The Tax Implications of Having a Clergy Position - Richard Greletski

The Tax Implications of Having a Clergy Position

By: Richard Greletski

April 19th, 2015

Richard Greletski 4/19/15 Research Project Final Paper

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Table of Contents

1. Table of Contents 2. Introduction

a. Writing for the purposes of a “minister of the Gospel” looking for the tax implications of his or her position (mostly focusing on Christian ministers)

b. Natural Progression c. Thesis Statement

3. Background a. Main Code Sections: Section 107 & 1402 b. What is a minister and what qualifies as ministry work?

i. Timeline ii. Five-Factor Test

iii. What categories of people actually qualify? iv. Key Issues & Non-Typical Examples

4. Dual Tax Status a. Both self-employed & employee of the church b. Variety of tests to determine tax status c. Employee Side d. Self-Employed Side e. Other Information

5. Participating in the Social Security System a. Subject to Self-Employed Contributions Act tax b. Form 4361 c. Other Information

6. Various Taxable Sources of Income for Clergy Members a. Compensation Love Offerings b. Different Examples of Taxable Income Sources c. Other Information

7. Two Major Exceptions to Those Taxable Sources of Income a. Parsonage Allowance

i. Excludable from Gross Income ii. Limitations to the Lesser of Three Amounts

iii. Qualified Home Expenses & Excess Parsonage Allowances iv. Double Dipping v. Multiple Residences

vi. Issues with Transferring Out of a Parsonage to an Individual Home vii. Constitutionality of the Parsonage Allowance

b. Gift Love Offerings i. Treated as a gift instead of compensation

ii. Examples & Cases 8. Health Care Costs

a. The Effect of the Affordable Care Act b. Employer Pays for Individual Health Insurance Coverage


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c. Employer Pays Out-of-Pocket Medical Expenses (Not Along With Group Coverage)

d. Employer Makes No Healthcare-Related Payments e. Employer Pays for Group Health Insurance Coverage f. Non-Insurance Arrangements: Health Care Sharing Ministries g. The Small Employer Health Insurance Tax Credit h. Things to Watch Out For

9. Retirement Plan Options a. General Retirement Options b. Tax Sheltered Annuities (TSAs) c. Traditional Individual Retirement Accounts (IRAs) d. Roth IRAs

10. Other Tax Snares to Avoid a. Tithing Expenses b. Executors of Trusts

11. Summary & Conclusion a. Restated Thesis Statement b. Balance is key c. Need to be aware d. Need to understand the benefits & ethical requirements e. Need to have a proactive approach

12. Footnotes 13. Bibliography


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The Tax Implications of Having a Clergy Position

One should doubt the first thing a minister or clergy member thinks of when getting

ordained is the tax implications of their new position. But that is an issue that must be thought

of and answered while having their vocation if they want to be able to save their hard earned

income. So in this research paper, I am writing for the purposes of a “minister of the Gospel”

looking for the tax implications of his or her position. In the process, I will be focusing mostly on

Christian ministers for my own interest and to limit the scope of this paper. When the term

“minister” is used throughout the paper, it is to coincide with the terminology of the Internal

Revenue Code (IRC) when it mentions “ministers of the Gospel”. It is important to understand

the natural progression a minister goes through in his or her life before we begin. First,

individuals interested in the ministry generally attend a college specializing in pastoral theology.

They obtain a degree from that college and usually become ordained by the institution’s

governing body or by their local church. However, sometimes before becoming ordained, the

individual works in a ministry for a period of time before becoming ordained by the institution’s

governing body, their local church, or church or religious order that employs them.1 So in this

paper I will be discussing what makes a person a minister, a minister’s dual tax status, a

minister possibly participating in the Social Security system, a minister’s various sources of

taxable income, the two exemptions to their taxable income, the possible health care costs that

ministers face, the retirement plan options available to ministers, and other tax snares for

ministers to avoid.

The two main sections located in the IRC, which is written by the Internal Revenue

Service (IRS), that determines who qualifies as a minister are Sections 107 and 1402. So what

makes someone a minister? According to Internal Revenue Service Publication 517 (2014), a

minister is someone who is “duly ordained, commissioned, or licensed by a religious body

constituting a church or church denomination.” The better question to ask first would be is

what classifies as minister work? Really what makes a minister a minister is what they do,

because a minister is defined by the duties he or she performs. Treasury Regulation 1.107-1(a)

1 Richard Marmon, Taxing Ministers of the Gospel, The CPA Journal (May 2013), p. 46


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states that the duties of a minister “include the performance of sacerdotal functions, the

conduct of religious worship, the administration and maintenance of religious organizations

and their integral agencies, and the performance of teaching and administrative duties at

theological seminaries.” In 1987, the Tax Court ruled in the case of Wingo v. Commissioner that

in order to identify oneself as a minister, the individual must carry out the duties and functions

of a minister within three types of services.2 According to Treas. Reg. 1.1402(c)-5(b)(2), these

three “services performed in the exercise of ministry” include the ministration of sacerdotal

functions; the conduct of religious worship; and the control, conduct, and maintenance of

religious organizations (including religious boards and societies) under the authority of a

religious body constituting a church or denomination.3 The Tax Court then realized that while

those three types of services must be met, the minister must also be qualified to provide such

services. Thus, the Wingo case led to the five-factor test we know today that determines who is

a minister and who is not. The test includes the previous three factors mentioned above, as

well as the individual being ordained, commissioned, or licensed, and the individual is

considered a spiritual leader by his or her church or denomination. However, the Court realized

the new test conflicted with the Regulations in that all five factors did not actually need to be

met, so the Court altered its position after the case of Knight v. Commissioner.4 In the case,

John Knight was ordained and could not manage the sacraments; but instead carried out

worship, was licensed, and was considered a spiritual leader in his church. So the Court stated

that a person must always be ordained, commissioned, or licensed, and the other four factors

must be evaluated for each taxpayer on a case-by-case basis.5 Because of the decision by the

Courts in Knight, an individual does not need to fulfill all five factors to qualify as a minister;

only the fourth factor is critical.

So according to the five-factor test, what categories of people actually qualify? For one,

those in traditional clergy roles (such as priests, pastors, and rabbis) who normally perform

sacerdotal functions and lead worship qualify as ministers. Second, those who work for secular

2 Wingo v. Commissioner, 89 T.C. 922 (1987)

3 Ted Englebrecht & Jonathan Cameron, Tax Planning Rules for Ministers, The CPA Journal (September 2008), p. 40

4 Knight v. Commissioner, 92 T.C. 199 (1989)

5 Paul Schloemer, Clergy Tax Rules Extend Beyond Churches, The Tax Adviser (July 2009), p. 467


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organizations to the extent they perform sacerdotal functions and lead worship also qualify.

Third, those who manage and uphold religious organizations at the local church or

denominational level qualify. Fourth and finally, teachers and administrators at seminaries

qualify as well; although there are some exceptions to this that will be addressed shortly.

Nevertheless, we run into two key issues when determining who meets the criteria for minister

status. Those two issues would be a matter of being under proper authority and following the

rules. Are the minister’s services performed under the authority of a church or denomination?

Are the minister’s duties included in the appropriate regulations (Reg 1.107-1)? Fulfilling the

requirements of the second issue would be more vital because “individuals performing minister

duties outside of their church or denomination can qualify as a minister depending on those

duties” anyway. An example of this is a chaplain employed by a secular organization, because

the chaplain manages sacraments and conducts worship.6 Looking at the Regulations,

specifically Treas. Reg. 1.1402(c)-5, we can find some uncommon illustrations of people who

qualify as a minister. For example, an ordained chaplain at a university who teaches a religion

class, provides spiritual counseling, and conducts worship services fits the requirements of a

minister.7 Also, a person who performs the duties of a minister while conducting religious

worship and performing sacerdotal functions, even if his or her other employment is not

ministry related, is considered a minister.8 Thirdly, an ordained minister managing an agency of

that denomination fits the bill for minister status.9 And lastly, an ordained minister assigned by

his or her denomination to direct a company in the publication of a book about that

denomination qualifies as a minister.10 So from those four examples, while some aspects are

different in each scenario, the main core concepts are similar; that is, the minister being official

and performing his or her duties.

