Clergy FAQ

This page contains a listing of frequently asked questions that have to do with clergy taxes. If you have a question on state taxing authorities, you will need to contact your state taxing authority directly or a local tax professional. Click on the area of interest below and you will be taken to the answer to your question. If you do not find the answer you are looking for, feel free to email us at ClergyTaxes.com.

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I. The Tax System for Ministers

1. Special Tax provisions that only apply to “ministry services.”
2. Do not withhold FICA tax from a minister’s salary!
3. Are you an employee or self-employed for income tax purposes?
4. May a minister be both an employee and self-employed for ministerial income?
5. What forms should the church provide to report ministerial compensation?

II. The Housing Allowance

1. How is the housing allowance reported by the church to the minister?
2.
Does a housing allowance provide any benefit for a minister living in church provided housing?
3.
Who is responsible to establish the fair rental value of church provided housing?
4.
Must the housing allowance designation be in writing?
5.
When must the housing allowance designation be made?
6.
May the total of the designated housing allowance be excluded for income tax purposes?
7.
Is there a maximum amount that may be set as the housing allowance?
8.
How many ministers serving one church may receive housing allowances?
9.
May the housing allowance be established as a percentage of salary?
10.
May the minister’s housing allowance be adopted at the denominational level?
11.
Does the minister or the church determine the amount of housing expenses to exclude from income on the minister’s return?
12.
What happens when actual housing expenses exceed the fair rental value of the residence?
13.
How is the housing allowance paid to the minister?
14.
Second mortgage payments may not qualify as housing expenses.

III. Business and Professional Expenses
1. What requirements must be met by a minister before deducting ministry related travel expenses?
2.
How does a minister treat trips that are partially personal or involve foreign travel?
3. How are the travel expenses of a spouse treated?
4. When may a minister use the standard mileage rate to deduct auto expenses?
5. When is the standard mileage rate not applicable?
6. Commuting mileage is nondeductible but trips between work locations may be deducted.
7. May minister’s deduct their personal meal when entertaining?
8. What are the limitations on deducting expenses for business gifts?
9. How does a minister deduct subscriptions and books?
10. Take an immediate write-off on business equipment.
11. Is a minister’s clothing ever deductible?
12. How to deduct your expressions of sympathy.
13. How does a minister compute auto expenses under the actual expense method?
14. What are the requirements for documenting business expenses?
15. Deduct more of your unreimbursed business expenses.

I. The Tax System for Ministers

1. Special Tax provisions only apply to “ministry services.”

There are four special tax provisions available to ministers: (1) exclusion I (for income tax purposes) of the housing allowance and the fair rental value of a church-owned parsonage provided to clergy rent free, (2) exemption of some clergy from social security coverage,(3) treatment of clergy (who do no elect exemption) as self-employed for social security tax purposes with respect to ministerial services, and (4) exemption of clergy wages from mandatory income tax withholding.

These four special tax provisions relate only to “services performed in the exercise of ministry” The definition of ministry may vary by church or denomination. Ministers generally qualify for the tax provisions if they are employed by a religious organization that is under the authority of a church or denomination. The position must relate to directing, managing, or promoting the activities of the organization.

If a minister is employed or self-employed in a secular job, i.e., working

at bank, selling insurance, etc., the swpecialmini9sterial tax provisions do not apply. Non-ministerial wages are subject to federal income tax and social security (FICA) withholding.

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2. Do not withhold FICA tax from a minister’s salary!

Federal Insurance Contributions Act (FICA) tax should never be withheld from the compensation of a qualified minister for services performed in the exercise of ministry matched by the church or other nonprofit organization, and remitted to the I

IRS. Ministers engaged in the exercise of ministry are always treated as self-employed for social security purposes. This is true whether you are an employee of your church or a self-employed person.

Ministers pay social security under the Self-Employment Contributions Act (SECA) instead of under FICA. It is possible to become exempt from SECA if your meet strict exemption requirements.

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3. Are you an employee or self-employed for income tax purposes?

