A PASTOR AND HIS COMPENSATION

Transcription

1 A PASTOR AND HIS COMPENSATION Pastors are considered dual-status employees, which means they are treated as an employee for federal income tax purposes, and self-employed for Social Security/Medicare purposes. Being an employee, they do receive a W-2. What is the difference between federal income tax and the self-employment tax? Self-employment tax is simply the vehicle a self-employed individual uses to pay his Social Security/Medicare tax (SECA). Income (whether you are an employee or self-employed) is subject to both federal income tax and Social Security/Medicare tax. Employees pay their taxes throughout the year as their employers withhold taxes from their pay. The amount withheld for federal tax is figured based on the W-4 an employee fills out when employment begins. For Social Security/Medicare the employer withholds 7.65% (6.2% for Social Security tax 5.2% in 2011 and 1.45% for Medicare) from the employees salary, then the employer matches that amount (pays an additional 7.65% which is not considered income to the employee). Self-employed individuals pay their taxes throughout the year by making quarterly estimated payments. This amount covers both their federal tax and self-employment tax (Social Security/Medicare SECA). The amount they pay is only an estimate; they figure the actual amount when they file their yearly tax return. How does a pastor pay his taxes? A pastor's options in paying taxes during the year are: The church treasurer can withhold enough FIT (Federal income tax) to cover both the FIT and Social Security/Medicare taxes (only with permission from the minister) The church treasurer can withhold FIT and you can file Social Security/Medicare taxes quarterly on Form 1040-ES. (only with permission from the minister) The minister can file quarterly on 1040-ES for all taxes. Prepaying your state taxes by withholding or quarterly estimates may also be required. What is included in a pastor's income for federal income tax purposes? The pastor pays federal taxes on the amount of his salary not including the actual expenses incurred for his designated housing allowance, and any tax free fringe benefits.* What is included in a pastor's income for self-employment tax purposes? The pastor pays self-employment tax on his salary, his housing allowance, the fair market rental value of any church owned parsonage, including any church paid utilities. Other outside income, such as

2 honorariums, would be included on Schedule C of the tax return and subject to self-employment tax.* *Additional church income such as Christmas gift, bonuses, etc. are to be include for all federal and state taxes. MINISTER EMPLOYMENT STATUS Can a minister choose whether to be considered an employee or self-employed? No, the facts and circumstances will determine a minister's employment status. Creating a contract or giving an individual a title or description in order to appear to be self-employed will not determine employment status the facts and circumstances make the determination. What is the correct tax treatment for an employee (non minister)? An employee should receive a W-2 and the employer should withhold and match Social Security and Medicare on his/her wages. Note: A church can hire a service, a general contractor, or an individual (if the individual is in business and offers his/her services to several churches/businesses) to provide miscellaneous services (i.e. yard maintenance, janitorial duties, secretarial duties, etc.). If a church chooses to hire an individual or church member then an employer/employee relationship has been established and proper employment forms must be completed. What is the correct tax treatment for a self-employed individual? If you pay a self-employed individual more than $ (not including reimbursements), you must give the individual a 1099-MISC. What is the correct tax treatment for a Minister of the gospel? An employing church of a minister of the gospel is to treat the minister as dual-status. This means the minister has 2 status' and is considered both an employee and self-employed. 1) he is an employee for federal income tax purposes and receives a W-2 and 2) he is self-employed for Social Security and Medicare purposes and does not have Social Security or Medicare withheld nor matched on his wages. What are some of the common mistakes when employing Ministers of the gospel? The most common error is for a church/mission agency to give their employed minister a 1099 as if selfemployed. This error is many times compounded by the housing allowance, expense reimbursements, and fringe benefits. Fringe benefits are available to dual-status ministers not to self-employed individuals. If a minister of the gospel receives a 1099 and employee fringe benefits, he is receiving wrong treatments. These "before tax" benefits are for "dual-status" ministers who receive W-2's. Selfemployed 1099 individuals are not entitled to employee fringe benefits. The second most common error is for churches to withhold and match Social Security and Medicare taxes from a minister's wages. This is further compounded when the church designates a housing