Outside of the examples from the Regulations however, it is harder to qualify as a

minister. That is when court cases and IRS Rulings come into play, because the courts issue

6 Paul Schloemer, Clergy Tax Rules Extend Beyond Churches, The Tax Adviser (July 2009), p. 466

7 Treas. Reg. 1.1402(c)-5(b)(2)(iii)

8 Treas. Reg. 1.1402(c)-5(c)(2))

9 Treas. Reg. 1.1402(c)-5(b)(2)(iv)

10 Treas. Reg. 1.1402(c)-5(b)(2)(v)


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different rulings depending on the specific circumstances of the taxpayer. For example, there

was a Jewish cantor who met the definition of a minister because he had a position of authority

similar to that of a rabbi and, with one exception, performed all of the duties of a religious

leader in the Jewish faith.11 In a case similar to Salkov was where another Jewish cantor

qualified as a minister, even though he was not officially ordained (formal ordination is not

required in the Jewish faith) and only worked part-time.12 In another case, there was a minister

of education in a Baptist church who the Tax Court ruled against, even though he had Master’s

Degree from a Baptist seminary. The Court ruled against him because he was not an ordained

minister and did not control sacraments or preach at any worship services.13 Mentioned earlier

was the fact that even though teachers and administrators at seminaries qualify as ministers

according to Treas. Reg. 1.107-1(a), there are some exceptions to the rule. In order to be

eligible for minister status, the educational institution the teacher or administrator works at

must be an essential part of a church or denomination. Because of this, faculty and

administrators at interdenominational seminaries do not qualify because the seminaries they

work for are not run by a specific church or denomination.14 Teachers and administrators at

elementary and secondary schools do not qualify as well because there is a lack of control from

a church or denomination, even if the school has a religious purpose.15 Even the people

“employed by church-controlled schools cannot qualify as ministers if they are not ordained or

commissioned and their duties are indistinguishable from those of employees at secular

schools.”16 However, there is a rare case when these teachers and administrators would qualify.

For example, an ordained rabbi at a school run by the local synagogue who teaches classes on

religion, performs worship services, and prepares students for adult life in the Jewish

11

Salkov v. Commissioner, 46 T.C. 190 (1966) 12

Silverman v. Commissioner, 57 T.C. 727 (1972) 13

Lawrence v. Commissioner, 50 T.C. 494 (1968) 14

Rev. Rul. 63-90, 1963-1 C.B. 27 & IRS Letter Ruling 7833017 15

IRS Letter Ruling 8646018 16

Paul Schloemer, Clergy Tax Rules Extend Beyond Churches, The Tax Adviser (July 2009), p. 468 & IRS Letter Ruling 200318002


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community would qualify as a minister in the eyes of the IRS.17 So eligibility really depends on

the facts and circumstances of each scenario.

If being outside of the examples in the Regulations but inside of the church or a church-

affiliated organization made it difficult to qualify as a minister, fitting the requirements as an

employee of a non-church organization is almost unobtainable. The IRS however leaves leeway

for some people to potentially qualify. For example, chaplains that lead worship and perform

sacerdotal functions qualify, even if they work for non-church organizations. A minister

“performing these two functions is the key factor” in the case and rulings to follow.18 There was

a chaplain by the name of Cauthion Boyd who was employed by the Indianapolis Police

Department. He qualified as a minister because he performed the specific duties of his position

under the close supervision of an alliance of churches, which gave Boyd a connection to a

precise religious organization.19 There was also an ordained minister named Ray Whittington

who was working for an evangelical organization that qualified. Even though the organization

produced religious media materials, as well as conducted various crusades, it was not affiliated

with a specific church or denomination. Nevertheless, the Tax Court stated that the followers of

the organization were like the "body of believers" of a church, because they were loyal to the

organization and time and again attended its worship services and crusades. Thus Whittington

qualified as a minister, but did not qualify for a housing allowance because he did not work for

an explicit church or denomination.20 While there are other relevant IRS Rulings, those

decisions are outdated and only the taxpayers that requested those specific rulings can rely on

them. Now since the Knight case, the IRS no longer issues private letter rulings or

determination letters because each case is unique.21 According to IRS Publication 1828, the IRS

also no longer provides an exact definition of what a minister is in its latest edition of their Tax

Guide for Churches and Religious Organizations, but instead a very broad one. Hopefully with all

of that information, one can properly determine whether or not they qualify as a minister.

17

IRS Letter Ruling 9126048 18

Paul Schloemer, Clergy Tax Rules Extend Beyond Churches, The Tax Adviser (July 2009), p. 468 19

Boyd v. Commissioner, T.C. Memo, 1981-528 20

Whittington v. Commissioner, T.C. Memo, 2000-296 21

Rev. Proc. 2012-3


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Now ministers have a unique dual tax status in which they are treated as both self-

employed and an employee of the church or other organization they work for. For federal tax

purposes they are employees, while for Social Security and Medicare tax purposes they are self-

employed. The IRS and the courts use a variety of tests to determine the tax status of an

individual. One of those tests is the Common Law Employee Test, which considers an individual

either employed or self-employed under common-law rules according to IRS Publication 517.

Next is the IRS 20-factor test, which includes twenty factors that the IRS looks at to consider if

an employer-employee relationship exists. These factors include: instructions; training;

integration; services rendered personally; hiring, supervising, and paying assistants; continuing

relationship; set hours of work; full time required; doing work on employer's premises; order or

sequence set; oral or written reports; payment by hour, week, month; payment of business

and/or traveling expenses; furnishing of tools and materials; significant investment; realization

of profit and loss; working for more than one firm at a time; making service available to the

general public; right to discharge; and the right to terminate.22 Then there is the Tax Court’s

seven-factor test that is used to differentiate between employee and self-employed status.

These factors include: degree of control exercised by the principal over the details of the work

(the most crucial test), which party invests in the facilities used in the work, opportunity of the

individual for profit or loss, whether the principal has the right to discharge the worker,

whether the work is part of the principal’s regular business, the permanency of the

relationship, and the relationship the parties believe they are creating.23 Because of these three

tests, most ministers will be considered employees for federal tax purposes.24 While some

ministers try to get out of paying federal income tax, they are not exempt and still have to pay

it. One pastor claimed that he was not liable for the income taxes the IRS thought he owed

because “he was not a citizen of the United States but rather, ‘of the place he intended to

eventually and permanently reside, which is heaven.’” McGugan also claimed that he “received

no wages, but that he and his family were ‘supernaturally provided for by the Lord Jesus Christ

22

Rev. Rul. 87-41, 1987-1 CB 296 23

Weber v. Commissioner, 103 T.C. 378 (1994) 24

Ted Englebrecht & Jonathan Cameron, Tax Planning Rules for Ministers, The CPA Journal (September 2008), p. 43


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through the unsolicited freewill love offerings of others.’”25 When ministers such as McGugan

make arguments such as these, they “are dismissed as frivolous by the IRS, and substantial

penalties, back taxes, and interest may result” because of a lack of payment.26 The IRS can call

these disputes frivolous because in the case of Murdock v. Pennsylvania, the Supreme Court

ruled that making ministers pay income tax on their earnings is not infringing upon their First

Amendment religious freedom.27

When it comes to the employee side of minister status, there are both pros and cons.

