General Info

General Info

We have compiled information for you based on what we would label our most frequently asked questions. Just click on the links below to retrieve the selected information.

 

Information Regarding Churches

Incorporate at the state level.  It is not necessary to file IRS Form 1023 (which results in a hefty fee) and obtain formal recognition of your exemption.  Incorporation at the state level insures you federal tax-exempt status.

As soon as you begin the process of incorporating at the state level you are considered a church in the eyes of the IRS.  As soon as you obtain an EIN (Employer Identification Number) you can open a bank account and accept contributions for which you can give tax deductible receipts.  File form SS-4 to request an EIN:  Form SS-4

SS-4 Employers file this forms to request a Federal EIN (Employer Identification Number).

W-4 All employees must fill out a W-4 for your records.  This form determines how much federal income tax is withheld.  If the pastor pays quarterly, and does not wish to have taxes withheld, he should mark his W-4 “exempt” and sign it.

I-9 All employees must fill out an I-9 for your records.  This form verifies the employee’s employment eligibility and must be retained by the employer.

W-2 All employees should be given a W-2 each year.  For detailed instructions on filling out a W-2 for the pastor, see the booklet “The Pastor and His Income Tax”.

W-3 One W-3 should be prepared to accompany all your W-2’s.  The W-3 acts as a face/summary sheet.

941 This is a quarterly form used to report wages and pay any taxes withheld by the employer (church).  This must be filed even when no taxes are withheld. All employers must file this form if they pay wages (the definition of wages in this situation would not include housing allowance). Housing allowance is never included on this form so subtract the cash housing allowance before listing the wages on line 2. If all the employees are ministers no social security or Medicares wages are paid so be sure to check the box on line 4.

Some states require state income tax to be withheld by the employer.  Be sure to check your state’s laws to determine your responsibility.  You may be required to withhold state income tax from the pastor’s wages, and file a state quarterly form to report and pay the amount withheld.

Incorporation documents should be kept forever.  W-2′s and payroll records should be kept forever.  Any receipts or documents relating to investments or investment properties should be kept for 6 years after selling or disposing of the investment. All other receipts, statements, bills, check stubs, etc. should be kept for six years.

Any trade or business that is regularly carried on, which is not substantially related to the charitable purpose of the organization, produces unrelated business income. The fact that the income is used to create funds that are used to further the charitable purpose does not exempt the activity from taxation.

Exceptions:

1. Activities in which substantially all the work is performed by unpaid volunteers.

2. Activities carried on for the convenience of the members or employees.

3. Selling merchandise that has been received as gifts or contributions (such as a church bake sale).

4. Dividends, interest, annuities, royalties, capital gains and losses, and rents from real property:

Exception: Debt-financed Property – Property that is held to produce income and is subject to “acquisition indebtedness” (such as a mortgage) at any time during the tax year is unrelated business income unless:

85% rule – if 85% or more of the total property is used for exempt purposes then the income is not considered to be unrelated business income. If less than 85% of the property is used for the exempt purpose than that part of the property, which is not used for exempt purpose, is considered to be unrelated business income.

The neighborhood land rule – If an exempt organization acquires property with the intent of using it for exempt purposes within 10 years (15 years for churches) than income which is produced during that time is not unrelated business income. See IRS publication 598 for details.

Note: Rent on real property is considered unrelated business income when the rent is based on a percentage (such as a percentage of profit). Rent should be a flat rate in order to qualify for any of the exceptions above.

For more information see IRS Publication 598.

Pastors pay their Social Security and Medicare tax the same way a self-employed person would, through self-employment tax. This tax is 15.3% of income including the housing/parsonage allowance and is calculated on the Schedule SE that is filed with a minister’s tax return each year. They must pay Self-employment tax on their ministry income, including their housing allowance. When a pastor lives in a parsonage he also pays SE tax on the Fair Market Rental Value of the parsonage plus church paid utilities.Regular employees have an advantage when paying their Social Security and Medicare tax. Employers withhold half (7.65%) of every employee’s Social Security and Medicare tax from their wages. The employer pays the other half and the employee does not pay any taxes on the employer’s “matching” part.Pastors pay the entire 15.3% without the benefit of a non-taxable “matching” employer part.Many churches have realized the tremendous burden this places on a pastor and his finances and are paying a 9.8% (7.65% = half of SE tax + additional amount to help offset the additional taxes incurred when the salary is increased) “matching” portion as additional salary.

According to the IRS gifts to staff members would be valued at under $25 and would never be cash or a gift card.  Gift cards which are given for a specific item may qualify - such as a certificate for a one pound box of assorted chocolates from a specified candy company.  Otherwise gift cards would never be a qualified gift.  An example of a qualified gift to an employee would be a turkey at Thanksgiving.  Cash gifts which are given to employees, pastors or volunteers are always taxable compensation.

Contributions

Yes, there are several steps you can take to protect your church and those that handle money.

1)    Offerings should be kept in a locked/controlled situation and counted as soon as possible.

2)    Offerings should be counted by two individuals who are not related.

3)    The results should be reported on a tally sheet and signed by both counters.

4)    The treasurer (not a counter) receives a copy of the tally sheet.

5)    The treasurer compares the tally sheet with the bank statement.

Donors are only able to deduct their charitable contributions when contributing to a 501(c)3 organization (such as a church) and if they are able to obtain a receipt.  Therefore it is advantageous for churches to give receipts to their donors.  A receipt should include the name of the church and the amount and date of the contribution.  The receipt should also include the following statement:  “No goods or services other than intangible religious benefits were provided in exchange for the contribution(s)”.  Although the giving for the year may be added together and reported as one total, individual contributions of $250 or more must be itemized separately.  Refer to IRS Publication 1771 for more information.

