William and Cathy A. Bennett v. Commissioner, TC Memo. 2007-355 (2007)
Background. Ministers have a dual tax status. Most are employees for federal income tax reporting purposes, but they are treated as self-employed for Social Security (except for some chaplains) with respect to services performed in the exercise of their ministry. This means that they pay the self-employment tax, rather than FICA taxes.
Ministers can exempt themselves from self-employment taxes if several requirements are met. These include the following:
- The minister is ordained, commissioned, or licensed by a tax-exempt church or religious denomination.
- The minister files a timely exemption application (Form 4361) with the IRS. The application is timely if filed by the due date of the federal tax return (Form 1040) for the second year in which the minister has net self-employment earnings of at least $400, any portion of which comes from the exercise of ministry. For example, if a minister was licensed in May of 2006, and was employed by a church as an associate pastor since July of that year, the deadline for the exemption application would be April 15, 2008. The basis for the exemption is opposition, based on religious convictions, to the acceptance of public insurance benefits (including Social Security).
- Ministers must notify the church or denomination that ordained, licensed, or commissioned them of their intention to apply for an exemption.
- The IRS must verify that a minister who applies for exemption is eligible. This is done by the minister signing Form 4361.
Tip. Churches should not withhold Social Security and Medicare taxes from the wages of a minister, even if the minister has requested voluntary withholding of income taxes. However, ministers who elect voluntary withholding of income taxes can request that additional income taxes be withheld from their wages in an amount sufficient to pay their self-employment taxes. This request is made by filling out a new Form W-4. The additional withholdings must be reported on the minister’s W-2 form as withheld income taxes. These additional taxes become a credit that can be applied to the minister’s self-employment tax liability when completing Form 1040.
What if I lose my Form 4361? Many ministers do not pay self-employment taxes because they believe they are exempt, even though they cannot find a copy of the Form 4361 they submitted to the IRS, or any other evidence that they are exempt. In some of these cases the minister in fact did submit a timely Form 4361, while in others the minister is relying on a vague recollection of something that never happened.
What happens if such a minister is audited? How can the minister prove that a timely Form 4361 was filed? What if the minister cannot do so? Will self-employment taxes be owed? The IRS takes the position in such cases that the minister is not exempt, based on the following two sentences in the income tax regulations:
The filing of an application for exemption on Form 4361 by a minister … does not constitute an exemption from the tax on self-employment income with respect to services performed by him in his capacity as a minister. The exemption is granted only if the application is approved by an appropriate internal revenue officer. (emphasis added)
A recent case. The United States Tax Court addressed this question in a recent case. Here are the facts. A minister was “commissioned and licensed” by a church in 1996, and served as its senior pastor. He received net ministerial income of $400 or more for 1997 through 2002 (except for 2000). In 1998, he paid self-employment taxes on his ministerial income, but did not do so for any of these other years based on his belief that he was exempt.
The IRS audited the minister’s 2002 tax return and determined that he incorrectly claimed to be exempt from self-employment taxes. Self-employment taxes, plus interest, were assessed. The minister claimed that he was exempt from self-employment taxes since (1) he filed a Form 4361 with the IRS in 1980 that the IRS approved, although he didn’t have a copy of the form or the IRS approval; and (2) he filed a new Form 4361 with his tax returns for 1997, 1999, 2000, and 2002.
The IRS claimed that it never received the minister’s 1980 exemption application, and that the subsequent forms he submitted were all too late. The minister appealed his case to the United States Tax Court.
The Court’s ruling. The Tax Court agreed with the IRS that the minister failed to submit his Form 4361 on time.
the 1980 Form 4361
The court concluded that the following facts undermined the minister’s claim that he owed no self-employment taxes in 2002 because he filed a timely Form 4361 in 1980 that was approved by the IRS:
- The minister produced no documentation to corroborate that in 1980 he filed a Form 4361.