Let us begin with the negative side. One negative aspect of being classified as an employee is

that unreimbursed business expenses are reported on Schedule A and are subject to the 2% of

adjusted gross income (AGI) floor. 28 However, if a minister does not itemize, he will not receive

any tax benefit from unreimbursed business expenses, so it will not matter anyways. Another

negative aspect is the Deason Rule. According to Section 265(a)(1), if a minister receives tax

exempt income, such as a parsonage or housing allowance, the expenses allocable to such

income are not deductible. The Deason Rule “requires ministers to reduce their deduction for

unreimbursed business expenses by the percentage of income that is tax-exempt”.29 However,

these business expenses are fully deductable from self-employment tax, and the rule itself does

not apply to real estate taxes or mortgage interest.30 At the end of the day, the Deason Rule is

easily countered with a properly structured accountable reimbursement plan, which will be

mentioned shortly. Now let us address the positive side. In the opinion of tax professional

Laurence Dresner, it is better to be classified as an employee than self-employed for federal tax

purposes. For one, certain fringe benefits may be excluded from taxable income. These include

benefits such as employer-paid health insurance premiums, life insurance premiums, group-

term life insurance, and contributions to retirement accounts. Ministers may also be

reimbursed for business expenses without an income tax effect, as long as the reimbursements

25

McGugan v. Katzmar, 96 AFTR2d 2005-7182 (DC NJ, 11/14/2005) 26

Ted Englebrecht & Jonathan Cameron, Tax Planning Rules for Ministers, The CPA Journal (September 2008), p. 41 27

Murdock v. Pennsylvania, 319 U.S. 105 (1943) 28

Laurence Dresner, Ministering to Clergy: Special Tax Rules Create Financial Planning Challenges & Opportunities for These Unique Clients, Financial Planning (December 2005), p. 1 29


Deason v. Commissioner, 41 T.C. 465 (1964)


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are part of an “accountable plan”. An accountable plan is an understanding that requires

business expenses to be legitimate, authentic, and reimbursable, all within a reasonable

amount of time. This plan counteracts the Deason Rule mentioned above. There are four

requirements for an accountable plan according to Section 1.62-2. These requirements include

the following: “the expenses must have a business connection (they must be incurred by the

minister while performing services as an employee of the organization), the minister must

provide adequate accounting of the expenses to the employer within a reasonable amount of

time (no more than 60 days after the expense is incurred), any excess reimbursements must be

returned to the employer within a reasonable amount of time (no more than 120 days after the

reimbursement is paid), and the reimbursements must be paid with the employer’s funds and

must not reduce the employee’s salary.”31 Some examples of qualifying business expenses for

ministers are telephone bills, supply purchases, fees for maintaining credentials, and even dry

cleaning for robes & other religious vestments. Now under an accountable plan that is

structured correctly, reimbursements are not included in taxable income. However, the

opposite is true with a non-accountable plan. And third, employees have a lower risk of being

audited than self-employed individuals. If a clergy member gets audited and is reclassified as an

employee by the IRS, there are penalties and additional taxes that the taxpayer will end up

having to pay. 32

And when it comes to the self-employed side of minister status, there are also both pros

and cons. Let us start with the negatives, besides the ones already mentioned. For one,

ministers must pay Social Security taxes of 12.4% on income up to $118,500 for 2015 and 2.9%

for Medicare on their entire net earnings, just like regular self-employed taxpayers. Also, if the

minister’s earned income is more than $200,000 ($250,000 for married couples filing jointly),

they must pay 0.9% more in Medicare taxes.33 Another negative would be that parsonage and

housing allowances are still includable in income when computing self-employment taxes. This

is not like federal income tax, where those allowances are excluded from income for tax

31



Social Security Administration, “If You're Self-Employed” (2015), p. 1


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purposes, and is a common error by tax preparers. On the other hand, it seems like that there is

really only one positive of being a self-employed minister that has not been touched upon. That

would be that one-half of self-employment tax may be deducted on Form 1040 when

computing AGI.34 It seems fairly certain that being an employee of a church or other

organization is definitely more beneficial than being a self-employed minister.

On top of being able to exclude income from federal income tax, ministers are also

exempt from federal tax withholding. According to Section 3401(a)(9), ministers who are

classified as employees are exempt from federal withholding only with respect to wages earned

for “services performed in the exercise of their ministry”.35 These services are the same as the

ones that help define a minister and include the following: “ministration of sacerdotal

functions, conducting religious worship services, and control and maintenance of religious

organizations under the authority of a church or denomination”.36 Because of this exemption,

ministers pay estimated taxes in quarterly installments. According to Section 3402(p)(3),

ministers can voluntarily elect to have federal taxes withheld from their W-2 wages. This is

often preferred to paying estimated tax payments because “voluntary withholding lessens the

quarterly or year-end tax liability and reduces the chance of incurring penalties for

underpayment of taxes”. However, even if ministers choose to opt into withholding tax, they

are still responsible for making estimated payments of self-employment tax. So rather than

paying an approximation of self-employment tax, ministers may specify (on Form W-4, Line 6)

an additional amount to be withheld from their wages to offset self-employment tax liability.

Such tax would be on self-employment income such as fees paid directly to the minister for

events like baptisms, weddings, and funerals. This income is also “not subject to withholding

and is reported on Schedule C.” Also, income earned at a secular job, in addition to and outside

of their duties as a religious leader, is not exempt from federal withholding tax because none of

the special tax rules for ministers apply to income earned from secular jobs. 37

34



Treas. Reg 1.1402(c)-5(b)(2) 37



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A crucial decision clergy members have to make when they first become ministers is

whether or not they want to participate in the Social Security system and be subject to Self-

Employed Contributions Act (SECA) tax. In order to opt-out, the minister needs to fill out Form

4361, which is the “Application for Exemption from Self-Employment Tax for Use by Ministers,

Members of Religious Orders and Christian Science Practitioner”, and state his or her specific

religious reason(s) for opting out. These reasons can only be ones of religious value, and not for

economic purposes. An example of a minister’s Biblical grounds for opting out would be being

opposed to accepting public insurance because he or she thinks it is “bad stewardship”, or a

poor way of investing his or her hard-earned money. According to Section 1402(e)(3), Form

4361 must be filed by “the due date for the tax return for the second tax year in which net

earnings from self-employment are at least $400” and the exemption will be effective for the

first taxable year in which the minister has net self-employment earnings from ministerial work.

The minister has to write a letter explaining the reason(s) for requesting an exemption on top

of sending in Form 4361. This request is subject to IRS approval, and may take as long as nine

months to be approved. But once the exemption is granted by the IRS, it is irrevocable

according to Section 1402(e)(4). In the meantime, the minister must also notify “the ordaining,

commissioning, or licensing body of the church or order” that he or she works for that he or she

opposes such insurance. Once the IRS receives the application, they will mail a statement to the

minister describing the rationale behind why the exemption was granted, if it is granted at all.

The minister has 90 days from the date of the IRS’s mailing to confirm that he or she is

requesting the exemption based upon those assigned reasons by signing a copy of the

statement under penalty of perjury and returning it to the IRS. In addition, there are some

members of religious orders who have already taken a vow of poverty, thus being automatically

exempt from Social Security and they do not have to file Form 4361.38 Now the taxpayer has

two years to opt-out from when he or she first became a minister. If he or she misses that two-

year deadline, the minister is forever disqualified from opting out of Social Security. This is not

38

Paul Schloemer, Clergy Tax Rules Extend Beyond Churches, The Tax Adviser (July 2009), p. 470


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an election that can be made by the minister’s spouse or estate, and terminates on the date of

death.39

When the minister is officially opted-out, he or she must provide for their own

retirement funds, long-term disability savings or insurance, life insurance or survivor savings,

and retirement era health care. Also his or her Social Security tax-exempt status only applies to

ministerial income, so FICA tax will continue to be withheld by the minister’s non-ministerial

employers, if he or she has any.40 Also, a minister who opted out of Social Security may

purchase Medicare insurance after the age of 65.41 Down the road, a minister can potentially

save thousands of dollars each year in self-employment taxes, but it is really important that

they have a plan to provide for their own financial stewardship. At the end of the day, some

ministers choose not to opt-out of Social Security. Those ministers who did not opt out of Social

