June 2020 - The Pastor's Wallet

Q & A: Reader Questions About 2019 Clergy Taxes

by Amy Monday, June 29, 2020

Tax Deductible Expenses

Q: Are my vestments tax deductible?

A: Since the passage of the 2017 Tax Cuts & Jobs Act, unreimbursed business expenses are no longer tax-deductible. That would include your vestments. The only way to avoid paying taxes on those expenses would be for your church to set up an accountable reimbursement plan according to IRS rules.

Correcting Tax Errors

Q: I have been a pastor since 2010. I use TaxAct to file my taxes and only became aware this year that I am supposed to be paying self-employment tax. For the first time this year, TaxAct asked if I was clergy (I don’t think we’d been asked that in the past) and then asked if I had ever filed Form 4361. For my pastoral role, I don’t believe I’ve ever paid self-employment tax though I have never filled out form 4361. Am I in error? Do you know what steps I need to take to correct my errors?

A: When you first become a pastor, you have about 2 years in which you can submit a Form 4361 to the IRS and get it approved to opt out of Social Security and Medicare taxes. It sounds like you didn’t do this, in which case all of your pastoral income is subject to those taxes. Churches are not allowed to withhold or pay payroll taxes for pastors, so you have to pay them as if self-employed, with Schedule SE. It sounds like TaxAct was not set up to understand clergy taxes until this year. I’m sorry about that.

You should look at your old tax returns to see if Schedule SE was filed. If not, you likely did not pay those taxes. Also, set up an account at ssa.gov so that you can review the earnings history that the Social Security Administration (SSA) has for you. It will show any earnings that you paid Social Security taxes on. If you haven’t paid them, then it will show 0 for all of those years since 2010.

To go back and pay those taxes and get credit for that income with the SSA, you would need to file amended tax returns for all of those years and pay the taxes owed. There may be a statute of limitations where the IRS cannot go back and collect those, though if you do not pay them you won’t get credit for them with the SSA. I recommend that you consult a tax preparer who is familiar with clergy tax issues. Make sure they understand clergy issues because many tax preparers are just as clueless as TaxAct was and get pastors into trouble. At the end of this article, there is a list of tax preparers that my readers have recommended.

Documenting Pastoral Income

Q: What is the best way for a pastor of a small church to document his income from the church when he/she does not receive a w-2 or 1099?

A: There is no specified way that you have to document your income if you don’t receive a W-2 or 1099. Personally, I would use a spreadsheet and record the date it was received, who it was received from, the amount of income, and what it was received for. The goal is for you to have good enough records to file your tax returns accurately.

Tax Deductions For Pastors

Q: I pastor a very small (10-15) church and receive no salary. Are there any deductions I can take or special reductions? I receive Social Security and work part-time.

A: Volunteer work is not tax-deductible the way that cash donations are. The only deduction I can think of that you may be eligible for would be mileage for driving you do for your church. This article explains how to calculate and claim a tax deduction for volunteer mileage.

Donations To Pastors

Q: Do pastors have to pay taxes on donations outside their ministerial income? The money is not reported on a W-2 and not due to services. It is just donations from people that want to give to the pastor.

A: If the donation would be given regardless of whether or not the person was a pastor, then they are not taxable. However, if the donation is due to the fact that the person is a pastor, then it would be considered taxable income, even if it is not tied to a specific service. The article in that link goes into more detail. This article describes a recent court case that provides more detail on what the IRS looks at to determine if a gift is taxable.

Do you have a question? Feel free to ask!

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How A Cash-Out Mortgage Refinance Affects A Pastor’s Housing Allowance

by Amy Monday, June 22, 2020

When the Federal Reserve slashed interest rates to near zero in response to the coronavirus crisis, everyone decided that it was a perfect time to refinance their mortgage. There were so many refinance requests that lenders had to artificially raise rates in order to lessen demand and give them a chance to keep up. Rates bounced around quite a bit but have spent the rest of the year near historic lows.

Because of this, a lot of people have refinanced their mortgages this year. If this is news to you, you should really look into refinancing because with a lower interest rate you could save thousands of dollars over the life of your loan.

What Is A Cash-Out Mortgage Refinance?

A choice you have to make when refinancing is how much you want your new mortgage to be for. One option is to borrow the same amount as you currently owe and just enjoy the benefits of a lower interest rate.

The second option is to take advantage of any equity you have in your home and take out a bigger mortgage. Borrowing more than your original mortgage balance allows you to pocket some cash in the process. That’s called a cash-out refinance because you are essentially taking cash out of your home’s equity.