3 allowance. Employees who have Social Security and Medicare taxes withheld do not qualify for a housing allowance. If a minister of the gospel has Social Security and Medicare taxes withheld, he is receiving wrong treatments. For more information refer to IRS Publication 517. SELF EMPLOYMENT TAX Many Churches are now helping their Pastor pay his SELF-EMPLOYMENT TAX. This is additional income to the minister which is subject to self employment tax. Pastors pay their Social Security and Medicare tax the same way a self-employed person would, through selfemployment tax. This tax is 15.3% of income including the housing/parsonage allowance and is calculated on the Schedule SE that is filed with a minister's tax return each year. They must pay Self-employment tax on their ministry income, including their housing allowance. When a pastor lives in a parsonage he also pays SE tax on the Fair Market Rental Value of the parsonage plus church paid utilities. Regular employees have an advantage when paying their Social Security and Medicare tax. Employers withhold half (7.65%) of every employee's Social Security and Medicare tax from their wages. The employer pays the other half and the employee does not pay any taxes on the employer's "matching" part. Pastors pay the entire 15.3% without the benefit of a non-taxable "matching" employer part. Many churches have realized the tremendous burden this places on a pastor and his finances and are paying a portion of the SE tax. (7.65% = half of SE tax ). HOUSING ALLOWANCE How does the housing allowance benefit a pastor? A pastor does not pay federal income tax on that portion of his income which is considered to be his housing allowance. The housing allowance is the smaller of the following: The amount designated by the church to be considered housing allowance. (This is limited to ministry income, but 100% of ministry earnings can be designated as housing allowance). The amount actually spent to provide a home (see below: What expenses are included in the housing allowance?) The FMRV (Fair Market Rental Value) of the furnished home plus actual expenses. The FMRV takes the place of the mortgage payments (including closing costs, down payments, principal, interest, taxes, insurance, and major repairs. Housing allowance is always subject to social security and Medicare taxes (Self employment tax) How does the housing allowance affect the paycheck of a pastor?

4 The pastor continues to be paid in the same manner he was paid prior to the designation of a housing allowance. The fact that a portion of his salary is now designated as housing allowance need not affect the amount nor the manner in which he is paid. What expenses are included in the housing allowance? Rent or mortgage payments. Including principal, interest, real estate taxes, insurance, closing costs, and down payment. Improvement, repairs, and upkeep. This includes a room addition, new roof, fence, sod, swimming pool, garage, refrigerator repair, etc. Furnishings and appliances. Including dish washer, TV, personal computer, pool table, piano, dishes, blender, lawnmower, etc. Decorator items. Such as rugs, curtains, pictures, plants, knick knacks, wallpaper, paint, towels, bedding, etc. Utilities. Electric, garbage, water, telephone (not business), cable TV, internet, gas, water softener rental, etc. Miscellaneous. This would include cleaning supplies, light bulbs, dry cleaning of drapes, carpet cleaning, landscape tools, garden hose, etc. Do not include maid or lawn care service, groceries, personal toiletries, cassette tapes, CD's, personal computer software, videos, dish soap, etc. In the eyes of the IRS, what needs to be done to establish a housing allowance? Simply include the following example in the minutes of any business meeting of the church or board. The names of the individuals making the motion and seconding it should be included. The housing allowance cannot apply to expenses paid before the date of these minutes. A housing allowance is never retroactive.

