Photo by Coast-to-Coast/iStock
The tax treatment of ministers and churches has been in the news in recent years. Much of the media attention has resulted from lawsuits filed by the Freedom From Religion Foundation. The organization has challenged the constitutionality of the tax-free housing allowance for ministers and electioneering activities of ministers in their official capacities.
Ministers work for churches or other religious organizations, which are usually tax-exempt organizations under Sec. 501(c)(3). This tax-exempt status allows contributions of cash or property to the church to be tax-deductible under Sec. 170.
Unlike in the case of other organizations that wish to be tax exempt, Sec. 508(c)(1)(A) provides that churches, integrated auxiliaries of churches, and conventions or associations of churches do not have to apply for tax-exempt status using Form 1023, Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code. A church's tax-exempt status is automatic as long as it operates exclusively for purposes specified in Sec. 501(c)(3), which include religious, charitable, and educational purposes.Prohibitions Against Private Inurement and Electioneering
Sec. 501(c)(3) prohibits any individual from receiving any private inurement from a church or other tax-exempt charity. Thus, a minister may receive payments from a church only for reasonable compensation for services rendered and reimbursements for expenses incurred on behalf of the church.
Sec. 501(c)(3) also prohibits the church from having as a substantial part of its activities the carrying on of propaganda or attempting to influence legislation. Sec. 501(c)(3) also prohibits the church from participating in any campaign for any candidate for public office or opposing such a candidate.
Some ministers believe the prohibitions on attempting to influence legislation and supporting or opposing candidates for public office are unconstitutional infringements on their rights of free speech and free exercise of religion under the First Amendment. Such ministers believe it is their duty to support candidates whose views are congruent with their religious views and oppose candidates whose views conflict with their religious views.
An organization called Alliance Defending Freedom has organized an annual event called "Pulpit Freedom Sunday," on which ministers are invited to preach a sermon "addressing" an upcoming election, including, if they wish, applying "Scripture to the stated positions of candidates." The organization states this could cause the IRS to impose an excise tax or challenge a church's tax-exempt status under Sec. 501(c)(3). Then the church could challenge the IRS in court on the constitutionality of the prohibitions on participating in elections. 1
Although the Alliance reports that the IRS "has not responded" to the tactic, engaging in such a protest activity could place the tax-exempt status of the church at risk. If a church loses its tax-exempt status, contributions to the church would no longer be tax-deductible.
In Freedom From Religion Foundation, 2 the plaintiff organization wanted the court to enjoin the IRS from failing to enforce the prohibitions in Sec. 501(c)(3) regarding supporting or opposing candidates for public office and to require the appointment of a high-level official in the IRS to enforce these provisions. The parties reached an agreement and made a joint motion to dismiss the case without prejudice, which the district court granted on July 29, 2014. The agreement requires the IRS to monitor churches for electioneering activities. However, the IRS may conduct inquiries into a church's tax-exempt status only as allowed by Sec. 7611 and Internal Revenue Manual (IRM) Section 4.76.7 (8/20/10).Other Tax Considerations Unique to Ministers
In addition to complying with the requirements of Sec. 501(c)(3), ministers have other tax considerations unique to them. These include the tax-free housing allowance, also known as the "parsonage" allowance, and exemption from income tax withholding. This article explains the requirements to be a bona fide "minister of the gospel" to qualify for the tax-free housing allowance and then discusses the exclusion for the housing allowance in depth, including its effects on the deductions for mortgage interest, real estate taxes, and business expenses. The discussion reviews some recent court decisions concerning the tax-free housing allowance.
This article also discusses how ministers are generally employees for income tax purposes but pay self-employment tax rather than having taxes withheld. The article examines whether offerings a minister receives directly from members of the congregation on special occasions are tax-free gifts or taxable compensation. It then concludes with some tax planning tips for ministers.Who Is a Minister?
For purposes of the exclusion for the housing allowance, a minister is an individual who performs ministerial services such as sacerdotal functions, conducting religious worship, and/or controlling or maintaining a religious organization as a function of a church that exists to carry out the religious beliefs of a particular faith. 3 In addition, the governing authority of the particular faith must have licensed, commissioned, or ordained the individual according to the requirements of the particular faith. The terms "minister" and "of the gospel" are not specific to any particular religion. Instead, the courts and IRS use them broadly to encompass the leader of worship in any religion.
