Tax Planning Tips and Considerations for Clergy
Ministers, pastors, and other clergy members must pay income taxes, the same as other workers. But there are a few important considerations when it comes to preparing your taxes when you're in this profession. Find out whether your compensation package is set up to minimize your tax liability.
Some churches give their pastors a travel allowance each month. If the amount given to the pastor is theirs whether or not they use it for travel expenses, then that amount would be included in a pastor's taxable income. The pastor could then (prior to 2019 tax law changes) have included their travel expenses as a miscellaneous itemized deduction, thus reducing their taxable income. However, in most cases, travel allowances are used as a reimbursement for travel expenses. Because expense reimbursements simply offset expenses incurred in the normal course of business, they do not provide economic benefit to the pastor (or other employee types), which makes them non-taxable.
However, miscellaneous deductions—which would have been limited to the portion that exceeds 2% of your adjusted gross income—are no longer allowed. You might be better off overall claiming the standard deduction for your filing status, which is $12,400 for single filers and married couples filing separately, $18,650 for heads of households, and $24,800 for married couples filing jointly for 2020 returns.
Furthermore, an itemized deduction would only reduce the amount of your income that's subject to income tax. A minister would still have to pay self-employment tax on the reimbursement amount. As a result, it is more tax-advantageous for the church or religious organization, which is generally organized as a non-profit, to treat the travel allowance as a reimbursement for travel expenses, thus maximizing the pastor's individual tax savings.
Accountable Reimbursement Plan
However, if the travel allowance was instead set up as an accountable reimbursement plan, the money could also be spent on things other than travel, plus it would not be taxed.
With an accountable reimbursement plan, the minister would have to give receipts and other documentation to the congregation to account for the out-of-pocket expenses. The expenses must be business-related, and the excess must be given back if not spent. If the expenses equal your reimbursement, there's no deduction.
The allowance is not added to your wages or salary, and it's not subject to either income tax or self-employment tax.
The benefit is that the minister is reimbursed in full for out-of-pocket expenses. The congregation can still set a limit based on its budget, but the monthly allowance will go a lot further if taxes aren't in the way.
Ministers are often compensated by way of a housing allowance, which is subject to self-employment tax but can be excluded from income tax up to its fair rental value.
There are rules and limits for the housing allowance. It's limited to 100% of your salary; it must be reasonable; it cannot be more than the amount actually spent on housing; and it cannot be more than fair rental market value. Allowance in excess of that must be included in gross income.
If you own the home, you can exclude the fair rental value from your gross income. Also, mortgage payments and property tax can be claimed as itemized deductions on Schedule A of your 1040 or 1040SR, even if you paid for them using your housing allowance.
Ministers occupy a rather unique position in the tax code when it comes to the self-employment tax, which represents your share of Social Security and Medicare taxes. Normally, an employee would pay half of these taxes and their employer would pay the other half. But if a minister is ordained, licensed, or commissioned, they're considered self-employed for purposes of Social Security, even though they're considered an employee for income tax purposes.
This dual status partly as an employee and partly as a self-employed individual has significant tax consequences. Ministers must use Schedule SE to calculate their self-employment tax.
However, clergy generally cannot use Schedule C to claim business expenses except for specific income earned from performing religious marriage, funeral, and other ceremonial services.
Social Security Exemption
Ministers can opt out of the self-employment tax, however. The exemption applies to wages for ministerial services, but not other self-employment income.
A word of caution: Ministers can opt out of Social Security and Medicare because of an objection to receiving public insurance in relation to ministerial earnings. Merely wanting to avoid paying self-employment tax, or some other economic reason, is not sufficient.
Your ministerial earnings won't count toward future Social Security and Medicare benefits if you opt out—and once the exemption is in place, it can't be undone.
Ministers might therefore receive less in the way of retirement or disability benefits from Social Security since their ministerial wages are exempt, and they might not even earn enough Social Security credits through other work over the course of their careers to be eligible for these benefits at all.
Planning for Retirement
Getting a side job—such as teaching at a college or part-time office work—produces wage income that's subject to Social Security and Medicare taxes, even if you've opted out of these taxes for your ministerial earnings. This helps the minister accumulate annual Social Security credits toward future retirement and toward disability benefits.
Putting some money into an individual retirement account (IRA) or other retirement plan is a core financial planning tactic, too, particularly for ministers who have opted out of Social Security. You can save retirement dollars through tax-deductible Traditional IRAs or an after-tax Roth IRA. If you have supplemental income on Schedule C, you might be eligible for a SEP-IRA, which is a retirement plan for the self-employed.
Ministers may also think about buying a house as part of their retirement goals. If the minister lives in a parsonage provided by their church, they may want to make some housing plans for when they retire and don't have that home any longer.