If you are serving local church, you may either be an employee or self-employed for income tax purposes. For many years, most ministers reported their income taxes as self-employed persons. This was consistent with the treatment of ministers as self-employed for social security purposes.

The IRS now uses the common law employee test to decide whether a minister is an employee or self-employed for income tax purposes. Generally you are an employee if your employer has the legal right to control both what you do and how you do it, even if you have considerable discretion and freedom of action.

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4. May a minister be both an employee and self-employed for ministerial income?

Almost every minister who is an employee of a church, for income tax purpose, may also be self-employed. Fees for baptisms, marriages, and funerals represent self-employment income even if a minister is an employee with respect to ministerial income from a church. In this instance, salary income is reported on page one of the Form 1040 and fee income is shown on Schedule C.

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5. What forms should the church provide to report ministerial compensation?

Churches must provide a W-2 to ministers reporting as employees (which should be the vast majority) and provide a Form 1099-Misc to ministers reporting as self-employed (which should be very few) for income tax purposes. Yet the minister may take an exception to the reporting of the church. For example, if the church gives the minister Form 1099-Misc or provides no Form 1099 Misc or W-2, the minister may report as an employee on Page 1, Form 1040 and attach a statement to explain why the church did not provide a W-2.

A better approach is for the minister to advise the church of his income tax reporting plans and ask the church to make the appropriate filings with the IRS.

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II. The Housing Allowance

1. How is the housing allowance reported by the church to the minister?

The housing allowance is not reportable by a church for income tax purposes on any IRS forms. The church should provide the minister with the housing allowance data in a letter or memo. There is no need to attach the statement to your income tax returns.

The inclusion of the housing allowance on Form W-2 or 1099-Misc and on Form 1040, page one, or Schedule C frequently is confusing to IRS examiners. IRS personnel are often not conversant with the special housing allowance provisions for ministers. You should ultimately have the housing allowance exclusion upheld. But the simple process of omitting the housing allowance from Form W-2 or 1099-Misc may save you a meeting with the IRS or shorten an audit.

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2. Does a housing allowance provide any benefit for a minister living in church provided housing?

Even a minister living in church provided housing should have a portion of salary designated as a housing allowance. In this situation, the allowance may be a modest amount to cover incidental expenses such as maintenance, furnishings and utilities. For the minister without a housing allowance, every dollar of compensation is taxable for federal income tax purposes.

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3. Who is responsible to establish the fair rental value of church provided housing?

The determination of the fair rental value is totally the responsibility of the minister. The church is not responsible to set the value. The fair rental value should be based on comparable rental values of other similar residences in the immediate neighborhood or community.

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4. Must the housing allowance designation be in writing?

The housing allowance should be evidenced in writing, preferably by board resolution, in an employment contract, or, at a minimum, in the church budget and payroll records. If the only reference to the housing allowance is in the church budget, the budget should be formally approved by the official board of the church.

Tax law does not specifically say an oral designation of the housing allowance is unacceptable. Still, the use of a written designation is preferable and highly recommended. The lack of a written designation significantly weakens the defense for the housing exclusion upon audit.

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5. When must the housing allowance designation be made?

The housing allowance must be officially designated before payment by the church. The allowance may be prospectively amended at any time.

It is improper and ineffective for a church to amend the housing designation mid-year in an attempt to compensate for an allowance that was too low for the first part of the year.

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6. May the total of the designated housing allowance be excluded for income tax purposes?

The housing allowance exclusion is limited to the lowest of (1) reasonable compensation, (2) the fair rental value of the home furnished plus utilities, (3) the amount used to provide a home from current ministerial income, or (4) the amount properly designated. When a minister lives in rented housing, there is no need to apply the fair rental value test.

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7. Is there a maximum amount that may be set as the housing allowance?

The IRS does not place a limit on how much of a minister’s compensation may be designated as a housing allowance by the employing body. In other words, as much as 100% of the compensation may be designated. But practical and reasonable limits usually apply.