- The IRS searched relevant files in its Ministerial Unit at the Philadelphia Service Center, which processes all Forms 4361 and which maintains individual folders containing Forms 4361 relating to all ministers, and the folder relating to the minister in this case did not contain any Form 4361 filed by him in 1980.
- The IRS also conducted a search of the minister’s other files and archives for the allegedly filed Form 4361, but this search yielded no Form 4361 filed in 1980.
- The fact that the minister for 1998 actually reported and paid self-employment taxes of $4,191 on his ministerial income undermined his claim that he believed that in 1980 he had filed a Form 4361 that was approved by the IRS.
- After approving or disapproving a Form 4361, the IRS is to submit to the Social Security Administration a copy of the approved or disapproved Form 4361, and there is in evidence a Certificate of Lack of Record from the SSA indicating that the SSA has no record of any Form 4361 filed by the minister in 1980.
The minister claimed that because he failed to pay employment taxes in some years proved that in 1980 he must have received an approved ministerial exemption. The court noted that “his failure to pay employment taxes in some years could be attributed to a number of reasons (e.g., unemployment).”
the other Forms 4361
The Court noted that the minister had income of at least $400 for both 1997 and 1998 from the exercise of ministry, and therefore the due date for his Form 4361 was April 15, 1999 (the due date for his federal tax return for the second year that he had net self-employment income of at least $400, any part of which derived from ministerial services). The minister insisted that he filed timely Forms 4361 (or letters containing the same information) in 1997, 1999, 2000, and 2002, and therefore his ministerial income was exempt from self-employment taxes for 2002. The Court disagreed. It addressed each of the minister’s submissions as follows:
- His 1997 tax return included a Form 4361, but this return was not submitted until 2000, a year after the filing deadline of April 15, 1999.
- His 1998 tax return was filed on April 15, 1999, and it included a letter requesting exemption from self-employment taxes, but the letter failed to include the “certifications” required for an exemption application. The Court acknowledged that the IRS “may accept from a minister, in lieu of a Form 4361, a letter if the letter is timely filed and if the letter includes the required certification statements.” The are two such statements that are required by the tax code: (1) a statement certifying that the minister is conscientiously or, on the basis of religious principles is opposed to, the acceptance of public insurance such as Social Security; and (2) an additional statement certifying that the minister “has informed the ordaining, commissioning, or licensing body of the church or order that he is opposed to such insurance.” Audit, Internal Revenue Manual, sec. 188.8.131.52.1(3), at 10,779-749-11. Since the letter the minister enclosed with his 1998 tax return did not contain either of these certifications, it was not a valid application for exemption.
- His 1999 tax return included a Form 4361, but it was filed in 2000 (after the April 15, 1999 deadline for his Form 4361).
- He did not file a tax return for 2000.
- His tax returns for 2000 and 2001 included a Form 4361, but these were filed after the April 15, 1999 deadline for filing his Form 4361.
The minister produced several additional copies of different Forms 4361 prepared and signed by him and dated prior to April 15, 1999, but he “produced no evidence that these Forms 4361 were ever properly addressed, stamped, mailed, and filed with the IRS prior to April 15, 1999.”
The Court stressed that (1) the Form 4361 filing deadline “is mandatory and is to be complied with strictly”; and (2) ministers “bear the burden of proof to establish that a Form 4361 or letter was timely filed.”
Relevance to other ministers. What is the relevance of this case to other ministers? Consider the following points:
1. Ministers should not assume they are exempt from self-employment taxes based on a hazy recollection that they filed a timely Form 4361. According to the income tax regulations (quoted above) the filing of a Form 4361 “does not constitute an exemption from the tax on self-employment income with respect to services performed by him in his capacity as a minister. The exemption is granted only if the application is approved by an appropriate internal revenue officer.” (emphasis added) Note the following:
- Ministers who cannot find a copy of the Form 4361 the submitted to the IRS, or, more importantly, the IRS approval of the exemption, should understand that their exemption may be challenged in an audit. Form 4361 is filed in triplicate, and the IRS returns one copy, marked “approved,” to the applicant if the application is approved. This is the key document that will establish unequivocally a minister’s exempt status. Ministers should make multiple copies of this approved form, and keep them in separate locations.