In Salkov, 4 the Tax Court defined a minister as "one who is authorized to administer the sacraments, preach, and conduct services of worship." The court held that Congress intended for the exclusion for the housing allowance to apply to both Christian ministers and individuals who are the equivalent of Christian ministers in other religions.Exclusion for Housing Provided by a Church
A minister may exclude from gross income the rental value of a home a church provides in kind or a cash housing allowance received from the church. 5 To qualify for the exclusion, the minister must receive the use of the house or cash housing allowance as a part of the minister's compensation. A minister may exclude a cash housing allowance only to the extent the minister uses it to rent or provide a home. Another limit on the exclusion for the housing allowance is the sum of the fair rental value of the home, furniture, and appurtenances such as a garage, plus the cost of utilities. 6
Two or More Homes
If a minister has two homes and receives a housing allowance for each home, may the minister exclude the housing allowance received for both homes? In Driscoll, 7 the Tax Court said yes. On appeal, the Eleventh Circuit reversed this decision. Driscoll petitioned the Supreme Court to hear the case, but it refused to do so. 8
The Tax Court follows the Golsen 9 rule, under which, if a similar case would have appeal rights to the Eleventh Circuit, the Tax Court would follow the decision of the Eleventh Circuit. Thus, if a minister lives under the jurisdiction of the Eleventh Circuit (Alabama, Georgia, and Florida), the minister may exclude a housing allowance for one home only. If a minister lives in a different circuit, the minister could file a petition in the Tax Court if the IRS denied the exclusion for two or more homes. Whether the Tax Court will follow its own precedent in future cases for which the right of appeal is to a different circuit or follow the decision of the Eleventh Circuit in all circuits remains to be seen.
Is the Tax-Free Housing Allowance Constitutional?
Is the exclusion for a minister's housing allowance constitutional? In Freedom From Religion Foundation, 10 the District Court for the Western District of Wisconsin said no. The court ruled the exclusion for a cash housing allowance is unconstitutional because it violates the Establishment Clause of the First Amendment. The court did not render an opinion on the constitutionality of the exclusion for the rental value of housing received in kind.
On appeal, the Seventh Circuit vacated this decision and remanded the case with instructions to dismiss the complaint for lack of jurisdiction. The Seventh Circuit concluded the plaintiffs lacked standing to challenge the constitutionality of the tax-free housing allowance. 11
A similar case in Kentucky is American Atheists, Inc., 12 in which the District Court for the Eastern District of Kentucky also ruled that the plaintiffs lacked the legal standing to assert their claims.
Limitations on the Housing Exclusion
If a housing allowance exceeds what the minister spends for housing, any excess is taxable to the minister as compensation. 13 The amount spent for housing can include:
- Mortgage payments;
- Real estate taxes;
- Insurance on the home;
- Repairs; and
- Other expenses of providing a home.
Amounts spent for food and servants are not amounts spent for housing. If a minister owns a farm or other business in addition to a home, the minister may not exclude from gross income the amounts the minister spends on the farm or business. 14 In addition, the housing allowance exclusion is only for income tax purposes. A minister must include the housing allowance in self-employment income to calculate the self-employment tax. 15
The church must designate a specific amount in advance for the housing allowance. Evidence for such a designation can include the minister's employment contract, minutes or resolution of the church's governing body, the church's budget, or other appropriate evidence. The designation is sufficient if it identifies a payment as a rental allowance separate from salary or other forms of compensation. 16
In Eden, 17 the Tax Court denied the exclusion for the housing allowance to a minister of education and music because the church did not officially designate any part of his salary as a rental allowance. A church must designate the amount of the housing allowance in advance, as Example 1 shows.
Example 1: P is a minister who receives a designated housing allowance of $36,000. He spends $28,000 for qualified mortgage interest and real estate taxes on his personal residence. He spends more than $8,000 for principal payments on his home mortgage, utilities, and furniture. The sum of his $36,000 housing allowance and his other compensation does not exceed the fair market value of his services. The $36,000 housing allowance does not exceed the fair rental value of his home and utilities. P may exclude all $36,000 of his housing allowance from his gross income.If the $36,000 had not been designated as a housing allowance, P would not be able to exclude the amount from gross income.
Effect of Housing Exclusion on Deductions
Usually, a taxpayer may not deduct otherwise deductible expenses if the expenses are attributable to tax-free income. 18 A minister must reduce deductions for business expenses by the percentage of compensation attributable to the tax-free housing allowance. 19 However, a minister may deduct the full amounts of home mortgage interest and real estate taxes as itemized deductions even if these deductions are attributable to the tax-free housing allowance. 20 Example 2 illustrates the treatment of deductions for home mortgage interest and real estate taxes for a minister who receives a tax-free housing allowance.