For a minister owned home, the lower of actual expenses or the fair rental value, including utilities, will usually be the limiting factor. For a minister renting a home, the actual expenses will typically be the limit. However, it is usually better to over designate than to under designate.

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8. How many ministers serving one church may receive housing allowances?

There is no limit on how many ministers may receive a housing allowance by one church. If there are multiple pastors on a church staff, the church may designate housing allowances for each of them.

The dollar amount should vary depending on the estimated housing expenses of the respective minister. A lump sum housing allowance covering multiple ministers of one church, without any designation of the amount relating to specific individuals, is not an appropriate designation.

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9. May the housing allowance be established as a percentage of salary?

Some churches set the housing allowance by applying a percentage to the total cash salary. Housing allowance percentages are often in a range of 40% to 60% of the total cash salary. Setting the housing designation based on an estimate of housing expenses for each minister is highly preferable over the percentage method.

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10. May the minister’s housing allowance be adopted at the denominational level?

If the local congregation employs and pays you, a resolution by a national, or area office of your denomination does not constitute a housing allowance designation for you. The local congregation must officially designate the part of your salary that is a housing allowance. But a resolution of your denomination can designate your housing allowance if you are employed and paid by national or area office.

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11. Does the minister or the church determine the amount of housing expenses to exclude from income on the minister’s return?

The church designates the housing allowance but the responsibility for determining the portion of the housing designation that can be excluded from income rests solely with the minister. Ministers often submit a prospective estimate of housing expenses to help the church establish a proper allowance. But the minister is not required to provide after-the-fact documentation to the church of housing expenses incurred.

There will usually be a difference between the housing allowance and actual housing expenses. There is no requirement for a church to issue a corrected Form W-2 or 1099-Misc to adjust compensation to agree with actual housing expenses since they are not required to be reported on either document.

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12. What happens when actual housing expenses exceed the fair rental value of the residence?

Actual housing expenses that exceed the fair rental value limitation are not deductible. There are no provisions to carry over “unused” housing expenses.

When housing expenses exceed the fair rental value, spreading some housing costs over two or more years may save some deductions. This approach reduces your taxable income by maximizing your exclusion.

The above is the current IRS interpretation which has been challenged in court. The IRS has lost the initial court decision and we are currently waiting to see if it is appealed.

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13. How is the housing allowance paid to the minister?

It is immaterial whether the payment of a properly designated cash housing allowance is a separate payment or is part of a payment that also includes other compensation. A cash housing allowance usually is included with the minister’s salary check.

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14. Second mortgage payments may not qualify as housing expenses.

Many ministers have claimed excludable housing expenses based on home equity line of credit payments or payments on a conventional loan secured y a mortgage on an otherwise debt-free home. This practice is not brought into question by an IRS ruling.

This ruling appears to relate only to mortgage payments (principal and interest) on the two specified types of loans. If loan proceeds are used for home furnishings, home repairs or other qualified housing expenses, the expenses may be excluded under a properly designated housing allowance. The tax year in which the housing expenses are excludable is based on when the housing expenses are made not when the loan payments are made.

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III. Business and Professional Expenses

1. What requirements must be met by a minister before deducting ministry related travel expenses?

You can deduct 100% of transportation expenses plus 50% of the meal and entertainment expenses you incurred while you were away, provided you meet a few guidelines:

o The trip must have a business purpose.
o The expenses cannot be :lavish and extravagant.”
o You must be away from home long enough to require sleep or rest.

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2. How does a minister treat trips that are partially personal or involve foreign travel?

Deriving some personal pleasure from a trip doesn’t disqualify it from being deductible. The IRS does, however, apply some important twists to the tax treatment of foreign travel expenses.

If you’re traveling within the United States, you can deduct all transportation costs, plus the costs of business related meals (subject to the 50% limit) and lodging, if business was the primary reason for the trip. If the trip is primarily personal, none of your transportation costs can be deducted, but you can deduct other business related travel expenses. If you are traveling outside the United States, expenses are subject to a strict set of rules depending on whether the trip is entirely business, primarily business, or primarily personal.