- Ministers generally will not be entitled to exemption even if they prove that they filed a timely Form 4361 if they cannot produce a copy of the form marked “approved” by the IRS that was returned to them.
2. This case provides interesting details on how the IRS processes ministers’ Forms 4361:
- The IRS Ministerial Unit at the Philadelphia Service Center processes all Forms 4361, and maintains individual folders containing Forms 4361 relating to all ministers. Ministers who recall filing a timely Form 4361, but who cannot find it (or the IRS approval), will have little chance of establishing their exempt status if their Form 4361 is not found in a file bearing their name at the Philadelphia Service Center.
- The IRS may also search other files it maintains on taxpayers to locate a missing Form 4361.
- After approving or disapproving a Form 4361, the IRS submits to the Social Security Administration a copy of the approved or disapproved Form 4361. The IRS can ask the SSA for evidence that a Form 4361 was filed by a minister. If none is found, the SSA issues a Certificate of Lack of Record indicating that it has no record of any Form 4361 filed by the minister.
3. Ministers who claim they filed a timely Form 4361 that was approved by the IRS, but who cannot locate a copy of their form of the IRS approval, will likely not prevail with the IRS or the Tax Court if they paid self-employment taxes for at least some of the years following the alleged submission of their Form 4361, since represents an inconsistent position.
4. The Form 4361 filing deadline “is mandatory and is to be complied with strictly,” and ministers “bear the burden of proof to establish that a Form 4361 or letter was timely filed.” This means that all doubts will be resolved against ministers who claim that they are exempt from self-employment taxes but who lack conclusive proof that they filed a timely Form 4361 (or letter with the required information) that was subsequently approved by the IRS.
5. The IRS “may accept from a minister, in lieu of a Form 4361, a letter if the letter is timely filed and if the letter includes the required certification statements.” The are two such statements that are required by the tax code: (1) a statement certifying that the minister is conscientiously or, on the basis of religious principles is opposed to, the acceptance of public insurance such as Social Security; and (2) an additional statement certifying that the minister “has informed the ordaining, commissioning, or licensing body of the church or order that he is opposed to such insurance.” Audit, Internal Revenue Manual, sec. 184.108.40.206.1(3), at 10,779-749-11. However, as this case illustrates, a letter in lieu of a Form 4361 must contain the representations required by law. In this case, at least one of the minister’s letters failed to include the required statements. For this reason, ministers seeking recognition of exemption from self-employment taxes should always use Form 4361 (which contains the required language).
6. The Court erroneously noted that a Form 4361 must be filed with the IRS “no later than the due date (including extensions) applicable to the filing of the minister’s federal income tax return for the second year in which the minister receives $400 or more of net self-employment income relating to his or her ministerial duties.” (emphasis added) It quoted section 1402(e)(3) of the tax code as the basis for this conclusion. In fact, section 1402(e)(3) states that the due date for filing Form 4361 is “the due date of the return (including any extension thereof) for the second taxable year for which he has net earnings from self-employment … of $400 or more, any part of which was derived from the performance of service [in the exercise of ministry].” (emphasis added) Form 4361 contains the correct language.
7. How far back can the IRS assess self-employment taxes in the case of ministers who assume they are exempt but who cannot prove that they filed a timely Form 4361 that was approved by the IRS? Can the IRS assess back taxes and penalties all the way back to the first year of the person’s ministry? Section 6501(a) of the tax code specifies that taxes must be assessed within three years after a return is filed, though taxes may be assessed at any time in the case of failure to file a return. In other words, the IRS generally can assess back taxes only for the three years preceding a return, but there is no limit on how far back it can assess taxes if no return is filed.
This article first appeared in Church Finance Today, March 2008.