Hybrid Employment Status
Example 2: T is a minister who received a designated housing allowance of $24,000. He spent $18,600 of the allowance on home mortgage interest, $2,400 on real estate taxes, and the remainder on utilities, furniture, and mortgage principal. He may deduct the $18,600 he paid for home mortgage interest and the $2,400 he paid for real estate taxes on his home as itemized deductions on Schedule A, Itemized Deductions, of Form 1040, U.S. Individual Income Tax Return, even though he paid those expenses with a designated housing allowance that he could exclude from gross income under Sec. 107.
The law treats a minister as self-employed for Social Security purposes. 21 For most other purposes, the law treats a minister as an employee. The IRS generally considers a minister to be an employee under the 20-factor test 22 used to classify workers as either employees or independent contractors. The IRS also looks at three other things: (1) behavioral control, (2) financial control, and (3) relationship of the parties. 23 A minister is exempt from withholding for income tax, 24 Social Security tax, and Medicare tax. 25 However, a minister may request the church to withhold income tax.
Ministers must calculate their self-employment tax on Schedule SE, Self-Employment Tax, of Form 1040. Although a minister excludes the housing allowance from gross income, the minister must include the housing allowance in self-employment income. 26
If a retired minister receives a housing allowance from a church, the minister does not include the housing allowance in self-employment income. 27 In the year a ministerretires, theminister must include the housing allowance in self-employment income for the months before retirement. Example 3 illustrates the treatment of the housing allowance for a retired minister.
Example 3: R is a minister who receives a housing allowance of $2,000 per month from his church. He spends more than $2,000 per month on housing, including utilities. The fair value of his compensation is worth more than $2,000 per month. He retired on June 1, 2014, after serving the church faithfully as its pastor for 35 years. The church will continue to provide R a housing allowance of $2,000 per month as a part of his retirement package. R may exclude all of the $24,000 ($2,000 per month × 12 months) housing allowance from his gross income. He must include $10,000 ($2,000 per month × 5 months) in his self-employment income for 2014. In future years, none of his $24,000 annual housing allowance will be included in his self-employment income.
Usually Classified as an Employee for Income Tax Purposes
In Weber, 28 the Tax Court held that a minister is usually an employee. A minister who is an employee may not deduct business expenses on Schedule C, Profit or Loss From Business (Sole Proprietorship), of Form 1040, except to the extent that the expenses relate to income from sources other than the employer. Such other income can include fees received directly from individuals for marriages, funerals, and baptisms. Rather, an employee must deduct business expenses on Form 2106, Employee Business Expenses. The expenses shown on Form 2106 flow to Schedule A and are deductible as miscellaneous itemized deductions. An individual must reduce total miscellaneous itemized deductions by 2% of adjusted gross income. 29
The taxpayer in Weber was an ordained minister who worked full time in one church. He was not a traveling minister. The court found that his duties were under the control of a bishop. Although the minister had a great deal of freedom to make decisions in his position, that autonomy was not enough for the court to consider him self-employed. Therefore, the court held he could not deduct his business expenses on Schedule C but could deduct them as an employee on Form 2106.
Many employees incur business expenses, such as professional dues, for which the employer does not reimburse them. Any unreimbursed business expenses a minister incurs, such as automobile expenses, professional dues, and publications, are deductible in full (except for the 50% reduction for meals and entertainment) 30 from self-employment income, even though these expenses are not deductible in full in calculating taxable income. Generally, a minister deducts such unreimbursed employee expenses only on Form 2106, which flows to Schedule A as a miscellaneous itemized deduction. Ministers may deduct the full amount of deductible business expenses in calculating self-employment income because the housing allowance is included in self-employment income. The minister should attach a schedule of the business expenses used to calculate self-employment income on Schedule SE. IRS Publication 517 31 contains some helpful schedules in calculating a minister's taxable income and self-employment income.
For income tax purposes, a minister must reduce the unreimbursed ministerial expenses by the percentage of salary attributed to the tax-free housing allowance. 32 In Deason, 33 the IRS disallowed a deduction for automobile expenses for a minister who used his personal automobile in connection with his ministry. He incurred the expenses in commuting back and forth to the church where he preached. (Although it was not an issue before the Tax Court, the IRS likely would have alternatively disallowed such expenses as commuter mileage.) 34 The church agreed to pay him a salary of $25 per week and designated the entire amount as a parsonage allowance. The Tax Court held that because his entire salary was tax-free income, he could not claim a deduction for any business expense.
If a minister receives a large portion of total compensation as a tax-free housing allowance, the minister should not expect a great benefit from out-of-pocket business expenses. Example 4 illustrates how a minister must reduce the deduction for business expenses by the same percentage as income excluded from gross income.