According to the IRS churches are not appraisers and should not assign a value to a gift of property.  A donor should be provided with a receipt which includes the name of the church and the date of the contribution.  The receipt should also include a detailed description, but not a value, of the donated property.  When the donated property is a vehicle  the church should prepare Form 1098-C and provide a copy to the donor as a receipt.The value of time or services is not deductible and can not be receipted.  See page 7 of IRS Publication 526 for more information.

Designated Contributions are contributions made to the church for a specified purpose.  Usually a donor designates his contribution to a specific fund or to an individual.

According to Revenue Ruling 62-113 contributions earmarked for a particular individual are treated as being gifts to the designated individual and are not deductible.  Churches should not issue tax-deductible receipts for contributions that are designated for individuals. Exception: Contributions earmarked for individuals who are employed or supported by the church are deductible when the church maintains control of the funds.  This would include pastors and missionaries.  When these funds are paid to the pastor or missionary as part of their support, they become taxable income and are included on their W-2.  Contributions received for missionaries should be sent to the mission board or the employer who issues the W-2 so that these amounts can be included on the W-2 when appropriate.

One way to ensure that the church maintains control is to have a written policy regarding designated contributions.  This policy should state that the church (or established team such as a finance committee or board) has exclusive control and discretion as to the use of all contributions and the church is not bound to honor the recommendations of the donors nor will donors be able to recover a contribution because the church failed to honor the donor’s designation.Honoring a donor’s designation encourages future giving and generates goodwill.  It is in the best interest of churches to honor such designations whenever the designation is in line with the church’s ministry purpose.

When the contribution is designated to an individual who is not an employee of the church:(1)   Return the check to the donor or(2)   Accept the check but stamp it “NONDEDUCTIBLE” on its face with red ink.When the contribution is designated to a fund or for a specific purpose:

(1)   Use the funds as designated by the donor or
(2)   Contact the donor and request permission to use the funds in a different way.

Organizations are required to provide a written acknowledgment to a donor who receives goods or services in exchange for a payment in excess of $75.  If a donor gives you a gift of $100 in exchange for concert tickets with a fair market value of $40, then you must provide a written acknowledgment because their gift exceeded $75.  The donor will not be able to deduct more than $60.  The written acknowledgment must include the name of the organization, the date and amount of the gift, and the following statement “In exchange for your contribution, we gave you __________ with an estimated fair market value of ____.”  Goods and Services are considered to be insubstantial if (1) the fair market value of the benefit does not exceed 2% of the contribution or $76 or (2) the gift is at least $43 and the only items provided bear the organization’s name or logo and the cost of these items is less than $8.60.

The IRS provides the following 3 examples of written acknowledgments:

  • Thank you for your cash contribution of $300 that First Baptist Church received on December 12, 2006.
  • Thank you for your cash contribution of $350 that First Baptist Church received on May 6, 2006.  In exchange for your contribution, we gave you a cookbook with an estimated fair market value of $60.
  • Thank you for your contribution of a used oak baby crib and matching dresser that First Baptist Church received on March 15, 2006.  No goods or services were provided in exchange for your contribution.

Generally, organizations send acknowledgments to donors no later than January 31 of the year following the donation. That’s because donors must receive the acknowledgment by the earlier of 1) the date on which the donor files his or her individual federal tax returns for the year of the contribution; or 2) the due date of the return (including extensions).

Payroll/Record Keeping

Typically we do not recommend a two signature requirement because it can become cumbersome.  Some churches may require two signatures when a check exceeds a maximum amount such as $5,000.The pastor(s) should not be a signer on the checks.

W-2′s should be kept forever, and all other receipts, statements, bills, check stubs, etc. should be kept for six years. Any receipts or documentation relating to incorporation should be kept forever.

Every couple of years someone(s) from within the church should conduct an internal audit focusing on procedures as their main objective.

Block 1 – Wages, tips, other compensation
This amount would not include any designated housing allowance.  Include all other wages, bonuses, gifts, non-substantiated reimbursements, the value of any non-cash gifts, and any other amounts given to the pastor that are not qualified fringe benefits.

Block 2 – Federal income tax withhold
Include any amounts you withheld from the pastor’s wages and paid by filing IRS form 941.

Block 3 – Social security wages
This block should have a zero or the word “none” in it.  Ministers are not employees for Social Security purposes and they do not have Social Security wages through their employers (churches).

Block 4 – Social security tax withheld
This block should have a zero or the word “none” in it.  Ministers are not employees for Social Security purposes and they do not have Social Security tax withheld through their employers (churches).

Block 5 – Medicare wages and tips
This block should have a zero or the word “none” in it.  Ministers are not employees for Medicare purposes and they do not have Medicare wages through their employers (churches).

Block 6 – Medicare tax withheld
This block should have a zero or the word “none” in it.  Ministers are not employees for Medicare purposes and they do not have Medicare tax withheld through their employers (churches)

Blocks 7 – 11
Leave these blocks blank.

Block 12 -
Employee benefits are reported in block 12.  A code is listed to identify the type of benefit and the amount provided is listed following the code.  Here is a list of the most common codes used by churches:
The value of group-term life insurance which is also included in block 1:  “C”
The elective deferred salary contributed to a 401(k) retirement plan:  “D”
The elective deferred salary contributed to a 403(b) retirement plan:  “E”
Moving expenses reimbursed to the employee (not included in block 1):  “P”
Employer contributions to a medical savings account:  “R”
Employer contributions to a health savings account:  “W”

Block 13 -
Check the “Retirement plan” box if employee or employer contributions are made to a retirement plan.

Block 14 – Other
The housing allowance is reported here.  List the amount of designated housing allowance and label it “Minister – see Schedule SE Housing Allowance”.