How Does Cashing Out Equity Affect Your Housing Allowance?

Doing a cash-out refinance can affect your mortgage’s eligibility for the housing allowance. Usually, mortgage and interest payments are eligible for federal income tax exemption through the clergy housing allowance. They are eligible because you are using that money to provide a home.

The big question with a cash-out refinance is What are you doing with the cash? If you use it to remodel your bathroom or build a deck, then you are still using the money to provide a home. As such, your entire mortgage payment still qualifies for the ministerial housing allowance.

What if you use the money for something non-home related? What if you use it to pay down debt or send a child to college? This is when it gets complicated. If part of your mortgage is paying for non-housing expenses, then part of it is not eligible for the pastor’s housing allowance.

How To Calculate Housing Eligibility For A Cash-Out Refinance

Luckily, mortgage payments are not an all-or-nothing deal. Using some money for non-housing things doesn’t disqualify your entire mortgage payment from the ministerial housing allowance. Just a portion of it. You can claim a pro-rata portion of your payments as qualified expenses for the housing allowance.

Let’s say you owe $180k mortgage and your house is worth $250k. You decide to refinance and borrow $200k so that you can pay off your student loans. Your new loan is broken down into $180k of housing costs and $20k in student loan costs. Only 90% of the mortgage was used for housing costs, so only 90% of your mortgage payment is eligible for the clergy housing allowance.

If your principal and interest payment is $1,000 a month, then only $900 of that qualifies for the housing allowance. Most of us don’t only make principal and interest payments, though. My monthly mortgage payment also includes escrow money for property taxes and homeowners insurance.

For this example, let’s say you’re like me and your monthly payment is $1,400, with the extra $400 covering insurance and taxes. Does that mean that you can only claim $1,260 for the housing allowance (90% of $1,400)?

Nope! Your property taxes and homeowners insurance are 100% eligible for the housing allowance even if your mortgage principal and interest payments are not. For accurate calculations, you have to break down your monthly payment into the portion that is used 100% for housing expenses (insurance and taxes) and the portion that is only partly used for housing expenses (mortgage principal and interest).

In this example, only $900 of the principal and interest payment is eligible for the housing allowance while the entire $400 for taxes and insurance is. So, $1,300 of the $1,400 monthly payment counts towards the housing allowance. If you just do 90% of the whole payment, you’ll be selling yourself short and paying some unnecessary taxes.

How The IRS Verifies Accuracy

After explaining this to a friend, he asked me what happens if you just claim it all. What happens if you take cash out of your mortgage for non-housing expenses but continue to include 100% of your payment as a housing allowance?

In most cases, nothing. The IRS does not check up on you and verify the accuracy of your housing allowance. That is until you get audited. If you cheat on your housing allowance, they may uncover it in an audit.

But just because the IRS isn’t watching you doesn’t mean that God isn’t. It isn’t necessarily a matter of whether or not you’ll get caught, it’s a matter of character. You get to decide for yourself how you want to proceed.

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How Do Mutual Fund Fees Work?

by Amy Monday, June 15, 2020

Are you invested in mutual funds? If so, you’re in good company. Over 46% of American households own mutual funds.

But do you know how much your mutual fund costs? That’s a much harder question. I’m sure 46% of Americans don’t know that one!

One of the key components of good stewardship is knowing where your money is going. That’s why having a budget is so important. Most things we spend our money on have a price tag, but mutual funds are a little bit more complex. Here is a breakdown of mutual fund fees, so that you have a better idea of what you’re spending on your investments and why.

Loads

Front-end loads are commissions or sales charges that you pay when you purchase shares of the mutual fund. If you buy an “A Share” mutual fund, that means you will be paying a commission, or front-end load.

A “B Share” mutual fund has a back-end load. That means that if you sell the shares within a certain timeframe, you will have to pay a deferred sales charge or surrender charge. While you always have to pay a front-end load, you can avoid paying a back-end load if you hold the shares long enough.

Loads can be anywhere from 0% to 6%. Zero percent funds are also called no-load mutual funds because there is no commission or sales charge when you buy or sell the fund. But that doesn’t mean they are free. This article explains how loads are calculated.

Management & Operating Expenses

Mutual funds also have ongoing fees that cover management and operating expenses. They are listed as a percentage of the account value and the fees are taken from the account on an annual basis.

The management fee compensates those who are managing the fund. That is why actively managed funds are usually more expensive than index funds. The operating expenses include things like record keeping, transaction costs, director’s fees, and legal and auditing expenses. All mutual funds have those expenses, even index funds.

