Question:

What bookkeeping system should our treasurer use to keep the church books?

Answer:

The bookkeeping system used by a church must be compatible with current and future treasurers’ training and experience. To adopt a system that is overly complex or suitable for only a highly qualified bookkeeper may create grave difficulty when there is turnover in the treasurer’s position. The following are several solutions that small local churches have found useful:

1. Accounting software. Intuit QuickBooks Desktop or Online and Sage (formerly Peachtree) are two general purpose accounting software packages. There are some church/ministry specific systems, such as Shelby Systems. These more specific software options tend to be more costly but also tend to have the features that the others do not.

All these software options offer government reporting, payroll processing, donor management, bank reconciliation tools, use of bank feeds (downloading transactions), budgeting, and many others features.

Costs for these software options vary (e.g., QuickBooks Online is a monthly subscription). We recommended researching which option is right for you. Techsoup.org or purchasing QuickBooks online through a QuickBooks Pro Advisor may allow for some potential cost-saving benefits.

Previous formal training in bookkeeping or considerable on-the-job training will be required for use of accounting software.

2. "Old school" bookkeeping. Electronic cash receipts and cash disbursements journals (e.g., MS-Excel, Google Sheets). The treasurer uses two separate worksheets with columns for the amount of each bank deposit or electronic transfer (in the cash receipts journal) or for the amount of each check or electronic payment (in the cash disbursements journal). Additional columns are used to record the transaction (receipt or disbursement) into categories consistent with the accounts presented in the church budget.

Each month both journals must be reconciled to the bank statement. The beginning account balance, plus the total receipts, less the total disbursements, must equal the ending account balance. If the amounts do not match, this indicates a mistake, and should result in the treasurer going back through the journals to find the mistake. Periodic reports may be prepared based on summarizing the month-end totals of the journals.

Question:

Should I "opt out" of the Social Security system?

Answer:

First, some background information:

The Internal Revenue Code (IRC) exempts ministers from mandatory federal and state income tax and Medicare and Social Security (FICA) tax withholding by their employers. However, if they do not elect to have income tax withholding, then most ministers must file and pay federal and state estimated tax vouchers.

In any case, the employers of ministers are not permitted to withhold and match the 7.65 percent FICA tax. Instead, the minister (unless he opts out of the Social Security system) is responsible to pay the entire 15.3 percent self-employment tax (SECA). Many ministers elect to have additional federal income tax withheld so that the excess can be applied to their self-employment tax obligation at the time they file their annual Form 1040.

Now, let's consider what opting out of Social Security might mean:

1. A minister may apply to opt out of the Social Security system only within the first two years of receiving at least $400 of self-employment earnings of which any portion is earned in connection to his services ministry as a licensed or ordained minister. (The IRS Minister's Audit Techniques Guide provides guidance as to the Service's answered to the question "Who Qualifies For Special Treatment As A Minister?" https://www.irs.gov/pub/irs-utl/ministers.pdf).

2. Social security tax-exempt status applies only to ministerial income. FICA tax will continue to be withheld by non-ministerial employers, if any. SECA tax will be due on any non-ministry self-employment income.

3. Ministers who have opted out may still qualify for Medicare and Social Security benefits if they meet the minimum requirements (typically 10 years). FICA and SECA tax paid on non-ministerial income helps a minister gain eligibility for Medicare benefits, even if the minister has opted out with regard to his ministerial income. Social Security benefits are based on wage history and, accordingly, may be severely limited when most of the minister's career income has not contributed to his life-time earnings.

4. If choosing to opt out, a minister must provide adequate retirement funds, long-term disability savings or insurance, life insurance or survivor savings, and retirement era health care for himself.

5. While beyond the scope of this blog post, ministers should also understand the return on investment (ROI) of remaining in Social Security, especially in light of a three-tiered calculation used by the Social Security Administration after determining one's "Average Indexed Monthly Earnings" (AIME). Briefly, the first roughly $900 of one's AIME returns 90% of that amount in Social Security benefits. Higher levels of earnings add significantly less to one's benefits. In most cases, minister's earnings hover in the lower range of career AIME.

6. Ministers applying for exemption must certify a statement of conscientious objection. An attempt at our paraphrase of the statement - "I am opposed to the government provision of financial support that is the responsibility of my church or Christian ministry to provide relative to my services as a minister. I believe it is the responsibility of these organizations to provide for me and my dependents 'in the event of death, disability, old age, [and] retirement' (Form 4361)." See Form 4361 for the full statement.

