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How The SECURE Act Affects Pastors

by Amy Monday, January 6, 2020

Back in 2017, the president timed things just right so that I spent the first day of my family’s Christmas vacation researching the tax reform bill and how it affects pastors. Now, almost two years to the day, he signed into law another sweeping financial reform just in time for me to fly down to visit my family for Christmas. Thanks, Congress, I really appreciate your timing.

The Setting Every Community Up for Retirement Enhancement (SECURE) Act was signed into law on December 20, 2019, as part of a year-end appropriations bill to keep the government running. It makes significant changes to retirement plan rules that affect most Americans. Also included in the 1,770-page bill was the Taxpayer Certainty and Disaster Relief Act of 2019, which could affect how you file your tax return in the coming months. While there are no changes to the laws as they relate to pastors specifically, there are a number of other changes that might affect you.

Changes That Affect Your 2019 Taxes

Tuition And Fees Deduction

The above-the-line deduction for tuition and fees that had expired has been reinstated for 2019 and 2020. Up to $4,000 of qualified tuition and fees can be deducted. For 2019, you will need to choose between taking the deduction and the American Opportunity Credit or Lifetime Learning Credit.

Mortgage Insurance Premium Deduction

Mortgage insurance premiums may once again be included as an itemized deduction for 2019 and 2020. If your mortgage bank requires insurance on your loan and the loan qualifies, you can include it on Schedule A.

Medical Expense Deduction Threshold

The percentage of your income that medical expenses have to exceed to be deductible was supposed to increase to 10%, but that has changed. The threshold will remain at 7.5% for 2019 and 2020. Any expenses above 7.5% of adjusted gross income can be deducted.

Mortgage Forgiveness

Usually, when a debt is forgiven, the amount forgiven is counted as income and you have to pay taxes on it. The new law makes it so that qualified primary residence indebtedness that is forgiven can be excluded from income so that no taxes will be due on it.

Federally Declared Disaster Areas

Taxpayers living in federally declared disaster areas have been allowed to take penalty-free money out of their retirement accounts for 2018 and 2019. In addition, the new law gives taxpayers living in those areas an automatic 60-day filing extension. This applies to all current and future disaster areas.

Changes That Affect Retirement Accounts

Traditional IRA Contribution Age Limit

Starting in the 2020 tax year, there is no longer an age limit for traditional IRA contributions. Previously, you had to stop making contributions at age 70 ½. Now, you can continue making contributions as long as you have earned income, regardless of your age. You still cannot make contributions for 2019 if you are over 70 ½.

Graduate & Post-Doctoral Student IRA Contributions

Previously, graduate and post-doctoral students could receive taxable stipends and non-tuition fellowships that were included in gross income but didn’t count to allow them to contribute to an IRA. (You or your spouse must have income to be able to contribute to an IRA.) Thanks to the SECURE Act, that taxable income now makes them eligible to contribute to an IRA.

Required Minimum Distributions

Up until December 31, 2019, once a person turned 70 ½ they were required to start taking withdrawals from their retirement accounts (except for Roth IRAs). These are called required minimum distributions (RMDs) and a 50% penalty is imposed on any amounts not withdrawn in time.

The new law changes the age at which RMDs must be taken to 72. It only applies to those turning 70 ½ after December 31, 2019, though. If you turned 70 ½ before then, you must start taking withdrawals already.

Birth And Adoption Withdrawals

You can now take up to $5,000 out of your IRA to cover qualified birth and adoption expenses penalty-free. The distribution must be made after the actual birth of the child or the adoption is finalized. However, you can use it to pay yourself back for your initial adoption expenses or money you spent preparing for your new child.

The $5,000 is a per-person, per-child limit. That means that both parents are eligible to take $5,000 withdrawals and they can take them for each of their children. There is also a provision in the law where you can repay your retirement account the amount that you removed in relation to a birth or adoption, but regulations have not yet been issued to clarify how or when that must be done.

Inherited Retirement Account Distributions

Previously, when someone inherited an IRA or another retirement account, they were required to start taking distributions calculated so that they would last over the heir’s lifetime. Many people with money to spare would leave their retirement accounts to grandchildren because of this so that the money could continue to grow over the 60-80 year life of the youth.