Pastors pay their Social Security and Medicare tax the same way a self-employed person would, through self-employment tax.  As a result it is incorrect to withhold and match Social Security and Medicare taxes for a minister.  When these taxes have been withheld in error the quarterly 941′s and W-2(s) need to be corrected.You will need an original W-2c and W-3c.  The downloaded version of these forms are for informational purposes only.  You may find forms at your post office or library.  You may also call 1-800-TAX-FORM and ask for copies to be mailed to you.

You will need to know the following amounts when correcting your 941′s and W-2(s):

1.  The “total tax” you paid in error as Social Security and Medicare taxes.

2.  Half of the amount of the “total tax” which will be referred to as the “half”.  (This is also the amount which was withheld from the pastor’s wages.)

Correct your 941′s:

The following instructions should not result in an overpayment or an underpayment.  The net result would be zero balance due.
1.  Prepare new quarterly 941′s correctly by not showing your minister’s income in column 1 of blocks 5a & 5c.  Neither would you show any taxes for your minister in column 2.

a.  Increase block 3 by the “total tax” you are no longer reporting in column 2 of blocks 5a & 5c.  (This will move the amounts you paid for Social Security and Medicare into Federal Income tax withholding).

b.  Increase block 2 by “half” of the amount you included in block 3.  (This is because the matching portion of the Social Security and Medicare taxes need to be included in income.)

2.  Prepare a 941-X showing the previously reported amounts (from your incorrectly submitted 941′s) and the correct amounts (from the 941′s you have just prepared).

3.  Mail your 941-X to the address where you would file your 941′s if you were not making a payment.

Correct your W-2(s):

1.  Prepare Form W-2c.

a.  Increase block 1 by the “half”.

b.  Increase block 2 by the “total tax”.

c.  Decrease blocks 3, 4, 5 and 6 to zero.

2.  Mail the top copy of W-2c with a W-3c to:

Social Security Administration
Data Operations Center
Wilkes-Barre, PA  18769-0001

3.  Keep a copy of the W-2c for your records and give the rest of the copies to the minister.

The following table represents the amount which must be added to income when an employer provided Life Insurance policy has a benefit value of greater than $50,000.  For each extra $1,000 above $50,000 you would calculate an amount using the chart below and multiply by the number of months the benefit was provided (usually 12 months).

Cost Per $1,000 of group term Life Insurance protection for 1-Month Period.

[Reg. 1.79-3(d)(2)]

For example a 47 year-old pastor who receives a non-taxable life insurance policy of $100,000 for the entire year would have $90 added to his W-2, block 1 (and block 12 of his w-2 would show code “c” and 90). 

Information Regarding Pastors

Pastors should have a cash salary that meets the physical needs of the family independent of the wife having to work.

In the middle 1960’s as a young accountant I began helping my pastor prepare his state and federal tax returns.  Needless to say I was surprised at his meager salary, lack of fringe benefits and his inability to provide for his future financially.  His family lived in a church owned parsonage totally controlled by the church; they couldn’t even paint a wall without committee approval.  It was a large farmhouse that was difficult to maintain and expensive to heat.  I can remember visiting that parsonage and finding his wife in tears over the frustration of living under those conditions.  I can remember thinking “this is not right”.  Little did I know how that experience would begin to sow the seeds for the Stewardship Services Foundation.  A ministry that would allow me to devote my energies to counseling pastors regarding finances, helping them to prepare their personal income tax returns and teaching church boards how to structure the pastors’ salary packages staying within the limits of IRS tax law.  As a result, in 1977 the Stewardship Services Foundation ministry was born.

In this article I will attempt to discuss salary packages and their proper application in the budget process.  The most important issue when it comes to this subject is attitude, a proper understanding by the board as it relates to the salary package issue including the desire to meet the needs of the family with a spirit of generosity.  When a church calls a pastor (senior, youth, music, visitation, etc.) it is important to consider the following issues:

1.     A cash salary to meet the physical needs of the family independent of the wife having to work.  A good starting point would be to review his personal budget and build on it.  A pastor who struggles to provide for his family is a pastor who will hesitate to teach Biblical stewardship from the pulpit.  If he can’t live it, he shouldn’t teach it.

2.     Full family medical plan that provides adequate health insurance and protects the family and the church from a catastrophic illness or accident.  (tax free fringe benefit)

3.     Disability Insurance – cash replacement that provides income and protects the family and the church due to a disabling illness or accident.  (can be a tax free fringe benefit)

4.     Retirement Plan – coupled with Social Security an amount that would give the pastor approximately 80% of his take home pay at retirement, assuming he has a debt-free home.  If he has opted out of Social Security, which I do not advise, the plan must be more aggressive to meet his needs.  I recommend the plan begin as early as possible with a minimum annual contribution of $2,400 building to $6,000 as soon as possible, and even more if he starts the plan after 40 years of age.  Pastors should not be in IRA’s or Roth IRA’s.  They should be in a 403-b pension plan where the deposits are made by the church which exempts the amount from self-employment tax and makes the distributions eligible for housing allowance upon retirement which would shelter it from Federal and State Income Taxes.

5.      Life Insurance – $100,000 of term life insurance, paid by the church, with the wife as beneficiary – this protects the church and provides for the family upon a premature death.  The church can pay the premiums on the policy but only the premium on the first $50,000 is a tax-free fringe benefit.  The pastor should provide his own additional life insurance as needed, probably in the $500,000 range.

6.     Professional Expense Reimbursement Fund – the IRS looks at a pastor as a business man and recognizes that he incurs reimbursable professional expenses that allow him to perform his duties and should be paid by the church (automobile mileage, conferences, entertainment, supplies, anything pertaining to his responsibilities).  In reality these expenses are incurred for the benefit of the church not the pastor.

I have advised churches for over 30 years to get out of the parsonage business.

