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Frequently Asked Questions
by the Rev. Ralph Mero
What is the correct income tax status for ministers?
In the U.S., ordained, licensed or commissioned clergy have dual tax status; the IRS considers them to be employees for purposes of income tax, and to be self-employed persons for purposes of social security. The important consequence of this is that ordained clergy pay the full 15.3 percent self-employment tax (SECA) for social security. Non-ordained employees are subject to FICA and have 7.65 percent withheld from their wages and 7.65 percent paid by the employer.
How should clergy taxes be paid?
Most ministers pay their own taxes quarterly using form 1040ES, however, they have the option of having funds withheld from their cash salary to cover both income tax and SECA with these funds then paid to the IRS by their employer-congregations. There does not reduce the amount of taxes finally paid, but the latter option avoids the quarterly paperwork. Many taxpayers owe some income taxes on April 15th, but this should not exceed 10 percent of the total amount due.
Isn't 15.3 percent for social security a lot to ask from modestly paid ministers?
Absolutely, that's why the Unitarian Universalist Association (UUA) and many other Protestant denominations encourage employer congregations to pay ministers half of that amount “in lieu of employer's FICA” in addition to their cash salary and housing allowance. This additional amount, however, is itself reportable as taxable wages.
Why not opt out of social security?
Only clergy whose denominations are conscientiously opposed to all forms of social insurance can opt out of the social security program in the U.S. The UUA is not on record as opposed to all forms of social insurance, and applications by ministers to opt out are not endorsed by the UUA.
But isn't social security in financial trouble?
Trust funds in the social security system in the U.S. are juicy targets for many financial investment firms who would like to take over that money, and collect the fees for managing it. See “The Trillion Dollar Hustle,” in the January 2002 issue of Harper's Magazine, for more on this. It may be necessary to make minor adjustments in the social security system in future decades, but it is hard to imagine the U.S. government defaulting on this successful social insurance program.
Social security benefits are also paid to millions of disabled as well as retired persons. More than any other government program, social security has lifted millions out of the poverty experienced by earlier generations of elderly people.
What about tax advantages for ministers?
The biggest is the clergy housing allowance (CHA), which permits all the annual expenses of running a home to be paid out of dollars that have not been reduced by income taxes. The minister should inform the church governing board each year how much is anticipated in housing costs, and the board should pass a motion identifying this amount as the CHA to be paid in monthly installments in a check separate from the cash salary. Like other taxpayers, ministers may itemize mortgage interest as a deduction on their 1040 tax return.
Also like other employees, ministers may have their health and life insurance premiums paid by the employer from tax-free dollars, and they can also have a professional expense allowance for business expenses. Neither of these is reportable as taxable earnings.
Is this available for community ministers as well?
Chaplains, pastoral therapists, and other clergy working in non-parish employment may also have part of their compensation designated for the CHA. If one's work qualifies as a ministry, the CHA is a legitimate manner of treating income allocated to housing costs. Self-employed community ministers can also participate in the Unitarian Universalist (UU) retirement plan.
Is the CHA reduced where there are two wage earners in the household?
The full amount of the costs of maintaining the residence (rent, mortgage, property taxes, utilities, repairs, and furnishings, almost everything except food) can be considered as expenses of the minister, and thus included in the CHA. Some clergy receive virtually all of their compensation from the church as the CHA. Other earnings by the minister, or by the spouse or partner are used for the other expenses of daily living.
What about where my health insurance is provided under a plan sponsored by my spouse's employer?
If insurance premiums to cover the minister are withheld from the spouse's wages, those dollars can be reimbursed to the minister by the church. In essence, the minister's spouse has advanced funds that would ordinarily be paid by the minister's employer-congregation, and the church is simply repaying those dollars. These would come from the line item for minister's insurance in the church budget.
What is an independent contractor?
An independent contractor is a self-employed person who operates a business through which he or she offers services to other persons or businesses. Many physicians, dentists, attorneys, and accountants are independent contractors. The IRS has several tests for who is an independent contractor and who is an employee, and in almost all instances, ministers and other church staff are found to be employees.
Some churches and other employers have deemed their staff independent contractors in order to avoid the 7.65 percent of wages the employer must pay toward an employee's FICA. (Ministers pay their own SECA as noted above.) This is a misclassification of employee status, and the IRS can fine the employer as well as make them responsible for any back taxes due.
How should earnings be reported to the IRS?