Under the new law, those inherited retirement accounts must be emptied within 10 years (though there is no requirement for how much must be taken each year). The only exceptions are spouses, disabled individuals, and individuals not more than 10 years younger than the account owner, who can still stretch out the distributions for their lifetime. Minor children of the original account owner have a special exception, but only until they reach the age of majority, at which point they have to empty the account within 10 years.

Changes That Affect Educational Savings

529 Plan Usage

The new law allows up to $10,000 from a 529 plan to be used to pay down student debt without taxes or penalties. This is a per-person limit and in addition to the 529 plan beneficiary, the siblings (of any age) of the beneficiary are also eligible for up to $10,000 to pay down their loans. Also, apprenticeship programs have been added to the list of institutions where 529 plan funds can be used, as long as they are registered with the Department of Labor. This part of the law is effective January 1, 2019, so you can use it retroactively for expenses incurred last year.

In earlier versions of the SECURE Act, there was a provision to allow 529 plan funds to pay for homeschooling expenses. However, that did not make it into the final version of the bill which has become law.

There are a number of other provisions in this law that became effective January 1, 2020, but most of them do not relate to you as an individual. The above changes are the most important parts of the law as they affect individual taxpayers.

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15 Things To Know About 2018 Clergy Taxes

by Amy Monday, October 7, 2019

Growing up, there was one thing that I was always confused about. I would hear people mention April 15 as tax day, but it never made sense to me. You see, in my house, October was tax season. And that’s about as far away from April 15 as you can get.

My dad was a self-employed entrepreneur who was always behind on his “office work.” As such, he would file an extension for his tax return every year. You see, the IRS automatically extends the tax return deadline by six months for anyone who takes the time to fill out Form 4868 correctly.

It turns out that my dad was in good company. More than 10 million taxpayers file for extensions every single year. Are you one of them? Did you file for an extension and are now scrambling to prepare your 2018 tax return?

I’m here to help!

Here are 15 things that you should be aware of as you file your 2018 taxes:

The Forms Are Completely Different

Thanks to the 2017 Tax Cuts & Jobs Act, your tax return is going to look completely different this year. Form 1040 is shorter and there are a handful of new schedules to make up for what was removed. You can see examples and read more about the changes here.

Forms 1040A And 1040 EZ Are Gone

In addition to shortening the original Form 1040, the new tax law completely got rid of its spin-off forms, Form 1040A and 1040EZ. So, if you were in the habit of using those forms, it’s back to the old 1040 for you.

You Still Have Dual Status

If you meet the IRS’s definition of a minister, regardless of your actual job title, you are a dual status taxpayer. This isn’t new, it’s been this way for a long time. However, it is important to understand in order to file and pay your taxes properly. If this is news to you, or you still don’t really understand it, this article explains it in much more detail.

The Standard Deduction Nearly Doubled

One of the most popular and loudly trumpeted changes in the new tax law relates to the standard deduction. It has nearly doubled from 2017 to 2018. That means that if you usually take the standard deduction, you’re in luck, and if you usually itemize, you might end up taking the standard deduction this year. These are the standard deduction amounts for tax years 2017 and 2018 (it increased again by a little bit for 2019):

	2017 Tax Year	2018 Tax Year
Married, Filing Jointly	$13,000	$24,000
Head of Household	$9,550	$18,000
Single	$6,500	$12,000

Personal Exemptions Are Gone

While all of the politicians like to talk about the higher standard deduction, they conveniently forget to mention something that they removed to make up for it: personal exemptions. Personal exemptions allowed you to lower your taxable income based on the number of people in your family. You may remember checking little boxes on the front of Form 1040 and then adding them up.

In 2017, each personal exemption was worth $4,050. So, a family of four would be able to automatically lower their taxable income by $16,200. That is now gone, there is only the standard deduction mentioned above. Now, do you see why none of the politicians talk about this part of the law?

You Still Have To Pay The Obamacare Penalty

The “shared responsibility payment,” also known as the Obamacare penalty, is still in force for your 2018 taxes. If you did not have qualifying health insurance coverage or an approved exemption in 2018, you will have to pay for it.