By opting out, ministers can save thousands of dollars each year in self-employment taxes, but they must have a plan to gain minimum eligibility for Medicare and Social Security benefits and to replace its lost benefits. Do not base a decision on rumors that the federal system might fail. In our opinion, if the economic woes of the U.S. become so acute that the politicians are forced to deny benefits to millions of retirees, then personal investment accounts will be severely impacted as well.

Question:

How can the church and I work together to sell the parsonage and get my family into a home of our own?

Answer:

The answer varies greatly based on the church’s and minister’s specific situation. However, the following are several issues that likely need to be addressed.

1. Any property transferred by the church to the minister will be considered taxable compensation at its fair market value (reduced by any payment by the minister to the church).

2. Because the minister will no longer be living in real estate that is exempt from property taxes, his costs of living will increase accordingly.

3. An excludable housing allowance is governed by a three-part test. Some ministers may believe that designating as housing allowance a one-time, large bonus from the church, which the pastor intends to use as a significant down payment, will fully qualify as exempt income under the three-part test. However, a large housing allowance designation may not fully eliminate the taxability of a one-time, large bonus to the minister even if entirely disbursed to construct or purchase a home. This is due to the requirement that a housing allowance cannot exceed the annual fair rental value of a minister’s housing.

4. Interest-free (or below market rate) loans from the church to the minister can aid in the transition from a church’s “parsonage era” to home ownership for its minister. Further, forgiveness of loan principal arrangements in reward for ongoing longevity can also be beneficial. However, care must be taken to comply with the IRS income reporting rules. The interest rate benefit and principal forgiveness are generally taxable income. In order to avoid classification of a loan with a forgiveness provision as immediately taxable income, a longevity stipulation must be enforceable. A written agreement must be established which reflects the true substance of the legally binding longevity arrangement. Truly, it must be the expectation of both church and minister that early departure will result in a repayment to the church of any remaining balance.

5. If the church does not want to require a longevity stipulation to the arrangement, it may at least consider splitting a bonus between two taxable years.

6. We strongly recommend that the church record the mortgage with the local county officials. This also protects the authenticity of the arrangement as "arms length" and the church from miscommunication that it has definite longevity expectations.

Question:
Can a church give non-taxable gifts to its pastor(s)?

Answer:

Typically, there are two ways members of a congregation can give gifts to its pastor(s) and staff member(s). One involves corporate action and the other involves personal and individual action.

1. The church can take up a collection for its pastor(s). In this case, the contributions are deductible to the donors, but must be reported by the pastor since they are deemed payments received from an employer as compensation for his services. Any gifts paid by employers to their employees are considered taxable income and must be reported together with other earnings on Forms 941 and W-2.

Additionally, churches should be aware of the Internal Revenue Service's "De Minimis Fringe Benefits" rules. According to IRS Publication 15-B, a de mininis benefit is any property or service provided to an employee that has so little value that accounting for it would be unreasonable or impractical. However, cash and cash equivalent fringe benefits (e.g., gift certificates, gift cards), no matter how little, are always taxable income.

In determining whether a benefit is de minimis, one should always consider its frequency and value.

Accordingly, the typical Christmas bonus collected by many congregations and given to their pastor(s) represent fully taxable compensation. Of course, as participants in a church-sponsored collection, donors may write-off their contributions as tax-deductible donations.

2. Church members can give directly to the pastor(s). In these cases, the donations are not deductible to the donors, but the pastor(s) does not have to report the gifts as income. This action cannot be orchestrated as a corporate activity of the church/employer (as the pastors' employer), but rather as the personal choices of individual members to other individuals.

Sources: IRS "De Minimis Fringe Benefits", IRS Publication 15-B, and IRS Publication 5137

Question:

What ideas can a church consider to control its rising health care costs?

Answer:

Many ministers and their employers are looking for alternative plans to control rising health care costs without neglecting those in need of medical services. Because of the Affordable Care Act (ACA) requirements, many churches have reconsidered the medical benefits it offers to employees. If the church employs a single employee—a solo minister, the ACA has one set of requirements. Generally, there is more flexibility when there is only one employee. But for churches with two or more employees who participate in medical benefits, the ACA has stringent requirements.

We suggest that you consult your tax professional when offering medical benefits. The benefits the church offers may very well be 100 percent taxable to the employee.

