…and What You Can Do to Avoid Them
It’s tax season again, and pastors across the U.S. are gathering the financial documents necessary to carry out their civic duty. With inherent complications of ministerial tax treatment, albeit with some benefits, how can ministers make sure their income tax filings are accurate and above reproach?
In more than 40 years of work with churches and non-profits, ECFA has observed five common tax mistakes made by pastors:
1. Insisting that the church deduct FICA-type Social Security from ministerial compensation.
When an individual qualifies as a minister in the eyes of the IRS, he or she automatically becomes subject to Social Security under the self-employment (SECA) rules and is ineligible for FICA-type Social Security treatment. In other words, a church or other employer of a qualified minister should never deduct FICA Social Security tax from a minister’s pay.
2. Failure to have a voluntary withholding agreement with the employing church.
While churches are not required to withhold income taxes from wages paid to an individual classified as a minister for tax purposes, most will agree to this type of arrangement. Having a voluntary withholding agreement is beneficial to the minister because the withholding can be set high enough to cover income tax and self-employment social security taxes (SECA) owed by the minister.
3. Not understanding the requirement to properly account for the housing exclusion on their tax return.
When used properly, the minister’s housing allowance can be the minster’s best tax friend, but it can be complicated to get right! Establishing an amount and having it handled properly by the employing church is one part of the equation. The minister must also account for the exclusion on their tax return. While the IRS does not place a limit on how much can be designated as housing allowance, it has placed limitations on how much can actually be excluded from income at tax time. A minister is able to exclude the lower of actual housing expenses incurred during the year, or the fair rental value – regardless of how much was designated by the church.
4. Failing to have at least a modest housing allowance designated when living in a church-provided parsonage.
Ministers who live in church-provided housing often miss out on the tax benefit provided by a housing allowance. Many ministers do not understand that a housing allowance can and should be designated in an amount that covers expenses such as furnishings, personal property insurance on contents as well as utilities.
5. Failure of ministers to be reimbursed for expenses under an accountable reimbursement plan.
An accountable reimbursement plan is a reimbursement arrangement established by the church whereby expenses can be reimbursed to the employee in a tax-free manner. It requires (1) a business purpose for the expenses, (2) substantiation of expenses, and (3) the return of any excess reimbursements. When a minister incurs expenses and receives reimbursement from the church in absence of a formal accountable reimbursement plan, the reimbursement becomes taxable income to the minister.
We know that ministerial tax treatment is a complicated endeavor, but it doesn’t have to be overwhelming. For a more extensive explanation of 2021 tax considerations, check out our free Minister’s Tax & Financial Guide. At ECFA, we want to help you to be the best possible steward of your God-given resources and free you to focus on ministry!
Michael Martin is president of the Evangelical Council for Financial Accountability. Founded in 1979, ECFA provides accreditation to leading Christian nonprofit organizations and churches that faithfully demonstrate compliance with the ECFA standards pertaining to financial accountability, fundraising and board governance. For more information about ECFA, visit ECFA.church.