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How Pastors Pay Federal Taxes

by Amy Monday, February 24, 2020

I recently received an email from a pastor’s wife of 15 years asking for clarification on how their taxes were paid. She was too embarrassed to ask their tax preparer after all this time, so I was a safe place to turn. (If you have any questions, no matter how dumb you may think they are, I’d be happy to help!)

She felt dumb asking, but it was unwarranted. Taxes for pastors are unusual and it’s very rare for someone to actually explain them to you when you enter the ministry. It took me a while to figure out how they all work, so I don’t fault anyone else for not knowing.

Today we are going to go over the three different options that pastors have for paying their taxes.

Five Facts About Ministerial Taxation

Before we get too far in, though, we need to lay the foundation for what we are going to be talking about. There are some basic facts that you need to understand about taxes for pastors before we get into how to pay them.

Pastors Are Dual Status Taxpayers

First, all “ministers” by the IRS definition are dual status taxpayers. That means that you pay income taxes as an employee but pay payroll taxes (Social Security and Medicare taxes) as if you were self-employed. Self-employed people pay these taxes under the SECA system. ALL ministers pay under the SECA system, it is not optional.

Churches Cannot Withhold SECA Taxes For Pastors

Second, churches are not allowed to withhold SECA taxes for pastors. Neither the pastor or the church has any say in the matter, that’s just the way it is. If a church withholds SECA taxes, it can mess up the pastor’s records with the Social Security Administration.

Churches Can Withhold Income Taxes For Pastors

Third, unlike SECA taxes, churches have the option to withhold income taxes for pastors. It is not required. Every other employer is required by law to withhold income taxes for their employees, but pastors are exempt from that. So, churches don’t have to withhold income taxes for their pastors but they can.

We Have A Pay-As-You-Go Tax System

Fourth, the US tax system is a pay-as-you-go system. That’s why we have employer withholdings. The IRS doesn’t want to wait until the end of the year to get your tax money. They want a little bit from every paycheck.

For self-employed people who don’t receive paychecks (and pastors who are treated as self-employed), that means they have to pay quarterly estimated payments four times a year. You do your own calculations for the amount that you pay quarterly, but if you don’t pay enough and have a big tax bill at the end of the year you can be penalized by the IRS.

SECA And Income Taxes Are Combined On Your Tax Return

Finally, when you file your tax return all of your taxes are lumped into one final bill. You calculate your income taxes and SECA taxes separately but then add them together. If you end up owing, you don’t write one check for SECA taxes and one for income taxes. If you get a refund, you don’t get two separate checks for each kind of tax. It all gets added together on your tax return.

In light of those five facts, these are the options that ministers have for paying their taxes:

Option #1: Quarterly Estimated Payments

Your first option is to handle everything on your own. Your church withholds nothing and pays you your full salary. Then you calculate your expected tax liability (both income and SECA taxes) each quarter and pay your estimated taxes. At the end of the year, you file your tax return to see how accurate your estimates were and either get a refund or owe a little bit more.

Option #2: Quarterly Estimated Payments & Employer Withholding

The second option is to split the responsibility with your church. You have them withhold income taxes from your paycheck and you handle the SECA taxes on your own. You calculate your expected SECA taxes quarterly and pay them. Then, at the end of the year, you file your tax return and make sure to count the taxes that your employer withheld and the estimated payments you made when determining if you get a refund or owe more.

Option #3: Only Employer Withholding

The third option is to have your church withhold all of the taxes you will need to pay. Wait, what happened to “churches can’t pay SECA taxes for ministers?” It still applies. Your church can withhold all of the taxes that you will need to pay if they are all labeled as income taxes, not SECA taxes. For example, if your SECA taxes from every paycheck would be $150 and your federal income taxes from each paycheck are $150, you can have your church withhold $300 for income taxes from each paycheck.

That way, you know that the IRS is happily getting everything they need on a regular basis, even though it is mislabeled. At the end of the year when you file your tax return, it will look like you overpaid income taxes and underpaid SECA taxes but it will all even out. Remember, in the end, they are lumped together for one tax bill. As long as you paid enough and don’t end up owing a lot, the IRS doesn’t mind.