For example, be aware that if a church covers the monthly share costs of an employee for a health-sharing plan (e.g., Samaritan Ministries International, Medi-Share, or Christian Healthcare Ministries), the amount paid by the church is subject to income tax for all employees and to FICA tax for all non-minister employees. Many health care benefits also disqualify church employees from receiving premium tax credits on the healthcare.gov Exchange.

Churches are considering several alternative options. One in particular is an HDHP tied to an HSA. By offering a High Deductible Health Plan (HDHP), the employees of the ministry may also be eligible for a Health Savings Account (HSA). The HSA benefit funds a bank account that the employee can use for qualified medical expenses. Any unused balance at the end of the year carries forward into the next year.

There are many forms of Health Reimbursement Arrangements (HRA) that are beyond the scope of this blog post. They include: Individual Coverage HRAs (ICHRA), Excepted Benefits HRAs, Qualified Small Employers HRAs (QSEHRA), and Flexible Spending Accounts (FSAs). Unfortunately, FSAs are "use it or lose it" benefits which are lost if the funds are not spent by year end.

Question:

What reports do churches need to file with the IRS regarding pastors' compensation?

Answer:

Other than for the pastor, a church files the same reports for all employees and is subject to the same withholding rules for standard employees as any other organization. Ministers compensation, however, is exempt from all withholding. The only exemptions churches enjoy compared to other organizations are (1) an exemption from unemployment taxes, and (2) an exemption from FICA (Social Security and Medicare) tax for churches that file Form 8274. IRS Publication 15 can answer church treasurers’ standard questions regarding church payroll.

Reporting a minster’s compensation is often confusing even to treasurers who are familiar with the rules for standard employees. The following is a sample compensation arrangement:

Question:

Should a church set up a car allowance for its pastor?

Answer:

Any financial assistance that a minster’s employer can give is appreciated. A car allowance can be especially helpful. Car allowances, however, must be established as “accountable plans.” This means that any advances given by the employer to the minster must be properly substantiated on a timely basis or the Internal Revenue Service requires the minster to refund the unspent, undocumented portion of the allowance.

It’s a better idea to offer a professional expense reimbursement under accountable plan rules of the IRS, instead of a car allowance. A reimbursement arrangement covers car expenses, plus other professional expenses. Documentation can then include non-auto costs such as air, travel, lodging, conferences, gifts, books, supplies, and any other legitimate ministry-related expenditure.

The minister documents car expenses when he provides a record of the date, business purpose, and number of miles for each trip. The total miles submitted for reimbursement should then be multiplied by a per mile rate adopted by the church. The IRS sets maximum per mile rates each year that may be used by the church. Rates greater than this may require inclusion of the excess on the minister’s annual Form W-2.

Even though the Internal Revenue Code permits the payment of advances, church funds will be managed more effectively if the church budget establishes an expense category with an annual limit and disburses reimbursements only as documentation is received.

Additional tax-saving opportunities:

1. For 2020, the IRS has set the allowable mileage reimbursement/deductibility rate at 57.5 cents per mile.

2. Ministers who incur unreimbursed employee business expenses may no longer include these costs as itemized deductions on Schedule A. However, ministers may continue to reduce their self-employment taxable income on Schedule SE by their unreimbursed ministry expenses.

3. For a more technical discussion see "Accountable vs. Nonaccountable Professional Expense Reimbursement Plans."

Question:

As a pastor, what are my retirement options and what are the advantages/disadvantages of each?

Answer:

The best retirement plan option for each minister depends on his objectives and his current tax situation. The three most common retirement plan options used by ministers include:

(a) Internal Revenue Code 403(b) plans (also called Tax Sheltered Annuities (TSAs))

(b) Traditional Individual Retirement Accounts (IRAs), and

(c) Roth IRAs

Ministers often select 403(b) plans when they want to maximize their eligible contributions, or to reduce their self-employment tax burden. For the year 2020, a minister may elect to have his employer withhold (“elective deferral”) up to $19,500 of his compensation and contribute it; instead, to his 403(b) qualified investment account. Ministers who are 50 and older are eligible to increase this amount by another $6,500 to catch-up for earlier years’ smaller deferrals (IRS Publication 571).

In addition, unlike other retirement plan choices, an employee minister is not subject to the 15.3% federal self-employment tax on amounts deferred into 403(b) accounts (IRS Revenue Rulings 68-395 and 78-6). This is also true of any amount that his employer contributes over-and-above the minster’s own elective deferral. These "matching contributions" or "non-elective contributions" are subject to strict rules that may limit their applicability to some ministers. IRC Section 403(b) includes subsections 1, 7, and 9 which are eligible as "church plans." The specific nuances of these subsections should be explored and understood in connection with a church's competent retirement plan adviser.

