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Minister Fined After Failing to Pay $25K in Income Tax

US Tax Court tosses minister’s ‘frivolous’ argument for underreporting tens of thousands of dollars in W-2 income, levies fine under section 6673 of Tax Code.

A minister’s federal tax return (Form 1040) was selected for examination by the IRS. The IRS determined that the minister had underreported his taxes by $24,884. The case was appealed to the Tax Court, which affirmed the IRS determination.

A frivolous argument

The minister’s tax return failed to report any wage income despite his church issuing a Form W-2 reporting $63,652 in compensation for his ministerial services.

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The minister argued he was not an employee, meaning his compensation was not taxable. The court observed, “The courts uniformly have rejected as frivolous the argument that money received in compensation for labor is not taxable income.”

The court noted that the church paid the minister as part of his compensation what were deemed “offsets” of the Social Security and Medicare taxes for which the minister was responsible.

It observed:

Because the minister’s compensation was not subject to the withholding and payment of such taxes by the church, the payments made by the church to [the minister] as “offsets” of his taxable income remain includible in his gross income. “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.” (Quoting Rev. Rul. 68-507, 1968-2 C.B. 485.)

Ministers’ wages subject to self-employment tax

The Tax Court agreed with the IRS’s conclusion that the minister owed additional self-employment taxes:

[The minister] has also failed to carry his burden of showing that [the IRS’s] determination of additional self-employment tax was erroneous. 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) provides that compensation for services paid to a “duly ordained, commissioned or licensed minister of a church” (church minister) is not wages for purposes of employment taxes and thus not subject to withholding and payment by a church employer. See Section 3402(a); see also Section 3121(b)(8).

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. Section 1402(c)(4); see also Knight v. Commissioner, 92 T.C. 199, 201-202 (1989). While a church minister is permitted to submit a certificate seeking exemption from self-employment tax on religious or conscientious grounds, see section 1402(e), [the minister] has not alleged — nor does the record indicate — that he timely did so . ...

[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.

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” where it is “contrary to established law and unsupported by a reasoned, colorable argument for change in the law.” (Quoting Coleman v. Commissioner, 791 F.2d 68 (7th Cir. 1986)).

Here, the court noted the minister “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.’” The court found the argument frivolous, and despite warnings from the court, the minister continued to advance them. The court fined the minister $2,500 under section 6673.

What this means for churches

First, wages paid to employees for services rendered constitute taxable income and must be so reported by both the employer and employee.

The argument that ministers are not employees of their church and so their church compensation is not taxable is regarded as frivolous and can result in substantial penalties for both the employer and employee.

Second, as this case illustrates, churches often assist ministers with payment of self-employment taxes. The reasoning typically is that the church pays half of the Federal Insurance Contributions Act (FICA) taxes of non-minister employees, and so, as a matter of simple equity, the church should pay some portion of its minister’s self-employment taxes (Self-Employed Contributions Act (SECA)) which otherwise would be paid entirely by the minister. But note that any portion so paid by the church represents taxable income to the minister in computing both income taxes and self-employment taxes.

Third, section 6673 of the tax code authorizes the Tax Court 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.

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

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Posted:
  • January 18, 2023

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