7.     Housing/Parsonage Allowance – I have advised churches for over 30 years to get out of the parsonage business.  I think it is very important to get a pastor into his own home as soon as possible for many reasons. Retirement – owning a home at retirement is a key ingredient to retirement planning.  Security – for his family particularly his wife, privacy – they can decorate how they want – it’s home.  I think it tends to add to longevity – the family feels more attached to the community because there’s a stronger sense of belonging.  Tax purposes – income tax law provides for generous benefits to the pastor who is buying his own home.  Federal and state income taxes are greatly reduced and sometimes eliminated due to the housing allowance and the double deduction for mortgage interest and real estate taxes.

8.     The self-employment tax is another issue that is often misunderstood – A pastor is a dual status employee.  He is an employee for income tax purposes and self-employed for Social Security and Medicare purposes (called self-employment tax).  Instead of paying 7.65% for his Social Security and Medicare and his employer paying 7.65% as all other employees do, he must pay 15.3% (less a small credit).  I recommend the church include in his salary an amount that would cover the 7.65% that the church would normally pay if he weren’t the pastor.  Because he must pay taxes on the additional 7.65% a proper increase would be 9.8%.

Note:  A pastor pays the self-employment tax on the total of his wages including his housing allowance (if buying or renting).  In the event that he lives in a church owned parsonage, he pays his self-employment tax on the total of his wages including the parsonage value and church paid utilities.

Now let’s express the above in a budget format:

This Pastor is 40 years of age, married and has 2 teenage children

Example – #1 – this pastor receives a cash salary of $45,000 per year and lives in a church owned parsonage with a monthly Fair Market Rental Value (FMRV) of $1600; the annual FMRV is $19,200.  The church pays the utilities (which they should) that amount to $2,800 per year.  His annual self-employment tax (Social Security) will amount to $9,467 ($45,000 + 19,200 + 2,800 = $67,000 x 92.35% = $61,875 x 15.3% = $9,467) of which the church agrees to pay $6,500 (9.8% of $67,000).

Pastor’s Financial Package

Cash Salary – (45,000 + 6,500)                                        $51,500

Fringe Benefits: Medical Plan $700/mo.                            8,400

Disability Insurance                                                                 1,500

Retirement Plan                                                                       9,000

Life Insurance                                                                      400

Total                                                                    $70,800

The above pastor drives his car an average of 13,000 miles a year for the church which is reimbursed by the church at the current IRS rate of .51¢ per mile for a total of $6,630.  In addition he spends approximately $1,000 for conferences he and his wife attend, $400 for ministry related books and periodicals, $500 for meals he provides for counselees and church related guests in his home and $300 for miscellaneous expenses.  A total of $8,830 is added to the church budget for church ministry expenses on a line item totally separate from the pastor’s financial package category.

Example #2 – Is the same as Example #1 except this pastor is buying his own home.  An additional amount of $20,000 has been added to his cash salary and a $30,000 housing allowance is designated to cover his mortgage payment ($22,000), utilities ($3,200), real estate taxes ($2,300), insurance ($500) and maintenance ($2,000).  The church has already been paying the utilities, insurance and maintenance of $4,700 for the parsonage in past years, so this portion of his increase is not new money.  His annual self-employment tax will amount to $9,184 ($35,000 + 30,000 = $65,000 x 92.35% = $60,028 x 15.3% = $9,184) of which the church agrees to pay $6,370 (9.8% of $65,000).

Pastor’s Financial Package

Cash Salary (35,000 + 30,000 + 6,370)                    $71,370

Fringe Benefit: Medical Plan 700/mo.                          8,400

Disability Insurance                                                           1,500

Retirement Plan                                                                 6,000

Life Insurance                                                                  400

Total                                                                        $87,670

The professional expense amount of $8,830 would appear in a line item in the budget separate from the salary package category.  The pastor would be reimbursed from this line item as he accounts to the treasurer with all details including mileage logs and receipts.  A church credit card can be used for many of these expenses.

I realize the above number may be currently out of reach for some churches.  However, stewardship principles require each of us to be responsible with the resources and families he has entrusted to our care.  A good procedure is to assign two board members to review the needs of the staff annually and make recommendations to the full board for consideration.  When it comes to our pastors we should take I Corinthians 9:14 and I Timothy 5:17 very seriously.  Addressing all of the above issues at one time may be difficult but by prayer, planning and proper stewardship all the issues can be addressed.

An individual who is licensed, commissioned or ordained and performing the services of a minister.  These services include:

  • Performing sacerdotal functions (communion, baptizing, marrying, burying, etc.),
  • Conducting religious worship, and
  • Controlling, conducting and maintaining religious organizations that are under the authority of a religious body that is a church or denomination. (You are considered to control, conduct, and maintain a religious organization if you direct, manage or promote the organization's activities.)

The front 1040 and Schedule SE should be kept forever, and all back-up to the tax return for six years.

Because we prepare returns via U.S. mail and do not actually meet with each pastor individually we do not efile returns and unfortunately we do not have the time to add efiling to our tax season.  In addition, we cannot help you when you run into problems (we have tried this in the past but without success). 
If you wish to efile we would suggest that you use a service which allows you to fill in the actual forms yourself rather than one that calculates for you.  A service such as "Free File Fillable Forms".  Efiling a minister's tax return can be challenging - sometimes we can make it work and sometimes even we cannot.

 

No, the facts and circumstances will determine a minister’s employment status.  Creating a contract or giving an individual a title or description in order to appear to be self-employed will not determine employment status – the facts and circumstances make the determination.

An employee should receive a W-2 and the employer should withhold and match Social Security and Medicare on his/her wages.Note: A church can hire a service, a general contractor, or an individual (if the individual is in business and offers his/her services to several churches/businesses) to provide miscellaneous services (i.e. yard maintenance, janitorial duties, secretarial duties, etc.).  If a church chooses to hire an individual or church member then an employer/employee relationship has been established and proper employment forms must be completed.

