I’m a Minister–How Should I Get Paid?
by Jeff Roberts
Clergy pay is one of the more complex areas of the law, and for many accountants who don’t handle a lot of pastors and pastoral employees, it can be frustrating to understand. There are a few key issues to address: Who is a minister? The SS system. Reimbursements. Housing. Reporting. Retirement. As succinctly as I can:
Who is a minister? A minister is determined to be someone who is licensed, commissioned, or ordained, and meets any two of the following: leads worship, administers sacraments, is considered a spiritual leader, or is administering or managing affairs of the church or organization. Many churches and orgs have a checklist or policy to help determine who, within their body, qualifies as a minister.
The Social Security system. One of the most important decisions you’ll make as a minister is whether you want to be covered in the SS system or not. You have two years after taking a new position in a church to make that determination and file with the IRS for exemption if you choose. The financial benefit is obvious-you control your retirement money instead of the government, and will return 6-10 times what you’d have through the government system. Ministers are the only people other than teachers and government workers who have the opportunity to dodge SS. But this is not an inherently financial decision. It’s a moral decision.
The requirement in filing for exemption is your signing off that you conscientiously object to the government providing welfare/retirement benefits, and that the church should do this job. If you don’t believe that, you can’t realistically file the exemption and sleep well at night. It is important to note a couple other key things. Many who were in the SS system in ‘real jobs’ will still receive SS benefits upon retirement, even after filing for exemption as a minister. This is confirmed in the SS code section 1131.4 “The exemption applies only to net earnings from the exercise of the ministry. Once having filed a valid application for exemption, a minister cannot later acquire Social Security credit for earnings from these services. However, Social Security taxes will continue to be paid by any minister on any other self-employment income or covered wages.” Finally, and perhaps this should NOT be mentioned, while the exemption is irrevocable, meaning that you cannot change your mind once that two year period is up, you may have other opportunities to alter your position with SS. First, if you change churches, you have a new two year window open for a new decision. Second, historically, about every 15-20 years, SS opens the window to allow previously exempt ministers to come back into the system.
This has been used for abuse, as someone chooses to dodge the system for many years, and then, near retirement age, comes back in, pays SS taxes for a few years and qualifies for decent benefits. My job is to give you all the facts, though, so that you can make the right decision.
Reimbursements. The general rule is that you want to get reimbursed for expenses first. Then housing, then, taxable salary. Reimbursed expenses don’t show up on any tax form, ever. So maximizing these helps keep taxable income down, while the same amount of money changes hands between the church and the minister. Let’s say that the church can afford to pay $40,000 total to the minister per year. If he/she turns in cellphone, mileage, dues, library, travel, meals, and the like, or the church pays these directly, $5,000-10,000 per year can change hands legitimately without any tax to anyone. Of the $30-35,000 that remains, in many metro areas, that will handle the housing allowance nicely. We’ll discuss that in the next section. But housing isn’t subject to income taxes, so you can see that this $40,000 compensation program can be kept from income taxes entirely. It’s a nice benefit. But we start with those reimbursements. Maximize those, and then…
Housing. Apart from opting out of SS, housing is the best deal going for ministers. To put into perspective, think of the old parsonage that was near the church that was provided to the pastor and his family. Those don’t exist much anymore, and the housing allowance is the replacement for it. The pastor could live in the parsonage tax free. And in the same way, the housing allowance which replaces the parsonage, is tax free. What is housing? Well, it’s whatever it costs in your area to live in that parsonage. Costs to pay for it (the entire mortgage payment, not just interest), furnish it, maintain it, light and heat it, clean it…just about anything except for food and clothing! Limited to a fair rental value for a furnished home, so you can’t live in a mansion and take it. But from my experience, $20-40,000 perhaps is pretty usual.
Now, you have to keep records and prove that you spent that much, or it gets added back to income. And that housing allowance must be declared, usually at year end, board approved, prior to receiving any housing allowance the next year. So you need to know at all times what you’ve spent so that you can set the amount for the following year. There is one other thing to know about housing. While it avoids income tax, if you’ve chosen to remain in the SS system, it is subject to SS taxes. So while you may owe no income tax, we compute SS taxes on the housing amount.
Reporting. Generally, the rule is that a minister is a dual status worker-an employee of the church, yet considered self employed for tax filing. This makes it very confusing, and many churches and orgs get this wrong. A minister should be issued a W2, nearly always. BUT, there should be no withholding of any kind, or social security/medicare wages. So it’s a W2 with one figure in the wage box, and the housing amount shown in box 14 as info only. That’s it. On the pastor’s return, we pick up the wages in the usual place on the 1040, but use a Sch. C for any unreimbursed business expenses, and the SE form to compute all the SS tax on salary and housing.
Retirement. Finally, the main thing to know here is that housing and reimbursments cannot be used to determine retirement contributions or benefits. So if you manage to dodge taxable income entirely, you’ve also dodged the ability to deduct a retirement contribution. And we should note as strongly as possible that if you do choose to opt out of the SS system, you owe it to yourself and your family to take that same money and put it into retirement, disability and life insurance. One other thing of note, upon retirement, distributions can still qualify for housing exclusion, making the money tax free. Again, it’s entirely possible to make tax deductible contributions to retirement over the years, and then not have to include the benefits in income when drawn for housing. It really gets no better than that, except for the retirement benefits after death…!