The most frequent question he’s asked by bivocational ministers is, “Can I take all my salary as a housing allowance?”
Lee Wright, coordinator of church compensation services at the Alabama Baptist State Board of Missions, said his answer is, “Yes, you can, but you might not want to.” And since bivocational ministers number about half of Alabama Baptist ministers, this is a timely question.
Wright directed a conference on ministers’ tax issues at First Baptist Church, Pelham, on Feb. 18. The ministers’ housing allowance is a unique tax designation for clergy, Wright said. Though it’s been challenged in court, he counsels ministers to take advantage of it while it is available, “which could be a matter of years or even decades,” he noted. The designation means that money expended for housing is not subject to federal income tax, but is subject to the self-employed Social Security tax rate of 15.3 percent.
Wright explained that a minister has a dual tax status that probably accounts for 90 percent of the tax issues he faces.
“The minister is considered an employee for federal income tax purposes, but self-employed for Social Security (FICA) purposes,” he said. “This means he should get a W-2 from the church. The 1099 form (miscellaneous income) would be given, for example, to a supply pastor who generated more than $600 of income in a year.”
Wright said a church can withhold taxes on the minister, or he can send quarterly payments as long as the payments are at least equal to the tax paid in the previous year or 90 percent of the current year obligation.
Housing allowance
A housing allowance should be basically no more than the fair rental value of the house, furnished, plus utilities, he said. It might be a good idea to request more in housing than less, since unused housing allowance can be reported and taxed without penalty on the federal 1040 form.
Wright is hesitant to suggest that bi-vocational ministers request their full salary in housing because he believes having some salary devoted to retirement savings is beneficial. Wright suggested that retirement contributions are the ministers’ best source of tax savings.
“Ministers can designate a portion of their salaries for retirement, so this amount is not taxed, and then they pay less tax on the proceeds in retirement since they’ll probably be in a lower tax bracket,” he said.
“Sometimes he can realize as much as a 50 percent tax savings through retirement contributions, making this a better tax savings plan than the housing allowance. And GuideStone Financial Resources can designate all or a portion of retirement income as housing allowance and there’s no tax whatsoever if the full amount is used for housing costs.”
Wright said retired ministers would pay Social Security tax on earned income, such as that received from interim or supply work, but not on retirement benefits. And another tax savings in retirement is an additional personal exemption on federal income tax for those who are 65 or older.
Wright said he also spends much of his time fielding questions about health care due to the Affordable Care Act passed in 2010.
Proof of insurance coverage
“The individual mandate means that everyone must be enrolled in a health care plan, and there are increasing penalties for noncompliance,” he said. “The penalty for 2016 is $695. And [2015] was the first time we saw a new document, Form 1095, giving proof of insurance coverage.”
A recent International Revenue Service ruling clarified individual health insurance premiums as a non-taxable fringe benefit for ministers in the smaller-membership churches where there is only one full-time employee. This is true as long as the plan isn’t part of the Health Insurance Marketplace with tax savings already built into it.
The old concept of giving ministers a lump sum and allowing them to designate it as they wish isn’t really a good plan anymore. Wright recommends an accountable reimbursement plan that pays for business expenses when the minister turns in regular receipts.
“If there’s no accountable plan, the minister’s business deductions, such as travel and books, can only be claimed as a tax deduction if he itemizes, and if the accumulated totals exceed 2 percent of the adjusted gross income on the 1040 tax form,” he said. “These expenses are also reduced by the Deason Allocation rule relating to the percentage of housing allowance. Thus a minister really loses out.”
Wright also cautioned participants about the tax liability of a Social Security offset. “Since the minister is considered self-employed for Social Security purposes and the tax is a hefty 15.3 percent, some churches offer an offset that is the equivalent of what they’d match on a nonministerial employee,” he said. “This is a nice thing to do, but it’s additional money that must be reported as income for taxation.”
Wright will offer church tax conferences for small membership churches in Montgomery on June 7 and in Dothan on June 21. For more information, contact him at 800-264-1225, ext. 241, or lwright@alsbom.org.
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