That will be the last year, though. For 2019 and beyond, there will be no penalty for not having health insurance. There has been a lot of confusion and misinformation about this because the change comes a year later than all of the other tax law changes. All you need to know, though, is that for 2018, the penalty is still in force.

You May Be Eligible For The 20% Qualified Business Income Deduction

Another thing that is brand new for 2018 is the 20% Qualified Business Income deduction. This is a way for people who file a Schedule C to lower their taxable income. If you use Schedule C, you may be able to benefit from it as well, even if you’re just a pastor and not traditionally self-employed. You can read all about it here.

The Moving Expense Deduction Is Gone

You can no longer deduct your moving expenses on your tax return. If you’re a part of a denomination that moves their pastors every several years, this one could hit you hard. I’m sorry. Just know that when you can’t find where to deduct your moving expenses on Schedule A, that’s because it’s gone.

You Can No Longer Deduct Unreimbursed Business Expenses

Similar to the last point, you can no longer deduct unreimbursed business expenses, either. This one affects a lot of pastors since it’s common for you to pick up the tab, knowing that the church doesn’t have a lot of money. Unfortunately, you can’t deduct those expenses anymore. If this affects you, you may want to look into having your church start an accountable reimbursement plan, which you can learn about here.

Standard Business Mileage Rate

While you can’t deduct your miles on Schedule A anymore, you may still use that information in other areas of your taxes. The IRS’s standard business mileage rate has gone up from 53.5 to 54.5 cents per mile for 2018 and is 14 cents per mile driven in service of charitable organizations.

There Are New Tax Brackets

Another thing that has changed for 2018 are the tax brackets. For most people, they are lower, though there are a few places where they have actually increased. You can see the numbers and read all about them here.

The Child Tax Credit Amount & Eligibility Are Both Higher

Here’s some more good news for those of us with kids; the child tax credit is higher and more people are eligible for it. The credit has doubled from $1,000 to $2,000 per qualifying child and up to $1,400 of it is refundable. Refundable means that they give you the money even if you don’t pay any taxes. This is a really nice break for all of the parents out there.

Your Housing Allowance Could Affect Your Child Tax Credit

The amount of child tax credit you are eligible for is affected by your taxable income. Pastors are able to lower their taxable income with the clergy housing allowance. This means that for some pastors, their housing allowance could actually harm their ability to receive a child tax credit. If you have kids, you need to read about this here.

Most People’s Withholdings Were Off

A lot of people were surprised to end up owing taxes in April. They were upset because they expected their taxes to go down. The truth is, even though the taxes went down, their employers didn’t withhold enough during the year, so they ended up owing. Remember, whether you owe taxes or get a refund when you file has more to do with your withholdings than the actual taxes you pay.

Because there were so many changes in the law, it was difficult to estimate withholdings accurately. So, expect to be surprised when you fill out your tax return and then adjust your withholdings appropriately.

The Housing Allowance Is Safe… For Now

Finally, the biggest thing on every pastor’s mind, the housing allowance. As of right now, there are no changes whatsoever to the clergy housing allowance. The new tax bill didn’t touch it. And the court case where it was ruled unconstitutional was overturned. So, you still have that benefit. At least for now. I’m sure there will be more challenges to it in the future.

There you have it, everything you need to know to file your 2018 taxes. You only have 1 week left, so get to work!

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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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Should You Keep A Mortgage Just For The Housing Allowance & Mortgage Interest Deduction?

by Amy Monday, July 8, 2019

Keep your mortgage so you don’t lose your housing allowance and mortgage interest deduction!

How many times have you heard that advice? A reader recently asked me about it. Is that really good advice?

I know for most people, keeping a mortgage just for the mortgage interest deduction doesn’t make financial sense (though a lot of people do it). But you pastors have an amazing benefit in the ministerial housing allowance. It made me wonder, could the housing allowance be enough to turn the tables and make a mortgage worthwhile?

