Clergy Information

SELF-EMPLOYMENT TAX: Schedule SE

For services in the exercise of the ministry, members of the clergy receive a Form W-2, but do not have social security or Medicare taxes withheld. For social security purposes, a duly ordained, licensed or commissioned minister is self-employed. This means that your salary on Form W-2, the net profit on Schedule C or C-EZ, and your housing allowance, less your employee business expenses are subject to self-employment tax on Schedule SE.

Exemptions from SE tax

Certain taxpayers can request an exemption from self-employment tax. To request an exemption from SE tax, you must be one of the following:

  • A minister.
  • A member of a religious order who has not taken a vow of poverty.
  • A Christian Science practitioner.
  • A member of a recognized religious sect.

You cannot be exempt from SE tax if you made one of the following elections to be covered under social security:

  • You elected to be covered under social security by filing Form 2031, Revocation of Exemption from Self-Employment Tax for Use by Ministers, Members of Religious Orders, and Christian Science Practitioners, for your 1986, 1987, 2000, or 2001 tax year
  • You elected before 1968 to be covered under social security for your ministerial services.

If you are a minister, member of a religious order, or a Christian Science practitioner and you wish to claim the exemption, you must meet all of the following conditions:

  • You file Form 4361, Application for Exemption from Self-Employment Tax for Use by Ministers, Members of Religious Orders and Christian Science Practitioners.
  • You are conscientiously opposed to public insurance because of your individual religious considerations (not because of your general conscience), or you are opposed because of the principles of your religious denomination.
  • You file for other than economic reasons.
  • You inform the ordaining, commissioning, or licensing body of your church or order that you are opposed to public insurance if you are a minister or a member of a religious order. This requirement does not apply to Christian Science practitioners.
  • You establish that the organization that ordained, commissioned, or licensed you, or your religious order, is a tax-exempt religious organization.
  • You establish that the organization is a church or a convention or association of churches.
  • You did not make an election discussed earlier that would negate your request.
  • You sign and return the statement the IRS mails you to certify that you are requesting an exemption based on the grounds listed on the statement.

If you are a member of a recognized religious sect, or a division of a recognized religious sect, you can apply for an exemption from payment of social security and Medicare taxes on both your wages and self-employment income, unless you have received social security benefits or payments based on your wages or self-employment income. If you pay these amounts back, you may be considered for exemption. If you wish to claim the exemption, you must meet all of the following conditions:

  • You must file Form 4029, Application for Exemption from Social Security and Medicare Taxes and Waiver of Benefits.
  • As a follower of the established teachings of the sect or division, you must be conscientiously opposed to accepting benefits of any private or public insurance that makes payments for death, disability, old age, retirement, or medical care, or provides services for medical care.
  • You must waive all rights to receive any social security payment or benefit and agree that no benefits or payments will be made to anyone else based on your wages and self-employment income.
  • The Commissioner of Social Security must determine that:
    • Your sect or division has the established teachings above,
    • It is the practice, and has been for a substantial period of time, for members of the sect or division to provide for their dependent members in a manner that is reasonable in view of the members' general level of living, and
    • Your sect or division has the established teachings above,
    • The sect or division has existed at all times since December 31, 1950.

Who must file Schedule SE

You must file Schedule SE if you had self-employment income of at least $400 or church employee income of $108.28 or more. Church employee income is wages you received as an employee (other than as a minister or member of a religious order) of a church or qualified church-controlled organization that has a certificate in effect electing an exemption from employer social security and Medicare taxes.

Ministers, members of religious orders who have not taken a vow of poverty, and Christian Science practitioners must pay SE tax on salaries and other income for services performed. If you must pay SE tax, include this income on either Short or Long Schedule SE line 2, but do not report it on Long Schedule SE line 5a; it is not considered church employee income. Include on line 2:

  • The rental value of a home or an allowance for a home furnished to you (including payments for utilities), and
  • The value of meals and lodging provided to you, your spouse, and your dependents for your employer's convenience.
  • Any amount a church pays toward your income tax or SE tax, other than withholding the amount from your salary. This amount is also subject to income tax.

Do not include on line 2:

  • Retirement benefits you received from a church plan after retirement, or
  • The rental value of a home or an allowance for a home furnished to you (including payments for utilities) after retirement.
  • Offerings that others made to the church.
  • Contributions by your church to a tax-sheltered annuity plan set up for you, including any salary reduction contributions (elective deferrals), that are not included in your gross income.