Example 4: M is a minister who receives a housing allowance of $24,000 per year, which does not exceed the fair rental value of her home and is considered reasonable compensation for the services she performs. Her expense to provide a home for her family is $24,000 per year. In addition, M receives a salary of $36,000 per year. She must reduce any unreimbursed business expenses by 40% of the expenses ($24,000 + $36,000 = $60,000; $24,000 ÷ $60,000 = 40%). M had business expenses of $10,000 after the 50% reduction of expenses for meals and entertainment. She may not deduct $4,000 of such expenses ($10,000 × 40%). She may deduct the remaining $6,000 as an employee business expense on Form 2106. This $6,000 deduction flows to Schedule A as a miscellaneous itemized deduction. She may deduct all $10,000 of her business expenses in calculating her self-employment income.
Although a minister pays self-employment tax and is not subject to federal income tax withholding, the church should issue the minister a Form W-2, Wage and Tax Statement, rather than a Form 1099-MISC, Miscellaneous Income, for nonemployee compensation. An exception applies if the minister is a visiting speaker or a traveling minister, because in those circumstances, the minister would be self-employed under common law.
However, a minister's Form W-2 will look quite different from a Form W-2 for a regular employee. Box 1 should show the minister's salary. Box 2 for federal income tax withheld should be blank unless the minister requested the church to withhold federal income tax. The minister's Form W-2 may include other items, such as retirement contributions. Because the minster is responsible for paying self-employment tax, boxes 3 through 6, which are for Social Security and Medicare taxable wages and taxes, should be blank.
Application for Exemption From Self-Employment Tax
A minister may apply to be exempt from self-employment tax on the earnings as a minister. Only self-employment income from service as a minister, member of a religious order, or Christian Science practitioner is exempt from the self-employment tax if the IRS grants the minister's application for exemption. 35 Thus, if the minister owns a side business as a sole proprietor or partner, the self-employment income from the side business will be subject to the self-employment tax. Of course, if the minister applies for and receives the exemption from Social Security tax, the minister is not eligible to receive Social Security benefits in the future.
A minister applies for the exemption on Form 4361, Application for Exemption From Self-Employment Tax for Use by Ministers, Members of Religious Orders and Christian Science Practitioners. The minister must attach a statement certifying the minister opposes accepting any type of public insurance on religious grounds or proof the minister has taken a vow of poverty. The minister must meet one of two tests: (1) a religious principles test based on the doctrines of the particular church, or (2) a conscientious opposition test. 36
The IRS will verify the information included on the application for exemption from Social Security tax. A minister who applies for an exemption must include a statement with the application certifying the minister has informed the church or order that the minister opposes accepting any public insurance. 37 The minister must sign the statement under penalties of perjury.
Once the IRS receives the statement, it will send a statement back to the minister that describes the requirements for receiving the exemption. The minister must certify that he or she has read the requirements and wishes to seek exemption from self-employment tax based on the requirements listed in the statement by sending a signed copy of the statement to the IRS not later than 90 days from the date the statement was mailed to the minister. If the signed copy of the statement is not sent to the IRS within 90 days, the minister's exemption will not be effective until the date that the signed copy of the statement is received by the IRS.
Exemption From Federal Income Tax Withholding
As mentioned above, a minister is exempt from federal tax withholding. 38 However, a minister may choose to have the church withhold federal income tax from the minister's compensation by filing Form W-4, Employee's Withholding Allowance Certificate, with the church.
Self-employed individuals must make estimated tax payments quarterly. If a minister does not have enough income tax withheld or make sufficient timely estimated payments, the minister will be subject to the penalty for underpayment of estimated tax. 39
Foreign Earned Income
Many churches and religious organizations send ministers on missionary trips to foreign countries to share their faith. A minister who is a citizen of the United States and works in a foreign country is still subject to federal income tax. 40 The foreign country or countries could also impose an income tax on the minister. The foreign earned income exclusion, 41 the foreign housing exclusion, 42 and the foreign tax credit 43 serve to reduce the effects of such double taxation.
The foreign earned income exclusion and the foreign housing exclusion apply for income tax purposes only. A minister may not use either of these exclusions in calculating self-employment income. To qualify for either of the exclusions, the taxpayer must meet the requirements of either (1) the foreign presence test or (2) the foreign residence test.
