~~Tips for Helping Ministers Minimize their Tax Liability
April 15. Just the mention of that day sends a shiver down the spine of many, and rightly so. No one likes paying taxes. Yet, what if April 15 arrived, and you had to pay unnecessary taxes? You would definitely not be happy, and you would make sure that the next year you did everything in your power to reduce your tax liability.
While no one wants to pay taxes they could have avoided (not evaded – that’s a different topic altogether), many ministers wind up paying unnecessary taxes every year. There are many reasons for this, but the main one is that far too few church members understand the uniqueness of a minister’s tax status. For example, did you know that:
• Ministers have a dual tax status. For income tax purposes, a minister who works on a church’s staff is considered an employee by the IRS. However, the Social Security Administration views ministers as self-employed.
• Since ministers are self-employed for Social Security purposes, they must pay the full 15.3% Social Security and Medicare tax on all of their income, including their housing allowance.
• Churches who give a lump sum amount to a new minister subject all of his or her income to income tax and self-employment tax.
• Churches with a compensation plan help their ministry staff to avoid paying unnecessary taxes.
Here are some tips churches can use to minimize their ministers’ tax liability by taking advantage of a minister’s unique tax status:
• Avoid giving a lump sum package to new ministerial employees. If an employee has control over how his “package” is distributed, then no matter what your church budget says, the IRS views the entire package as salary. This means that the minister will have to pay both income tax and self-employment tax on every dollar the church provides in his or her package.
• Develop a compensation plan that has three main divisions: reimbursed expenses, benefits, and taxable income.
o Provide money in the church’s budget to reimburse the minister for money he or she spends doing his or her job. This is called an accountable reimbursement plan or an expense account. If done in an accountable fashion, the minister does not have to spend his or her own money to do the job they were hired to do, and none of the reimbursements are considered taxable income. There are five major types of business related expenses that may be reimbursed: 1. The cost of operating a personal vehicle for church-related business. 2. Meetings, workshops, or conferences and all expenses associated with them. 3. Materials purchased to enhance ministry, such as commentaries, magazines, software, or videos. 4. Continuing education that enhances job-related skills and does not prepare the employee for another career path. 5. Providing hospitality in the course of ministry.
o Provide benefits to your ministers. Most employer-provided insurances are considered non-taxable by the IRS. While health care reform is making it more difficult for small employers to provide health insurance on a tax-free basis, it is not impossible, and doing so lets your church’s employees know how much you value them. Likewise, providing an employer sponsored retirement plan gives your staff a way to make pre-tax investments, thus reducing their tax liability.
o Utilize the Housing Allowance exclusion. The IRS allows churches to designate a portion of their ministers’ salary as a housing allowance. The housing allowance is considered an exclusion from income in the eyes of the IRS. Therefore, while it is still subject to self-employment taxes, it is not subject to income taxes as long as the minister uses the money to provide, maintain, or improve his or her home.
o Consider providing a Social Security offset. Since ministers are considered self-employed for Social Security and Medicare, some churches choose to provide additional income to help offset the half of Social Security and Medicare taxes that employers must contribute for non-minister employees. The minister should understand from the beginning that if a Social Security offset is given, it is completely taxable income and should be treated like salary or a bonus for tax purposes.
Churches who plan a compensation structure for their employees, especially their ministerial employees, provide an immeasurable service to their ministry staff. A compensation structure helps the church provide structure and protection for the ministers and their families as well as the church itself. It lets the employees know that they are loved by the people they have been called to serve, and it effectively minimizes a minister’s tax liability. Because, let’s face it, who wants to pay unnecessary taxes?