Security will be responsible for self-employment tax on their earnings. They will have to file

Form SE (Self-Employment Tax) and include their net self-employment earnings in the

calculation of the tax. Net self-employment earnings for this purpose are computed without

using Sections 107, 119, and 911; and will also include income tax or self-employment tax from

the religious organization that the minister works for paid on the minister’s behalf.42

It is time to address the various taxable sources of income that clergy members may

potentially have. The two main sources would be salary and various love offerings that are

treated like a contribution. A love offering is any payment for services rendered in an official

capacity in the ministry. These offerings will be discussed more later on, but it is important to

know that love offerings that are treated as contributions are essentially the minister’s taxable

gross income. Examples of these love offerings are book sales, honorariums for weddings and

funerals, publishing royalties, and various speaking arrangements. According to Bishop Jamie

Soto, a leader of the Sacramento diocese of the Catholic Church, “priests are allowed to accept

offerings for sacraments, but they must be given freely.” In the Catholic faith, sacraments, such

as weddings and baptisms, are sacred ceremonies signifying God's grace and presence. He

39


Top 10 Questions that Ministers, Missionaries, & Church Treasurers Ask Tax Preparers, Ministry CPA (2014), p. 11 41

Richard Hammar, Church & Clergy Tax Guide, Christianity Today International (2007), p. 458 42

Rev. Rul. 68-507, 1968-2 C.B. 485


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states that “any practice that would imply that a Catholic must pay for the sacraments would be

contrary to the Church's understanding of God's love.” And according to the Right Rev. Barry

Beisner, a leader of the Episcopal Diocese of Northern California based in Sacramento, “it is up

to each individual clergy person as to whether they are paid something beyond their usual

salary.” Both statements would imply that these fees are still contributions to a minister, and

therefore taxable income. However some clergy prefer not to be paid and do not accept a fee,

such as Rabbi Mona Alfi of Congregation B'nai Israel in Sacramento. She states that she does

not “get paid for weddings because that is covered in their membership”. Instead, she has a

discretionary funds account so that members who want to give her a gift can donate to the

fund instead for scholarships for local children.43 There was also the case of Chambers v.

Commissioner where the Tax Court determined that a minister and his wife must include

amounts deposited in the bank accounts of their church in their gross income.44 This was

because the taxpayer and his wife exercised complete control over the bank accounts and used

money from the accounts to pay for personal expenses.45 Had the couple kept better records

and produced them to the IRS, another result may have occurred in this case.

After discussing various sources of income ministers may have, it is very important to

discuss the two major exceptions to those taxable sources of income. The first main topic is the

parsonage allowance. Almost 100 years old, “parsonage originated when many congregations

provided housing to attract clergy to their communities".46 The parsonage allowance began as

just an allowance for the actual housing the minister received. Now it includes parsonage

allowances, as well as rental allowances and housing allowances.47 So these allowances are

excludable from gross income as long as the funds are used to provide a home for the pastor.

The items includable in the allowance are total mortgage payments; mortgage interest; real

estate taxes on homes purchased with tax-exempt parsonage income; down payment on

house; homeowner’s/renter's insurance; structural repairs/remodeling; maintenance items

43

Jennifer Garza, Clergy Pay for Wedding - Or Is It a Gift, McClatchy - Tribune Business News (2010), p. 1 44

Chambers v. Commissioner, T.C. 2011-114 45

Church Account Deposits Were Includable In Minister's Gross Income, Practical Tax Strategies (2011), p. 1-3 46




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(pest control, etc); furniture, furnishings, and appliances; utilities (heat, lights, water, sewer,

telephone, water softener, cable, waste disposal, etc); yard maintenance & improvements; rent

paid; repairs paid personally; loan refinancing costs; and more. Costs for food and household

employee compensations (essentially servants) are not excluded from the allowance.48 The

amounts received by ministers for parsonage are not deducted from income, but instead just

not included in their income. Now the allowance is limited to the least of the following three

amounts: the amount used to provide the home, the amount officially designated as a housing

allowance, and the fair rental value of the home. There is no limit to the allowance as long as

the proper procedures are followed. In regards to the amount officially designated as a housing

allowance, the minister needs to be meticulous when it comes to estimating living expenses for

the upcoming year in order to accurately determine the amount of housing allowance he or she

will need. If the designated housing allowance ends up being less than the actual expenses

incurred, the exclusion from the minister’s income is limited to the amount of the housing

allowance actually used; thus losing potentially significant tax benefits. In regards to the fair

rental value of the home, the amount should equal the rental value of the furnished home plus

utilities. Determining the fair rental value should be done at arm’s length, and possibly by a real

estate professional. The agent should come up with an estimate which is usually a range of

values, and should write up and sign an appropriate estimate report in the event of an IRS

audit.49 Churches view this allowance as “a tool to provide much-needed compensation tax-free

because many congregations are only able to pay their ministers a low or modest salary.”50 It

shouldn’t be unreasonably large compared to the minister’s compensation package however,

because otherwise the excess may be considered taxable income.51 Also, “the amount of

parsonage allowances paid should be kept consistent by a religious organization, especially in

situations where the pastor is in control of setting the allowance.”52 There was one court case,

where a church lost its tax-exempt status over the widely fluctuating parsonage allowances it

48

Rev. Rul. 87-32, 1987-1 C.B. 131 & Richard Hammar, The Church & Clergy Tax Guide (2007), p. 233 49


Frances McNair, Edward Milam, & Deborah Seifert, Tax Planning for Servants of God, Journal of Accountancy (October 2004), pp. 65-69 51

Rev. Rul. 78-448, 1978-2 C.B. 105 52

Richard Marmon, Taxing Ministers of the Gospel, The CPA Journal (May 2013), p. 48


17

paid to a pastor.53 In addition, if more than 50% of an employee's time is devoted to non-

ministry duties, a church would struggle with granting a housing allowance to its minister.54

It is important that the church the minister works for designates the specific parsonage

amount in an employment contract, in minutes of a business meeting, in its budget, or another

appropriate instrument that shows an official amount.55 According to IRS Publication 517, this

definite amount must be decided upon at the beginning of each year, and it cannot be

retroactive. It is also important that the church estimates the fair rental value of the parsonage,

including a separate amount for any church-paid utilities. The church should then include those

amounts in the minister’s W-2 as amounts that are subject only to self-employment tax.56 Also,

while property taxes and mortgage interest may be included in a designated housing allowance,

these items may also be taken as itemized deductions on Schedule A.57 And if a pastor has

officially opted out of Social Security, “remuneration received in the form of a parsonage

allowance or the rental value of a church-provided dwelling will be totally exempt from all

federal taxes”. This exclusion does not fall within Section 119, which requires that lodging is an

employment stipulation.58 Now let us look at the difference between qualified home expenses

and excess parsonage allowances. Like mentioned earlier, excess parsonage allowance must be

reported as taxable income to the extent of how much of the allowance exceeds actual usage

or rental value.59 The Clergy Housing Clarification Act of 2002 got rid of the previous rule, which

had all excess housing allowances excluded from income. Qualified home expenses on the

other hand help alleviate the problem of excess parsonage allowances. These expenses become

a part of the parsonage allowance, and are why they are includable in the items list above. For

example, these expenses may include “outbuildings or appurtenances; repairs and

maintenance; utilities; and furnishings”, and excludes food and servants.60 An allowance used

53

Unitary Mission Church of Long Island v. Commissioner, 74 T.C. 507 (1980) 54

Paul Schloemer & Ryan Wilson, Minister Housing Allowance Presents New Challenges, The CPA Journal (December 2005), p. 46 55

Treas. Reg. 1.107-1(b) 56

Richard Marmon, Taxing Ministers of the Gospel, The CPA Journal (May 2013), p. 47 57

Rev. Rul. 87-32, 1987-1 C.B. 131 58



Treas. Reg. Section 1.107-1(c)