There you have it, the three different options that pastors have for paying their taxes. If you want to do options #2 or #3, you’ll have to make sure that your church is willing to cooperate. And, as you file your tax return this year, make sure that anyone who is helping you understands ministerial taxes because not all paid preparers do!

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How To Determine If A Pastor Is An Employee Or Self-Employed For Federal Tax Purposes

by Amy Monday, January 20, 2020

Tax season is just around the corner and that means I’m about to be inundated with tax-related questions. Today, I’m going to try to get ahead of the game and start answering the questions before you ask them. Up first, when is a pastor an employee or self-employed?

Pastors Are Always Self-Employed For Social Security Taxes

We’ll start with the easy part. When it comes to Social Security and Medicare taxes, also known as payroll taxes, you are always considered self-employed. Pastors are always self-employed for Social Security taxes and pay under the SECA system. You have no choice in the matter and there is no debate. You’re always considered self-employed. You can read more about why and what that looks like here.

When A Pastor Is Self-Employed For Federal Income Taxes

Because pastors are always taxed as if they are self-employed for Social Security purposes, that brings a lot of confusion into the income tax side of things. If I work at a church but pay payroll taxes as if I’m self-employed, does that mean I’m considered self-employed for everything else? What’s the difference? Why is this so confusing?

Most pastors, though self-employed for Social Security, are still common law employees for income tax purposes. If you work for a church that tells you what to do and how to do it, you are an employee. I know, it’s confusing to be told you’re two different things, but that’s the way it works. It’s called dual-status taxation.

Some pastors truly are self-employed, though. Think of a traveling evangelist or someone else whose ministry is not tied to nor directed by a specific church. You see, for the IRS, employment status all comes down to control. Is someone else controlling your methods and your results? Then you’re an employee.

The US Tax Court has developed a 7-factor test to determine when a pastor really is self-employed for federal income tax purposes. Here are the seven factors that they look at:

How much control the employer exercises over the details of the work
Who invests in the work facilities
The pastor’s opportunity for profit or loss
Whether or not the employer has the right to fire the pastor
Whether the work is part of the employer’s regular business
How permanent the relationship is
The relationship that both parties believe they are creating

This is what they look at to see who is in control of the relationship. Based on these seven factors, most pastors are employees. At least for the work they do for their churches.

Can A Pastor Be Both An Employee And Self-Employed?

Even if you’re a common-law employee of your church, you may still be self-employed at times. What about when you perform a wedding for a friend and they give you $100? Your church didn’t give you the money. They didn’t tell you to perform the wedding. They might not even know you did it!

Clearly, in that case, you were not acting as an employee of your church. You were acting as a self-employed person. Just like a lot of workers have self-employment side-gigs outside of their normal jobs, when you perform ministerial services outside of your church you are acting as a self-employed person. These could be things like performing weddings or funerals or guest speaking engagements. They are services performed outside of your church where others are paying you for them.

Let me summarize it for you:

All of your income is taxed as a self-employed person for Social Security and Medicare taxes.

Your church income is taxed as employee income for income taxes.

Your side income from outside of the church is taxed as self-employed income for income taxes.

Employee income is reported to you on Form W-2 and self-employment income is reported to you on Form 1099. If it’s something like $100 that an individual gave you for a wedding, they aren’t going to report it at all and it’s your responsibility to track it. To learn more about how these different types of income are taxed, read this article.

I hope that helps clarify things for you at least a little bit. Let me know if you have any other questions!

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How To Make Quarterly Estimated Tax Payments For Ministers

by Amy Monday, September 9, 2019

As we’ve discussed previously, churches are not required to withhold taxes for pastors and other clergy. Because of a minister’s dual taxation status, the IRS expects them to pay as if they were self-employed.

How do self-employed people pay taxes?

