Planning the federal income tax treatment for ministers1 must consider several topics that are unique to ministers.
A minister is considered an employee under the common law rules and yet payments for services as a minister are considered income from self employment pursuant to IRC §§ 1402(c ) and 3121(b)(8). This is the unique distinction that gives rise to other tax considerations.
Election to pay taxes as self-employed
A minister (unless exempt from tax as described below), pays social security and Medicare taxes under the Self-Employment Contributions Act (SECA) and is not subject to Federal Insurance Compensation Act (FICA) taxes or income tax withholding.
If the employer and employee agree, IRS allows an election can be made under IRC § 3402(p)(3) to have income taxes withheld.
IRS recognizes that some ministers may receive a Form 1099-MISC for the performance of services they clarify that he or she may be a common law employee and should in fact be receiving a Form W-2.
Workers compensation coverage
Workers compensation insurance is not a federal income tax issue however coverage is based on the taxable income as defined and adjusted under state law. In general ministers must be covered by workers compensation insurance.
A minister is frequently provided a parsonage or is paid a housing allowance, which is exempt from income tax under IRC § 107. The “allowable” allowance is subject to self employment tax under SECA and IRC § 1402(a)(8). The “allowable” allowance is computed subject to limitations imposed by law as to the amount and the required designation by the employing church which is discussed in detail under the section on the parsonage allowance. Please be aware of the special rules for retired ministers. See 42 U.S.C. § 411(a)(7). Because of the exemption from income tax for the “allowable” parsonage or housing allowance, the operation of IRC § 265 requires business expenses to be allocated between taxable and non taxable income.
Amounts excluded from income
The earnings for qualified services a member of an exempt religious order, who has taken a vow of poverty, performs as an “agent” of their church or its agencies, may be exempt from income tax and self employment tax.
Employee benefits are treated the same as for other employees; some employee benefits may be excluded from income.2
Gifts given to a minister, other than retired ministers or , may actually be compensation for services and included in gross taxable income under IRC § 61.
State and local income tax issues
This article does not consider state and local income tax issues. I’m happy to discuss those issues in a private consultation.
1 Generally also including a rabbi or cleric, but IRS discussed who qualifies at https://www.irs.gov/pub/irs-utl/ministers.pdf
2 I’ve set up a number of payroll and employee benefit plans, especially Health Reimbursement Arrangmements (HRAs) for churches.