If you pay a self-employed individual more than $600.00 (not including reimbursements or housing allowance), you must give the individual a 1099-MISC.  There is no place to report housing allowance on form 1099-MISC.

An employing agency of a minister of the gospel is to treat the minister as dual-status.  This means the minister has 2 status’ and is considered both an employee and self-employed.   1)  he is an employee for federal income tax purposes and receives a W-2 and   2)  he is self-employed for Social Security and Medicare purposes and does not have Social Security or Medicare withheld nor matched on his wages.

The most common error is for a church/mission agency to give their employed minister a 1099 as if self-employed.  This error is many times compounded by the housing allowance, expense reimbursements, and fringe benefits.  Fringe benefits are available to dual-status ministers not to self-employed individuals.  If a minister of the gospel receives a 1099 and employee fringe benefits, he is receiving wrong treatments.  These “before tax” benefits are for “dual-status” ministers who receive W-2’s.  Self-employed 1099 individuals are not entitled to employee fringe benefits.The second most common error is for churches to withhold and match Social Security and Medicare taxes from a minister’s wages.  This is further compounded when the church designates a housing allowance.  Employees who have Social Security and Medicare taxes withheld do not qualify for a housing allowance.  If a minister of the gospel has Social Security and Medicare taxes withheld, he is receiving wrong treatments. (Click here for instructions on how to correct this error.)

For more information refer to IRS Publication 517.

Pastors are considered dual-status employees, which means they are treated as an employee for federal income tax purposes, and self-employed for Social Security/Medicare purposes.  Being an employee, they do receive a W-2.Self-employment tax is simply the vehicle a self-employed individual uses to pay his Social Security/Medicare tax (SECA).  Income (whether you are an employee or self-employed) is subject to both federal income tax and Social Security/Medicare tax.Employees pay their taxes throughout the year as their employers withhold taxes from their pay.  The amount withheld for federal tax is figured based on the W-4 an employee fills out when employment begins.  For Social Security/Medicare the employer withholds 7.65% (6.2% for Social Security tax and 1.45% for Medicare) from the employees salary, then the employer matches that amount (pays an additional 7.65% which is not considered income to the employee).Self-employed individuals pay their taxes throughout the year by making quarterly estimated payments.  This amount covers both their federal tax and self-employment tax (Social Security/Medicare).  The amount they pay is only an estimate; they figure the actual amount when they file their yearly tax return.

A pastor’s options in paying taxes during the year are:

1.     Your treasurer can withhold enough FIT (Federal income tax) to cover both the FIT and Social Security/Medicare taxes.

2.     Your treasurer can withhold FIT and you can file Social Security/Medicare taxes quarterly on Form 1040-ES.

3.     You can file quarterly on 1040-ES for all taxes.

4.     Prepaying your state taxes by withholding or quarterly estimates may also be required.

The pastor pays federal taxes on the amount of his salary not including the actual expenses incurred for his designated housing allowance, and any tax free fringe benefits.*

The pastor pays self-employment tax on his salary, his housing allowance, the fair market rental value of any church owned parsonage, including any church paid utilities.  Other outside income, such as honorariums, would be included on Schedule C of the tax return and subject to self-employment tax.*

I have never recommended a minister in our fundamental circles to apply for exemption from Self-Employment Tax (Form 4361). The election to apply for exemption is very clearly not to be a financial decision. A minister must be “conscientiously opposed to.. any public insurance that makes payments in the event of death, disability, old age, or retirement; or that makes payments toward the cost of…medical care.” In addition, this conscientious objection must be because of his religious principles. Any minister who files Form 4361 must notify his church that, because of his religious principles, he is opposed to public insurance. I see no scriptural support for opposition to public insurance, and therefore, I do not believe a fundamental minister of the gospel can sign such a statement.There is a general misconception about the election, which implies it to be a good financial decision. I would not concur with that notion! The Social Security program is a good one, and the benefits paid upon retirement are usually the only source of income a minister may have available. The important issue financially is self-discipline. Typically those who have opted out of Social Security have not made adequate provisions for retirement, disability, and Medicare insurance.

We recommend that you call our office for counsel before you file form 4361 to apply for exemption from Self-Employment tax.The following steps should be taken in applying for exemption from Self-­Employment Tax: 1) A prayerful and complete study of Scripture should be made, and notes recorded and kept for your records, documenting your conclusions with regard to public insurance. 2) Request Form 4361, Application for Exemption from Self-Employment Tax for Use by Ministers, Members of Religious Orders and Christian Science Practitioners, from the IRS. 3) Notify your church of your religious opposition to public insurance.4) Mail your completed Form 4361 to the appropriate IRS office, as indicated on the form, and keep a copy for your records. 5) When you receive your approval from the IRS (the approval will be a copy of your form 4361 with some sort of IRS stamp across the face of the application) make several copies and keep them in several different locations. If you are ever audited and cannot produce your approved exemption, you could be accessed penalties and interest and required to pay your Self-Employment Tax for the past three years.

W-2′s should be kept forever, and all other receipts, statements, bills, check stubs, etc. should be kept for six years. Any receipts relating to capital expenditures or improvements (home improvements) should be kept for 6 years after the sell of a home. Any receipts or documents relating to investments or investment properties should be kept for 6 years after selling or disposing of the investment.

Fringe Benefits

1. Pay his salary based on a fair and livable wage (the principle of generosity).

2. Fringe benefits should include:

Full family medical insurance

Retirement plan (403b)

Disability insurance

$100,000 of term life insurance

add value of $50,000 as income

3. Reimburse pastor for all professional expenses out of general fund category not compensation.

4. Church should pay portion of pastor’s social security obligation as a taxable bonus.

5. Help pastor buy his own home.

6. Give pastor and wife opportunity to attend three church conferences a year at church expense.

7. Church should give pastor four weeks of vacation per year including four Sundays.

Disability Insurance – The church can reimburse its pastor for this premium or pay it directly.