5 Resolution Motion 1. It was discussed that under the tax law a minister of the gospel is not subject to federal income tax on the "housing allowance paid to him as part of his compensation to the extent used by him to rent or provide a home." 2. After considering the statement "Pastor's Estimate of Home Expenses" prepared by, a motion was made by and seconded by and passed to adopt the following resolution: 3. Resolved that Pastor is to receive a total cash remuneration of (salary) for the year 20. Of this amount, $ (housing expenses paid from salary) is hereby designated as housing allowance. Resolved that as long as Pastor is our employee the above amount of housing allowance shall apply to all future years until modified. Date Signed Can the amount of designated housing allowance be changed mid-year? You can amend your housing allowance at any time and as often as needed throughout the year. Because a housing allowance is not retroactive you can never pick up expenses which were paid before the amount was designated as housing allowance and you cannot designate salary which you have already received. Example #1 - You have a housing allowance designation of $10,000. In June you realize you have already spent $10,500. You lose $500 and even though you amend your housing allowance so you can include your housing expenses for the remainder of the year, you cannot go back and pick up the $500 you spent above what was designated at the time you spent the $500. Example #2 - In mid-october you realize your $30,000 housing allowance designation will not be enough to cover all your housing expenses for the year because you have already spent $29,500. You know that your remaining salary for the year is $7,000. So you cannot increase your housing allowance by more than $7,000. You can amend your total housing allowance to $37,000 for the year

6 Who keeps track of the housing allowance and how is it reported to the IRS? The pastor keeps track of his housing expenses. When the pastor has his tax return prepared, the pastor and the tax preparer will determine how much of the expenses qualifies as housing allowance.. What happens when all of the designated housing allowance is not spent for housing allowance? Any unused housing allowance is added to the tax return as additional How does a pastor estimate his housing expenses? I recommend that a pastor use the following form to estimate his housing allowance. Always overestimate, the amount a pastor cannot justify as being spent will be declared as income. It is important to keep accurate records of expenditures. The housing allowance can be amended in mid-year, but the housing allowance is never retroactive. Name Housing allowance for the coming year of 20. I expect to incur the following expenses to rent or otherwise provide a home. I understand that my actual expenses are what I will deduct on my next year's tax return, and I will not be allowed to deduct any expenses not estimated and designated officially. ITEM AMOUNT Rent, principal payments, interest, taxes, and improvements Furnishings and appliances... Utilities... Other housing expenses (cleaning supplies, etc.) Miscellaneous repairs... Total... Signature Date

7 POSSIBLE HOUSING EXPENSE ITEMS' FURNISHINGS AND APPLIANCES Air-Conditioner Bed Bedspread Bookcase Bulletin Board Carpeting CD Player Cedar Chest Chairs China Cabinet Clocks Clothes Dryer Coat Racks Coffee Table Curtains Decorations for Wall Desk Dishes Drapes Dresser/ Chest of Drawers End Tables MAINTENANCE EXPENSE: Air Fresheners Bathroom Fixtures /Racks Bath Mat/Shower Curtain Brooms Bug Sprays Candles Carpet Cleaners/Rentals Chain Saw Chair/Sofa Coverings Cleaning Supplies Clothes Hamper Clothes Hangers Disinfectants Dust Pans Extension Cords Flash Lights/Batteries Fans Fire Extinguishers Fire/Smoke Alarms Flowers/Plants Flower Pots/Hangers Food Freezer Glasses/Cups Heaters (Electric or Gas) Hutch Kitchen Appliances Lamps/Light Fixtures Lamp Shades L a m p S t a n d s Lawn Decorations Lawn Furniture Microwave Oven Mirrors Pictures/Frames for Wall Pillows Pillow Cases Pots/Pans Floor Polish Food Containers Furnace /Air Filters Furniture Polish Gas for Lawnmower Grass/I-ledge Trimmer Hardware Supplies Hoes Ladders Lawn Hose Lawn Mower Light Bulbs Mops Nails Oil (all purpose) Paint Radio Refrigerator Rugs Sheets Shelves Sofa Step Stools Stereo Stove Tables Telephone Answering Machine Television Television Cabinet Tool Shed Towel Rack TV Trays Utensils Vacuum Cleaner Venetian Blinds Washing Machine Window Shades Paper Towels Rakes Screws/Bolts/Washers Shelf/Contact Paper Soap Sponges Toilet Bowl Cleaner T o i l e t P a p e r Tools Towels Trash Bags Wallpaper Waste Baskets Wash Rags Weed Eater Window Cleaners NON-TANGIBLE EXPENSES Cable TV Fees Chimney/Furnace Cleaned E l e c t r i c P o w e r Heat (Gas/Wood) Household Insurance Lawn/Yard Care & Mowing Lawnmower Repair M o r t g a g e P a y m e n t s R e a l E s t a t e T a x e s Repairs Sewer Fees Snow Removal Trash Removal Water

