Jump directly to the Content

US Tax Court Fines Pastor $2,500 for “Frivolous” Tax Argument

This case highlights some of the most important provisions of federal tax law pertaining to ministers.

The United States Tax Court rejected a minister’s frivolous tax arguments and subjected him to back taxes, interest, and a penalty for filing a frivolous tax return.

Background

A minister was employed by a church in Connecticut. He resided in the parsonage of the church as part of his employment and did not make rental payments to the church.

On April 15, 2018, the minister timely filed a Form 1040, US Individual Income Tax Return for the 2017 tax year. On his return, the minister self-reported $16,632 in pension income and $1,480 in taxable Social Security benefits. He did not report any wage income, despite the church issuing him a Form W-2 reporting $63,652 in compensation for his ministerial services.

The IRS selected the minister’s tax return for examination. The IRS proposed an adjustment in the amount of $24,884, resulting from the addition of the omitted wages to gross income and resulting adjustments to the minister’s taxable Social Security income, self-employment adjusted gross income, and self-employment tax. On August 19, 2020, the IRS issued a Notice of Deficiency to the minister in that same amount.

On November 23, 2020, the IRS timely filed a petition with the Tax Court. In both his petition and in subsequent filings, the Court noted that the minister made arguments “that resemble those that this Court has previously deemed groundless and frivolous.” The Court warned the minister that if he continued to pursue such arguments, he would be potentially subject to penalties under section 6673 of the tax code of up to $25,000. The Court repeated this warning during the trial.

Claims addressed by the Tax Court

At trial, the taxpayer continued “to advance groundless arguments, namely that due to his status as a minister, his wages are not subject to income tax nor self-employment tax.” The minister explained that he is a “worker of common right and a nontaxpayer” and thus “not subject to the jurisdiction of revenue law because of his occupation.”

The court addressed claims made by the minister related to taxable income and self-employment tax.

Taxable income

The Court began its ruling by noting that section 61 of the tax code purports to tax “all income from whatever source derived,” including “compensation for services rendered.” The scope of section 61 “is broad, and exclusions from gross income must be narrowly construed.”

The Court continued:

[The minister’s] primary contention is a familiar tax protester refrain; he claims that he is not an employee and that the compensation he received as a minister is not wages and thus nontaxable. We will not “refute these arguments with somber reasoning and copious citation of precedent; to do so might suggest that these arguments have colorable merit.”. . . (“Courts uniformly have rejected as frivolous the arguments that money received in compensation for labor is not taxable income.”)

The minister also alleged that the IRS’s calculation of his W-2 income was erroneous because it included his employer’s Social Security contributions. The Court disagreed. It noted that the church regularly paid the minister additional income to cover his income tax and self-employment tax liabilities. The IRS concluded that these additional amounts of income were taxable to the minister, and the Court agreed:

“To the extent that the church pays any amount toward the minister’s obligation for income tax or self-employment tax other than from the minister’s salary, the minister is in receipt of additional income that is includible in his gross income and must be considered in determining his income tax and self-employment tax liability.”

The minister also alleged that the IRS improperly included in his gross income the business expenses reimbursed to him by the church. The Court did not address this allegation since the minister had provided no evidence to support it. Since the IRS included these reimbursements in the minister’s taxable income, they presumably were nonaccountable reimbursements, which are fully taxable to the employee recipient. Only accountable expense reimbursements are nontaxable.

Determination of self-employment taxes

The minister claimed that the IRS’s determination of self-employment tax was erroneous. The Court noted:

Individuals are subject to tax under section 1401 [of the tax code] on their net earnings from self-employment, which is defined as the net income from any trade or business carried on by the individual. . . . Section 3401(a)(9) [of the tax code] provides that compensation for services paid to a “duly ordained, commissioned or licensed minister of a church” . . . is not wages for purposes of employment taxes and thus not subject to withholding and payment by a church employer. . . . Instead, the provision of services by a church minister generally constitutes a trade or business, and a church minister’s wages are subject to self-employment tax. . . . While a church minister is permitted to submit a certificate [Form 4361] seeking exemption from self-employment tax on religious or conscientious grounds, . . . [the minister] has not alleged—nor does the record indicate—that he timely did so for tax year 2017.

[The minister] performed the duties and functions of a minister in his role at the Church, which included leading worship services and ministering to members. . . . [He] received wages as compensation for those services. Due to [his] status as a minister under section 1402, the Church did not withhold employment taxes from his compensation, which was properly subject to self-employment tax. We hold that [the minister] has failed to demonstrate that [the IRS’s] determination of self-employment tax was erroneous.