Example Mortgage

I decided to calculate it out to see for myself and to share with you. Here are my assumptions for this exercise:

Home Price: $200,000

Loan Amount: $160,000 (20% down payment avoids private mortgage insurance)

Mortgage Type: 30-year fixed rate

Mortgage Interest Rate: 5%

Income Tax Rate: 12%

Based on those assumptions, I calculated out the amount you would save in taxes with the housing allowance and mortgage interest deduction as well as the total amount of interest you would pay over the life of the loan.

I also looked at the opposite extreme, paying cash for the house, but that’s not a very realistic alternative for most people. Because of this, I figured out what the numbers would be if you made bi-weekly payments. The idea behind biweekly payments is that you make a mortgage payment every other week instead of monthly so by the end of the year you’ve made an extra payment, 13 instead of 12. Here are the numbers:

Calculations

Minimum Payments

Annual Principal & Interest Payments: $10,306.98

Total Interest Paid Over Life Of Loan: $149,209.25

Loan Paid Off In: 30 Years

Bi-Weekly Payments

Annual Principal & Interest Payments: $11,165.96

Total Interest Paid Over Life Of Loan: $121,723.99

Loan Paid Off In: 25.25 Years (I rounded it to 25 for my calculations)

No Mortgage

Annual Principal & Interest Payments: $0

Total Interest Paid Over Life Of Loan: $0

Loan Paid Off In: 0 Years

Now, there are a lot of other things that count towards the housing allowance besides just principal and interest payments. You have property taxes, homeowners insurance, utilities, furnishings, etc. However, those are all the same regardless of whether or not you have a mortgage. Here we are only looking at the effects of a mortgage, so those are the only numbers I included.

Here is how total loan costs compare between the three situations:

	30-Year Fixed Rate	Biweekly Payments	Pay Cash
Total Interest Paid	$149,209.25	$121,723.99	$0
Tax Benefit Of Housing Allowance*	$37,105.13	$33,497.88	$0
Mortgage Interest Deduction**	$17,905.11	$14,606.88	$0
Cost of Loan***	$94,199.01	$73,619.23	$0

*Tax Benefit Of HA calculated as 12% of annual principal and interest payment multiplied by the duration of the loan.

**Interest Deduction calculated as 12% of the total interest paid.

***Cost Of Loan is calculated as the total interest paid less the tax benefit of the housing allowance less the mortgage interest deduction.

Other Factors To Note

There are other factors that will affect how this would apply to you personally:

You have to itemize your deduction to receive a benefit for paying mortgage interest. With the new higher standard deduction, it is possible that you will not itemize and receive this benefit.

Being in a lower tax bracket will decrease your tax savings and a higher tax bracket will increase them. For 2019, the 12% rate applies to singles with a taxable income of $9,701 – $39,475 and married couples with a taxable income of $19,401 – $78,950.

Having a lower interest rate will decrease the overall cost of the loan and a higher one will increase the cost.

Your housing allowance is limited by the fair market rental value of the house. If it is less than your biweekly payments then you will not save as much in taxes as in my calculations above.

What About Opportunity Costs?

So, if you took out this mortgage you would save $55,010.24 in taxes over the next 30 years. That’s great! Except that it will cost you $149,209.25 in interest. That’s essentially giving the bank $3 in order to avoid giving the government $1. Without a mortgage, you may pay more in taxes but you pay less overall.

Those calculations make paying off the mortgage as fast as possible the clear winner. But, as with most things financial, it’s not quite as simple as that. There are opportunity costs involved. An opportunity cost is basically what you miss out on by not making another choice.

You see, ditching your mortgage is obviously best if you’re just going to be spending or sitting on your money. But, what if you invest it? What if you put $160,000 into the stock market when you got your mortgage? Would you still end up worse off financially 30 years later?

Not necessarily. If you invest your money rather than pay off your mortgage you may end out ahead. It’s a possibility, though, not a guarantee. The end results will depend upon your discipline, the investment decisions you make, and the way the market behaves.

What Should You Do, Then?

Wouldn’t life be easy if the internet could just tell you the best decisions to make about everything?