18

for rent or for a down payment or mortgage payment, including real estate taxes and insurance

on a minister’s home, qualifies for the exemption. For example, a minister who lives in a

church-provided parsonage and at the same time receives a housing allowance will have

taxable income to the extent of the allowance, that is subject to both SECA and federal income

taxes, if he or she has not opted out of Social Security.61

Then there are the issues of separate double dipping, having multiple residences, and

transferring out of a parsonage. In regards to double dipping, clergy can use income that is not

taxed to purchase a home, while at the same time being able to deduct the interest they pay on

their mortgage and property taxes.62 When ministers own multiple residences, having those

two (or more) separate residences can possibly qualify for a parsonage allowance. In the case of

Driscoll v. Commissioner, the Tax Court did not find any convincing evidence from previous

history that Congress had intended to limit the parsonage allowance to just one home, and

believed that although the word “home” is singular in Section 107, it should be interpreted

broadly as one that includes multiple homes because of Section 7701(p) and the

plurality/singular substitution rule of 1 Section 11.63 However, this all depends on the court

circuit that the residences are located in. Driscoll was overturned by the US Court of Appeals for

the 11th Circuit, which looked to previous history of Section 107 to find that Congress did intend

to limit the parsonage allowance for only one home, not multiple homes. Because the Tax Court

will only follow appellate decisions for plaintiffs situated in the particular circuit where that

decision was made, rather than generally, dual exclusions may still be an option in other

circuits.64 Then there is the issue of transferring out of a parsonage to an individual home. First,

any property given to the minister by the church will be regarded as taxable income at its fair

market value, and has its value reduced by any payment by to the church by the minister.

Second, because the minister will no longer be living in the tax-exempt housing, his or her costs

of living will increase as a result. Third, a housing allowance being tax-free may not fully

eliminate the taxability of any singular large bonus to the minister, even if it is entirely paid out

61


Erin Wisdom, Recent Ruling Challenges Clergy Housing Allowance, McClatchy - Tribune Business News (2014), p.1 63

Driscoll v. Commissioner, 135 T.C. 557, 558-59 (2010) 64

Commissioner v. Driscoll, 669 F.3d 1309 (11th Cir. 2012)


19

to build or purchase a home for the minister. This is because a housing allowance cannot

exceed the annual fair rental value of a minister’s housing. And fourth, interest-free or below

market rate loans made to the minister from the church, as well as “principal forgiveness

arrangements” as a return for being a loyal employee can help the minister’s transition from a

parsonage to homeownership. It is important however that IRS income reporting rules are

followed, and a written agreement that “reflects the true substance of a legally binding

arrangement” between the minister and the church does exist. A possible tax saving

opportunity for a minister is to use December and January “bonuses” to assist him or her in

building or purchasing a home. If done correctly, this can spread the income and self-

employment tax costs over two different tax years for the minister. Even “principal forgiveness

arrangements” created as legitimate income for loyalty can spread these tax costs even further

out over several consecutive years.65

It is easy to see how useful the parsonage allowance is for ministers, and there are some

critics out there that are not such a fan of what they think is an unfair advantage. For starters,

religion in the United States is a multi-billion dollar industry. The value of real estate held by

religious institutions has multiplied by over 200 times in the last 100 years, and is consistently

growing at an exponential rate, reaching an amount in the hundreds of billions. Interestingly

enough, religious institutions are the largest private owners of land in the United States. They

also “own thousands of radio stations, hundreds of television stations, thousands of magazines

and newspapers”, as well as “insurance companies, hospitals, health maintenance

organizations, banks, and transportation companies”. It is not that critics have a problem with

religious institutions, regardless of size, getting special treatment by the IRS. They merely think

that such organizations do not really need government assistance in the form of a parsonage

allowance exclusion, and tax-exemptions in general.66 In defense of the parsonage allowance,

ministers will state that if the courts end up eliminating the housing allowance, it would likely

“raise the question of whether clergy must pay income tax on the fair rental value of their

parsonage”. Rev. Scott Killgore of Wyatt Park Christian Church claims that “if the taxing

65


Kamron Keele, No More Tax-Free Mansions for Dubious Ministers of the Gospel, The Tax Lawyer (2002), p. 26


20

authorities would let (him) pay the 7.65% that most employed people pay for Social Security,

(he would) gladly give up the housing allowance.” Rev. Donna Ross of Zion United Church of

Christ notes that since many ministers move frequently because of a change in potential calling,

the housing allowance helps compensate for that lack of being able to take advantage of “tax

breaks for home ownership”. Ultimately Rev. Kilgore believes that potentially losing the

exemption “should not keep anyone from becoming a minister” because “the tax laws did not

have any influence on (his) decision to enter the ministry...God's love and God's call upon (his)

life did”.67

Some people do not buy what those ministers selling however, and question the

constitutionality of the parsonage allowance. There are two major cases that deal with the

constitutionality of that exemption, and one of them is the case of Warren v. Commissioner. It

was surprising to see that an appeals court questioned the constitutionality of these

allowances, even though the parties in the Warren case did not raise the question of

constitutionality.68 In the case, the IRS challenged the Warrens on how much the couple spent

on their housing and the home’s fair rental value. The IRS originally took away the housing

allowance exclusion for the amounts they spent in excess of the fair rental value. However as a

result of the case, the Tax Court determined that the Warrens could exclude the full amount.

They came to this conclusion by assessing the wording and history of Section 107, and agreed

that the Code Section did not limit their exclusion. 69 The IRS then appealed to the Ninth Circuit,

and the Clergy Housing Allowance Clarification Act (PL 107-181) was passed by “unanimous

vote” in order to avoid future Warren cases from occurring in the future. This law allows the IRS

to limit housing allowances to the home’s fair rental value. However the IRS’s appeal to the

Ninth Circuit was ultimately dismissed, but creating the law was a victory for the IRS in itself.70

The second case is Freedom from Religion Foundation, Inc. v. Lew and shows that the parsonage

allowance is still under fire today. In 2013, a US District Court in Wisconsin ruled that the

67

Erin Wisdom, Recent Ruling Challenges Clergy Housing Allowance, McClatchy - Tribune Business News (2014), p. 1-2 68


Warren v. Commissioner, 90 AFTR2d 2002-6058 (CA-9, 2002) 70

Ronald Hiner & Darlene Smith, The Constitutionality of the Parsonage Allowance, Journal of Accountancy (2002), p. 1-2


21

exclusion violated the Establishment Clause of the First Amendment according to Section

107(2). In the case, Freedom from Religion Foundation Inc. (FRF) and its two co-presidents,

Annie Gaylor and Dan Barker, claimed that the exclusion from income went against the

language of the First Amendment.71 The First Amendment specifically states that “Congress

shall make no law respecting an establishment of religion”.72 The Court agreed with FRF after

using a customized version of a test created in the case of Lemon v. Kurtzman, and established

that it “lacks a secular purpose or effect and that a reasonable observer would view it as

endorsing religion”.73 Therefore, the Court also agreed with FRF’s claim that they were unjustly

excluded from claiming an exemption given to certain other individuals, and that the Court

could help fix the situation. The lawsuit against Lew had also originally challenged Section

107(1) as well, which deals with the exclusion of the rental value of a home from gross income,

but FRF eventually dropped that claim because the case was determined so quickly without

going to trial. In addition, the Court cited the Supreme Court’s holding in Texas Monthly, Inc. v.

