Minister, but not a minister

Can a minister elect to be treated as a non-minister?

In other words, while ministers are defined by the Internal Revenue Code as employees in every respect except for purposes of computing their 15.3% Self-Employment tax on Schedule SE (Form 1040), may a minister choose to have the church withhold the 7.65% FICA tax and then match the other half out of church money? The simple answer: "no."

Many churches, in recognition that they are saving 7.65% by not having to match their ministers’ FICA tax, choose to increase their pay by this amount and then immediately withhold it as federal income tax. That way, when the minister computes his full 15.3% SE tax at least ½ is already paid in through withholding.

And there may be good reason not to be treated as an employee even if the Internal Revenue Code allowed it. Before calculating one's SE tax a minister can reduce his reportable earnings by the excess of his employee business expenses over any reimbursement by the church. An employee cannot do this. He or she must pay FICA tax on his full earnings. Also, any contributions to 403(b) plans reduce a minister's SE reportable earnings. This provision is not available to employees. They must pay FICA on their full pay even though income taxable wages are reduced by 403(b) or 401(k) elective deferrals.

Minister's Retirement Distributions Designated as Housing Allowance

There's lots of IRS authority (or precedent) for a local church or a denominational body to designate a minister's retirement benefits as housing allowance:
1. Audit Guide: Ministers: Market Segment Specialization Program
2. Letter Rulings 7734028, 7939077, and 8344062
3. Revenue Rulings 62-117, 63-156, and 75-22

A church is considered to be the sponsor of a 403(b) (Tax Sheltered Annuity) plan that receives the elective deferral withholdings of and matching contributions for its pastor. Accordingly, distributions from these plans qualify for housing allowance designation by the church.

I find no evidence that funds in an IRA account, either originally contributed to it or rolled into it from a 403(b) plan qualify for housing allowance designation by the church.

Taxation of Love Gifts to a Pastor

Question:
I received a love gift from the church for pastor's appreciation. In the past I have declared this as business income and paid self-employment tax on it. Is this correct?

Answer:
Yes, virtually all gifts from an employer are considered taxable in the same manner as an employee's standard compensation. The church should report this income along with the pastor's standard compensation in Box 1 on his Form W-2. However, if the church should omit the gift, you are still responsible to report it as both earnings for income tax purposes and for self-employment tax purposes. Generally, the only exception to the taxation of gifts by an employer to an employee relates to non-cash gifts of nominal value.

Per IRS Publication 525: Holiday gifts: If your employer gives you a turkey, ham, or other item of nominal value at Christmas or other holidays, do not include the value of the gift in your income. However, if your employer gives you cash, a gift certificate, or a similar item that you easily can exchange for cash, you include the value of that gift as extra salary or wages regardless of the amount involved.

Ministers’ Retirement Options

Your congregation wants to contribute to your retirement? Great! Now, how can/should you handle this?

First, let's discuss the options; then we'll consider how the church can get involved.

The best retirement plan option for each minister depends on his objectives and his current tax situation. The three most common retirement plan options used by ministers include:
(a) IRC 403(b) plans (also called Tax Sheltered Annuities (TSAs)),
(b) Traditional Individual Retirement Accounts (IRAs), and
(c) Roth IRAs.

Ministers often select 403(b) plans when they want to maximize their eligible contributions, or to reduce their self-employment tax burden. For the year 2008, a minister may elect to have his employer withhold ("elective deferral") up to $15,500 of his compensation and contribute it, instead, to his 403(b) qualified investment account. Many ministers are eligible to increase this amount by another $5,000 to catch-up for earlier years' smaller deferrals (IRS Publication 571). In addition, unlike other retirement plan choices (Traditional and Roth IRAs, and for-profit company 401(k) plans), a minister is not subject to the 15.3 percent federal self-employment tax on amounts deferred into 403(b) accounts (IRS Revenue Rulings 68-395 and 78-6). This is also true of any amount that his employer contributes over-and-above the minister's own elective deferral.

The situations for which Traditional IRAs are the best choice for a minister's retirement plan are less frequent, especially since the establishment of Roth IRAs beginning with the 1998 tax year. For the year 2008, a minister and his wife may each contribute up to $5,000 to qualified IRA accounts; an additional $1,000 each may be contributed if they are 50 years of age (IRS Publication 590). A minister who has opted out of the social security system but is still looking for additional income tax deductions may find the Traditional IRA his best choice. These contributions can often be made even if the minister participates in a 403(b). However, he may not be able to deduct his full Traditional IRA contribution. For this reason and others, many ministers choose Roth IRA's instead of Traditional IRAs.

Roth IRAs enable ministers to make the same amount of contributions as do Traditional IRAs but without receiving an income tax deduction. For many ministers, especially those with young families and ample housing allowances, additional tax write-offs are not needed. Unlike Traditional IRAs, not only will future retirement (age 59½ or later) distributions of their current Roth IRA contributions be untaxed, the earnings distributed from the Roth IRA will not be taxed. Further, pre-retirement distributions may be made without penalty for:
(a) Medical expenses (and health insurance premiums for the unemployed).*
(b) Qualified higher education expenses.*
(c) New home purchase costs for taxpayers who have not owned a personal residence for at least two years ("first time homebuyers").
*Also available for some Traditional IRA distributions.

Now, how can the church get involved? The best way for a church to be assured that funds set aside for contribution to its minister's retirement are deposited into qualified accounts is to deliver its payments directly to the financial institution entrusted with the pastor's investments. Unless the church wishes to exceed the limits mentioned above (from $5,000/$6,000 for IRAs to $15,500/$20,500 for 403(b) plans) a check written by the church to the financial institution will work fine. Reporting on the pastor's Form W-2 at year-end will depend on the plan chosen. The options:

(a) IRC 403(b) plan—treat the payment as if it was additional compensation that was immediately elected by the pastor for withholding as an "elective deferral." The amount is excluded from his taxable income and reported in Box 12 (Code letter "E" is also entered). This amount can be increased by any additional amounts the minister elects to be withheld from his own cash compensation for deferral into the 403(b) plan.
(b) Traditional Individual Retirement Accounts (IRAs)—treat the payment as additional compensation reported as taxable income in Box 1. The pastor will take his IRA deduction on his personal return.
(c) Roth IRAs—treat the payment as additional compensation reported as taxable income in Box 1.

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