The foreign presence test states an individual must be present in one or more foreign countries during at least 330 full days during 12 consecutive months. 44 The foreign residence test states the individual must be a bona fide resident of one or more foreign countries for an uninterrupted period that includes an entire tax year. 45
The taxpayer must elect to have the foreign earned income exclusion apply by filing Form 2555, Foreign Earned Income, with his or her return. The taxpayer must make a separate election for the housing exclusion. The foreign earned income exclusion may not exceed the foreign earned income. 46 The foreign earned income exclusion amount is $80,000 as adjusted for inflation. 47 (The inflation-adjusted amounts are $99,200 for 2014 48 and $100,800 for 2015. 49) A taxpayer may claim a partial exclusion if the income is below the maximum exclusion. A taxpayer may not claim two or more benefits with respect to the same income. 50 Therefore, a taxpayer may not claim the foreign earned income exclusion and the foreign tax credit with respect to the same income.
Sec. 911(f)(1) provides a special rule in calculating the income tax liability when the foreign earned income exclusion applies, using the following three steps:
Step 1: Calculate the income tax liability using the regular tax rates on the base of the sum of the regular taxable income and the amount of the foreign earned income exclusion.
Step 2: Calculate the tax using the regular tax rates applied to the amount of the foreign earned income exclusion.
Step 3: Subtract the amount calculated in Step 2 from the amount calculated in Step 1.
Example 5 illustrates these three steps. A minister who is working in a foreign country might receive a better result by claiming the housing allowance exclusion under Sec. 107 rather than the foreign housing exclusion under Sec. 911.
Example 5: K is a minister who received $115,000 in 2014 for mission work in a foreign country on behalf of a church in the United States. He went to the foreign country in late 2013 and lived there for all of 2014. He is single, under age 65, and claims the standard deduction. His income tax liability calculation is shown in the exhibit.
The tax on the regular taxable income of $5,650 would have been $568. Therefore, the special rule cost K an additional $1,006.75 ($1,574.75 − $568) in income tax.
Although K may exclude $99,200 of his earned income from his gross income for 2014, he must calculate his self-employment tax on the entire $115,000 because the exclusion applies only to income tax, not to self-employment tax. 51What Is Gross Income for a Minister?
In addition to the minister's salary, the minister includes in gross income compensation for services such as marriage fees, baptism fees, counseling fees, funeral honoraria, and other amounts received for services. 52 The minister reports the fees received from the individuals who receive those services on Schedule C of Form 1040. As stated earlier, ministers must also include in gross income the portion of the housing allowance that exceeds the fair rental value of the home or the amount that exceeds reasonable compensation for the services performed. 53 The taxable portion of the housing allowance is a part of the minister's compensation as an employee of the church. Example 6 illustrates the calculation of a minister's gross income.
Example 6: J is a minister who receives a salary of $40,000 per year from the church. He also receives a housing allowance of $18,000 per year, which does not exceed the fair rental value of the home or reasonable compensation for the services he performed. The minister also receives $2,000 in other income for funerals, weddings, and baptisms. The church reimbursed all of J's business expenses related to his service at the church under an accountable plan. He had no business expenses related to the $2,000 he received in other income. Although J's gross income is $42,000 ($40,000 salary + $2,000 other income), his income from self-employment is $60,000 ($40,000 salary + $18,000 housing allowance + $2,000 other income). This is the case regardless of whether he receives $18,000 as a cash housing allowance or the church provides him with a home with a fair rental value of $18,000 per year.
Another tax consideration for some ministers is how to treat a love offering, which is usually cash received directly from members of the congregation on a special occasion. A love offering resembles a gift because the donor gives it out of love and affection. However, when the minister is a current employee, as opposed to retired, the courts and the IRS have considered any love offering to be payment for prior or future service. Therefore, a minister must include such love offerings in the minister's gross income rather than exclude them as gifts.
In Banks, 54 the taxpayer was an ordained minister who often received cash amounts that she called "love gifts" and did not include them in her gross income. The congregation at the church she founded made such payments on her birthday, Mother's Day, the church's anniversary, and Christmas. The Tax Court held the payments were not gifts but instead were compensation for services.
In Goodwin, 55 a pastor and his wife regularly received cash gifts three times per year, on the pastor's birthday, Christmas, and the anniversary of the pastor's coming to the church. The pastor never reported these gifts as income because he believed they were nontaxable gifts. 56 The pastor argued that the average gift per member of the congregation was only $12.50. The pastor attempted to distinguish his case from Banks by testifying that he did not ask for these gifts and did not require the congregation to make them. However, the Eighth Circuit did not accept this argument. The court held that the gifts were taxable even though made out of love and affection.
However, the following cases show that in some circumstances, a minister may receive tax-free gifts.