If you are reimbursed for travel expenses and adequately account to the church, you should not report your travel expenses on Form 2106 or Schedule C. Further, you are not subject to the 50% limitation for business meals and entertainment.

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3. How are the travel expenses of a spouse treated?

If your spouse accompanies you on your business trip, the spouse’s travel expenses are not deductible unless his or her presence serves a bona fide business purpose. The duties and responsibilities of the spouse should be clearly identified by the organization with accountability required. When the spouse’s expenses are not deductible, you may deduct the single room rate instead of one-half the double room rate for purposes of allocating lodging expense

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4. When may a minister use the standard mileage rate to deduct auto expenses?

If your employer pays you a fixed mileage allowance of 34.5 cents (36.5 cents in 2002) per mile or less and your provide your employer with the time, place, and business purpose of your driving, you have made an adequate accounting of your automobile expenses.

If your employer does not reimburse you for auto expenses or reimburses you under a nonaccountable plan, you may deduct business miles on Form 2106. The totals from Form 2106 are carried to Schedule A, Miscellaneous Deductions, subject to the 2% AGI limitation. If you are self-employed for income tax purposes, report these expenses on Schedule C.

The mileage rate is based on the government’s estimate of the average cost of operating an automobile. Depending upon the age and cost of the car, the mileage rate may be more or less than your actual auto expense.

For 2001, the standard mileage rate, which includes depreciation and maintenance costs, is 34.5 cents per mile. If you use the mileage rate, you also may deduct parking fees and tolls and the business portion of personal property tax (and the business portion of interest if filing as self-employed for income tax purposes).

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5. When is the standard mileage rate not applicable?

You may not use the mileage rate if:

o you have claimed depreciation under MACRS, ACRS, or another accelerated method.
o you have claimed first year expenses under Section 179
o you have used two or more cars simultaneously in business, for example, operating a fleet of vehicles.

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6. Commuting mileage is nondeductible but trips between work locations may be deducted.

Personal mileage is never deductible. Commuting expenses are nondeductible personal expenses. commuting is “getting ready” to do business.

Your expenses of traveling between your home and a regular business location in the area of your tax home are nondeductible, regardless of the distance. But the cost of traveling between your home and a temporary work location may be deductible.

Once you arrive at the first work location, temporary or regular, you may deduct trips between work locations. A regular place of business is any location at which the minister works or performs services on a regular basis. A temporary place of business is any location at which the minister performs services on an irregular or short-term (i.e., generally a matter of days or weeks) basis.

A minister is considered as performing services at a particular location on a regular basis whether the minister performs services at that location every week or on a set schedule. Thus, daily transportation expenses incurred by a minister in going between a church-sponsored school and the minister’s office at the church or between the minister’s home and a temporary work location such as a hospital to call on a church member are deductible business expenses.

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7. May minister’s deduct their personal meal when entertaining?

Personal expenses are not deductible since you would be eating anyway. Granted, you might not be spending $10 for your lunch, but you would be eating. In theory, only the amount over what you normally spend for breakfast, lunch, or dinner is deductible. But the IRS has decided not to enforce this part of the tax law. Unless a taxpayer is deducting outrageous amounts of personal expenses, 50% of the cost of the taxpayer’s own meals while entertaining will be allowed (100% under an accountable expense reimbursement plan).

Certain entertainment expenses incurred in your home may be deductible if you can show a ministry relationship.

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8. What are the limitations on deducting expenses for business gifts?

You can write off up to $25 per done for business gifts to any number of individuals every year. Incidental costs, such as for engraving, gift wrapping, insurance and mailing do not need to be included in determining whether the $25 limit has been exceeded.

The gifts must be related to your ministry. Gifts to church staff or board members would generally be deductible. If gifts (of $25 or more) are made by the church to staff members, they must be reported as compensation on Form W-2 or 1099-Misc.

The tax law does not prevent you from spending as much as you prefer for a gift for oneindividual. The law simply disallows expenses over $25.

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9. How does a minister deduct subscriptions and books?

