Clergy Tax Considerations
Note: you should not rely on the information on this page as a substitute for independent reference to original sources of authority.
Social Security Law
For Social Security Tax purposes only, all clergy employed by churches are considered to be self-employed. All clergy so employed must therefore file a 1040 SE return and pay the Self-Employment Tax. Only clergy who have exempted themselves from the Social Security system on the grounds of conscientious objection to the receipt of government-funded insurance are excluded from this requirement. See also Social Security/Self Employment Tax.
Federal Income Tax Law
Except as related to Social Security Tax, the clear consensus of professional opinion is that Episcopal clergy are almost always employees of their respective churches. Clergy who are employees must therefore file their tax returns as employees according to Revenue Ruling 80-110, and should no longer use Schedule C to report church compensation. They should receive W-2 forms from their church employers. These W-2s will, however, differ from those of lay employees of the church. The chief differences are these:
(1) No Social Security taxes are withheld. Clergy are considered to be self-employed for Social Security Tax purposes only.
(2) Federal income taxes may be withheld or not, as the cleric wishes.
(3) The income reported includes the salary and automobile and other expense allowances for which the cleric has not reported in detail to the church. The income reported does not include the Section 107 housing allowance designated by the vestry or the value of church-provided housing.
Each cleric should have a portion of compensation designated as a Section 107 parsonage allowance, even if he or she lives in a rectory. The parsonage allowance will normally be less for those who live in rectories, because such clergy do not incur all the expenses of those who live in their own residences.
The parsonage allowance is the most important single tax break available to clergy. The amount spent by the cleric to provide, furnish, and maintain a principal residence is excludable from federal income tax, subject to certain limitations detailed below. This amount is subject to the Self-Employment Tax, however, as is the value of any housing provided by the church.
The amount excluded from federal income tax is the lowest of the following:
(1) The amount of actual cash spent during the year by the cleric.
(2) The fair annual rental value of the residence occupied by the cleric; plus the fair annual rental value of the furnishings, maintenance, insurance, and utilities. These valuations do not include the value of housing and furnishings provided by the church.
(3) The amount set forth in the vestry minutes in a specific resolution, adopted before the money is paid.
As a general rule, employee expenses may be deducted from gross income only if the reimbursement arrangement:
(1) Requires the employee to substantiate at least monthly (in detail, with receipts) his or her expenses to the employer,
(2) Relates only to expenses that are reasonable in amount, and
(3) Prohibits the employee from retaining any excess reimbursement.
Detailed substantiation requires the documentation of the amount, time and place, business purpose, and business relationship of each such expense with the same kinds of documentary evidence as would be required to support a deduction of the expense on the employee’s federal income tax return.
The parish shall not include in an employee’s Form W-2 the amount of any business or professional expense properly substantiated and reimbursed. The employee should not report the amount of any such reimbursement as income on his or her Form 1040.
Meal and Entertainment Expenses
Only 50% of meal and entertainment expenses are deductible from gross income. These expenses are best treated as reimbursements for which the individual submits a detailed accounting to his or her employer and for which he or she receives full reimbursement. Then the employer takes a partial deduction, which for a non-profit organization has no tax significance.
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