will be able to afford it. (2) Revoke his exemption beginning with the year 2001. He will be liable for “back taxes” to January 1, 2001, or one year plus the first quarter of year 2002 self-employment taxes. This will amount to approximately $9,600 (multiply the 15.3% self-employment tax rate times one year of net self-employment earnings of $50,000, plus the first quarter of compensation for 2002). Obviously, this liability is also substantial, making it unlikely that Rev. D will be able to afford revoking his exemption. The problem in this example is that Rev. D waited too long to decide whether or not to revoke the exemption. The key point is this-the longer ministers delay in making this decision, the less likely they will be able to afford revoking their exemption.
Example. Assume that Rev. D has net self-employment earnings of $50,000 in 2000 and 2001, including his church-designated housing allowance. Rev. D learns of the new law, and decides to revoke his exemption immediately by filing a revocation form with the IRS in January of 2000. He designates on the form that he wants to revoke his exemption beginning with the year 2000. Rev. D uses the quarterly estimated tax procedure to pay his taxes, and so he simply begins basing his quarterly estimates on both income taxes and self-employment taxes. This will increase his quarterly payments by approximately $1,900 (one-fourth of his annual self-employment tax, computed by multiplying net self-employment earnings of $50,000 times the self-employment tax rate of 15.3%). By making the decision to revoke the exemption early, Rev. D is avoiding the problem of having to make large payments of “back taxes”. It is more likely that Rev. D will be able to “afford” revoking his exemption in the event that he would like to do so.
Example. Rev. D revokes his exemption in January of 2000. After a few years, he regrets having done so, and wants to revert back to exempt status. He will not be permitted to do so. A decision to revoke an exemption is irrevocable.
Tip. Here is a very important point to note-if the new bill does become law, ministers who would like to revoke an exemption from social security should do so as soon as possible. Back in 1987, ministers were given an opportunity to revoke an exemption, and they could do so from January 1, 1987 through April 15, 1988. The problem was that ministers who revoked an exemption were liable for self-employment taxes back to January 1, 1987. Most ministers who were seriously considering revoking their exemption waited until the deadline, only to discover that the revocation of their exemption would make them liable for five quarters of self-employment tax. Even on modest income, this was a crushing tax liability that few could afford. As a result, very few ministers revoked their exemption.
(4) Senate Bill 170
On January 19, 1999, Senator Bob Smith (R-NH) introduced Senate Bill 170. The bill currently has 11 cosponsors (Senators Moynihan, Harkin, Lott, Dodd, Kerrey, Chafee, Mack, Murkowski, Santorum, Reid, Inouye). The text of this bill is identical to that of Senate Bill 331, quoted above.
In explaining the bill, Senator Smith observed:
Today I am introducing a bill to allow qualified members of the clergy of all faiths to participate in the Social Security program. This bill would provide a two-year open season during which certain ministers who previously had filed for an exemption from Social Security coverage could revoke their exemption. These members of the clergy would become subject to self-employment taxes, and their earnings would be credited for Social Security and Medicare purposes. Before 1968, a minister was exempt from Social Security coverage unless he or she chose to elect coverage. Since 1968, ministers have been covered by Social Security unless they file an irrevocable exemption with the Internal Revenue Service, usually within two years of beginning their ministry. On two other occasions, in 1977 and again in 1986, ministers were given a similar opportunity to revoke their exemption from Social Security coverage. Despite the existence of these brief open season periods, many exempt ministers did not take advantage of or have not had the opportunity to revoke their exemption from Social Security coverage. Because the exemption from Social Security is irrevocable, there is no way for them to gain access to the program under current law. Only an individual who is a duly ordained, commissioned, or licensed minister of a church, or a member of a religious order who has not taken a vow of poverty, would be able to revoke his or her exemption from Social Security, under my bill. Of course, this measure would not permit ministers who already have reached retirement age to gain access to the Social Security program.