The situations for which Traditional IRAs are the best choice for a minister’s retirement plan are less frequent, especially since the establishment for Roth IRAs beginning with the 1998 tax year. For the year 2020, a minster and his wife may each contribute up to $6,000 to qualified IRA accounts; an additional $1,000 each may be contributed if they are 50 years of age.

A minister who has opted out of the Social Security system but is still looking for additional income tax deductions may find the Traditional IRA his best choice. These contributions can often be made even if the minister participates in a 403(b) plan. However, he may not be able to deduct his full Traditional IRA contribution. This is true for the rare minister whose modified AGI is greater than $104,000 (2020). For this reason and others, many ministers choose Roth IRAs instead of Traditional IRAs.

Roth IRAs enable ministers to make the same amount of contributions as do Traditional IRAs but without receiving an income tax deduction. For many ministers, especially those with young families and ample housing allowances, additional tax write-offs are not needed. Unlike Traditional IRAs, not only will future retirement distributions of their current contributions be nontaxable, the earnings distributed from the Roth IRA will not be taxed. Further, pre-retirement distributions may be made without penalty for:

(a) Medical expense (and health insurance premiums for the unemployed)*

(b) Qualified higher education expenses*

(c) New home purchase costs for taxpayers who have not owned a personal residence for at least two years (“first time home buyers”)

*Also available for some Traditional IRA distributions.

Additional tax-saving opportunities:

1. Many ministers who participate in retirement plans have also reduced their federal income tax by taking advantage of the retirement savings contributions credit. For 2020, the credit is equal to 50% of Traditional IRA, Roth IRA, and 403(b) plan "elective deferral" contributions for married filling joint taxpayers with Adjusted Gross Income less than $39,000. Reduced credits are available for those with AGI greater than $39,000 but less than $65,000 (IRS Form 8880). With housing allowances reducing their AGI to these levels, many ministers are eligible.

2. Retired ministers who receive 403(b) distributions from their "church plans" may enjoy housing allowance exclusions if their churches designate them as such (Minister's Audit Techniques Guide). Caution: ministers are well advised to receive assistance from a tax professional who understand the proper filing of these ministers' returns.

Question:

As a pastor, what can I deduct for a housing (parsonage) allowance?

Answer:

A minister who receives a housing allowance may exclude the allowance from gross income to the extent it is used to pay expenses in providing a home. A minister living in a parsonage qualifies for a housing allowance to the extent of his own out-of-pocket costs. The IRS lists only food and servants as prohibitions to allowable housing expenses.

The minister’s church or other qualified organization (e.g. religious school or college with board members accountable to local churches) must designate the housing allowance by official action taken in advance of the payment. If none of the minister's salary has been officially designated as housing allowance, the full salary must be included in gross income.

If a minister owns a home, the amount excluded from the minister’s gross income as a housing allowance is limited to the least of the following three amounts: (a) the amount actually used to provide a home, (b) the amount officially designated as a housing allowance, (c) the fair rental value of the furnished home, including furnishings and appurtenances such as a garage, plus the cost of utilities.

The following is a list of allowable housing expenditures:

Total mortgage payments (be careful not to duplicate amounts included under "real estate taxes" and "homeowner's insurance")

Real estate taxes

Homeowner's or renter's insurance

Furniture, furnishings, appliances

Utilities (e.g. heat, lights, water, sewer, telephone, water softener, cable, waste disposal)

Rent paid

Repairs paid personally

Loan refinancing costs

Other household supplies (everything except food and household employee compensation)

Question:

As a pastor, am I an employee of the church or am I self-employed?

Answer:

The answer is "yes" to both. Most ministers are considered employees in every respect except for the purposes of paying self-employment tax (SECA), which includes Medicare and Social Security tax. This means that they are eligible for virtually all employee benefits that are given favorable tax treatment in the Internal Revenue Code. Many of these benefits are unavailable to the typical self-employed individual.

Ministers are not permitted to have employee Social Security and Medicare (FICA) withheld and matched by the church. Ministers who have not been granted exemption from SECA tax must pay the entire 15.3% of self-employment tax. Many churches provide additional funds to assist their ministers in the payment of this tax, but this additional compensation, while very helpful, is subject to both income and self-employment tax.

Itinerant evangelists are a common example of ministers who do not have employee status, for they are entirely self-employed.