Tax Provisions Affecting Clergy

A.   COMPENSATION. The compensation of ministers is subject to several significant exceptions and exclusions compared not only to non-church employees, but also to other church employees.

1.   For §403(b) plan purposes, ministers get special breaks in computing contribution limits compared to other plan participants.

2.   For church plan purposes, ministers who are self-employed may be covered the same as regular employees. Even ministers who are employed by a non-church organization may nonetheless sometimes participate in a church plan through their ecclesiastical structure.

3.   Wages earned by a minister performing services "in the exercise of his ministry" are excluded from withholding requirements. §3401(a)(9).

4.   Ministers and other church employees have special exemptions from FUTA (unemployment tax). §3309(b)(1) & (2).

5.   Be aware that some ministers, in certain religious traditions, view themselves as self-employed and not as employees, i.e., their compensation is reported on Form 1099 rather than Form W-2. Generally, this position cannot be properly sustained. However, even here there are exceptions and recent cases occasionally still conclude the minister is truly self-employed. But this is the exception, not the rule.

B.   SOCIAL SECURITY TAXES.

1.   Although regular church employees have been subject to FICA since 1984, FICA is inapplicable (per IRC §3121(b)(8)) to:
a.   a minister "performing services in the exercise of his ministry" [a term of art], or a member of a religious order performing services in the exercise of duties required by the order; and

b.   employees of a church or church-controlled organization if: (a) the organization is opposed for religious reasons to the payment of FICA taxes; and (b) the services are not performed in an unrelated trade or business. See also §3121(w).

2.   What this means is that ministers are treated, for social security purposes, as though they were self-employed. [CAVEAT: This does not mean a minister is actually self-employed, either for other federal tax purposes (ministers do not file Schedule C just because they are covered by SECA) or for any state law purpose. But it is confusing - especially to clients.]

a.   Thus, ministers come under the provisions of SECA (the self-employment tax). See IRC §1402(a)(8). SECA must be paid with respect to a pre-retirement housing allowance, but not with respect to a post-retirement housing allowance or a post-retirement benefit received from a church plan.

b.   Of course, there are special rules for certain church employee income. See §1402(j). And the regulations under §1402 are absolutely crucial.

c.   For ministers, all 403(b) contributions within the exclusion allowance are not subject to SECA, whether made by the employer or the minister.   For other church employees, salary deferrals are subject to FICA, but employer contributions are not subject to FICA. For all employees, 403(b) contributions in excess of the exclusion allowance are subject to SECA or FICA. Now isn't that simple?

3.   Opting out of social security. Additionally, ministers and members of religious orders may 'opt out' of social security altogether under §1402(e)(1) if they are conscientiously or religiously opposed to the acceptance of public insurance payments. This is a fairly common practice among missionary organizations or any 'support-raising' ecclesiastical organization.

C.   MINISTERS' PARSONAGE (RENTAL HOUSING) ALLOWANCE.

1.   Ministers, but not other church employees and not members of a religious order, may exclude from income the housing allowance permitted by IRC §107. It is quite common for ministers to take up to 50% of their total compensation in the form of a housing allowance.

2.   There are a host of rules applicable to housing allowances, most of which relate to the definition of what constitutes "services performed in the exercise of ministry" and can be found in the Regs. under §1402. The amount excludible from income is the least of the following three amounts:

a.   The actual expenses incurred by the minister for qualified housing purposes;

b.   The amount declared in advance of payment by the minister's employer as constituting a housing allowance; and

c.   The fair rental value of the minister's home, and for years after 2001, this amount includes the fair rental value of furnishings and appurtenances such as a garage, plus the cost of utilities.

3.   Some key points to remember:
a.   Exclusion from income as a housing allowance is not something which the minister can decide, or accomplish, on their own. Merely being a minister does not qualify someone for taking the exclusion. Unless the employer has formally adopted a housing allowance for the minister, it does not exist.

b.   Whenever a minister is employed by any organization unrelated to his or her ordaining body, a "letter of assignment" from the ordaining body which meets certain prerequisites is required to sustain the income exclusion.

c.   Not all compensation received by the minister qualifies for the income exclusion. Only compensation paid for services performed in the exercise of ministry qualify. Generally, this is not a problem for clergy who perform administrative tasks for a church or who teach at a religious seminary, but are more problematic for chaplains and other ministers employed by a secular employer.