I’m sorry, but I’m not God, so I can’t tell you what’s best in your situation. I can only suggest things to think through as you make your decision:

Consider your priorities; how does your desire to be debt free compare with your desire to maximize your finances?
Consider your habits; would you have the discipline to invest your extra money instead of spending it?
Consider your risk tolerance; do you have the guts to keep your money invested even if the market tanked?
Consider various scenarios; what rate of return do you need in order to make investing instead of paying down the mortgage worthwhile for you? 5%? 8%? 12%? Is your required rate of return realistic?

Remember, the math clearly shows that giving $3 to the bank to keep $1 from the government is unwise. However, you may have other opportunities that make giving $3 to the bank worthwhile. Talk to your spouse, pray through it, do the math, and I wish you the best of luck!

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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 To Set Up A Church Accountable Plan To Reimburse Ministry Expenses

by Amy Monday, April 29, 2019

Last week we discussed the value of an accountable reimbursement plan for churches now that pastors can no longer deduct their unreimbursed business expenses. Today, I will tell you how to actually set one up.

What Makes A Reimbursement Plan Accountable

The confusing thing about accountable plans is that you don’t need to file any forms or get any kind of permission from the IRS. We’re used to needing authorization for things, like Form 4361, so we get nervous when we don’t have the IRS’s official stamp of approval. However, you don’t have to communicate with the IRS about an accountable plan, you just have to follow their rules.

What makes a reimbursement system an accountable plan is that it complies with these three IRS rules:

Expenses Must Be Ministry-Related

The expense that you’re seeking to be reimbursed for must have been incurred while performing services as an employee of your employer (the church). I’m calling them ministry expenses here because that’s what they are for pastors and churches, but the IRS calls them business expenses. For our purposes, the words business and ministry are interchangeable.

Basically, any expense that was previously deductible is allowed under an accountable plan. Examples of qualifying expenses are:

Ministry use of an automobile: IRS standard mileage rate and parking fees and tolls (miles between the church and home do not count)
Convention, conference, seminar, and workshop expenses
Ministry travel: lodging, transportation, and meals on overnight trips (receipts are not required for most travel expenses under $75, not including lodging)
Continuing education expenses (if it does not qualify you for a new position)
Sermon resources and educational material, if church-related
Subscriptions, books, internet, and software, if ministry or work-related
Office supplies and church gifts
Ministry-related legal and professional services
Equipment such as computers. Cell phones are only reimbursable for the portion of their use that is ministry-related and require a detailed accounting of ministry versus personal use.
Hospitality and entertainment when church-related. Reimbursements can cover the entire cost of meals.

If the church reimburses an employee for expenses that are not ministry-related, then they must be reported in the employee’s wages for income tax purposes and are not deductible.

Expenses Must Be Accounted For In A Timely Manner

Accounting for your expenses means that you have to keep a record of them along with proof like a receipt. It works the same way as if you were deducting them on your personal tax return. You can use a church-provided form, diary, account book, log, statement of expense, or another similar record to document each or your expenses when they occur (or shortly thereafter). Your records should show:

Date
Place
Description of expense
Ministry purpose
Names or ministry relationship of people involved
Dollar amount

In addition to keeping adequate records, they must be submitted to your church in a timely manner. “Timely” is a very subjective word and open to interpretation. The IRS acknowledges that “a reasonable period of time” can vary depending on the facts and circumstances of your situation. However, to be safe, they recommend giving advances within 30 days of the expense incurring and accounting for expenses no more than 60 days after incurred.

Excess Reimbursements Must Be Returned In A Timely Manner

Any advances that are not completely used on qualified expenses or adequately accounted for within a reasonable period of time must be returned to the church. If they are not returned, they will count as taxable income for you.

Again, the IRS offers guidelines for what they consider to be a reasonable period of time. Excess reimbursements must be returned within 120 days after the expense was paid or incurred. Another option is for the church to issue quarterly statements asking employees to return or adequately account for outstanding advances. In those cases, the employee has 120 days after receipt of the statement in which to comply.

How Reimbursements Under An Accountable Plan Are Reported To The IRS And Taxed

Under an accountable plan, reimbursements come out of the church’s funds and not the employee’s salary. The reimbursements are not reported to the IRS as taxable income on Form W-2. And the employee does not need to report them to the IRS either. If the church mistakenly includes them on Form W-2, they should issue a corrected form as soon as possible.

