There are some tricky income tax and Social Security tax rules that ministers have to face with regards to how their income is taxed, how to claim an exemption from self-employment tax, how to take advantage of a tax-free parsonage allowance, and a lot more.
The earnings for the services performed by a minister of a church are subject to self-employment tax unless the minister requests and an exemption. Any salary that a minister receives as payment for being an employee of the church, as well as offerings and fees including those for performing marriages, funerals, and baptisms, is subject to taxes.
You are only treated as a minister once you are duly ordained, commissioned or licensed by a church or church denomination. You will be given the authority to conduct religious worship, perform sacerdotal functions and administer ordinances or sacraments. If you are a Christian Science practitioner or reader, the same thing applies. Generally, your earnings from services you performed are subject to self-employment tax although there are significant exceptions we’ll discuss below.
You are allowed to claim an exemption from the self-employment tax by filing IRS Form 4361 if you are conscientiously opposed to public insurance due to individual religious considerations, or you are opposed because of the principles of the religious denomination you are a member with. You no longer have to pay Social Security or Medicare taxes on your earnings once your application to be exempted is approved. The same thing happens with the credit toward Social Security or Medicare benefits in retirement, you won’t get any. If you earned at least $400 of self-employment earnings as a minister, you will be required to file Form 4361 by the due date of your tax return for the second tax year.
You won’t be able to revoke the election after you claim the exemption. You can use the income you earn as the basis for contributions to a qualified retirement plan even though it’s not subject to self-employment tax if the election is granted. Keogh plan or individual 401(k) are just a few of the examples of a qualified retirement plan.
The rental allowance or the fair rental value of a parsonage provide to the minister as pay for their services can be excluded from their income. However, this only applies for the purposes of income tax. This exemption is not applicable to self-employment taxes.
The church first has to officially designate it as a housing or rental allowance before it is actually paid in order for the payment to qualify for the income tax exlusion. There must be designated a definite amount.
You may not include the rental allowance you received from your gross income if the the amount is to provide or rent a home. It does not constitute as an overpayment for your services or exceed the fair rental value of the home, as well as furnishings, plus the utility cost.
The utilities and the fair rental value of the house given to you as part of your earnings can be excluded from gross income only if the church provides a residence. The exlusion, however, cannot be greater than the reasonable pay for your services just like a rental allowance. You don’t have to include any allowance designated for utility costs up to your actual cost if you’re the one paying for the utilities.
There are different places to report a minister’s income tax return. It will depend on whether it is salary (W-2) income or self-employment income.
Income received for offerings and fees—Must be reported as self-employment income on Form 1040, Schedule C or Schedule C-EZ, Profit or Loss from Business.
Salary income—Must be reported on Form 1040.
Salary income-related expenses— You must report the expenses as miscellaneous deductions subject to the 2% limit of adjusted gross income on Form 1040, Schedule A. We previously mentioned that the expenses must be prorated in the middle of your W-2 income and your housing allowance which makes a portion of them nondeductible. Unreimbursed employee expenses become nondeductible after 2017.
Self-employment income-related expenses— Schedule C or Schedule C-EZ is where these expenses must be deducted. They are expenses like travel, office expenses, subscriptions, books, and computers.
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