The following article was written by The Editorial Staff at TheTaxBook and contributed for use on the TaxSlayer Pro blog.
As a tax preparer, you will serve clients from all different backgrounds. Ministers (and other types of religious leaders like pastors) have a unique tax situation.
What clients qualify as ministers for tax purposes?
To qualify for the special tax provisions available to ministers, your client must be a minister and perform services in the exercise of their ministry. A minister is defined as an individual who is duly ordained, commissioned, or licensed by a religious body constituting a church or church denomination. Because religious denominations vary in their formal procedures for these designations, whether an individual is duly ordained, commissioned, or licensed depends on the facts and circumstances.
What is ministerial income?
Total ministerial income includes church wages, gross self-employment income from ministerial service, and tax-exempt allowances.
A minister usually receives compensation from their church or church agency for personal services but may also receive bonuses or special gifts. The minister may also receive fees paid directly from parishioners for performing weddings, funerals, baptisms, masses, and other contributions received for services. All of the above are includible in their gross income, along with allowances for travel, transportation, or other business expenses received under a nonaccountable plan.
What qualifies as ministerial income?
Employee income and expenses
Your client should receive Form W-2 from their church employer. The form should be filled out as follows:
- The minister’s income is reported as wages in box 1, Form W-2
- Social Security and Medicare taxes are not withheld from a minister’s income
- Form W-2 shows no amounts in boxes 3 through 6. The wages will be included in the minister’s self-employment tax computation.
- Ministers are not subject to federal income tax withholding. However, a minister and their employer may agree to voluntary withholding to cover income and self-employment tax. All tax withheld is reported in box 2, Form W-2
- Parsonage or housing allowances are reported in box 14, Form W-2
- Before 2018, employee business expenses were generally reported on Form 2106, Employee Business Expenses, and then carried to Schedule A (Form 1040) as miscellaneous itemized deductions subject to the 2% AGI limitation. For tax year 2020, miscellaneous itemized deductions subject to the 2% AGI limitation are not allowed. These expenses are prorated to the extent the minister has tax-exempt income from a parsonage allowance
Self-employment income and expenses
Amounts received by a minister for performing marriages, baptisms, funerals, etc., are considered self-employment income, even if your client doesn’t receive Form 1099-NEC, Nonemployee Compensation.
- Help your client report their self-employment income on Schedule C (Form 1040), Profit or Loss from Business
- These self-employment expenses are deductible on Schedule C, prorated to the extent the minister has tax-exempt income from a parsonage allowance
If the church or church agency pays amounts in addition to salary to cover the minister’s self-employment tax or income tax, these are also includible in your client’s gross income.
Fees for weddings, funerals, etc., given directly to the church rather than to the minister, are not considered compensation to the minister.
Contributions made to or for the support of individual missionaries to further the objectives of their missions are includible in gross income.
A minister’s compensation package often includes a designated parsonage allowance: the use of church-owned housing, a housing allowance, or a rental allowance. This allowance is treated differently for income tax and self-employment tax purposes.
Services for nonreligious organizations
Services for a nonreligious organization are ministerial services if the services are assigned or designated by the church. Assigned or designated services qualify even if they do not involve performing sacerdotal functions or conducting religious worship.
If the services are not assigned or designated by the church, they are ministerial services only if they involve performing sacerdotal functions or conducting religious worship.
Services that are not part of a ministry
Income from services performed by a minister as an employee that are not ministerial services is subject to Social Security and Medicare tax withholding under the rules that apply to employees in general. The following are not ministerial services:
- Services performed for nonreligious organizations other than the services stated above
- Services performed as a duly ordained, commissioned, or licensed minister of a church as an employee of the United States, the District of Columbia, a foreign government, or any of their political subdivisions. These services are not ministerial services, even if the minister performs sacerdotal functions or conducts religious worship
- Services performed in a government-owned and operated hospital. These services are considered performed by a government employee, not by a minister as part of the ministry. However, services performed at a church-related hospital or health and welfare institution, or a private nonprofit hospital, are considered to be part of the ministry and are considered ministerial services
Books or articles
Writing religious books or articles is considered to be in the exercise of ministry and is considered a ministerial service.
Gifts or compensation for services
The Internal Revenue Code excludes from gross income the value of property acquired by gift. The facts and circumstances of each transfer determine whether the transaction is a gift or taxable income. Some transfers are obvious gifts, while others might actually be compensation for services. The most significant factor is the intention of your client. Whether an item is a gift is a factual question, and your client bears the burden of proof.
Numerous court cases have ruled that the organized authorization of funds to be paid to a retired minister at or near the time of retirement were gifts and not compensation for past services.