In Abernethy, 57 the District of Columbia Circuit reversed a decision of the Tax Court and held that payments to a former pastor were made out of love and/or affection and not as payment for any prior or future services. Therefore, the court allowed the taxpayer to exclude the payments as a nontaxable gift.
In Schall, 58 a pastor retired because of bad health from the church where he had worked for 18 years. The congregation knew that the pastor could not afford to move to Florida as his doctor had recommended. The congregation gave him what it called in a resolution a "salary or honorarium" of $2,000 annually. The Fifth Circuit held that the payments were a nontaxable gift. The court stated that "all the facts and circumstances surrounding the adoption of the resolution clearly proved an intent to make a gift, [and] the mere use of the terms 'salary' and 'honorarium' do not convert the gift into a payment for services." 59
In Rev. Rul. 55-422, the IRS stated it would follow the holdings in these and several other similar court cases and treat payments made to a retiring minister as a nontaxable gift. The church must have fully compensated the minister for his or her prior service. The minister must have no intention or obligation to provide future service to the church.Need for Tax Planning
Although the housing allowance is a generous tax benefit, ministers can reduce their tax liabilities even more with good tax planning. A minister must also consider that the law does not allow most ministers to take some common deductions.
Advantages of Buying a Home
If a minister has a choice of receiving either the free use of a house provided by the church in kind or a cash housing allowance, the minister should seriously consider choosing the allowance and purchasing a home. The minister must consider the local real estate market and how long the minister plans to live in the area. If the minister receives a cash housing allowance and purchases a home, the minister will pay the mortgage payments with tax-free income yet can deduct real estate taxes and mortgage interest. 60 If the minister later sells the home at a loss, like all taxpayers, the minister may not deduct the loss. 61 However, ministers and other taxpayers who meet all the requirements may exclude up to $250,000 ($500,000 on a joint return) of the gain on the sale of the home. 62 Example 7 shows why a minister should consider the purchase of a home over a church-provided parsonage.
Example 7: A is a minister who receives a cash housing allowance. He may rent a home or purchase a home. A decides to purchase a home because he and his wife believe it would be a good long-term investment. His housing allowance is tax-free, and the couple may deduct their mortgage interest and real estate taxes. They expect to sell the home when they retire and use the proceeds to help them pay for their retirement in another state. They plan to take full advantage of the exclusion for gain of up to $500,000 on the sale of their home. This exclusion is available to them even though they paid for the home with tax-free income.
Although a minister pays self-employment tax, the law treats most ministers as common law employees of their church. As employees, ministers may take advantage of employee fringe benefits such as health insurance and retirement plans. A minister may choose to contribute to an individual retirement account or a Sec. 403(b) plan.Suits and Vestments
Generally, a taxpayer may deduct the cost of uniforms as a business expense if the taxpayer must wear them on the job and they are not suitable for street wear. 63 In Ratcliff, 64 the Tax Court denied a minister a deduction for suits worn to church because the church did not require them. Rather, the wearing of a suit was only customary. Even if the church requires a minister to wear a suit while conducting church services or counseling church members, the cost of the suit would not be deductible because it is suitable for ordinary street wear. If a church requires a minister to purchase and wear special clothing or vestments during church services, that fact should be in the minister's employment contract. If the special clothing or vestments are not suitable for street wear, they should be deductible.Accountable Plans for Employee Business Expenses
As stated above, ministers may deduct business expenses only after reducing them by the percentage of income attributed to the tax-free housing allowance. 65 A minister may not use Schedule C to deduct business expenses unless the minister is truly self-employed. If the church has an accountable plan for employee expense reimbursements, 66 a minister could use it for a tax benefit. A reimbursement under an accountable plan does not constitute gross income. An employee may not deduct expenses to the extent the employee receives reimbursement under an accountable plan. Example 8 illustrates the use of an accountable plan.
Example 8: T is a minister who works for a church that has an accountable plan. T buys a book that costs $35 to use in a church class. T requests reimbursement for the cost of the book. The church issues T a check for $35. T does not include the $35 reimbursement in his gross income, and he may not deduct the $35 he spent for the book.
Example 9 illustrates the tax consequences for the book purchase if the church does not have an accountable plan.