8 A PASTOR AND HIS BUSINESS EXPENSES What are the advantages of the church reimbursing the pastor for his business expenses rather than claiming them on his tax return? Pastors may now be targets for IRS audits on professional expenses. The IRS regulations state that an employee must be accountable for professional expenses either to the IRS through schedules 2106 and schedules A miscellaneous, or to their employers by reimbursement. We recommend the reimbursement method. It will prevent an audit by the IRS for those areas now targets - you eliminate schedules 2106 and A miscellaneous from your tax return. It will also save taxes as a portion of expenses listed on your 1040 will be subject to limitations (the Dalan ruling* and 2% of Adjusted Gross Income). They are not subject to limitations if reimbursed. You do not report the reimbursed amount on the Pastor's W-2. It is not income. How does a church set up an expense reimbursement account for its pastor? The church pays the Pastor a salary and reimburses all his professional expenses separately (from the general operating budget). This keeps the Pastor's salary and professional expenses totally separate. Note, the Pastor must account to the church with receipts/mileage logs for those expenses to be reimbursed. This is the best method to use. 1. The Pastor accounts to the treasurer/bookkeeper monthly with his expenses and gets reimbursed with a separate expense check out of the professional expense category in the budget. 2. If the Pastor does not use the total amount of budgeted expenses by the end of the year, he loses it - the unused portion belongs to the church. IT DOES NOT BECOME SALARY. If you do not follow the procedures as the IRS stipulates for reimbursement, and they audit your return, they will declare your reimbursement as nonaccountable professional expenses. They will add your reimbursed expenses to your income and they will require you to file Form 2106 and Schedule A Miscellaneous with that year's return and then apply the Dalan ruling* and the 2% limitation. What expenses are considered reimbursable business expenses? The following are examples of reimbursable business expenses: Education - Tuition, fees, books, supplies, and (if the school is away from the pastor's home area) transportation, meals, and lodging are reimbursable. Education expenses which qualify your pastor for a new trade or business (such as carpentry, etc.) are not reimbursable.

9 Meal & Entertainment - Reimburse a pastor 100% of his cost for meals and entertainment. When his spouse is present because the spouse of the person being entertained is present, her meal is reimbursable. The cost of meals for the pastor's children are never deductible. Mileage - The pastor should keep a log of his miles (including the mileage at the beginning and end of each year) and be reimbursed for his business miles at the standard mileage rate. Travel - The cost of train, airplane, boat, bus fare, auto rental, taxi, hotel, motel, meals, gratuities, telephone, travel insurance, baggage charges, cleaning, and laundry costs are reimbursable when a pastor travels on business. A pastor might travel to attend a church convention, a speaking engagement, to lecture, to perform a wedding or a funeral, to provide pulpit supply, an evangelistic meeting, on deputation, to church camp, etc. What expenses are not considered reimbursable business expenses? Clothing which is adaptable for general wear, one subscription to a local newspaper (which the IRS claims must be personal), magazine subscriptions, CD, and books which are purchased for personal reasons, travel expenses which relate to anyone other than the person earning an income, commuting miles, contributions, tithes, offerings, tuition expenses for your dependents, education expenses which do not relate to your ministry, taxes, or personal use of your computer. What is required to substantiate expenses? A taxpayer must substantiate by adequate records or by sufficient written evidence the following types of expenses: 1. Traveling expenses including meals and lodging while away from home. 2. Entertainment expenses. 3. B u s i n e s s g i f t s. Since 1985, taxpayers have been required to answer questions on their returns regarding the business use of an automobile including: 1. The total number of miles driven during the year. 2. The total number of business miles driven during the year. 3. Whether the vehicle was used for commuting and, if so, the distance normally commuted. 4. Whether the vehicle was available for personal use in off-duty hours. 5. Whether another vehicle was available for personal use. 6. Whether adequate records or sufficient evidence exists to justify the deduction and whether or not the evidence is written. Taxpayers are required to substantiate the following elements: 1. The amount of each expense or other item.

