All The Confusing Ways The IRS Treats A Pastor’s Income

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This post breaks down all of the major types of income a pastor can earn and explains how the IRS treats them for Social Security, income tax, retirement plan and payroll tax purposes. It is based on IRS Publication 517.

 

Have you ever taken the time to read IRS Publication 517, Social Security and Other Information for Members of the Clergy and Religious Workers? Did you get through the whole thing without falling asleep or going cross-eyed?

 

As a licensed minister, it is dangerous for you not to know what it says. But, it is a tedious piece of literature, to say the least. They make things so complicated and confusing that it’s almost as if they are trying to punish pastors for being able to opt out of Social Security.

 

I spent some quality time in Publication 517 for you, sorting through all of the various tax treatments for the different kinds of income a pastor can earn. Below I will attempt to make things clear and easy to understand in regards to how different kinds of income are treated for different purposes.

 

I know this doesn’t sound very interesting, but it’s important. You need to know this stuff if you’re a licensed minister. I’ll do my best to make it bearable for you. Let’s go!

 

Four IRS Areas That Income Affects

There are four different tax-related areas that are affected by income. Different sources of income are treated differently for the following purposes:

 

Social Security Purposes

As a licensed minister, you have the option to opt out of Social Security. If you choose to do so, it only applies to income you earn performing “ministerial services,” not income that you earn in a secular job. Below when it says that income is exempt from Social Security, that only applies to those who have applied and been approved for an exemption. If you have not, all income is subject to Social Security for you.

 

Income Tax Purposes

For income taxes purposes, you can be considered a common-law employee or self-employed:

Employees earn wages that are reported on Form W-2. When filing taxes, those wages are reported at the beginning of Form 1040, the individual income tax return. Unreimbursed business expenses associated with these wages can be an itemized deduction on Schedule A if they exceed 2% of adjusted gross income (see IRS Publication 529 for more information).

 

Self-employment income is reported on Schedule C. It is calculated by reducing the total income by applicable business expenses reported on Schedule C.

 

Retirement Plan Purposes

Aside from employer-sponsored retirement plans, the only available tax-advantaged retirement savings vehicles for employees are IRAs, both traditional and Roth.

 

In addition to IRAs, self-employed people have the ability to establish other kinds of tax-advantaged retirement plans, such as SEP, SIMPLE, and qualified plans, and deduct contributions as business expenses. For more information, see IRS Publication 560

 

Payroll Tax Purposes

The payroll tax has two parts: Social Security and Medicare. The IRS has two systems for collecting payroll taxes, FICA and SECA. Without getting into details, the basic difference is that under FICA the employer pays half of the taxes, while under SECA, the worker pays the entire tax.

 

Church employees are taxed under FICA unless their church opts out because they “are opposed for religious reasons to the payment of social security and Medicare taxes.” If the church opts out, then its employees pay their payroll taxes under the SECA system. If you are a minister who has opted out of Social Security altogether, neither apply because you don’t have to pay payroll taxes.

 

Types of Income & Their Treatment

Ministerial services, in general, are defined as the services you perform in the exercise of your ministry. These could include sermon preparation, pastoral counseling, running church business meetings, etc.

 

#1 Income paid by your church for your ministerial services

This is the paycheck you receive from your church for being on staff.

Social Security: This income is exempt from Social Security.

Income Tax: This income is considered employee wages.

Retirement Plan: You are considered an employee for retirement plan purposes.

Payroll Taxes: Not applicable if you are exempt. Otherwise, this income is under FICA (SECA if your church is exempt).

Other: If you do not have access to an employer health insurance plan, you may be able to take a deduction for your payments as if you are self-employed. See IRS Publication 535, chapter 6.

 

#2 Income paid by others for your ministerial services

This includes money that individuals give you directly for performing weddings, baptisms or other personal ministry-related services.  

Social Security:This income is exempt from Social Security.

Income Tax: This is considered self-employment income.

Retirement Plan: You are considered self-employed and qualified to establish a small business retirement plan.

Payroll Taxes: Not applicable if you are exempt. Otherwise, you pay under SECA.

 

#3 Income earned as an employee from non-ministerial services

This would be any income you earn from a secular job where you work for someone else.

Social Security: Subject to Social Security, even if you have a ministerial exemption.

Income Tax: This income is considered is employee wages.

Retirement Plan: You are considered an employee for retirement plan purposes.

Payroll Taxes: Paid under FICA.

 

#4 Income earned as a self-employed person from non-ministerial services

This would be any income you earn from side jobs, your own business or as a contractor or freelancer.

Social Security: Subject to Social Security, even if you have a ministerial exemption.

Income Tax: This is considered self-employment income.

Retirement Plan: You are considered self-employed and qualified to establish a small business retirement plan.

Payroll Taxes: Paid under SECA.

 

#5 Other kinds of income

Royalties from books, songs, etc.

Religious books are considered to be a part of your ministerial duties and fall under category #1 income. Songs written for congregational worship are seen in the same way.

 

Gifts & Love Offerings (Birthday, Christmas)
  • If they come from the church, they are taxable income and fall under category #1.
  • If they come from an individual as a result of a ministerial duty you performed (counseling, preaching, etc.), they are taxable income and fall under category #2.
  • If they are from an individual and not related to a ministerial duty you performed, they are tax-free.

Reimbursements For Employee Expenses

How these are treated depends on whether or not your employer has an accountable plan or not.

 

Accountable Plan: These are not reported on Form W-2 and only excess expenses can be deducted. The rules state that your expenses must have a business connection—that is, you must have paid or incurred deductible expenses while performing services as an employee of your employer. You must adequately account to your employer for these expenses within a reasonable period of time and you must return any excess reimbursement or allowance within a reasonable period of time.

 

Non-accountable Plan: Any excess reimbursements or reimbursements of nondeductible business expenses are reported on form W-2 as wages and are deductible.

 

Housing Allowance

The housing allowance must be an officially designated specific amount. It is not considered income for income tax purposes. However, it is considered income when calculating self-employment taxes for those who are not exempt. The housing allowance must also be taken into consideration when calculating deductible business expenses on Schedule A.

 

 

There you have it. A bunch of different kinds of income that you, a pastor, can have, and how the IRS treats each one.

 

I hope this has helped clarify things for you. If you have any further questions, let me know if the comments!

 

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