Through quarterly estimated tax payments. So, as a pastor, you’re required to make quarterly estimated tax payments.

What Are Quarterly Estimated Tax Payments?

Our American tax system is a pay-as-you-go system. Many people don’t realize this because they think they only pay once a year- on April 15. However, most employees are paying all year long, out of every paycheck. The yearly tax return they file is just to check their balance for over- or under-payments.

The IRS doesn’t want to wait a year to get their money. They want it immediately, which is why most employees are subject to mandatory tax withholding. Self-employed people, though, don’t have an employer to withhold their taxes for them. And many of them do not pay themselves a regular paycheck from which taxes could be withheld. Therefore, the IRS set up the quarterly estimated tax payment system.

Self-employed people (or those treated as if self-employed, like clergy) are required to pay taxes four times a year with IRS Form 1040-ES. These payments include federal income tax and SECA taxes, which are the Social Security and Medicare taxes.

When Are Quarterly Estimated Tax Payments Due?

While quarterly payments are due four times a year, the year is not divided up equally. This is when each payment is due and what each payment covers:

If the due date falls on a weekend or holiday, it gets pushed back to the next business day. For example, this September 15 is a Sunday, so the payment is due the next day, Monday, September 16, 2019.

How Should Pastors Calculate Quarterly Estimated Tax Payments?

IRS Form 1040-ES includes a worksheet for calculating estimated payments. However, it gets complicated. Use that if you want something comprehensive and exact. Otherwise, I will explain the basics of calculating your estimated payments.

Calculating Estimated Income Tax Payments

I’ll start by addressing income taxes, because that applies to all pastors, whether or not you’ve opted out of Social Security. If you’ve opted out, this is all you have to worry about. If not, you need to read the next section as well.

The basic way to figure estimated taxes is to take your expected salary and subtract expected deductions (standard or itemized, plus half of SECA taxes due) to find your expected taxable income.

Expected Salary – Expected Deductions = Expected Taxable Income

Then look up the tax on that expected taxable income in the 2019 tax rate schedules below (taken from IRS Form 1040-ES).

Picture of the IRS's 2019 Tax Rate Schedules

That is your expected annual tax. You can lower it by any tax credits you expect to receive, such as the child tax credit. Once you’ve accounted for credits, you can just divide it so that it represents the quarter you are paying. This month’s estimated payment covers 3 months (June, July, and August), so the equation would look like this:

Estimated Annual Tax (Less Expected Tax Credits) * 3/12 = Quarterly Tax Payment Due

If you have irregular income, you should look back at just the months in question. Take your income from those months, subtract the time period’s portion of your expected annual deduction (for example, 3/12 of the standard deduction), and use that amount to figure your tax for the quarter.

Remember that your housing allowance is exempt from federal income taxation, so it should not be included in these calculations!

Pastors Participating In Social Security

If you chose to remain in the Social Security system, then you have to pay SECA taxes on top of your income taxes. Remember that your housing allowance is not exempt from SECA taxes, so you will need to include it in your total income. If you live in a parsonage, you also have to include the fair market rental value of the parsonage in your total income.

If you earn under $132,900, then your SECA taxes are 15.3% of 92.35% of your income. For this September’s payment, you would calculate it as:

Income (including housing or parsonage allowance) * 0.9235 * 0.153 = Annual SECA Taxes

Annual SECA Taxes * 3/12 = SECA Taxes Due This Quarter

If your total income exceeds $132,900, then you SECA taxes are 15.3% of 92.35% income up to that amount plus 2.9% above that amount.

Your quarterly estimated tax payment is comprised of both your estimated income taxes due and SECA taxes.

