Income Tax Reporting
For many years, clergy were considered to be self-employed for income tax reporting purposes. Local churches generally paid a pastor a single amount each month that included salary and the cost of professional expenses incurred in his/her ministry. The church reported the whole amount paid to the pastor on Form 1099. The pastor would file a Schedule C, Sole Proprietorship, with their Form 1040 individual income tax return. The pastor would report the total amount received from the church (and other sources such as wedding honorariums) on Schedule C and deduct all the ordinary and necessary professional expenses of ministry to arrive at net income for Page 1 of Form 1040.
Virtually all of this changed in 1995. A Federal Appeals Court ruled in Weber vs. IRS Commissioner that Methodist pastors are Employees for income tax purposes. This decision applies for IRS reporting purposes only. It does not change United Methodist polity and clergy status for church purposes, including the appointment process.
While the Weber case has had substantial impact, there are many tax issues that have not changed:
Social Security Taxes
The Weber decision applies only to clergy income taxes. Clergy are still considered self-employed for purposes of Social Security and Medicare taxes. The church does not withhold Social Security and Medicare Taxes from a pastor’s salary the way it does for lay employees. Likewise, the church does not have to pay the employers share of Social Security and Medicare taxes for the pastor as it does for lay employees.
Pastors are required to file Schedule SE with their Form 1040. This form is used to calculate the pastor’s self-employment taxes for Social Security and Medicare.
Housing Exclusion Allowance
Pastors are eligible for special treatment of their housing expenses under Section 107 of the Internal Revenue Service Code.
The terms “Housing Allowance” (when the pastor is in his/her own home), “Parsonage Allowance” (when the pastor is in church provided housing), “Rental Allowance”, etc. are used by local churches to describe these payments.
However, the “Housing Exclusion Allowance” described in Section 107 of the IRS Code has a special meaning and can save clergy thousands of dollars in taxes at no additional cost to the church.
The Code permits clergy to exclude from reported income amounts actually spent by the pastor (not the church) on housing, including pastors living in a church parsonage. (Note: The expenses incurred by the local church in providing a parsonage are not affected by Section 107. It only affects the income tax status of a part of the pastor’s salary.) The exclusion is limited to the lesser of:
There are a number of IRS requirements the church and pastor must comply with in order to properly take advantage of this tax break. Both treasurers and clergy are strongly encouraged to review the GCFA Clergy Tax Information package to insure full compliance with the law.
Following are several key points about the Housing Exclusion Allowance:
State and Federal Income Tax Withholding
Clergy are not subject to mandatory Federal and State Income Tax Withholding. However, the pastor may elect to voluntarily have the church withhold these taxes in lieu of filing quarterly personal estimated taxes.
Accountable Reimbursement Plan
Accountable Reimbursement Plans are not unique to clergy. However, these plans are covered in this section because the Weber decision has caused them to be adopted by many churches.
Our Conference’s Equitable Compensation resolution, adopted each year at Annual Conference, provides that each church shall adopt an Accountable Reimbursement Plan. Prior to the Weber decision clergy could deduct all their professional expenses on Schedule C of Form 1040. After that decision, the clergy were subject to limits on deducting these expenses since they were no longer eligible to use Schedule C. This created a disadvantageous tax situation for clergy.
Under an Accountable Reimbursement Plan, the church adopts a policy whereby travel, dues, continuing education and other professional expenses are part of the church operating expense budget. The pastor (and lay employees, if any) submits requests for reimbursement of actual expenses incurred in serving the church along with receipts, invoices, mileage logs, etc. that document the expenses (this is what makes it an “Accountable” plan under IRS rules). Reimbursements to a pastor or lay employee under an “Accountable” plan are not taxable compensation to the recipient and are not reported to the IRS or state tax authorities.
As with Housing Exclusion Allowances, Accountable Reimbursement Plans require compliance with IRS rules and Pastors and Local Church Treasurers are strongly encouraged to review the GCFA Clergy Tax Information package. This document also contains various forms and policies that local churches can use in setting up and administering Accountable Reimbursement Plans.