Home Office Deduction
Example 9: Assume the same facts as in Example 8, except that T does not receive reimbursement under an accountable plan. T must save the receipts for all business expenses and deduct them on his tax return. However, he must reduce such expenses by the percentage of income from the ministry that is attributable to his tax-free housing allowance. T receives a salary of $64,000 and a housing allowance of $16,000, for total income of $80,000. Of his $80,000 income, 20% ($16,000 ÷ $80,000) is attributable to his tax-free housing allowance. Therefore, he must reduce his deductible business expenses by 20%. He may deduct 80% of the cost of the $35 book. Therefore, he may deduct $28 ($35 × 80%) as an employee business expense. He must reduce his total miscellaneous itemized deductions by 2% of his adjusted gross income (AGI). Unless he had substantial employee business expenses and his total itemized deductions exceed his standard deduction, he is likely to receive little, if any, income tax benefit from his employee business expenses. He may deduct all $35 of the cost of the book in calculating his self-employment tax.
In Strohmaier, 67 the Tax Court held that a part-time minister who was an independent contractor and not affiliated with any church could not claim a home office deduction because his home was not his principal place of business. 68 He never conducted religious worship services there, nor did he receive any religious patrons there. He was not an employee of a church. (If a taxpayer is an employee, another requirement for a home office deduction is that the home office must be for the convenience of the employer. 6 9)
The law also allows a deduction for a home office if it is where the taxpayer regularly meets patients, clients, or customers in the normal course of business. 70 In addition, a home office as a principal place of business includes a place where the taxpayer conducts administrative or management activities if there is no other fixed place where the taxpayer conducts substantial administrative or management activities. 71 Thus, if a minister had no office at a church building and performed significant counseling activities, management activities, or administrative activities in a home office, the minister might be able to claim a home office deduction.
However, if a minister's tax-free housing allowance covers all housing costs, the minister may not claim any home office deduction because the tax-free housing allowance is directly allocable to the home office expenses. 72 Any home office deduction would be subject to the reduction for the percentage of home office costs attributable to the tax-free housing allowance.Charitable Contributions
A minister may not deduct charitable contributions to a church as a business expense but only as itemized deductions on Schedule A. 73 This is true even if the church requires the minister to make a minimum amount of contributions to retain employment. The required charitable contributions are not deductible in calculating self-employment income because they are not business expenses. 74
Some ministers may work for a church without receiving any compensation from the church. If the minister incurs expenses for such things as books, supplies, and transportation, the minister may deduct such expenses only as charitable contributions. 75 The minister may not deduct such expenses as business expenses because the minister has no expectation of profit for serving the church without compensation.
This rule against deducting charitable contributions as business expenses could benefit the minister because, if the expenses were business expenses, they would be deductible only as miscellaneous itemized deductions. 76 The minister would have to reduce total miscellaneous itemized deductions by 2% of AGI. 77 Charitable contributions are not subject to this reduction. A disadvantage is that the standard mileage rate for miles driven on behalf of a charity is 14 cents per mile, 78 which is less than the standard mileage rate for business miles. 79 Unlike the standard mileage rate for business miles, 80 the standard mileage rate for miles driven on behalf of a charity is not indexed for inflation. The minister may not deduct any travel expenses with a significant element of personal pleasure, recreation, or vacation. 81
How does the IRS treat church contributions a minister must make to retain employment in determining available income to pay a delinquent federal income tax liability? In determining ability to pay, the IRS will allow expenses that the taxpayer must incur to provide for the health and welfare of the taxpayer and the taxpayer's family or to generate income. 82 The IRS instructs its employees to review the employment contract to determine whether charitable contributions are necessary to retain employment. 83
In Pixley, 84 the Tax Court held the IRS usually must reduce the income a minister has available to pay a delinquent tax liability by the church contributions a minister must make to retain employment. However, in this case, the taxpayer did not prove he was employed as a minister when or after the IRS began collection procedures. The Tax Court held the IRS did not abuse its discretion in disallowing the tithing expenses in calculating how much he could pay the IRS. Further, the Tax Court held the IRS did not violate the minister's rights under the First Amendment.Conclusion
The main tax consideration for ministers is the exclusion for the housing allowance. It provides ministers with a potentially large exclusion from their gross income. The tax-free housing allowance does not reduce the deductions for mortgage interest and real estate taxes, but it reduces the deduction for business expenses. If the church has an accountable plan for reimbursing business expenses, the reduction in deductible business expenses will not apply to the extent the minister receives such reimbursements. Love offerings to active ministers are generally taxable compensation and not tax-free gifts. However, under some circumstances, a love offering may be a tax-free gift.
