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Clergy are Blessed with (almost) Tax-Free Status

 

March 23, 2012

The Congress officially recognizes the value of all clergy and religious workers, and provides significant income tax benefits not generally available to lay people.  There are rules to follow, but by and large clergy can fairly easily take advantage of these special concessions.

Clergy receive special tax treatment for these reasons:

  1. Even though clergy are considered employees of a church or religious denomination, they can be treated as being self-employed for Social Security and Medicare tax purposes.
  2. Clergy receive an income tax-free housing allowance and/or may live in a church-provided parsonage.
  3. Since clergy are treated as self-employed, the religious institution they work for cannot withhold Social Security or Medicare tax from their paychecks. However, extra federal tax can be withheld at the request of the clergy-person to cover the self-employment tax.
  4. Most salaried clergy people might also be eligible for the Earned Income Tax Credit.

The values of the first two items above are excluded from a clergy-person’s calculation of income tax, but are still subject to self-employment (SE) tax. Clergy who have elected to be covered by Social Security are considered Self-employed. The IRS Instructions for Schedule SE has significant information dealing with ministers and other religious workers.

When and how can clergy opt out of Social Security?

An important fact for clergy to remember when considering opting out of paying in to Social Security is that they would then not be eligible for any Social Security retirement benefits. If the clergy-person does decide to opt out, then he or she must opt out by the second year in which they have earned more than $400 of ministerial income. IRS Form 4361 must be completed, and it must be filed on the correct basis of religious belief. If approved by the IRS, only earnings from ministerial services are exempt from self-employment tax. Form 4361 indicates that once the exemption is approved, it cannot be revoked.

To claim the exemption from Social Security tax, clergy must follow these rules:

  • File Form 4361
  • State they are conscientiously opposed to public insurance (which includes insurance systems established by the Social Security Act)
  • State they desire to opt out because of their individual religious considerations (not because of their general conscience), or because of the principles of their religious denomination--either opposition must be based on religious belief
  • They cannot opt-out for economic reasons
  • They must inform the ordaining, commissioning, or licensing body of their church or religious order that they are opposed to public insurance. This includes an opposition for insurance that helps pay for or provide services for medical services (such as Medicare) and Social Security benefits.
  • The religious organization that ordained, commissioned, or licensed them must be a tax-exempt religious organization.
  • The religious organization must be a church, convention, or association of churches.

Upon receipt of the Form 4361, the IRS will mail a statement to the clergy-person which must then be signed and returned to verify that they are requesting an exemption based on the grounds listed on the statement.

What is the difference between a parsonage allowance and a housing allowance? Are there limits? How does the church or religious organization designate these allowances?

Parsonage Allowance: A parsonage is a church or religious organization-provided dwelling that is offered as compensation for ministerial services, and generally owned or controlled by the religious organization. Clergy who live in a parsonage provided by the religious organization they work for do not have to report the fair rental value of the parsonage as income, although they do need to include it when figuring their self-employment tax. The housing allowance is sometimes called a “parsonage allowance” for clergy who are provided with a parsonage and a “rental allowance” for clergy who rent their home.

Example: A church pays its pastor an annual salary of $35,000. In addition, she is provided the rent-free use of a furnished home owned by the church. The parsonage’s annual fair rental value is $10,000. Neither the church nor the pastor will be required to report the $10,000 fair rental value as income for federal income tax purposes.

Note: Many ministers who live in a parsonage are unaware that they do not pay tax on that portion of their salary that is designated in advance by their church as a parsonage allowance. Such an allowance costs the church nothing, but it provides a minister with a significant tax benefit.

Housing Allowance: On the other hand, a housing allowance is a rented home or apartment, or a home owned by the clergy-person, that they live in while performing ministerial services. The minister elects and the church approves a percentage of the minister's total compensation as a housing allowance.

When reporting gross income for federal income tax purposes, clergy can exclude a portion of their income designated by their church or salary paying unit as a "housing allowance." However, housing amounts are subject to Self Employment Taxes unless the minister opted out with Form 4361. To be excludable, designated housing allowance amounts must conform to these guidelines:

  • The allowance must be designated in advance by their church or religious organization
  • The allowance must only be used to pay for housing-related expenses
  • The allowance must not exceed the annual rental value of the house

Note: A clergy-person who is a homeowner and receives a housing allowance may receive additional benefits. As a homeowner, he or she may be eligible for a "double deduction." While property taxes and mortgage interest may be included in a designated housing allowance, these items may also be taken as itemized deductions on Schedule A.

The Importance of "Pre-designating" the Housing Allowance

It is extremely important that the church or religious organization makes the housing allowance designate sometime before the clergy-person is paid. The designation may take the form of a specific dollar amount or a per cent of total compensation. The designation can never be made retroactively. It may be amended from time to time as necessary, but each amendment must be formally adopted by the employer and can only affect income paid after the date of the amendment.

Besides the clergy-person’s salary from the religious organization for his/her wages for services, what other earnings do they need to report as income?

Most ministers and church staff receive compensation for personal services – which are services provided outside of regular ministerial services. Compensation paid to clergy employees by a religious congregation for personal services such as baptisms, weddings, bar-mitzfahs, etc. is wages and is reported on Form 1040, line 7. Compensation for these same services paid to self-employed religious workers constitutes self-employment earnings and is reported on Schedule C

There are also some other very important points that Church or Synagogue Treasurers have to take into account in order for clergy to get the tax benefits.  This significant tax information for clergy can be found in the IRS Publication 517, “Social Security and Other Information for Members of the Clergy and Religious Workers.”

Your PRO-TAX professional preparers are happy to help clergy and religious workers to find answers to their tax questions, and to file their returns. Drop by or contact your local PRO-TAX office at 434-220-4705 or click on this link www.protax.com/resources/clientappointments to set an appointment today!