Tax preparation software packages, such as TurboTax, TaxAct, H&R Block, and TaxSlayer, have become popular ways for individuals to prepare their own income tax returns.
However, these software packages are not specifically designed to address some of the tax rules unique to ministers.
Ministers using a tax software package should be familiar with these unique rules and should consider seeking the advice of a tax professional with experience in preparing ministers’ returns, just to ensure everything is accurately prepared.
The upside of using off-the-shelf programs
Most of the leading income tax software products are offered in boxed, downloadable, or online versions, making them easily accessible.
They are also relatively inexpensive, generally in the $50 to $100 range for the federal self-employed version, with an additional cost to prepare a state income tax return (some versions are even free for lower income individuals).
These packages also offer the ability to electronically file the federal (and sometimes the state) income tax return, which greatly speeds up the refund process. A top-notch package will also include additional features (sometimes for an additional price), such as:
- the ability to import tax data from other sources (e.g., from investment accounts or from Quicken/QuickBooks);
- the ability to track real-time information during the year (such as TurboTax’s ItsDeductible feature for tracking charitable donations);
- an interview interface to guide you through the preparation process;
- error-checking of the return after it has been prepared;
- a deduction finder to alert you to income tax deductions that may be applicable;
- easy access to IRS publications and tax practitioner explanations;
- tax planning assistance;
- audit defense (for example, in the case of an IRS audit, the manufacturer will defend the income tax filer if there is an error resulting from the use of the manufacturer’s product), and
- financial or retirement planning assistance.
Three rules unique to ministers
While using tax preparation software packages can be an attractive alternative for ministers, these packages are often limited in their ability to address some of the unique tax rules applicable to ministers.
Three rules are applicable to duly ordained, licensed, or commissioned ministers who are being paid for services performed in the exercise of their ministry. These rules are not applicable to income or wages earned by a minister outside of the ministerial context (such as for secular employment).
1. Social Security and Medicare taxes
Under federal tax law, ministers employed by a church have a “dual tax status.”
They are considered employees for federal income tax purposes but are considered self-employed for federal employment tax purposes. Therefore, a minister will generally receive a Form W-2 from his employing church for wages earned, but those wages are not subject to employee- and employer-paid FICA taxes (the 7.65 percent each respective side pays into the Social Security and Medicare systems).
Instead, ministers are responsible for paying the full 15.3 percent due into Social Security and Medicare through the payment of self-employment taxes (also known as SECA), which are computed on Schedule SE of their personal income tax returns.
Ministers who are conscientiously opposed to, or because of their religious principles are opposed to, the acceptance of any public insurance (such as Social Security or Medicare) with respect to their ministerial earnings may elect out of the Social Security and Medicare system by filing Form 4361 with the IRS.
Form 4361 generally must be filed within two years of the first year that a minister has earnings from ministerial work. Ministers who have made this election would not complete Schedule SE but would enter “Exempt-Form 4361” on the dotted line next to Form 1040, Schedule 2, line 4, and/or Form 1040, line 23 (other taxes, including self-employment tax).
Ministers using tax preparation software should check to make sure that the software accepts their Form W-2, since a properly prepared Form W-2 will not show their wages as subject to Social Security or Medicare taxes.
The minister also should make sure that their wages are properly being treated by the software package as self-employment income, for purposes of computing the self-employment tax, if applicable to the minister. For ministers opting out of the Social Security and Medicare system, check to make sure that the tax software package makes the notational entry on Schedule 2, line 4, and/or line 23 of the Form 1040.
2. Parsonage or housing allowance exclusion
Ministers may exclude from their taxable income the annual fair rental value of a parsonage provided rent-free by their church as part of their compensation package.
Ministers living in their own homes may exclude from their taxable income cash payments that have been properly designated by their employing church as a ministerial housing allowance, up to the lesser of (1) the amount used to pay for housing-related expenses (such as mortgage payments or rent, utilities, repairs, furnishings, insurance, property taxes, improvements, maintenance, and homeowners’ association dues), or (2) the fair rental value of the home, including furnishings and utilities.
The excess of the amount designated over the excludible amount should be included in taxable income (and the words “Excess Allowance” should be added on the dotted line next to the appropriate Form 1040 line item).
The allowance is excludable for income tax purposes only. For ministers who have not opted out of the Social Security and Medicare system, their parsonage/housing allowance must generally be included in determining their self-employment tax.
Therefore, ministers using tax preparation software should check to make sure the package is properly limiting the housing allowance exclusion based on the limitations noted above, including the ”Excess Allowance” notation, and that the package is properly including the parsonage/housing allowance amount in the calculation of self-employment income.
3. Limitation on—or disallowance of—business expense deductions
Many ministers may incur unreimbursed expenses in connection with their church employment. For tax years 2018 through 2025, such unreimbursed employee business expenses are not deductible for federal income tax purposes. (However, such expenses are still deductible for self-employment tax purposes.)
Ministers may also incur expenses, such as travel expenses, in connection with ministerial income earned outside of their employment (such as honorarium payments received for speaking engagements, weddings, or funerals). Business expenses related to ministerial income earned outside of a minister’s employment (reportable on Form 1040, Schedule C) incurred in connection with ministerial earnings are not deductible for federal income tax purposes to the extent that they are allocable to tax-exempt parsonage or housing allowances.
To compute the nondeductible portion, the minister should first determine his total ministerial income, including the parsonage/housing allowance. The minister should then divide the parsonage/housing allowance by the total ministerial income to determine the nontaxable percentage. This percentage should then be applied to any business expenses incurred to determine the nondeductible portion. Only the deductible portion should then be reported on Schedule C.
Many tax software packages do not automatically calculate the nondeductible portion of business expenses allocable to the tax-free portion of a minister’s income. Ministers will therefore need to manually adjust these expenses and input the reduced figure into the software for purposes of computing the income tax deduction. However, since the parsonage/housing allowance is included in the computation of the amount subject to the self-employment tax, the full amount of the business expenses should be used to compute the net earnings from self-employment reportable on Schedule SE.
Exercise caution
Tax preparation software packages offer many benefits and conveniences, making them an attractive alternative for individuals wishing to prepare their own income tax returns. However, ministers who are considering using an income tax software package should carefully check their returns to ensure that the situations outlined above are correctly addressed.
Michele Wales, CPA, is a shareholder in the firm of Batts Morrison Wales & Lee, an accounting firm dedicated exclusively to serving nonprofit organizations and their affiliates throughout the United States. Wales practices primarily in the area of nonprofit income taxation and is responsible for training members of the firm who specialize in this area of taxation. Wales has over 20 years of experience in public accounting and has been a conference speaker on nonprofit taxation issues both locally and nationally.