2 Freedom From Religion Foundation, Inc., No. 12-C-0818 (W.D. Wis. 7/29/14).
3 Regs. Secs. 1.107-1(a) and 1.1402(c)-5(b)(2).
4 Salkov, 46 T.C. 190 (1966).
5 Sec. 107.
6 Sec. 107(2).
7 Driscoll, 135 T.C. 557 (2010).
8 Driscoll,669 F.3d 1309 (11th Cir. 2012), rev'g and remanding 135 T.C. 557 (2010), cert. denied, 133 S. Ct. 358 (2012).
9 Golsen, 54 T.C. 742 (1970), aff'd on other issues, 445 F.2d 985 (10th Cir. 1971).
10 Freedom From Religion Foundation, Inc., No. 11-cv-626-bbc (W.D. Wis. 11/21/13).
11 Freedom From Religion Foundation, Inc., No. 14-1152 (7th Cir. 11/13/14).
12 American Atheists, Inc.,21 F. Supp. 3d 856 (E.D. Ky. 2014).
13 Regs. Sec. 1.107-1(c).
15 Sec. 1402(a)(8).
16 Regs. Sec. 1.107-1(b).
17 Eden,41 T.C. 605 (1964).
18 Sec. 265(a)(1).
20 Sec. 265(a)(6)(B).
21 Secs. 1402(a)(8) and 3121(b)(8)(A).
22 Rev. Rul. 87-41.
23 Field Service Advice 200127004 (7/7/01) and IRS Publication 1779, Independent Contractor or Employee? (rev. March 2012).
24 Sec. 3401(a)(9).
25 Sec. 3121(b)(8)(A).
26 Sec. 1402(a)(8).
28 Weber,103 T.C. 378 (1994).
29 Sec. 67(a).
30 Sec. 274(n)(1).
31 Publication 517, Social Security and Other Information for Members of the Clergy and Religious Workers.
32 Sec. 265(a)(1).
33 Deason, 41 T.C. 465 (1964).
34 Regs. Sec. 1.162-2(e).
35 Sec. 1402(e)(1).
36 Regs. Sec. 1.1402(e)-2A(a)(2).
37 Regs. Sec. 1.1402(e)-5A.
38 Sec. 3401(a)(9).
39 Sec. 6654.
40 Sec. 61(a).
41 Sec. 911(a)(1).
42 Sec. 911(a)(2).
43 Sec. 27(a).
44 Sec. 911(d)(1)(B).
45 Sec. 911(d)(1)(A).
46 Sec. 911(d)(7).
47 Sec. 911(b)(2)(D).
48 Rev. Proc. 2013-35.
49 Rev. Proc. 2014-61.
50 Sec. 911(d)(6).
51 Sec. 1402(a)(8).
52 Regs. Sec. 1.61-2 and Sec. 3401(a)(9).
53 Regs. Sec. 1.107-1.
54 Banks, T.C. Memo. 1991-641.
55 Goodwin, 67 F.3d 149 (8th Cir. 1995), aff'g 870 F. Supp. 265 (S.D. Iowa 1994).
56 Sec. 102(a).
57 Abernethy, 211 F.2d 651 (D.C. Cir. 1954).
58 Schall,174 F.2d 893 (5th Cir. 1949).
59 Id. at 894.
60 Secs. 163(h)(3), 164(a)(1), and 265(a)(6)(B).
61 Sec. 165(c)(3) and Regs. Sec. 1.165-9(a).
62 Sec. 121.
63 Rev. Rul. 70-474.
64 Ratcliff,T.C. Memo. 1983-636.
65 Sec. 265.
66 Regs. Sec. 1.62-2.
67 Strohmaier,113 T.C. 106 (1999).
68 Sec. 280A(c)(1)(A).
69 Sec. 280A(c)(1), flush language.
70 Sec. 280A(c)(1)(B).
71 Sec. 280A(c)(1), flush language.
72 Sec. 265(a)(1) and Regs. Sec. 1.265-1(c).
73 Regs. Sec. 1.162-15.
74 Sec. 1402(a).
75 Rev. Rul. 69-645 and Estate of Gibson, T.C. Memo. 1981-668.
76 Secs. 62(a)(1) and 67(b).
77 Sec. 67(a).
78 Sec. 170(i).
79 News Releases IR-2013-95 (2014) and IR-2014-114 (2015).
80 Regs. Sec. 1.274-5(g).
81 Sec. 170(j).
82 IRM §184.108.40.206 (10/2/12).
83 IRM §220.127.116.11 (11/17/14).
84 Pixley,123 T.C. 269 (2004).
85 Thompson, 140 T.C. 173 (2013).
86 Religious Freedom Restoration Act of 1993, P.L. 103-141.
|Alan Campbell is an associate professor of accounting at Troy University in Montgomery, Ala., and Jaela Robbins is a senior staff accountant at Hanak & Wells PC in Daphne, Ala. For more information about this article, contact Prof. Campbell at firstname.lastname@example.org.|