12b-1 Fee

It may be hard to imagine, but there once was a time when people were not familiar with mutual funds. Back when the Securities and Exchange Commission (SEC) wanted to help get the word out about mutual funds, they allowed fund managers to use some of the fund’s assets to pay for marketing and advertising expenses. These are called 12b-1 fees and are rather unnecessary in today’s world. Yet they still exist. And they are typically found in “C Share” mutual funds and are charged on an annual basis.

Short-Term Trading Fees

Mutual funds are not checking accounts and their managers do not want you to treat them as such. They want you to put your money in and leave it there for an extended period of time. In order to encourage that, some mutual funds have short-term trading fees. These are basically extra fees that you have to pay if you withdraw your money within 30-90 days of investing it. Investing should be a long-term game, and if you treat it that way then you won’t have to worry about short-term trading fees.

Fee Schedule Example

Here is an example of a real life mutual fund fee schedule. It’s a screenshot of what they have listed on their website.

In the top right-hand corner, you can see that it is for A shares. As such, it lists sales charges that decrease the more money you invest. Next, it lists the ongoing expenses. There are management fees, 12b-1 fees, and “other expenses.” These are combined to create the expense ratio, which is the percentage of your account that you will pay on an annual basis. You will notice that even though these are A shares they still have a 0.25% 12b-1 fee. When I chose C shares in the top right corner the sales charges disappeared and the 12b-1 fee jumped up to 1%.

As you can see, there are a number of fees that you may end up paying when you invest in mutual funds. Make sure you are aware of all of the fees involved as you make your investment decisions. Also, compare fees among like funds. You would be surprised how the fees can vary by fund company for essentially the same investment, especially with index funds. Click here to learn more about the powerful way that fees affect your overall returns.

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What Social Security Spousal Benefits Can A Pastor Who Has Opted Out Receive?

by Amy Monday, June 8, 2020

While pastors have the unique opportunity to opt out of the Social Security system, that doesn’t mean that they cannot participate at all. If your spouse has earned enough Social Security credits to be eligible for benefits, then you are eligible for some benefits as well. These are the spousal benefits that you can receive:

Medicare Benefits

Many people wrongly believe that opting out of Social Security means that you can no longer participate in Medicare. Everyone age 65 or older who is a US citizen or permanent resident and has lived in the US for at least 5 years is eligible for Medicare (and some other people, too). The difference that opting out makes is whether or not you have to pay for Part A, which is hospital insurance.

If you opt out with Form 4361, then you have to pay premiums for Part A while everyone else gets it for free. Unless your spouse is eligible for benefits. You can get premium-free Part A as a spousal benefit if you are at least 65-years-old and your spouse is at least 62-years-old. If your eligible spouse is only 60 when you turn 65 and sign up for Medicare, then you will have to pay Part A premiums for a couple of years until your spouse turns 62.

Retirement Benefits

You can also receive retirement benefits based on your spouse’s record if he or she is also collecting retirement benefits. To be eligible for spousal retirement benefits, you must be at least age 62 or caring for a qualifying child. To qualify, a child must be under age 16 or receiving Social Security disability benefits.

Social Security retirement benefits change based on when you start collecting them. The base benefit for spouses of eligible workers is half of the benefit the worker is eligible for at full retirement age. The benefit is reduced if taken before full retirement age (using the same schedule as eligible workers). For spousal benefits, they can be reduced to as little as 32.5% of the worker’s full retirement age benefit. Here is a calculator that illustrates the effects of claiming early benefits.

While workers can increase their benefits by waiting until after their full retirement age to collect them, that option is not available for spouses. No matter how long you wait, the most you can get is half of the benefit that your spouse is eligible for at full retirement age. At least while your spouse is alive.

Survivor Benefits

If your spouse passes away, you can still receive Social Security benefits based on their work record. Widows and widowers are eligible for a one-time lump sum payment of $255. Luckily, you are also eligible to receive their retirement benefits, since $255 won’t get you very far these days.

You can receive your spouse’s full retirement benefit at your full retirement age or can receive a reduced benefit as early as age 60. You can receive benefits as early as age 50 if you are disabled and the disability started before or within seven years of your spouse’s death. If you are not remarried and are taking care of your deceased spouse’s qualifying child (under 16 or disabled), then you can receive benefits at any age. Remarriage will not affect these benefits if you remarry after age 60 (or 50 if you are disabled).