How To Avoid Penalties

If you don’t pay your estimated taxes, you will be penalized by the IRS. You can also incur penalties if you underpay. Sometimes it can be hard to estimate taxes, so the IRS created “safe harbor” calculations. If you use these calculations you will not be penalized, even if you underpay. You should be safe from penalties if you:

Expect to owe less than $1,000
Pay 100% of your previous year’s tax liability if your adjusted gross income is under $150,000. If it is over that, you have to pay 110% of the previous year’s tax liability.
Pay within 90% of your actual tax liability for the year

Another Way To Do It

Making quarterly estimated tax payments can be a real pain. If you don’t want to have to deal with this, ask your church to withhold taxes for you. While they aren’t required to, they are allowed to. They can’t pay your SECA taxes for you, but they can withhold enough to cover your SECA taxes at the end of the year.

Another way to avoid paying quarterly estimated taxes is by having another employer withhold more. If you or your spouse is an employee of a secular company that withholds taxes, just have them withhold enough to cover your pastoral income. Changing your withholdings is as simple as filling out a Form W-4 and filing it with the company’s Human Resource department.

I hope this sets you up for success this September 16 and in the future. If you have further questions, ask me in the comments or email me!

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What Taxes Can Churches Withhold For Pastors?

by Amy Monday, June 24, 2019

Thanks to the Tax Cuts & Jobs Act, people are paying a whole lot more attention to their tax withholdings this year. Employers had a hard time calculating withholdings with all the changes in the law and the result was far fewer people getting big tax returns (which I think is actually a good thing!) and more people owing. (Don’t get mad at the employers, though, no one really knew how it would all play out.)

So, with this renewed interest in tax withholding, I thought it would be a good time to go over how it all works for pastors. Because this is yet another area where it’s different for pastors than for everyone else. While some church employees do have to pay their taxes differently, the information in this article is only for pastors and does not apply to non-ministerial church workers.

Mandatory Withholdings

If you work a secular job, your employer withholds money from every one of your paychecks to cover federal income taxes, Medicare taxes, and Social Security taxes. They do it regardless of how you feel; you have no say in the matter. Because it’s the law.

Well, this is an area where pastors are truly above the law. Or at least they are an exception to the law. There is no mandatory withholding for pastors on those taxes. That means that your church is allowed to pay you all of the money you’ve earned, without sending some to the government first.

FICA/SECA (Payroll) Taxes

In fact, not only do they not have to withhold taxes, but churches aren’t allowed to withhold Social Security and Medicare taxes (also called FICA or payroll taxes). This is because pastors always have to pay those taxes under the SECA program (as opposed to FICA) as if they were self-employed. If a church withholds FICA taxes for a pastor, they are breaking the law and will mess up his or her records with the Social Security Administration. Neither of those are good things.

Let me say it again because there seems to be a lot of confusion about this. Ministers always pay under SECA, not FICA. You don’t have a choice in the matter, it’s the law.

Also, you don’t get to decide whether or not you want to be treated as a minister. The work you do and your ordination/licensure determine whether or not you are a minister. It is not your decision. You can’t just have your church treat you like a regular employee. It doesn’t work that way.

Federal Income Taxes

The IRS is more flexible with income taxes. While pastors aren’t required to have income taxes withheld, you are allowed to. Why would you want your church to withhold taxes if it isn’t required? Because you have to pay the taxes yourself if you don’t.

Like the rest of us, you pastors have to pay federal income tax. And like the rest of us, if you don’t have an employer withholding those taxes on a regular basis then you have to pay quarterly estimated taxes four times a year. Either way, the government is getting your money. A lot of pastors simply find it easier to have their church handle it rather than doing it on their own.

Withholding Extra

While your church can’t withhold payroll taxes, it is common practice to have them withhold extra income taxes to cover the amount that you will owe in self-employment taxes. When you file your taxes at the end of the year, everything you owe gets lumped into one tax bill regardless of whether it is for income tax, self-employment taxes, or something else. So, if you owe $5,000 in self-employment taxes and your church withheld an extra $5,000 in federal income taxes, then it all evens out in the end and you don’t end up with a big bill on April 15.

To do this, you first need to estimate how much you will owe in taxes. And don’t forget about the housing allowance when you make your calculations. I found a great online calculator for estimating pastors’ taxes here.

