Pastors should make sure to avoid tax errors
JEFFERSON CITY—Tax season is a time of the year that is dreaded most by the millions of Americans who live in this great country. Whether we want to think about this crazy, hectic time of the year or not, to not keep one aware of what needs to be done could cause needless struggle and loss.
This is the case when it comes to most of the churches here in Missouri when they deal with the handling of their ministers’ payroll and taxes.
There are 10 common ministerial mistakes that churches make when it comes to providing their pastors with proper tax procedures. The first has to do with the pastor’s parsonage or housing allowance. Generally, a minister’s taxable gross income does not include the fair rental value of a home (parsonage) provided, or a housing allowance paid, as part of the minister’s compensation for services performed in the exercise of his ministry.
A minister who is furnished with a parsonage may exclude from income the fair rental value of the parsonage, including utilities. However, the amount excluded cannot be more than the reasonable pay for the minister’s services. One receiving a housing allowance may exclude the allowance from gross income to the extent it is used to pay expenses in providing a home with certain limitations. The minister’s church or other qualified organization must designate the housing allowance pursuant to official action taken in advance of the payment. IRS Publication 525, Taxable and Nontaxable Income, has information on particular types of income for ministers.
Improperly prepared W-2 forms cost the minister tax money in many cases. This is the second ministerial mistake made by churches. An example would be something such as a minister buying material to preach from and turning the receipt in to the church, only to have the church fail to properly process the reimbursement. So in turn, the expense for the material he is preaching from comes straight out of his pocket.
Some churches take up a love offering for special occasions such as the pastor’s birthday, anniversary, or family funeral. These love offerings are taxable wages; however, many churches do not include these amounts in the pastor’s W-2 form, which is the third mistake.
Fourth, some pastors are not making their quarterly estimated tax payments, which results in the minister being penalized when the tax return is filed.
A minister is known as a dual status employee by the Internal Revenue Service, meaning he can claim himself as both a self-employed employee and a regular employee. So when a minister does not calculate self-employment taxes on the fair rental value of the parsonage or his housing allowance, the result is an underpayment of tax and potential future liability.
For ministers just starting out or still taking classes, it is important to know that they can include many of their college-purchased books and other study materials as part of their professional library, a portion of which may be deductible. That is the sixth mistake, made not so much by churches but by the ministers themselves. Also, ministers who own a home cannot claim an office in home if the housing allowance through the church covers all of his allowable housing expenses.
The eighth mistake would be that some churches are withholding Social Security and Medicare (FICA) taxes out of a minister’s pay. FICA stands for Federally Insured Contribution Act. The compensation that a church or religious organization pays to its ministers for performing services in the exercise of ministry is not subject to the FICA taxes. However, income that a minister earns in performing services in the exercise of his ministry is subject to SECA (Self Employment Contribution Act) tax, unless the minister has timely applied for and received an exemption from Social Security.
No. 9 is a big and common mistake made by churches when they first hire a pastor. Many churches issue 1099-MISC forms when they should be issuing W-2s to the minister and other staff at year end. Such was the case with a minister right here in Missouri.
“I wound up paying about $400 a month in past-due taxes in addition to my normal tax withholdings from my paycheck,” he said. “I would highly recommend that churches research and make sure their pastors are getting what they’re legally supposed to.”
The final mistake that is common is churches do not properly process the minister’s health insurance premiums or their retirement payments. Failure to properly process these transactions may result in additional income and self-employment taxes. Use the utilization of medical insurance and retirement premiums as salary reductions.