Reimbursements that do not qualify based on the above rules because they are not ministry-related or were not substantiated in a timely manner do qualify as taxable income. These amounts are included in wages on an employee’s Form W-2 and subject to income and payroll taxes.

How To Establish An Accountable Plan

As I mentioned above, there are no specific IRS forms that you need to fill out or get approved to establish an accountable reimbursement plan. Your church simply has to make an official decision that they are going to have one. It doesn’t even require a church vote or anything like that. As long as the church has given their finance committee or executive staff power over budgeted funds, then they can decide to establish an accountable plan and the IRS is okay with it.

Just say the word and you have an accountable plan. Of course, you need to train your employees on how to follow the plan correctly. If they don’t do it right, they will receive no benefit from it. Also, if the committee or staff overseeing the plan wants to place additional requirements on it beyond what the IRS lays out, that is their prerogative. And remember, the accountable plan is open to all employees of the church and not just the pastor or leadership.

I hope you find this article helpful. If you need more detailed information about things like per diem travel reimbursement or other specific situations, you can find it on this IRS web page.

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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.

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Are Pastors Eligible For The 20% Qualified Business Income Deduction?

by Amy Monday, February 4, 2019

The Tax Cuts & Jobs Act introduced a 20% deduction for qualified small businesses. As a pastor, even if you don’t have a side business, you may still be able to take advantage of it.

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The 2018 Form 1040: How It Looks & What It Means For You

by Amy Monday, January 14, 2019

In just a few short weeks, tax season begins! Now, this isn’t like the Christmas season where everyone is giddy, singing, and trying to start it earlier and earlier each year. For most people, tax season is more akin to going to the dentist than to Disneyland.

This year, though, there is more excitement than normal. Why? Because we have new tax forms, thanks to the new law that was passed a year ago.

What, you don’t think that’s exciting? It’s been decades since the Form 1040 has gotten a makeover. She was still wearing bell bottoms, and I mean the ones from the ‘70s, not the ‘90s!

Ok, so maybe new tax forms aren’t your idea of fun, but they are important. You are going to be signing these forms sometime in the next couple of months, so you should probably take a look at them.

Form 1040 Changes

In June of 2016, Republicans from the House of Representatives announced that they wanted to simplify the tax code to the point where most people could file their taxes return on a postcard. Did they do it?

Depends on how you define a postcard! They didn’t meet the international standard of a 5.8” x 4.1” card, but they did get it down to a half page. Luckily, the Universal Postal Union is a little bit more flexible and allows for larger postcards. This is what the new 1040 looks like:

Aside from the size, the biggest difference is on the right-hand side. See how the little boxes and math problems for exemptions are gone? That’s because there are no more exemptions, which was one of the key changes in the legislation.

All of the actual numbers were moved to the back, as you can see here:

A lot of familiar lines were removed in order to fit it onto a smaller page, as you can see. Most people’s favorite part of this side is the left-hand column that lists the much higher standard deduction.

New Schedules

What happened with all those other lines? Did they really simplify things that much?

No!

C’mon, this is the US government we’re talking about here! When has simplification ever been one of their strengths?

They simply cut out those lines that don’t apply to everyone and moved them to new forms, or schedules. Six new ones, to be exact. Yep, that means that for me and for some of you, you’ll actually have to fill out MORE forms this year. These are the new schedules:

Schedule 1: Additional Income And Adjustments To Income

This is a lot of the stuff that used to be on the lower half of the first page of Form 1040. You will need to fill out this form if you fill out a Schedule C (for money from performing weddings or other ceremonies or special offering you receive not through your church), have capital gains or losses from investments, earn royalties, or have income from rental properties. You will also need to submit this schedule to deduct your IRA or health savings account contributions and half of your self-employment taxes.

Schedule 2: Tax

You probably aren’t subject to the Alternative Minimum Tax, so you would only need to submit this schedule if you made more than expected and need to refund the government part of the Premium Tax Credit they gave you to purchase healthcare.