The calculator will show you how much you would owe in federal, Social Security, Medicare, and state taxes each paycheck. It also gives a breakdown of how much to pay each quarter if you pay the taxes on your own. You can use the same information to adjust your withholdings with your church. Then they will withhold enough to cover your entire tax bill and you don’t have to make quarterly estimated payments.

If you’re a pastor, it’s important to understand the nuances of your tax situation, even if you find it incredibly boring. Get over it and be proactive. Taking a little bit of time to prepare at the beginning of the year can save you a huge headache and a big hit to your bank account come tax time. You’ll be glad you did.

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How Pastors & Church Employees Can Get A Tax Break For Their Unreimbursed Business Expenses

by Amy Monday, April 22, 2019

If you’re like a lot of clergy members, you had an unpleasant surprise this tax season when you learned that you can no longer deduct unreimbursed church business expenses with your itemized deductions. You’re probably used to covering a lot of church expenses yourself, knowing that you’ll get some kind of reward for it come tax time. Except this year it didn’t come.

Why not?

What Happened To The Unreimbursed Business Expense Deduction

Part of the 2017 Tax Cuts & Jobs Act was the elimination of the unreimbursed business expense deduction. The goal was to simplify taxes as much as possible, so a number of deductions were eliminated or changed.

Before 2018, you could deduct unreimbursed business expenses if you itemized your deductions. The deduction amount would be calculated on Form 2106 and then deducted on Schedule A so that you wouldn’t have to pay income taxes on it. That line (line 21) is gone from the new Schedule A.

How To Avoid Paying Taxes On Unreimbursed Church Business Expenses

So, the deduction is gone. What can pastors do? Are you just simply out of luck?

I’m happy to tell you that no, you’re not out of luck. There is another way to avoid paying taxes on the church expenses that you pay for out of pocket.

How? By having your church set up an Accountable Plan.

What Is An Accountable Plan?

An accountable plan is a business expense reimbursement plan that follows IRS rules. With an accountable plan, expenses can be reimbursed without being subject to withholding taxes or W-2 reporting. This is important for pastors because it is one of the only ways (aside from a 403(b) plan) to lower taxable income for Social Security purposes.

If your church reimburses you with a non-accountable plan (meaning it doesn’t follow IRS rules), then that reimbursement is considered part of your compensation, which is taxable. Even if you don’t end up paying income tax on it (because of the housing allowance, deductions, etc.), it is still subject to the 15.3% self-employment taxes (for those who haven’t opted out).

What Church Expenses Qualify?

Accountable plans cover all expenses that are ordinary and necessary. Ordinary means that it is common and acceptable for people in your position. If you are a Methodist minister who wears a robe every Sunday, then cleaning those robes would be an ordinary expense. If you wear ripped jeans when you preach on Sunday, then dry cleaning costs for robes would not be ordinary for you.

A necessary expense is one that is helpful and appropriate for someone in your position. If you live in the Montana countryside, then the gas you use to drive to your parishioners’ homes is a necessary expense. It’s not like you can take the subway or anything.

Also, though it seems obvious, the expenses must be ministry expenses and not personal. Your travel expenses to visit your family for the holidays do not count, even if your brother-in-law really needs Jesus. It’s just not the same as when you travel to visit one of your congregation members in the hospital.

Other Benefits Of Accountable Plans For Churches

Another great thing about accountable plans is that they aren’t just for pastors. Unlike perks like the housing allowance, all church employees can benefit from an accountable plan. That means the children’s ministry coordinator, the church secretary, even the janitor can make use of the plan.

Finally, and this is usually a church’s favorite, they are free! You don’t have to pay a bunch of money to set up or maintain one. Complying with the IRS rules may take a little bit more staff time, but other than that, they’re free. Does it get any better than that?

So, if you regularly pay church expenses out of your own pocket and are mourning the loss of the unreimbursed business expense deduction, cheer up. Have your church set up an accountable plan and you’ll be better off than when you started.

This article explains exactly how to set one up.