Bullock in defense of their reasoning. In the case, Texas Monthly “dealt with a state sales tax

exemption for religious literature”, and it was ruled that the exemption went against the

Establishment Clause because it was “provided only to religious persons”. So going back to the

case of Freedom from Religion Foundation, Inc. v. Lew, the Court agreed with the decision in

Texas Monthly, Inc. that “because the primary function of a minister is to disseminate religious

messages, a housing exclusion provided only to ministers treats religious messages

preferentially over secular ones”.74 Nevertheless, the Court kept the enforcement of this new

look at Section 107(2) pending until the appeal of the case was completed. It was not until

November 13th, 2014 that the Seventh Circuit “rejected the atheists’ lawsuit, allowing ministers

of all faiths to continue receiving housing allowances on the same terms as thousands of

secular employees.75

71

Alice Upshaw, District Court Rules Parsonage Allowance Unconstitutional, Journal of Accountancy (2014), p. 1-2 72

Freedom from Religion Foundation, Inc. v. Lew, 14-1152 (7th Cir. 2013) 73

Lemon v. Kurtzman, 403 U.S. 602 (1971) 74

Texas Monthly, Inc. v. Bullock, 489 U.S. 1 (1989) 75

Freedom from Religion Foundation v. Lew – Parsonage Exemption Case, Becket Fund (2014), p. 1


22

Now it is time to discuss love offerings, but more specifically gift love offerings.

Mentioned earlier was the compensation form of love offerings, and the fact that it is taxable

income for the minister who receives it. According to Section 61, compensation is taxable gross

income that ministers earn doing their job. This includes items such as fees, commissions, fringe

benefits, and many others. So if a member of the minister’s church wants to provide additional

compensation to his or her minister in recognition of services rendered, on top of his or her

already-existing salary, it will normally be treated as taxable income rather than a tax-free gift.

Below is an example of how a minister’s compensation may look like:

76

On the other hand, the gift form of love offerings are treated as exactly that, a gift, and

therefore not taxable income for the minister who receives it. There are no clear Code sections

or Regulations specifically about love offerings, but certain court cases help us determine this

fact. But what exactly is a gift? A gift is defined as a transfer made with donative intent; one

made out of “affection, respect, admiration, charity or like impulses”77 However, just because a

donor declares that a transfer is a gift does not make it so. Any “gifts” paid to employees by the

76


Commissioner v. Duberstein, 60-2 USTC, 363 U.S. 278 (1960)


23

churches they work for are considered taxable income and must be reported along with his or

her other earnings on Forms 941 and W-2. The only exception to the rule involves “gifts of

tangible personal property valued less than $25”.78 Below are examples of how a minister’s

Form 941 and W-2 form may look like:

79

78


Top 10 Questions that Ministers, Missionaries, & Church Treasurers Ask Tax Preparers, Ministry CPA (2014), p. 8


24

80

In order to get a better understanding of gift love offerings, we need to look into the

case of Goodwin v. United States. The United States Court of Appeals for the Eighth Circuit

reflected on two main criteria when determining that “special occasion gifts” received by a

pastor were taxable income. One of those key criteria was the existence of a “collection for a

pastor initiated by congregational leaders in a routinized, highly structured program, even if not

compelled and made anonymously by individual members”. Another one of those key criteria

was the fact the determination of certain payments being made “on behalf of the entire

congregation” or not. So the case of Goodwin showed that there was a difference between

“spontaneous gifts given to a pastor by individual members in response to an inspiring sermon”

and those made officially by the church the pastor works for; the former being a gift and the

later being taxable income. 81 The Court came to the conclusion “that the special occasion gifts

were substantial in comparison to the pastor’s salary and that the congregation knew that

without the routine cash payments, the church could not reasonably assure the pastor’s

continued service”. 82 Thus, the typical Christmas bonus collection received by many ministers

80


Goodwin v. United States, 95-2 USTC, 67 F3d 149 (8th Cir. 1995) 82

Richard Marmon, Taxing Ministers of the Gospel, The CPA Journal (May 2013), p. 48


25

from their congregation represents fully taxable compensation, and not a gift.83 So individuals

who donate to a “church-sponsored collection” may write off their contribution as a tax-

deductible donation. On the other hand, personal gifts to a minister from an individual in the

church are tax-free to the minister, but not deductible by the individual. This is important to

know for ministers because only one party gets the tax benefit. There are three potential safe

harbors ministers may use to avoid calling income compensation, and instead calling them a

gift. One of those safe harbors would be for churches to “not take up an official collection for a

particular church worker for any reason” if they want those payments to remain tax-free.

Another one of those safe harbors would be taking care “in drafting language that conveys

donative intent rather than a compensatory motive”. The third safe harbor would be having the

church paying the minister a competitive salary and parsonage allowance on a consistent basis,

without having those ministers relying upon “supplementary additional collections”.84 So if the

correct procedures are followed, ministers should be able to avoid unnecessary contributions.

But enough discussion about the taxability of a minister’s income, and let us move

towards discussing a minister’s potential health care costs, possible health care plans, and how

the Affordable Care Act (ACA) plays a role in all of this (PL 111-148). First, we need to look at

the effect of the ACA on ministers and their health. The ACA forces a large majority of churches

to re-assess the medical benefits that they present to their employees. For a church that

employs a single employee (a solo minister), the ACA has one set of requirements, and thus

allows room for more flexibility. According to the Health Care and Education Reconciliation Act

of 2010 (PL 111–152), “members of a religious sect whose members oppose government

insurance benefits are exempt from maintaining the minimum essential coverage” the ACA

requires.85 However for churches that employ two or more employees who participate in

medical benefits, the ACA has stringent requirements. The good news is that organizations are

exempt from the employer part of the ACA if they have fewer than 50 full-time employees

(FTEs). But the bad news is that without knowing it, many of these same organizations may be

accruing penalties “of up to $100 per employee, per day, per violation for making voluntary

83


Richard Marmon, Taxing Ministers of the Gospel, The CPA Journal (May 2013), p. 48-49 85

Treas. Reg. 1.5000A3(a)


26

healthcare payments on behalf of employees” that do not conform with “ACA market reforms”.

An example of a possible healthcare payment that does not comply with ACA market reforms

would be “individual policy premiums or other out-of-pocket medical costs”. These heavy

penalties also apply to health plans that begin on or after January 1st, 2014 and heavily target

“smaller churches and ministries that are unable to offer group health insurance coverage” who

in the past have helped “their employees with the cost of their individual health insurance

coverage and/or other out-of-pocket medical expenses”. The way it used to work was that the

minister’s employers would pay these costs directly for the employees or provide their

employees with reimbursements after they paid for the expenses themselves. If certain

procedures were followed, these arrangements were fine by the IRS and even allowed on a tax-

free basis for their employees. But now with the ACA, the tax-free reimbursement of individual

healthcare insurance premiums would trigger an excise tax of $100 per employee, per day, per

violation. By creating these penalties, the government has made it clear to churches and other

organizations to discontinue these payments or reimbursements to avoid paying possible excise

tax.86

So what options do churches and ministers have in regards to a minister’s health care

plan? There are five main ideas that churches and ministers need to consider when determining

what to potentially do. The first main idea to consider is an employer possibly paying for a

minister’s health insurance. If a church or ministry has been paying or refunding the cost of

individual health insurance policy premiums for their employees, the minister should advise

them to stop doing so before June 30th, 2015. This is because those payments may “subject the

organization to significant tax penalties for noncompliant reimbursements under the ACA” like

mentioned earlier, even if the payments count as tax-free income. However, the exception to

the rule would be when the church has only one employee who participates in medical

benefits. And even if the church has multiple employees, if only one of them is involved in

getting reimbursed for those healthcare related payments, the church falls within the “one

participant” exception. Next, the second main idea to consider is an employer paying out-of-

pocket medical expenses that are not a part of group coverage. The same rules apply here as in

86

Five Roads for Healthcare Reimbursements by Churches and Ministries, ECFA (March 2015), p. 1-3


27

the last scenario. If a church or ministry has been paying or refunding out-of-pocket medical

expenses for their employees without proper group health insurance coverage, the minister

should advise them to stop doing so immediately. Those payments would also “subject the

organization to significant tax penalties for noncompliant reimbursements under the ACA”, and

would possibly constitute taxable income to the employee. However, the same exception to the

rule still applies with the church having only one employee who participates in medical

benefits. And even if the church has multiple employees, if only one of them is involved in

getting reimbursed for those healthcare related payments, the church falls within the “one

participant” exception.87

Following those two is the third main idea to consider, which is that an employer makes

no healthcare-related payments. Instead, a church or ministry can increase the taxable income

they pay to employees without specifically designating them as healthcare-related payments.