Schedule 3: Nonrefundable Credits

You will only need to fill out this form if you are eligible for the foreign tax credit, child and dependent care credit, education credits, retirement contribution credit, or residential energy credit. These credits lower your tax bill but you don’t benefit if the credit amount exceeds your tax liability.

Schedule 4: Other Taxes

If you haven’t opted out of Social Security, you will definitely have to file this schedule. This is where you enter your SECA taxes from Schedule SE as well as any other taxes you may owe.

Schedule 5: Other Payments And Refundable Credits

If you pay quarterly estimated tax payments, this is the form that you will use to get credit for them. This is also where you will claim your Premium Tax Credit for your 2019 healthcare expenses.

Schedule 6: Foreign Address And Third Party Designee

You only need to fill out this form if you have a foreign address or want to give someone else the right to speak to the IRS on your behalf.

Basically, they took the old Form 1040 and cut it into 7 different pieces. You may have noticed some lines on those forms that say “Reserved.” That just means they are saving room so they can add more to these forms in the future.

There you have it. A sneak peek at what filing your tax return will look like this year. Now, when your tax preparer starts talking about schedules with numbers instead of letters (don’t worry, all of those still exist and need to be filed too!), you won’t think they’ve gone crazy or you’re hearing wrong.

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The Top 10 Personal Finance Blog Posts For Pastors Of 2018

by Amy Monday, December 31, 2018

The most popular Pastor’s Wallet blog posts of 2018, based on number of views.

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Tag Archives taxes

Changes That Affect Your 2019 Taxes

Tuition And Fees Deduction

Mortgage Insurance Premium Deduction

Medical Expense Deduction Threshold

Mortgage Forgiveness

Federally Declared Disaster Areas

Changes That Affect Retirement Accounts

Traditional IRA Contribution Age Limit

Graduate & Post-Doctoral Student IRA Contributions

Required Minimum Distributions

Birth And Adoption Withdrawals

Inherited Retirement Account Distributions

Changes That Affect Educational Savings

529 Plan Usage

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The Forms Are Completely Different

Forms 1040A And 1040 EZ Are Gone

You Still Have Dual Status

The Standard Deduction Nearly Doubled

Personal Exemptions Are Gone

You Still Have To Pay The Obamacare Penalty

You May Be Eligible For The 20% Qualified Business Income Deduction

The Moving Expense Deduction Is Gone

You Can No Longer Deduct Unreimbursed Business Expenses

Standard Business Mileage Rate

There Are New Tax Brackets

The Child Tax Credit Amount & Eligibility Are Both Higher

Your Housing Allowance Could Affect Your Child Tax Credit

Most People’s Withholdings Were Off

The Housing Allowance Is Safe… For Now

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What Are Quarterly Estimated Tax Payments?

When Are Quarterly Estimated Tax Payments Due?

How Should Pastors Calculate Quarterly Estimated Tax Payments?

Calculating Estimated Income Tax Payments

Pastors Participating In Social Security

How To Avoid Penalties

Another Way To Do It

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Example Mortgage

Calculations

Minimum Payments

Bi-Weekly Payments

No Mortgage

Other Factors To Note

What About Opportunity Costs?

What Should You Do, Then?

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Mandatory Withholdings

FICA/SECA (Payroll) Taxes

Federal Income Taxes

Withholding Extra

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What Makes A Reimbursement Plan Accountable

Expenses Must Be Ministry-Related

Expenses Must Be Accounted For In A Timely Manner

Excess Reimbursements Must Be Returned In A Timely Manner

How Reimbursements Under An Accountable Plan Are Reported To The IRS And Taxed

How To Establish An Accountable Plan

RELATED

What Is Dual Status Taxation?

Why Are Pastors Subject To Dual Status Taxation?

What Does Dual Status Taxation Look Like For Pastors?

How Does The Housing Allowance Fit In?

RELATED

RELATED

Form 1040 Changes

New Schedules

Schedule 1: Additional Income And Adjustments To Income

Schedule 2: Tax

Schedule 3: Nonrefundable Credits

Schedule 4: Other Taxes

Schedule 5: Other Payments And Refundable Credits

Schedule 6: Foreign Address And Third Party Designee

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