Some earnings are reportable for tax purposes, and some are not. In the case of non-ordained staff, all salaried or hourly earnings are reported as wages in box #1 on the W-2 form. Income taxes withheld are reported in box #2. In the case of ordained clergy, the cash salary is reported in box #1, and income taxes withheld at the minister's option are reported in box #2. If no income tax or social security taxes have been withheld, then the word “minister” can be written in box #2; the IRS will expect that those amounts have paid quarterly by the minister. If an employee is enrolled in a qualified retirement plan or receives a CHA, a check mark may be placed in box #13 of the W-2 form.
When should a form 1099 be used?
Wages paid to a person who is not a regular employee are reported to the IRS on form 1099 if they exceed $600 in any calendar year. Hourly amounts paid to babysitters and for other casual labor do not have to be reported if the total is less than $600. Persons who are not regular employees do not usually receive paid benefits such as health insurance, vacations, etc.
Is it true that church owned parsonages are coming back?
The recent run up in real estate prices is making it impossible for some clergy in many denominations to afford single family homes in the communities where their congregations are located. This means that churches in high-income areas will be able to call as ministers only persons who are already well off financially or who have partners with adequate incomes. Some congregations are going back to buying a parsonage for the minister to live in; others are offering loans or equity sharing arrangements whereby the minister can purchase a house of his or her own. These generally assume that endowment funds can be tapped for this purpose.
It is precarious for any taxpayer to commit to a more expensive house than he or she can really afford, and some ministers fall into major difficulties when an expensive home leaves little else to live on. On the other hand, increases in home equity have made it possible for many persons to enjoy a comfortable retirement. It is likely that affordable housing will become a major problem for thousands of U.S. congregations and their parent denominations in the years ahead.
How much should I save for retirement?
Save as much as you can. Start as soon as you can. Millions of Americans are woefully under-funding their savings for retirement, and there are likely to be catastrophic economic and political consequences as a result. Post WWII generations have grown up in an advertising-dominated culture that has taught us “you deserve it” and “you can always borrow now and repay it later.” We must expect that many of our fellow citizens will be sorely disappointed during their senior years if they have not saved through investments.
The UUA trustees and GA delegates recommend that 14 percent of earnings should be deposited by our congregations in the UU retirement accounts of ministers and other staff. This is actually a sensible percentage for anyone who wants a decent income over and above social security during his or her later years and who does not have inherited assets to rely on.
The UU retirement plan permits additional voluntary contributions by participants where the employer-congregation is already contributing 10 percent. The U.S. tax law that took effect on January 1, 2002 permits annual retirement savings of up to $14,000 by employees ($18,000 if age 50 and older) for 2005, and $15,000 and $20,000 respectively for 2006, and up to 100 percent of the employee's wages in a combination of employer and employee contributions.
Wage earners who are not enrolled in an employer-sponsored retirement plan can now save up to $3,000 per year in a regular IRA ($3,500 if age 50 and older), and these contributions are deductible from taxable income. Persons who are enrolled in a retirement plan can use the Roth IRA for annual contributions of the same amounts, and though these contributions do not reduce their taxable earnings, the distributions are exempt from income tax when withdrawn after retirement.
How can I simplify my retirement savings plans?
As of January 1, 2002, persons enrolled in the UU plan who have IRA rollover accounts or 403(b) accounts from previous employment may have those assets transferred into their accounts in the plan sponsored by the UUA. And, if those additional dollars were funded based on earnings from ministry, they become eligible for the special advantageous tax treatment as a retired clergy housing allowance, thus eventually reducing their income taxes.
Also, it is often possible to reduce IRA management fees by combining accounts held by several firms into one account with a low cost mutual fund company such as Vanguard.
I feel like I don't understand finances. What should my priorities be?
First, reduce debt by any means possible; payoff all credit cards, then student loans. This generally means reducing all discretionary expenses to the absolute minimum and/or obtaining additional income. It is not enough to balance expenses and income; expenses must be reduced so that they are less than income.
Second, build up an emergency reserve in a money market fund that will cover three to six months of living expenses, plus money for travel to job interviews.
Third, make a financial plan for the long-term. Honestly examine your future income needs and make a complete list of all your assets and liabilities. Review these every April when your tax returns are filed. Consider the compensation you could realistically expect if you continue in or change professions. Imagine what you could do if a change in your health or family situation suddenly imposed new challenges or opened up new possibilities.
Fourth, everybody needs a last will and testament. Plus a durable power of attorney, plus a living will or health care proxy. Avoiding these may impose a painful situation on loved ones and beneficiaries.
Lastly, we have to start talking about each other about money. Uncertainty often leads to fear which leads to denial which leads to isolation and depression. There may be no quick solutions to personal financial difficulties, but being honest about where we are and what we value can lead us into open dialogue and supportive comradeship.
We also have many new opportunities and ways to learn. Is this hard? Sure, but as religious people, we do hard quite well. Hard is what we do.