This would help some smaller employers avoid ACA penalties and “offset the economic burden

to employees who are no longer allowed to receive reimbursements (taxable or tax-free) for

healthcare-related costs”. If this occurs, ministers could then set aside a part of the extra

taxable income to “help pay for their other out-of-pocket medical costs incurred throughout

the year and itemize medical expenses on Schedule A of their tax returns if these expenses

exceed 10% of AGI for the year”. Moving on to the fourth main idea to consider, which is where

an employer pays for group health insurance coverage. This idea offers the most tax advantages

of all of the ideas mentioned, but are pretty costly and might be too costly for churches and

ministries of a smaller size, depending on what needs to be covered and the accessibility of the

plan. Payments of group health insurance premiums for a minister on the organization’s behalf

are not viewed as taxable income to employees. Then there are Health Flexible Spending

Accounts (FSAs), where an employer can support a proper health FSA without being subject to

ACA penalties. These health FSAs are funded from an employee’s pre-tax income and must be

offered along with group health insurance coverage in order for it to be exempt. There is also a

Health Reimbursement Arrangement (HRA), where an employer can support a proper HRA

without being subject to the ACA penalties if offered along with group health insurance

87

Five Roads for Healthcare Reimbursements by Churches and Ministries, ECFA (March 2015), p. 5-20


28

coverage that “meets ACA integration requirements set forth in IRS guidance, as well as certain

nondiscrimination requirements”.88 Lastly, the fifth and final main idea to consider is non-

insurance arrangements such as health care sharing ministries. Some churches and ministries

should have their employees consider being a member of a health care sharing ministry

because they provide their members with an exemption from the individual ACA penalties. A

health care sharing ministry is defined as an organization that is “described in Section 501(c)(3)

and tax-exempt under Section 501(a); has members that share a common set of ethical or

religious beliefs, according to which they share medical expenses among themselves; has

members that retain membership even after they develop a medical condition that (or a

predecessor of which) has been in continuous existence and operation since December 31st,

1999; and that conducts an annual audit performed by an independent CPA firm in accordance

with GAAP and makes the audit report available to the public upon request”.89 If a church or

ministry covers the monthly costs of an employee’s group health-sharing plan, the amount paid

by the organization is “subject to income tax for all employees and to FICA for all non-

ministerial employees”. Possible health-sharing plans include Samaritan Ministries

International, Medi-Share, and Christian Healthcare Ministries. According to websites of these

plans, these ministries act as “clearinghouses for members’ medical bills”. Basically, the

ministry takes a member’s monthly payments and applies them to other members’ current

health care expenses. These ministries require their members to describe their Christian faith,

health practices, and even sometimes personal morals. Those requirements could potentially

include “agreeing to a certain statement of Christian faith; pledging to attend regular worship;

and promising to abstain from extramarital sex, abstain from tobacco use and drug abuse, and

abstain from or limit alcohol consumption”.90 Also, Medicare coverage is not considered a

group health plan. Instead, payments or reimbursements for Medicare Part B or Part D

premiums go against the ACA, unless they are a part of an employer’s group health care plan.

88

Five Roads for Healthcare Reimbursements by Churches and Ministries, ECFA (March 2015), p. 5-20 89

Treas. Reg. 1.5000A3(b) 90

Dayna Roane, Religious Exemptions from the Health Care Individual Mandate, Journal of Accountancy (2014), p. 1-3


29

However payments of Medicare supplement premiums are different, and are therefore an

excepted benefit under the ACA.91

Shifting focus back to health care sharing ministries, ministers are exempt from the

“monthly share payments” the organization makes on his or her behalf towards the health care

sharing ministry. For purposes of federal income tax, the monthly share payment is not

deductible as “either a medical expense (because it is not a payment for insurance under

Section 213(d)(1)(D)) or as a charitable deduction (because it is a payment in consideration for

goods or services)”. However, whatever the member pays over the required monthly minimum

amount can be deductible as a charitable contribution. Members also do not qualify for the

premium tax credit in Section 36B, or for “federal tax subsidies” for insurance associated with

employment under the ACA. It is crucial that members in those ministries display their

membership for every month of the taxable year for which they seek an exemption, because

eligibility for the exemption is established on a monthly basis. It is also important to note that

health-sharing plans are not the same as health insurance plans, so they do not guarantee that

they will pay any medical bill. Health care sharing ministries have “no actuarial calculations, no

reserves, and do not negotiate with medical providers”. They are not subject to most state

insurance regulations and members are usually treated as “self-pay” patients who are expected

to settle on lower rates directly with health care providers themselves. Because of this “do it

yourself” mentality, members are also expected to budget for their own preventive care. These

ministries do not have to conform with the ACA minimum standards, so they avoid covering

costs that go against ministry guideline; abortion being a big one. Treatment for alcoholism,

drug addiction, and even obesity might not even be covered because of the required statement

of faith mentioned earlier. After all of that, ministers and churches alike need to watch out that

payments or reimbursements for employees’ contributions in health care sharing ministries do

not count as taxable income because their plan does not qualify as group health insurance

coverage, and thus subject to ACA penalties.92 One last health care option not mentioned yet is

the Small Employer Health Insurance Tax Credit. This credit was created by the ACA to help

91

IRS Notice 2015-17 92

Dayna Roane, Religious Exemptions from the Health Care Individual Mandate, Journal of Accountancy (2014), p. 1-3


30

small businesses and small Section 501(c) tax-exempt organizations pay for their employees’

health insurance coverage. In order to be eligible, an employee must “pay premiums for

employee health insurance under a qualifying arrangement, have fewer than 25 FTEs for the tax

year, and pay average annual wages of less than $50,800 per FTE”. The credit often involves

intricate calculations, but can be useful for employers ever since the maximum credit amount

allowable has increased from 35% of employer premium payments to 50% in 2014. When trying

to use the credit, a minister is classified as a FTE only if he or she fits the requirements of the

common law test mentioned earlier. However, the minister’s gross wages are “excluded from

the total wages paid, resulting in a lower average annual wage base”.93

Now let us fast-forward to the end of a minister’s career, and discuss the potential

retirement plan options they have. First off, retired ministers are not required to include any

type of parsonage allowance or value of the parsonage when calculating self-employment

earnings, even if the minister never opted out of the Social Security system. According to

Section 1402(a)(8), they also do not need to include any retirement benefits they have obtained

from a church plan before retirement. In addition, the clergy housing allowance is “available to

retired clergy if a church pension board annually designates retirement income as housing

allowance subject to the IRS rules”.94 A spouse can potentially help with retirement benefits. A

minister can be eligible to receive retirement benefits based on the insurance coverage of his or

her spouse from their previous non-ministerial job, even if the minister never had to pay self-

employment taxes. The worst advice one could give a clergy member would be for them to roll

their 401(k) pension plans into a self-directed IRA, just like regular taxpayers do, because it

forces them to lose forever the ability to designate a portion of their distributions as tax-free

parsonage.95 But in regards to retirement plans, many ministers use the Retirement Savings

Contributions Credit. The credit is ”equal to 50% of Traditional and Roth IRA and 403(b) plan

contributions for married filing joint taxpayers with AGI less than $35,500”. If the minister has

93

Vicki Bernardi, Claiming the Small Employer Health Insurance Tax Credit, Journal of Accountancy (2014), p. 1-6 94

Rev. Rul. 75-22, 1975-1 C.B. 49 & The Presbyterian Church (U.S.A.), Frequent Tax Questions and Answers for Active Clergy (2015), p. 2 95

Laurence Dresner, Ministering to Clergy: Special Tax Rules Create Financial Planning Challenges & Opportunities for These Unique Clients, Financial Planning (December 2005), p. 4-5