Optional Methods for Calculating Net Earnings from Self-Employment

There are two methods for figuring your net earnings from self-employment as a minister, member of a religious order, Christian Science practitioner, or church employee: regular method and nonfarm optional method. Worksheets 1-4, included on the last 3 pages of this document, may be helpful in calculating your net earnings from self-employment.

Regular Method

Under this method, you figure your net earnings from self-employment by totaling your gross income for services you performed as a minister, a member of a religious order who has not taken a vow of poverty, or a Christian Science practitioner. Then, you subtract your allowable business deductions and multiply the difference by .9235 (92.35%). Use Schedule SE to figure your net earnings and SE tax.

If you are an employee of a church that elected to exclude you from FICA coverage, multiply your wages shown on Form W-2 by .9235. Do not reduce your wages by any business deductions when making this calculation. Use Section B of Schedule SE to figure your net earnings and SE tax.

When figuring your net earnings from self-employment, deduct all your nonemployee ministerial expenses. Also, deduct all your allowable unreimbursed trade or business expenses that you incur in performing ministerial services as a common-law employee of the church. Include this net amount on Schedule SE line 2.

If you received reimbursements for your expenses, how the amounts are reported depends on if the plan is an accountable plan or a nonaccountable plan.

Accountable plans must include all of the following rules:

  • Your expenses must have a business connection - that is, you must have paid or incurred deductible expenses while performing services as an employee of your employer.
  • You must adequately account to your employer for these expenses within a reasonable amount of time.
  • You must return any excess reimbursement or allowance within a reasonable period of time.

Generally, if your expenses equal your reimbursement, you have no deduction and the reimbursement is not reported on your Form W-2. If your expenses are more than your reimbursement, you can deduct your excess expenses for SE and income tax purposes).

Nonaccountable plans include the following:

  • Excess reimbursements you fail to return to your employer.
  • Reimbursement of nondeductible expenses related to your employer's business.

The employer will combine any reimbursement paid to you under a nonaccountable plan with your wages, salary, or other compensation. Your employer will report the combined total in box 1 of your Form W-2. You can deduct your related expenses (for SE and income tax purposes) regardless of whether they are more than, less than, or equal to your reimbursement.

If a husband and wife are both duly ordained, commissioned, or licensed ministers and have an agreement that each will perform specific services, the self-employment income must be divided according to the agreement. If only one spouse has an agreement and the other spouse is not paid for any specific duties, the income must be allocated to the spouse with the agreement.

Noonfarm Optional Method

The nonfarm optional method is intended to permit continued coverage for social security and Medicare purposes when your income for the tax year is low. The following requirements must be met to use the nonfarm optional method:

  • You are self-employed on a regular basis. This means that your actual net earnings from self-employment were $400 or more in at least 2 of the 3 tax years before the one for which you use this method. The net earnings can be from either farm or nonfarm earnings or both.
  • You have used this method less than 5 years. There is a 5-year lifetime limit. The years in which you use this method do not have to be consecutive.
  • Your net nonfarm profits were:
    • Less than $1,733, and
    • Less than 72.189% of your gross nonfarm income.

Your actual net earnings are 92.35% of your total earnings subject to SE tax. Actual net earnings are equivalent to net earnings using the "Regular Method."

INCOME TAX: Income and Expenses

Income Items

If you are a member of the clergy, you must include in your income offerings and fees you receive for marriages, baptisms, funerals, masses, etc., in addition to your salary. If the offering is made to the religious institution, it is not taxable to you.

If you are a member of a religious organization and you give your outside earnings to the organization, you still must include the earnings in your income. However, you may be entitled to a charitable contribution deduction for the amount paid to the organization. These amounts can be included on Schedule A if the taxpayer chooses to itemize their deductions.

Exclusion of Rental Allowance and Fair Rental Value of a Parsonage

You may be able to exclude the rental allowance or fair rental value of a parsonage that is provided as pay for your services. Services include:

  • Qualified services
    • Performing sacerdotal functions.
    • Conducting religious worship.
    • Controlling, conducting, and maintaining religious organizations (including the religious boards, societies, and other integral agencies of such organizations) that are under the authority of a religious body that is a church or denomination.
    • Services for a nonreligious organization if the services are assigned or designated by your church, even if they do not involve performing sacerdotal functions or conducting religious worship (if services are not assigned by your church, they are only qualified services if they involve performing sacerdotal functions or conducting religious worship).
    • Writing religious books or articles.
  • Administrative duties and teaching at theological seminaries.
  • The ordinary duties of a minister performed as an employee of the United States (other than as a chaplain in the Armed Forces), a state, possession, political subdivision, or the District of Columbia.