Health Insurance – Group health insurance plans are a qualified fringe benefit.  If the church does not qualify for a group plan because there is only one employee, you will need to establish either a Medical Reimbursement Account or a Health Reimbursement Arrangement.

Health Reimbursement Arrangement – This is an amount which the church sets aside to be used for reimbursement of non-covered medical expenses.  Left-over funds may be carried forward to the following year.  An HRA is subject to discrimination laws and all employees would receive the same amount.

Housing Allowance – This is a part of the pastor’s salary which is designated to be available for housing costs. This needs to be approved by the board or church in writing and in advance of expenses. The portion of this designation which is used to provide housing is exempt from Federal Income taxes, but not self-employment tax (Social Security/Medicare).

Life Insurance – The church may provide up to $50,000 group term life.

Medical Reimbursement Policy – This is an amount set aside to be used for reimbursement of non-covered medical expenses. The funds are made available through salary reduction. This is a “use it or loose it” proposition, so any funds remaining at year end cannot be given as salary.

Reimbursement/Expense Account – The church must require receipts (it is not enough for the pastor to voluntarily substantiate his expenses). This is a “use it or loose it” proposition; any unused portion cannot become salary.

Tax Sheltered Annuity (403-b) – The church contributes directly to the financial institution chosen. The Pastor or church determines the amount of the contribution, which would exclude it from taxes.

Tuition Benefits for your dependents – The school must also be the employing body in order for this to be a tax-free benefit (i.e. the church and school are one corporation).

What benefits are taxable?

 

Health Insurance - Insurance obtained through a government website is taxable.  Any amounts paid for individual policies are taxable (unless a one person stand-alone HRA or MRP is used).  Any amount paid using a sharing ministry is taxable (unless a one person stand-alone HRA or MRP is used).

Life Insurance – in excess of $50,000, or any policy which is not considered group term life.

Personal use of a Church/School owned Auto – a log must be kept to determine the value of this taxable benefit.

Reimbursements – when a Pastor is not required to substantiate or “pay back” the excess.

Tuition Benefits for your dependents – These benefits are considered a part of the Pastor’s taxable salary when the school is not a part of the church.

Option #1
The church pays the Pastor a salary and reimburses all his professional expenses separately (from the general operating budget). This keeps the Pastor’s salary and professional expenses totally separate. Note, the Pastor must account to the church with receipts/mileage logs for those expenses to be reimbursed. This is the best method to use.

1. The Pastor accounts to the treasurer/bookkeeper monthly with his expenses and gets reimbursed with a separate expense check out of the professional expense category in the budget.

Option #2
The church pays the Pastor a salary and the Pastor uses a salary reduction plan to make funds available for expense reimbursement. A portion of the Pastor's salary becomes a separate line item in the general operating budget. This keeps the Pastor’s salary and professional expenses totally separate.

1. The Pastor accounts to the treasurer/bookkeeper monthly with his expenses and gets reimbursed with a separate expense check out of the professional expense category in the budget.

2. If the Pastor does not use the total amount of budgeted expenses by the end of the year, he loses it – the unused portion belongs to the church. IT DOES NOT BECOME SALARY.

If you do not follow the procedures as the IRS stipulates for reimbursement, and they audit your return, they will declare your reimbursement as non­accountable professional expenses. They will add your reimbursed expenses to your income and they will require you to file Form 2106 and Schedule A Miscellaneous with that year’s return and then apply the Dalan ruling* and the 2% limitation.

Pastors may now be targets for IRS audits on professional expenses. The IRS regulations state that an employee must be accountable for professional expenses either to the IRS through schedules 2106 and schedules A miscellaneous, or to their employers by reimbursement. We recommend the reimbursement method. It will prevent an audit by the IRS for those areas now targets – you eliminate schedules 2106 and A miscellaneous from your tax return. It will also save taxes as a portion of expenses listed on your 1040 will be subject to limitations (the Dalan ruling* and 2% of Adjusted Gross Income). They are not subject to limitations if reimbursed. You do not report the reimbursed amount on the Pastor’s W-2. It is not income.

The following are examples of reimbursable (tax deductible) business expenses:  Education – Tuition, fees, books, supplies, and (if the school is away from the pastor’s home area) transportation, meals, and lodging are reimbursable.  Education expenses which qualify your pastor for a new trade or business (such as carpentry, etc.) are not reimbursable.  Meal & Entertainment – Reimburse a pastor 100% of his cost for meals and entertainment.  When his spouse is present because the spouse of the person being entertained is present, her meal is reimbursable.  The cost of meals for the pastor’s children are never deductible.  Mileage – The pastor should keep a log of his miles (including the mileage at the beginning and end of each year) and be reimbursed for his business miles at the standard mileage rate.  Travel – The cost of train, airplane, boat, bus fare, auto rental, taxi, hotel, motel, meals, gratuities, telephone, travel insurance, baggage charges, cleaning, and laundry costs are reimbursable when a pastor travels on business.  A pastor might travel to attend a church convention, a speaking engagement, to lecture, to perform a wedding or a funeral, to provide pulpit supply, an evangelistic meeting, on deputation, to church camp, etc.

Clothing which is adaptable for general wear, one subscription to a local newspaper (which the IRS claims must be personal), magazine subscriptions, tapes, and books which are purchased for personal reasons, travel expenses which relate to anyone other than the person earning an income, commuting miles, contributions, tithes, offerings, tuition expenses for your dependents, education expenses which do not relate to your ministry, taxes, or personal use of your computer.

Ministers should be reimbursed for entertainment expenses as these are greatly reduced when taken to the tax return.  When reimbursement is not available these expenses may be included on the tax return.

RESTAURANT MEALS: The cost of meals when entertaining out-of-town ministry guests (visiting missionary, evangelist, etc.) is deductible.  The cost of children’s meals are never deductible.