Subscriptions to ministry-related periodicals are deductible. If you can show that the information in a periodical relates to ministerial preparation, news magazines may qualify for a deduction.

Books related to the ministry with a useful life of one year or less may be deducted. The cost of books (such as commentaries) with a useful life of more than one year may be depreciated over the useful life. There is an option to deduct the books in the year of purchase under Section 179 if the cost is less than $24,000

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10. Take an immediate write-off on business equipment

Some ministers become so involved in setting up depreciation schedules for newly acquired business and professional assets that they forget a valuable tax benefit---the immediate write-off.

Suppose, for example, that you buy $11,000 of computer equipment this year and it is classified as five-year property. Using the modified accelerated cost recovery system, you could then deduct a modest amount each year for five years.

Far better, you can deduct up to $24,000 of the cost of the equipment in the first year. This write-off is linked to your business income: you can’t deduct more than you make. The write-off is also subject to the luxury auto limits. Section 179 generally has limited use for automobiles because of the luxury limits.

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11. Is a minister’s clothing ever deductible?

The cost of clothing is deductible if the church requires the clothes and they are not suitable as normal wearing apparel. A regular suit won into the pulpit on Sunday is not deductible but vestments would be deductible.

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12. How to deduct your expressions of sympathy.

Flowers and other sympathy gifts are deductible only if there is a business connection. However, you can always deduct a charitable contribution given in memory of a deceased person, whether there is a business tie-in or not.

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13. How does a minister compute auto expenses under the actual expense method?

Under the actual expense method, you can use either accelerated depreciation or straight line depreciation. As the names imply, the accelerated method front loads your depreciation, giving you larger deductions sooner. The straight line method gives you the same depreciation deduction every year.

With either method, you calculate your depreciation deduction just as your would for any other asset used for business purposes. Your “depreciable basis” is the purchase price of the car multiplied by the percentage it is used for business purposes.

Allowable expenses under the actual expense method include:

- gas and oil interest on auto loans
- repairs lease payments
- tires automobile club membership
- batteries car washes and waxes
- insurance supplies, such as antifreeze
- license plates parking fees and tolls.

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14. What are the requirements for documenting business expenses?

For expenses to be allowed as deductions, you must show that you spent the money and that you spent it for a legitimate business reason.

To prove that you spent the money, you generally need to provide documentary evidence that can be corroborated by a third party. Canceled checks or credit card slips are excellent evidence. To the IRS, third-party verification is important; if you pay business expenses in cash, be sure to get a receipt.

Documenting a business expense can be time-consuming. The IRS is satisfied if you note the following information on the back of your credit card slip, or other receipt:

o business purpose
o business relationship (including names of persons present)
o cost (itemized accounting)
o time and place.

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15. Deduct more of your unreimbursed business expenses.

Unless you take the smart way out, your unreimbursed business and professional expenses can cost you a lot these days. That’s because they’re lumped under miscellaneous itemized expenses. As a result, you can only deduct costs that exceed 2% of your adjusted gross income (AGI).

If you have AGI of $50,000, you’d have to rack up a total of $1,000 in miscellaneous expenses for such things as mileage, continuing education and library expenses before you could deduct a single dollar. And you couldn’t deduct that $1,000 at all. Further, if you have unreimbursed entertainment expense, you can’t even use all of them to boost the total. That’s because you can only deduct 50% of such expenses.

The best way to keep from having to eat those business-related expenses is to convince your employer to reimburse you. Many churches are reluctant to reimburse all business expenses unless there is a ceiling on the reimbursements.

For example, your business and professional expenses normally cost you about $5,000 per year and they are not presently reimbursed. Ask your church to reduce your salary by the amount and reimburse you for your costs u to that level. This way you avoid the AGI “floor” and also cut your tax bill because your AGI is smaller. If your actual expenses are less than the $5,000 limit, the church should not pay you the difference unless you are willing to convert the business expenses reimbursed from an accountable plan to a nonaccountable plan.

You will have to regularly turn over to your employer the logs and records, you now keep for your car and other expenses, so that the church as the expense documentation in their files.

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