Imposition of a section 6673 penalty

Section 6673 of the tax code authorizes the Tax Court on its own initiative to impose a penalty not in excess of $25,000 when it appears that (1) the proceedings have been instituted or maintained primarily for delay or (2) the taxpayer’s position in such proceeding is frivolous or groundless.

A position maintained by the taxpayer is “frivolous” if it is “contrary to established law and unsupported by a reasoned, colorable argument for change in the law.” The Court is given full discretion in deciding whether to impose the penalty.

The Court concluded:

We find that [the minister] has advanced a frivolous and groundless argument in this proceeding. In his petition, [he] contended that he is a “worker of common right and a nontaxpayer” and thus “not subject to the jurisdiction of revenue law because of his occupation.” Despite the Court’s warning . . . that such an argument is frivolous, [the minister] continued to advance it . . . at trial. In his most recent filing, [he] continues to claim that his compensation is excluded from gross income and that he is not subject to self-employment tax. These contentions have no merit and reflect common tax protestor arguments. . . .

[The minister] has been warned multiple times that his arguments were frivolous and that the Court would consider imposing a penalty should he continue to advance them. [He] has done just that. Under such circumstances, we believe the imposition of a penalty under section [6673] in the amount of $2,500 is warranted here.

What this means for churches

This case presents an excellent review of some of the most important provisions of federal tax law pertaining to ministers. Consider the following.

Compensation is taxable income

Ministers’ wages received in providing ministerial services to a church are not exempt from federal income taxes.

Wages are exempt from withholding

Ministers’ wages received in providing ministerial services to a church are exempt from income tax withholding. A minister may request voluntary withholding, but this is not required. Ministers who have not elected voluntary withholding pay their income taxes using the estimated tax procedure.

Pay self-employment tax, not Social Security and Medicare taxes

Social Security benefits are financed through two tax systems. Employers and employees each pay the Social Security and Medicare tax, which for 2022 is 7.65 percent of an employee’s taxable wages (a total tax of 15.3 percent).

Self-employed persons pay the self-employment tax, which for 2022 is 15.3 percent of net self-employment earnings. Ministers are considered self-employed for Social Security with respect to services performed in the exercise of ministry.

This means they do not pay Social Security or Medicare taxes with respect to such services. Rather, they pay the self-employment tax (15.3 percent)—unless they have filed a timely application for exemption from self-employment taxes (Form 4361) and have received written approval of their exemption from the IRS.

Because ministers pay the entire self-employment tax without any contribution by their employing church, many churches pay their minister an additional sum to cover a portion (i.e., one-half) of the minister’s self-employment tax liability.

Caution. Note that any amount paid to a minister to help pay self-employment tax must be reported as additional compensation on the minister’s Form W-2 and Form 1040. The amount paid by the church must be reported as compensation for Social Security as well.

Handle business expenses through an accountable reimbursement plan

Most church staff members have business expenses. The tax treatment of these expenses depends on whether a person is an employee or self-employed, whether the expenses are reimbursed by the church, and whether any reimbursed expenses are paid under an accountable or a nonaccountable reimbursement plan.

Employee business expenses reimbursed by a church under a nonaccountable arrangement are no longer deductible by employees as itemized expenses on Schedule A (Form 1040) through 2025. But the limitations on the deductibility of employee business expenses (summarized above) can be avoided if a church adopts an accountable reimbursement plan. An accountable plan is one that meets four specific requirements (see sidebar).

A penalty for frivolous or groundless court proceedings

Section 6673 of the tax code authorizes the Tax Court, on its own initiative, to impose a penalty not in excess of $25,000 when it appears that (1) the proceedings have been instituted or maintained primarily for delay or (2) the taxpayer’s position in such proceeding is frivolous or groundless. A position maintained by the taxpayer is “frivolous” if it is “contrary to established law and unsupported by a reasoned, colorable argument for change in the law.”

The Court in this case concluded that the minister’s arguments were frivolous and accordingly imposed a penalty. These arguments included his claim that he was a “worker of common right and a nontaxpayer” and thus “not subject to the jurisdiction of revenue law because of his occupation.”

Van Pelt v. Commissioner, 2021 U.S. Tax Ct. LEXIS 69 (T.C. 2021)

Related Topics:
Posted:
  • June 24, 2022

Related ResourcesVisit Store

2023 Church and Clergy Tax Guide
2023 Church and Clergy Tax Guide
Support your ministry with the most authoritative and comprehensive, year-round tax resource.