This bill primarily would benefit modestly paid clergy, who are among the most likely to need Social Security benefits upon retirement. Many chose not to participate in the Social Security program early in their careers, before they fully understood the ramifications of filing for an exemption. If enacted, this measure would raise about $45 million over the next five years, according to the Congressional Budget Office. CBO has scored the bill as a revenue raiser and, as a result, it will require no budget offset. Over the long-term, the legislation would cost money, but I do not expect its costs to be that significant because CBO has estimated that only about 3,500 members of the clergy would exercise the option that this bill provides.
Similarly, Senator Moynihan observed:
Today I join my colleague, Senator Bob Smith of New Hampshire, in introducing a bill to allow certain members of the clergy who are currently exempt from Social Security an open season to opt in. Under section 1402 of the Internal Revenue Code, a member of the clergy who is conscientiously, or because of religious principles, opposed to participation in a public insurance program generally, may elect to be exempt from Social Security coverage and payroll taxes by filing an application of exemption with the Internal Revenue Service within two years of beginning the ministry. To be eligible for the exemption, the member of the clergy must be an individual who is a fully ordained, commissioned, or licensed minister of a church, or a member of a religious order who has not taken a vow of poverty. Once elected this exemption is irrevocable. This legislation would allow members of the clergy who are not eligible for Social Security a two-year open season in which they could revoke their exemption. At the time of exemption, many clergy did not fully understand the ramifications of their actions, and it is not until later in life, when they are blocked from coverage, that they realize their need for Social Security and Medicare. This decision to “opt in” would be irrevocable and all post-election earnings would be subject to the payroll tax and credited for the purposes of Social Security and Medicare. The Congressional Budget Office estimates that this legislation would affect approximately 3,500 members of the clergy and would increase revenues by about $45 million over the next five years. Similar legislation was passed both in the 1977 Social Security Amendments (Section 316) and in the Tax Reform Act of 1986 (Section 1704). This bill has been endorsed by the United States Catholic Conference and the National Conference of Catholic Bishops. It is a simple but much-needed measure, and I urge every member of the Senate to support it.
Conclusions
There are several important conclusions for ministers to note:
1. Nothing has been enacted, yet. No law giving ministers an opportunity to revoke an exemption from self-employment tax has been enacted yet. Ministers who would like to revoke an exemption should do nothing now-except to review their options and be prepared to act quickly if any of the pending bills becomes law.
Key point. As soon as any of the pending bills allowing ministers to revoke an exemption from self-employment tax is enacted, we will alert you immediately in this newsletter and in our weekly email newsletter for subscribers to our website library.
2. Enactment is likely. It is very likely that Congress will enact legislation giving ministers an opportunity to revoke an exemption from self-employment tax. Remember that 72 of 100 senators are sponsoring one of the pending bills (Senate Bill 331), and this bill is identical to the one contained in the Ticket to Work and Self-Sufficiency Act of 1998 which was approved by the House of Representatives by a vote of 410 to 1.
3. Be prepared to act. Since it is likely that Congress will enact legislation giving ministers an opportunity to revoke an exemption from self-employment tax, ministers should be reviewing their options at this time. Here are some questions to ask:
“Am I am exempt from self-employment tax? You are if you filed a timely Form 4361 in triplicate with the IRS, and received back one of the forms marked “approved.”
“Was I eligible for exemption at the time I filed Form 4361? Review the conditions for exemption that are summarized at the beginning of this article. Many ministers were not.
“Do I want to revoke my exemption? Some ministers will want to revoke an exemption because they now realize that they were not eligible. It is an ethical matter for them. For others, the inducement to revoke an exemption may be to qualify for Medicare coverage and the other benefits of social security.
“If I decide to revoke my exemption, when should I do so? Remember that the longer you wait to revoke your exemption, the more “back taxes” you will have to pay-up to a maximum of two years plus one quarter of self-employment taxes. Even on modest incomes, this can result in a crushing tax liability. If you decide to revoke your exemption, consider doing so as soon as the law allows. This will minimize the financial impact of your decision, and make it more “affordable” by avoiding a large “back taxes” liability.