10 2. The time and place of the travel, entertainment, amusement, recreation, or the date and description of the gift. 3. The business purpose of the expense or other item. 4. The business relationship to the taxpayer of the persons being entertained, or receiving the gift. Adequate records or sufficient evidence include the following: 1. Account books, diaries, and logs. 2. Documentary evidence (receipts, paid bills). 3. T r i p s h e e t s. 4. E x p e n s e r e p o r t s. 5. Written statement of witnesses. If a taxpayer does not have adequate records to substantiate his expenses, or if he cannot supply sufficient written evidence thereof, no tax deductions or credits will be allowed with respect to an item. It should be noted that Congress has emphasized that different types of evidence have different degrees of probative value and that oral evidence alone has considerably less probative value than written evidence. *The Dalan Ruling - In January of 1990, the IRS took another step toward reducing the amount of professional expenses ministers can deduct on their tax returns. It involves a case known as the Dalan Case. In effect, the IRS ruled that, beginning in 1988, ministers would not be able to deduct all of their professional expenses because of earning nontaxable income. For example, the Housing Allowance: Pastor Smith earns $45,000 per year of which $18,000 is housing allowance. His professional expenses amount to $6,000 for the year. Since forty percent of his income is non-taxable ($18,000 divided by $45,0000), $2,400 of his expenses are non-deductible ($6,000 x 40%). If Pastor Smith is reimbursed by his church for professional expenses, then the Dalan ruling has no effect on the minister. FRINGE BENEFITS FOR PASTORS What non-taxable fringe benefits are available to pastors? And what requirements must be met to qualify each benefit as nontaxable? Disability Insurance - The church can reimburse its pastor for this premium with a reimbursement plan or pay directly the churches own plan.. Health Insurance - It is best for the church to have their own health insurance policy. If the church does not, you will need to establish either a Medical Reimbursement Account or a Health Reimbursement Arrangement. Health Reimbursement Arrangement This is an amount which the church sets aside to be used for reimbursement of non-covered medical expenses. Left-over funds may be carried forward to the following year. An HRA is subject to discrimination laws and all employees would receive the same amount. Housing Allowance - This is a part of the pastor's salary which is designated to be available for

11 housing costs. This needs to be approved by the board or church in writing and in advance of expenses. The portion of this designation which is used to provide housing is exempt from Federal Income taxes, but not self-employment tax (Social Security/Medicare). Life Insurance - The church may provide up to $50,000 group term life. Medical Reimbursement Account - This is an amount set aside to be used for reimbursement of noncovered medical expenses. The funds are made available through salary reduction. This is a "use it or loose it" proposition, so any funds remaining at year end cannot be given as salary. Reimbursement/Expense Account - The church must require receipts (it is not enough for the pastor to voluntarily substantiate his expenses). This is a "use it or loose it" proposition; any unused portion cannot become salary. Tax Sheltered Annuity (403-b The church contributes directly to the financial institution chosen. The Pastor or church determines the amount of the contribution, which would exclude it from taxes. Tuition Benefits for your dependents - The school must also be the employing body in order for this to be a tax-free benefit (i.e. the church and school are one corporation). What benefits are taxable? Life Insurance - in excess of $50,000, or any policy which is not considered group term life. Personal use of a Church owned Auto - a log must be kept to determine the value of this taxable benefit. Reimbursements - when a Pastor is not required to substantiate or "pay back" the excess. Tuition Benefits for your dependents - These benefits are considered a part of the Pastor's taxable salary when the school is not a part of the church. For comments or questions, direct them to: info@yourchurchmatters.com

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