The church or organization that employs you must officially designate the payment as a housing allowance before the payment is made. A definite amount must be designated. The allowance amount cannot be determined at a later date. If you are employed and paid by a local congregation, a national resolution cannot designate a housing allowance. This must be made by the local congregation, unless directly employed by the national agency.

The amount of allowance you exclude cannot be more than the fair rental value of the home, including furnishings, plus the cost of utilities. The allowance (including an amount to pay utility costs) can be excluded from your gross income if:

  • The amount is used to provide or rent a home, and
  • The amount is not more than reasonable pay for your services.

If you own your own home and you receive a housing or rental allowance as part of your pay, you may exclude from gross income the smallest of the following:

  • The amount actually used to provide a home,
  • The amount officially designated as a rental allowance, or
  • The fair rental value of the home, including furnishings, utilities, garage, etc.

You must include in gross income the amount of any rental allowance that is more than the smallest of your reasonable pay, the fair rental value of the home plus utilities, or the amount actually used to provide a home. Include the excess rental allowance on Form 1040 line 7.

If you are a minister employed as a teacher or administrator by a church school, college, or university, you are performing ministerial services for purposes of the housing exclusion. However, if you perform services as a teacher or administrator on the faculty of a nonchurch college, you cannot exclude from your income a housing allowance or the value of a home that is provided to you. If you serve as a minister of music or minister of education, or serve in an administrative or other function of your religious organization, but are not authorized to perform substantially all of the religious duties of an ordained minister in your church (even if you are commissioned as a minister of the gospel), the housing exemption does not apply to you.

If you are a theological student serving a required internship as a part-time or assistant pastor, you cannot exclude a parsonage or rental allowance unless you are ordained, commissioned, or licensed as a minister.

You can exclude a designated rental allowance from out-of-town churches if you meet all of the following requirements:

  • You are an ordained minister.
  • You perform qualified services at churches located away from your community.
  • You actually use the rental allowance to maintain your permanent home.

If you have a bona fide commission and your congregation employs you on a full-time basis to perform substantially all the religious functions of the Jewish faith, you can exclude a rental allowance from your gross income.

You may deduct the home mortgage interest and real estate taxes you pay on your home, using Schedule A, even though all or part of the mortgage is paid with tax-free rental or parsonage allowance.

If you are a retired minister, exclude from your gross income the rental value of a home (plus utilities) furnished to you by your church as a part of your pay for past services, or the part of your pension that was designated as a rental allowance. A pension or retirement pay for a member of the clergy usually is treated as any other pension or annuity. It must be reported on lines 16a and 16b of Form 1040 or on lines 12a and 12b of Form 1040A.

Expense Items

When you figure your income tax, you must itemize your deductions on Schedule A to claim allowable deductions for ministerial trade or business expenses incurred while working as an employee. You also may have to file Form 2106, Employee Business Expenses (or Form 2106-EZ, Unreimbursed Employee Business Expenses). These expenses are claimed as miscellaneous itemized deductions and are subject to the 2% of AGI limit. Additionally, these expenses may have to be reduced by the amount that is allocable to tax-free income before being limited by the 2% AGI limit.

If you receive a rental or parsonage allowance that is exempt from income tax, you must allocate a portion of the expenses of operating your ministry to that tax-free income. You cannot deduct the portion of your expenses that is allocated to your tax-free rental or parsonage allowance. (This rule does not apply to your deductions for home mortgage interest or real estate taxes on your home.)

If you receive a tax-free rental or parsonage allowance and have ministerial expenses, attach a statement to your tax return that contains the following:

  • A list of each item of taxable ministerial income by source (such as wages, salary, weddings, baptisms, etc.) plus the amount.
  • A list of each item of tax-free ministerial income by source (parsonage allowance) plus the amount.
  • A list of each item of otherwise deductible ministerial expenses plus the amount.
  • How you figured the nondeductible part of your otherwise deductible expenses.
  • A statement that the other deductions claimed on your tax return are not allocated to your tax-free income.

If you are self-employed, you may be able to deduct the amount paid in 2006 for medical and dental insurance and qualified long-term care insurance on Form 1040 line 29. The following special rules apply to the self-employed health insurance deduction:

  • The expenses taken into account for purposes of this deduction are not allowed as a medical expense deduction on Schedule A.
  • The deduction is not allowed for any month you are eligible to participate in a subsidized plan of your (or your spouse's) employer.
  • The deduction is not used to reduce your net earnings for your SE tax.
  • The deduction cannot exceed your net earnings from the business under which the insurance plan is established. Your net earnings under this rule do not include the income you earned as a common-law employee (discussed earlier) of a church.