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-34 + 36 = -10? How To Make Sense Of Stock Market Returns

by Amy Monday, June 1, 2020

If you’ve been paying any attention to the news (and I don’t blame you if you haven’t), you’re probably aware that the stock market has been very active lately. Active like a volcano. You see headlines like “Stocks Lose 34% in One Month” and “Stocks Jump 2%.” What does it all mean, though? Do you really understand what they’re talking about?

What Do We Mean By The Stock Market?

First of all, what is the stock market? Stocks are portions of ownership in publicly traded companies. They can be bought and sold on exchanges, or markets. When people talk about the stock market, they are usually referring to the valuation of stocks. When they talk about the market going up or down, they mean that overall stock prices are going up and down.

If that’s as clear as mud, read my more in-depth explanation of the stock market here. For the sake of this article, you just need to understand that the stock market refers to all stocks all over the world, which is really hard to measure. There are so many publicly traded companies in the US alone that just measuring the US stock market is a challenge.

To overcome this challenge, it is common to use a stock index, or fixed group of stocks, as a proxy to represent the stock market as a whole. One of the most popular ones is the S&P 500, which is made up of the largest 500 or so companies in the US. We can look at the S&P 500’s behavior and infer how the rest of the US stocks are doing.

What The Stock Market Has Done In 2020

Here is a graph of what the S&P 500 has done so far this year:

Looks like a bumpy roller coaster ride, doesn’t it? That’s exactly how it felt for many investors. The S&P 500 reached a new record high on February 19, 2020. And then came the free fall. In a little over a month, between February 19 and March 23, the S&P 500 lost 34% of its value. That’s the big jagged drop that you see.

Since then, stocks have staged a remarkable comeback, rising in value by 36% as of May 27. That’s the date I will use for all of these calculations because I’m being good this week and not waiting until the last minute to write this!

What All The Numbers Mean

If stocks dropped 34% and then rose again by 36%, why isn’t the right side of the graph higher than the left side?

The percentages don’t add up because they are based on different numbers. On February 19, the S&P 500 reached a high of 3,386.15 points. Then it lost 1,148.75 points and bottomed out at 2,237.40. To calculate the percentage of value it lost, divide the loss by the starting point:

1,148.75 / 3,386.15 = 34%

After bottoming out at 2,237.40, the S&P 500 has since gone up by 798.73 points to 3,036.13. This growth is reported as a percentage of where it is growing from. So, to calculate the growth, you divide the gain by the starting point:

798.73 / 2,237.40 = 36%

As you can see, the percentages don’t add up because they are based on different numbers. Overall, the S&P 500 is still down 10% from where it was on February 19. Hence the equation in the title of this article: -34 + 36 = -10. The stock market dropped 34%, recovered 36%, but is still down by 10%. All because of how the numbers are calculated.

So, as you see news headlines throwing out percentages for stock market returns, don’t think you can use basic arithmetic to make sense of it all. You have to look a little bit deeper to really understand what they are talking about.

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Monthly Archives June 2020

Q & A: Reader Questions About 2019 Clergy Taxes

Tax Deductible Expenses

Correcting Tax Errors

Documenting Pastoral Income

Tax Deductions For Pastors

Donations To Pastors

How A Cash-Out Mortgage Refinance Affects A Pastor’s Housing Allowance

What Is A Cash-Out Mortgage Refinance?

How Does Cashing Out Equity Affect Your Housing Allowance?

How To Calculate Housing Eligibility For A Cash-Out Refinance

How The IRS Verifies Accuracy

How Do Mutual Fund Fees Work?

Loads

Management & Operating Expenses

12b-1 Fee

Short-Term Trading Fees

Fee Schedule Example

-34 + 36 = -10? How To Make Sense Of Stock Market Returns

What Do We Mean By The Stock Market?

What The Stock Market Has Done In 2020

What All The Numbers Mean

Looking For Something Specific?

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Monthly Archives June 2020

Tax Deductible Expenses

Correcting Tax Errors

Documenting Pastoral Income

Tax Deductions For Pastors

Donations To Pastors

RELATED

What Is A Cash-Out Mortgage Refinance?

How Does Cashing Out Equity Affect Your Housing Allowance?

How To Calculate Housing Eligibility For A Cash-Out Refinance

How The IRS Verifies Accuracy

RELATED

Loads

Management & Operating Expenses

12b-1 Fee

Short-Term Trading Fees

Fee Schedule Example

RELATED

Medicare Benefits

Retirement Benefits

Survivor Benefits

RELATED

What Do We Mean By The Stock Market?

What The Stock Market Has Done In 2020

What All The Numbers Mean

RELATED

Looking For Something Specific?

What’s New…

Categories

Tags

Recent Posts

Recent Comments

Archives

Categories

Meta