31

an AGI between $35,500 and $59,000, he or she is still eligible for a reduced credit. With

housing allowances reducing minister’s AGI to these lower levels on income, many ministers are

qualified for this credit and just need to fill out Form 8880 as a result.96

So when it comes to retirement plans, there are three specific ones that can work for a

minister. The first option is the Tax Sheltered Annuity (TSA), also known as a Church Plan. Based

on Section 403(b), this plan is often selected when ministers want to “maximize their eligible

contributions or reduce their self-employment tax burden”. A minister may choose to have his

or her employer withhold up to $18,000 of his or her income and make a payment towards his

or her TSA. Ministers 50 and older can also increase that elective deferral amount by another

$5,500 to “catch-up for earlier years’ smaller deferrals”.97 According to the IRS, a minister is not

subject to the 15.3% federal self-employment tax on the amounts put into their Church Plan or

any amount that the employer puts in that is over the minister’s own elective deferral.98 The

second option is the traditional individual retirement account (IRA). A minister and his or her

spouse may choose to contribute up to $5,500 to a traditional IRA account, and an additional

$1,000 each if they are 50 or older. Traditional IRAs are helpful for ministers who have opted

out of the Social Security system, but are still looking for an extra income tax deduction.

Payments to the traditional IRA can be made even if the minister participates in a TSA, but he or

she may not be able to deduct the full payment made to traditional IRA as a result. While still a

useful option, IRAs are used less frequently since the Roth IRA was introduced in the beginning

of the 1998 tax year. So therefore, the third option would be that Roth IRA. This type of IRA

allows ministers to make the same amount of contributions as with Traditional IRAs, but

without obtaining an income tax deduction. Many ministers do not need those additional

deductions; especially ones with “young families and ample housing allowances”. With a Roth

IRA, future retirement distributions of the minister’s payments to the plan begin at the age of

59½ or later, and are untaxed, along with the earnings that the plan makes. In addition,

distributions can be made from the Roth IRA before retirement and without penalty if the

payments are used for “medical expenses and health insurance premiums for the unemployed,

96


IRS Publication 571 98

Rev. Rul. 68-395, 1968-2 C.B. 375 & Rev. Rul. 78-6, 1978-1 C.B. 273


32

qualified higher education expenses, or new home purchase costs for taxpayers who have not

owned a personal residence for at least two years”. The medical expenses and health insurance

premiums exception is also available for some Traditional IRA distributions, as well as the

qualified higher education expenses exception. So the big benefit of the Roth IRA compared to

the Traditional IRA is that exemption for first time homebuyers, which is very relevant for

ministers using parsonage allowances.99

Before concluding, let us discuss two other tax snares ministers want to avoid. One of

these tax snares involves tithing expenses. In the case of Pixley v. Commissioner, an ordained

Baptist minister by the name of Bradley Pixley claimed that the tithing expenses he and his wife

paid were “necessary monthly living expenses”. The IRS disagreed and sent Pixley and his wife a

notice of intent. In response to the notice, the Pixleys requested a due process hearing and in

attempt to compromise with the IRS, submitted a counter-offer. That offer was denied, and the

IRS then began to request that Pixley show proof of his “ministerial status and the fact that the

tithe was a condition of his employment”. Pixley failed to gather the proper evidence for the

IRS after multiple requests, so the IRS prohibited the monthly tithing expenses and easily came

to the conclusion that the Pixleys were able to fully pay the taxes they owed. After the IRS’s

decision, the Pixleys then appealed to the Tax Court, claiming that the disallowance of the

tithing expenses went against their First Amendment right to freely exercise their religion.100

However, the Court ended up ruling in favor of the IRS, stating that the tithing expenses the

minister was required to pay were not allowed as a deduction. While the Court did admit that

“paying taxes will leave taxpayers with less funds to support their religion”, the burden of

contributing to religious organizations is common to all taxpayers, and not a “burden on their

free expression of religion” like the Pixleys originally claimed. 101 The lesson learned in this case

is that tithing expenses are not deductable from your taxable income.

99

Top 10 Questions that Ministers, Missionaries, & Church Treasurers Ask Tax Preparers, Ministry CPA (2014), p. 3-4 100


Pixley v. Commissioner, 123 T.C. 269 (2004)


33

The second of the two tax snares involves trusts. In the case of Estate of Tamulis v.

Commissioner, there was a Catholic priest called Father Tamulis who died in 2000, leaving most

of his $3.4 million estate to a living trust. The trust was supposed to continue for “the longer of

10 years or the joint life of Tamulis’s brother and his brother’s wife”, who had property owned

and real estate taxes paid by the trust. The net income of the trust was supposed to be

disbursed between Tamulis’s three grandnieces. Once the trust was terminated, the assets

would be paid to a diocese of the Catholic Church. While working on Tamulis’s estate tax

return, the executor ended up taking a deduction of $1.5 million for the present value of the

charitable remainder. However, the trust did not specify a “specific percentage of the trust’s

fair market value to be paid to the non-charitable beneficiaries to qualify as a charitable

remainder unitrust (CRUT), nor did it specify a fixed dollar amount to be paid to non-charitable

beneficiaries to qualify as a charitable remainder annuity trust (CRAT)”. So therefore the IRS

disallowed the deduction using Section 2055 as their defense. Usually in order to fix this

problem, the trust can be recreated by “filing a judicial proceeding within 90 days after the due

date of the estate tax return”. Oddly enough, the proceeding was never filed by the executor.

The executor suggested a way to recreate the trust to the income beneficiaries, but one niece

did not sign the appropriate document; thus nothing was completed. Regardless, the executor

supervised the trust as if it were a qualified unitrust. 102 So it was up to the Seventh Circuit

Court of Appeals whether or not it was appropriate to treat the trust as a qualified unitrust.

Because the trust did not qualify as a CRUT or CRAT when Tamulis’s died, and no action was

taken to specify the amounts to be paid to the beneficiaries or reform the trust, the Seventh

Circuit Court of Appeals agreed with the Tax Court and ruled that the trust did not properly

qualify as a CRUT. The executor of the estate had no excuse for failing to reform the trust when

he knew a substantial deduction was on the line. 103 The lesson learned from the case is to leave

your estate in good hands if you are a minister contemplating an executor of your estate.

After reading this research paper, one should be able to understand what makes a

person a minister, a minister’s dual tax status, a minister’s involvement with the Social Security

102


Estate of Tamulis v. Commissioner, 2007-2, USTC para. 60,553 (CA-7, 2007)


34

system, a minister’s various sources of taxable income, the two exemptions to their taxable

income, the possible health care costs that ministers face, the retirement plan options available

to ministers, and other tax snares for ministers to avoid. There is a lot of debate on both sides

of the coin in regards to these topics that have been discussed. On one side of the coin, some

groups and individuals want religious organizations to be treated like other non-profit

organizations, or even like corporations.104 On the other side of the coin, some ministers and

churches are abusing the special benefits that the IRS gives them in the Code and court cases. It

is important for ministers and religious organizations to keep a balance between the two, never

fully on one side of the coin, because they have a lot of tax implications at stake. So in the end,

ministers must be aware of the tax benefits available to them and what they each require;

understand the benefits and ethical requirements of their vocation; and have a proactive

approach to tax planning early on in their profession.105 It will be very interesting to see what

happens in this area in the next few years. But all a minister can do right now is keep doing his

or her job, which is preaching about God for the entire world to hear – even the IRS.

104

Victoria Bekiempis, Are Churches Making America Poor, Newsweek (October 2013), p. 1 105

Ted Englebrecht & Jonathan Cameron, Tax Planning Rules for Ministers, The CPA Journal (September 2008), p. 45 & Richard Marmon, Taxing Ministers of the Gospel, The CPA Journal (May 2013), p. 49


35

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Documents

The Tax Implications of Having a Clergy Position - Richard Greletski