IN-HOME ENTERTAINING: Most ministers provide substantial entertaining in their home.  The main expense of entertaining is the cost of meals and those meals usually consist of items which you have on hand rather than items which you purchase for the occasion.  For this reason many pastors find it more convenient to use a per diem rather than an actual amount.  Depending on your circumstances a reasonable per diem for a complete dinner might vary between $6 to $8 per person.  Afternoon meetings with refreshments or after evening snacks for the youth group might vary between $1.50 to $2.50 per person.  If you purchase many items during one visit to the grocery store you might wish to keep your receipt to validate the per diem amount you use.

A taxpayer must substantiate by adequate records or by sufficient oral or written evidence the following types of expenses:

1.     Traveling expenses including meals and lodging while away from home.

2.     Entertainment expenses.

3.     Business gifts.

Since 1985, taxpayers have been required to answer questions on their returns regarding the business use of an automobile including:

1.     The total number of miles driven during the year.

2.     The total number of business miles driven during the year.

3.     Whether the vehicle was used for commuting and, if so, the distance normally commuted.

4.     Whether the vehicle was available for personal use in off-duty hours.

5.     Whether another vehicle was available for personal use.

6.     Whether adequate records or sufficient evidence exists to justify the deduction and whether or not the evidence is written.

Taxpayers are required to substantiate the following elements:

1.     The amount of each expense or other item.

2.     The time and place of the travel, entertainment, amusement, recreation, or the date and description of the gift.

3.     The business purpose of the expense or other item.

4.     The business relationship to the taxpayer of the persons being entertained, or receiving the gift.

Adequate records or sufficient evidence include the following:

1.     Account books, diaries, and logs.

2.     Documentary evidence (receipts, paid bills).

3.     Trip sheets.

4.     Expense reports.

5.     Written statement of witnesses.

If a taxpayer does not have adequate records to substantiate his expenses, or if he cannot supply sufficient oral or written evidence thereof, no tax deductions or credits will be allowed with respect to an item. It should be noted that Congress has emphasized that different types of evidence have different degrees of probative value and that oral evidence alone has considerably less probative value than written evidence. *The Dalan Ruling – In January of 1990, the IRS took another step toward reducing the amount of professional expenses ministers can deduct on their tax returns. It involves a case known as the Dalan Case. In effect, the IRS ruled that, beginning in 1988, ministers would not be able to deduct all of their professional expenses because of earning non­taxable income. For example, the Housing Allowance: Pastor Smith earns $35,000 per year of which $30,000 is housing allowance. His professional expenses amount to $7,000 for the year. Since forty-six percent of his income is non-taxable ($30,000 divided by $65,000), $3,220 of his expenses are non-deductible ($7,000 x 46%). If Pastor Smith is reimbursed by his church for professional expenses, then the Dalan ruling has no effect on the minister.

Pastors pay their Social Security and Medicare tax the same way a self-employed person would, through self-employment tax. This tax is 15.3% of income including the housing/parsonage allowance and is calculated on the Schedule SE that is filed with a minister’s tax return each year. They must pay Self-employment tax on their ministry income, including their housing allowance. When a pastor lives in a parsonage he also pays SE tax on the Fair Market Rental Value of the parsonage plus church paid utilities.Regular employees have an advantage when paying their Social Security and Medicare tax. Employers withhold half (7.65%) of every employee’s Social Security and Medicare tax from their wages. The employer pays the other half and the employee does not pay any taxes on the employer’s “matching” part.Pastors pay the entire 15.3% without the benefit of a non-taxable “matching” employer part.Many churches have realized the tremendous burden this places on a pastor and his finances and are paying a 9% (7.65% = half of SE tax + additional amount to help offset the additional taxes incurred when the salary is increased) “matching” portion as additional salary.

Transportation

What is considered commuting miles?

Commute miles are from your home to your first business location and from your last business location to your home.  Multiple trips you make throughout the day to your home are also considered commuting.  Returning to the church from home for an evening meeting (such as a board meeting) would be considered commuting.  Driving to church on Sunday would be considered commuting.  Commute miles are always personal miles.When you leave the metropolitan area where you live and normally work you are no longer commuting.  Miles from your home to a business location outside of the area would not be commute miles.

What is considered business miles?

Business miles are any miles which you drive from one business location to another.  Such as from the church to the post office or from the church to visit a church member.Any miles you drive for business that require you leave the metropolitan area where you live and normally work are also business miles.  Such as making a hospital visit to a member in a hospital which is located out of the area in which most of your church members live.  In this case you may begin the trip from your home or any other location in your area.

When a church owns the vehicle driven by the Pastor and the Pastor uses the vehicle for personal use, an amount must be added to his income.  Personal use is any use which is not church business.  Commuting is considered personal use. The Pastor must log his miles and provide the church with a statement showing the business miles driven and the total miles driven.

Calculating Personal Use on an Employer Owned Vehicle

Subtract the pastor’s business miles from his total miles.  This gives you his personal miles.  Divide his personal miles by the total miles.  This gives you the percentage of personal use. Using the Annual Leave Value table below, multiple the percent of personal use by the annual lease value (if the vehicle was not made available for the entire year, multiple by the fraction – the number of days available divided by 365).  Add this amount to the Pastor’s income on his W-2, block 1*.
*If the employer provides the gasoline then add 5½ cents for each personal mile.
*If the employee provides the gasoline then deduct 5½ cents for each business mile.

Annual Lease Value

Generally, you figure the annual lease value of an automobile as follows.

1)  Determine the fair market value (FMV) of the automobile on the first date it is available to any employee for personal use.

2)  Using the following Annual Leave Value Table, read down column 1 until you come to the dollar range within which the FMV of the automobile falls.  Then read across to column 2 to find the annual lease value.