You can deduct on-half of your SE tax in figuring adjusted gross income. This is an income tax deduction only on Form 1040 line 27.

Income Tax Withholding and Estimated Tax

An employee usually has income tax withheld from his or her pay. However, your pay is generally not subject to federal income tax withholding if both of the following apply:

  • You are a duly ordained, commissioned, or licensed minister, a member of a religious order (who has not taken a vow of poverty), or a Christian Science practitioner.
  • Your pay is for qualified services.

If your salary is not subject to withholding, or if you did not pay enough tax through withholding, you may have to pay estimated tax to avoid penalties from the IRS. You generally must make estimated tax payments if you expect to owe taxes (including SE tax) of $1,000 or more when you file your return.

Determine your estimated tax by using the worksheet in Form 1040-ES. Using the 1040-ES payment voucher, pay the entire estimated tax or the first installment by the due date. This date applies whether or not your tax home and abode are outside the United States or Puerto Rico.

If you perform your services as a common-law employee and your pay is not subject to income tax withholding, you can enter into a voluntary withholding agreement with the church to cover any income and SE tax that may be due.

FILING YOUR RETURN

Even if you are not required to file an tax return based on the amount of your income, you must file a Form 1040, and attach a completed Schedule SE, if:

  • You are not exempt from SE tax, and you have net earnings from self-employment of $400 or more in the tax year,
  • You are exempt from SE tax on earnings from qualified services and you have $400 or more of other earnings subject to SE tax, or
  • You had wages of $108.28 or more from an electing church or church-controlled organization.

Retirement Savings Arrangements

You generally cannot deduct contributions to a tax-sheltered annuity (403(b)) plan on your tax return. However, an exception applies to your contributions if you are a minister or chaplain and, in the exercise of your ministry, you are either self-employed or employed by an organization that is not exempt from tax under section 501(c)(3) of the Internal Revenue Code. If the exception applies:

  • If you are self-employed, deduct your contributions on Form 1040, line 28.
  • If you are not self-employed and your employer does not exclude your contributions from your earned income, deduct your contributions on Form 1040, line 36. Enter the amount of your deduction and "403(b)" on the dotted line next to line 36.

You may be able to take a tax credit for certain contributions you make to other retirement plans or IRAs. The amount of your credit is based on the contributions you make and your credit rate. The maximum contribution eligible for the credit is $2,000. The credit rate can be as low as 10% or as high as 50%, depending on your AGI. The credit can be figured on Form 8880, Credit for Qualified Retirement Savings Contributions. You cannot take the credit if any of the following apply:

  • You were born after January 1, 1988.
  • You were a full-time student in 2006.
  • Someone, such as your parents, claims an exemption for you on his or her 2005 tax return.
  • Your adjusted gross income for 2006 is more than:
    • $25,000, if your filing status is single, married filing separately, or qualifying widow(er) with dependent child.
    • $37,500, if your filing status is head of household.
    • $50,000, if your filing status is married filing jointly.

When figuring AGI, you must add back any exclusion or deduction claimed for the year for:

  • Foreign earned income,
  • Foreign housing costs,
  • Income of bona fide residents of American Samoa, and
  • Income of bona fide residents of Puerto Rico.

Earned Income Credit

You cannot take the credit if your earned income (or AGI) is:

  • " $11,750 or more ($13,750 or more for married filing jointly) and you do not have a qualifying child,
  • " $31,030 or more ($33,030 or more for married filing jointly) and you have one qualifying child,
  • " $35,263 or more ($37,263 or more for married filing jointly) and you have more than one qualifying child.

Earned income includes your wages, salaries, tips, and net earnings from self-employment minus the amount you claimed (or should have claimed) on Form 1040, line 27, for one-half of your SE tax.

Earned income for a minister with an approved Form 4361: Amounts you received for performing ministerial duties as an employee are earned income. This includes wages, salaries, tips, and other taxable employee pay. Amounts you received for nonemployee ministerial duties are not earned income. This includes fees for performing marriages and baptisms, and honoraria for delivering speeches. If you had nonministerial duties, any net earnings from your self-employment, minus one-half of your SE tax, and any pay received as an employee, is earned income.

Earned income for a member of a recognized religious sect with an approved Form 4029: All wages, salaries, tips, and other taxable employee compensation are earned income. Amounts you received as a self-employed individual are not earned income.

Losses from Schedules C, C-EZ, or F cannot be subtracted from wages on Form 1040, line 7.