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What Is Dual Status Taxation & Why Does It Matter For Pastors?

by Amy Monday, March 11, 2019

If you’re a pastor, hopefully you’ve been told that you are subject to dual status taxation. If not, I’m really glad you’ve found this post!

What Is Dual Status Taxation?

Dual status taxation simply means that you are taxed two different ways in the same tax year. My husband was subject to dual status taxation back in 2011 when he became a US citizen. For the first part of the year, he was taxed as a resident alien and the second part of the year he was taxed as a citizen. Dual status just means that he had two different statuses during the year.

My husband was only subject to dual status taxation for one year, but pastors aren’t so lucky. You are subject to permanent dual status taxation. That means that every single year you are going to be taxed in two different ways. It isn’t something you can avoid, it’s simply something that comes along with being a pastor.

Why Are Pastors Subject To Dual Status Taxation?

I wish I could tell you why pastors are always subject to dual status taxation. Unfortunately, as with many government policies and procedures, it’s hard to find the why behind it. Though I can’t tell you why things are the way they are, I can at least tell you how it all works.

For federal income tax purposes, pastors are considered common-law employees and taxed as employees. For Social Security and Medicare taxes, also called payroll taxes, pastors are taxed as if they were self-employed. Of course, if you’ve opted out of Social Security, you aren’t subject to these taxes at all. So, in review:

Federal Income Tax: Pastor = Employee

Social Security/Medicare Tax: Pastor = Self-Employed

What Does Dual Status Taxation Look Like For Pastors?

What does it mean to be taxed as an employee or as self-employed?

For your federal income taxes, you get Form W-2 from your church and you enter the wages they paid you on line 1 of Form 1040. Just like any other employee of a company would do. You don’t have to fill out Schedule C like self-employed people (unless you have income paid to you by someone other than the church, such as fees paid directly to you for performing weddings).

Even though you feel and act like an employee and you file Form 1040 like an employee, the IRS does not consider you one for your payroll taxes. Employees only have to pay 6.2% of their wages (on up to $132,900 of wages in 2019) for Social Security and 1.45% of their wages for Medicare (0.9% more when your wages exceed $200,000). That’s what employees pay and their employer matches it for a total of 15.3% of wages paid to the government.

As a pastor, the double portion falls on you. But you don’t want it the way Elisha did. You get to file as a self-employed person and pay BOTH the employee and employer portion of your payroll taxes.

Why? Boy, do I wish I knew! If you know, please tell me!

What I do know is that pastors have to pay the full 15.3% and it’s actually against the law for churches to try to pay payroll taxes for pastors. Strange, huh?

So, even though your Form 1040 looks like you’re an employee, you will have to fill out Schedule SE to pay your Social Security and Medicare taxes as a self-employed person. The only good thing is that half of those taxes are deductible. (You’ll have to file the new Schedule 1 in order to do so.)

How Does The Housing Allowance Fit In?

One thing that you need to be aware of in all of this is your clergy housing allowance. It, as well, is treated differently for the different taxes.

What the housing allowance is is an exemption from federal income taxation. That means you don’t have to pay taxes on that amount and it won’t appear on your form 1040. So, for federal income tax purposes, the housing allowance is tax-free free money.

Sadly, the housing allowance is not exempt from Social Security and Medicare taxation. On Schedule SE, where you calculate your self-employment taxes, you will have to add your housing allowance back into the wages shown on your W-2 to arrive at your total taxable income.

This doesn’t just apply to the cash or rental housing allowance, either. It applies to the parsonage allowance as well. Even though you never saw any actual money, the fair rental value of your church-provided home must be included in your income on Schedule SE.

So, you have to pay 15.3% of all of the cash you received, even if it was used for housing expenses. And, if you live in a parsonage, your bill will be even more than 15.3% of the cash that you have received since the value of your home is calculated as if you had received it in cash. In summary:

Federal Income Tax: Housing Allowance = Tax-Free

Social Security/Medicare Tax: Housing Allowance = Taxable

And that is what it means for pastors to be subject to dual status taxation. Click here for more articles that will help you file your taxes this year.