When the IRS examines tax returns relating to ministers, there are specific issues they look for. Thus, if you should be chosen for an audit, it’s important that we appropriately document your compliance with these issues. Doing so ahead of time will save time and money should an audit arise. It’s also important to identify issues that could result in you being picked for an audit so we can resolve those issues before you get chosen for an audit.
The ministerial duties you perform are important to the initial determination of whether you are a duly ordained, commissioned, or licensed minister and, thus, entitled to special tax treatment. Because religious disciplines vary in their formal procedures for these designations, whether you are a “duly ordained, commissioned, or licensed” depends on facts and circumstances. While this is generally easily determined, there are some situations where it is not so clear.
One of the issues the IRS will examine is the way in which you report your income. The determination of whether you are an employee or an independent contractor depends on certain established factors. How you are classified for income tax purposes affects how your expenses are treated. If you are a common law employee, you are limited to claiming trade or business expenses as an itemized deduction on Form 1040 Schedule A. Such expenses are subject to the 2 percent-of-adjusted-gross-income (AGI) limitation and are not deductible in computing alternative minimum tax.
As a minister, you are generally considered an employee. Your income, however, is considered self-employment income unless you’ve taken a vow of poverty or elected to be exempt from self-employment tax. If you have done either of these things, I need copies of the relevant paperwork. If not, we should discuss whether you meet the requirements to qualify for an exemption from self-employment tax.
Unless exempt, you are responsible for paying social security and Medicare taxes. Additionally, the payments you receive for services as a minister, unless statutorily exempt, are subject to income tax. Thus, you should be making estimated tax payments to avoid potential penalties for not paying enough tax as you earn income. An election is available to have income taxes withheld. If you do not already have such an election in place, we should discuss if this is appropriate for you.
Another issue the IRS focuses on with ministers is parsonage or housing allowances, which are exempt from income tax. However, the amount that is exempt is subject to limitations imposed by law and the exempt amount is subject to self employment tax. Because of the exemption from income tax for the “allowable” parsonage or housing allowance, business expenses must be allocated between taxable and non taxable income.
Other issues the IRS will examine are whether gifts given to you may actually be compensation for services and, thus, includible in income.
If you have any questions about what I’ve mentioned or you have any other issues you would like to discuss, please call me at your earliest convenience so we can resolve any issues before preparing your tax return.