Minister Tax - Things To Know
THINGS TO KNOW - There are 3 federal payroll taxes that come into play for all organizations (for profit and not for profit): 1) Federal Income Tax (FIT), 2) Social Security Tax, and 3) Medicare Tax.
Social Security and Medicare Tax are commonly combined in a term known as FICA (Federal Insurance Contributions Act) and is a flat tax of 15.3% of wages. For everyone except ministers, the IRS assesses 1/2 of the tax directly on employees and 1/2 on the employer. This tax is easy to pay over to the feds since it is a flat percentage and is calculated at the time of each payroll processing and most payroll systems simply route the funds electronically to the IRS.
This is NOT the case for ministers; however. The IRS has defined ministers as "self-employed" ONLY for the purpose of settling Social Security and Medicare taxes! As such, ministers participate in SECA (Self Employment Contributions Act) rather than FICA. Because of this, the church CANNOT assess and pay SS and Medicare taxes on behalf of ministers. If a church does (and they mistakenly do), then they are violating both FICA and SECA and the minister will run into problems when they apply for SS and Medicare benefits later in life. On a side note - the minister doesn't necessarily lose out on benefits if they paid into FICA over the years, it's just that the Social Security Administration will have trouble calculating their benefit. The risk is that they under-calculate - not to mention the headache the retired minister will deal with sorting it out.
MINISTER TAX - Since the church isn't allowed to assess, collect and remit SECA taxes as mentioned above, the responsibility rests solely on the minister to settle the tax directly with the IRS. This is accomplished when the minister files the annual 1040 tax return by completing Schedule SE. This schedule simply takes the ministers wages AND housing allowance and multiplies the amount by 15.3%. The SECA tax that is calculated then gets added to the Federal Income Tax liability on the 1040 and the minister weeps (and runs to the HR and Payroll folks for answers). Another side note - a minister can elect out of SECA altogether. If they do, they don't have to pay the 15.3% BUT they will NOT qualify for any SS and Med benefits on their exempt earnings so they better plan accordingly. They have to apply and be approved by the IRS before they can claim the exemption. Many new ministers conflate the practice of the church not paying into FICA on behalf of the minister as them being "Exempt". In fact, it is the CHURCH that is "Exempt" from paying into FICA. The minister can also become "Exempt" by way of SECA, but they have to apply as noted above.
HOW TO MOVE FORWARD - Churches should pay ministers a SECA allowance (8% of wages and housing) to align them economically with every other non-ministerial position. The minister can avoid a huge tax debt due April 15th every year by electing "Extra Withholding" (box 4c) on the W4. This way, the church is authorized to withhold extra FIT taxes (not to be confused with FICA or SECA) and pay over to the IRS each pay period. These FIT withholdings can be applied to the total tax liability when the minister does their tax return. How much should the minister elect? The answer will be different for each minister and is based on the minister's other forms of income, family size, etc. I suggest that the minister elects the SECA Allowance amount (8%) at a minimum. This works when they have several kids (i.e. child tax credits) and claim a housing allowance (since the housing allowance isn't assessed FIT tax). But if the spouse works, this may not be sufficient. If this is the case, the minister will need to make further additional withholdings or start making quarterly estimated tax payments.
FREE TAX ADVICE - Here is some free advice to pass along - ministers that don't have a lot of income variability year-over-year can estimate their tax debt simply by looking at last year's tax return. They can see what the prior year's tax liability was and set up extra withholdings via the W4 to make sure at least that amount is paid in. Sure, they may have to also pull their wife's most recent pay stub to see what her FIT withholdings are and do a little math, but it is a simple exercise. If the minister has rental properties and other investments, they need to hire a tax pro and chalk it up as a cost of doing business.