Annual Lease Value Table
Annual Lease Automobile FMV Value
$ 0 to 999 600
1,,000 to 1,999 850
2,000 to 2,999 1100
3,000 to 3,999 1350
4,000 to 4,999 1600
5,000 to 5,999 1850
6,000 to 6,999 2100
7,000 to 7,999 2350
8,000 to 8,999 2600
9,000 to ,9999 2850
10,000 to 10,999 3100
11,000 to 11,999 3350
12,000 to 12,999 3600
13,000 to 13,999 3850
14,000 to 14,999 4100
15,000 to 15,999 4350
16,000 to 16,999 4600
17,000 to 17,999 4850
18,000 to 18,999 5100
19,000 to 1,9999 5350
20,000 to 20,999 5600
21,000 to 21,999 5850
22,000 to 22,999 6100
23,000 to 23,999 6350
24,000 to 24,999 6600
25,000 to 25,999 6850
26,000 to 26,999 7250
28,000 to 29,999 7750
30,000 to 31,999 8250
32,000 to 33,999 8750
34,000 to 35,999 9250
36,000 to 37,999 9750
38,000 to 39,999 10250
40,000 to 41,999 10750
42,000 to 43,999 11250
44,000 to 45,999 11750
46,000 to 47,999 12250
48,000 to 49,999 12750
50,000 to 51,999 13250
52,000 to 53,999 13750
54,000 to 55,999 14250
56,000 to 57,999 14750
58,000 to 5,9999 15250

For automobiles with a FMV of more than $59,999, the annual lease value equals
(.25 x the FMV of the automobile) + $500.

For more information refer to IRS Publication 15-B.

Mileage Rates Business Moving Medical Charitable
2016 54¢ 19¢ 19¢ 14¢
2017 53.5¢ 17¢ 17¢ 14¢

Housing

Designate the housing allowance in a regular church/board meeting.  Use the following wording:

 

Insert for Minutes of Meeting to Approve the Housing/Parsonage Allowance

 

1.  It was discussed that under the tax law a minister of the gospel is not subject to federal income tax on the “housing allowance paid to him as part of his compensation to the extent used by him to rent or provide a home.”

2.  The parsonage owned by the church has a rental value of $____________ and is provided for the convenience of the church.  Actual utility expenses will be paid by the church and they will amount to approximately $__________________ for the year.

3.  After considering the statement “Pastor’s Estimate of Home Expenses” (see next page) prepared by ____________________, a motion was made and seconded and passed to adopt the following resolution:

4.  Resolved that Pastor _______________________ is to receive a total cash remuneration of $________ (salary) for the year 20____. Of this amount, $_______ (housing expenses paid from salary) is hereby designated as housing allowance.

5.  Resolved that as long as Pastor _____________ is our employee the above amount of housing/parsonage allowance shall apply to all future years until modified.

Date____________ Signed__________________________________

Note: Using the above insert for the minutes is probably the most convenient for church use. The names of the individuals making the motion and seconding it should be included. If the church does not provide the home and pay the utilities, then the second paragraph is to be omitted. All out of pocket costs in providing your home are to be included in paragraph 4. IRS regulations state that the housing allowance should be designated in writing each year.

 

 

A pastor does not pay federal income tax on that portion of his income which is considered to be his housing allowance*. The housing allowance is the smaller of the following: The amount designated by the church to be considered housing allowance.  (This is limited to ministry income, but 100% of ministry earnings can be designated as housing allowance). The amount actually spent to provide a home (see below: What expenses are included in the housing allowance?) The FMRV (Fair Market Rental Value) of the furnished home plus actual expenses. The FMRV takes the place of the mortgage payment (including closing costs, down payment, principal, interest, taxes, insurance) and major repairs.

*Housing allowance (parsonage value, church paid utilities and designated cash portion) is always subject to social security and Medicare taxes.

The pastor continues to be paid in the same manner he was paid prior to the designation of a housing allowance. The fact that a portion of his salary is now designated as housing allowance need not affect the amount nor the manner in which he is paid.

Housing Allowance is limited to the smallest of the following:

1.   The amount officially designated for housing.

We recommend you estimate high because you do not want to be limited to what is designated.  This can never be more than 100% of the income you earn from ministry.  Other sources of income cannot be designated as housing allowance.

2.   The amount you actually used to provide a home.

Housing is always out-of-pocket expenses, the amount you spend from your own personal funds.

3.   The FMRV limitation (this applies when you own your own home).

The IRS is rather vague about how to figure your Fair Market Rental Value (FMRV).  Your FMRV is an amount which you could collect in rent if you rented your home.  A general rule of thumb for FMRV is one percent of the appraised value per month.  For example, if the appraisal equals $100,000, the monthly FMRV would be $1,000.  If you lived in your home for 12 months, the annual FMRV would be $1,000 x 12 = $12,000.  This is only a general rule and does not apply in all areas of the country.

The FMRV limit takes the place of the mortgage payment, (including closing costs, down payment, principal, interest, taxes, insurance) and major repairs.  Once you have determined your FMRV you would add to that the actual costs of utilities, decorator items, furniture, appliances, and miscellaneous expenses (such as repairs and cleaning supplies).

 

Rent or mortgage payments. Including principal, interest, real estate taxes, insurance, closing costs, and down payment.Furniture, appliances, computers, curtains, rugs, vacuum sweepers, washing machines, dryers, pictures, kitchen and garage utensils.Utilities:  heat, electric, telephone or cell phone, water, cable TV, sewer charge, wood for fireplace, and internet.Cleaning supplies, brooms, light bulbs, lawn care.miscellaneous repairs.

The date a housing expense is considered to be paid depends on the type of payment:

Cash:  Expenses are considered to be housing allowance in the year they are paid. $_____________
Loan:   Expenses are considered to be paid when the loan payments are made. $_____________
Major Credit Card: Expenses are considered to be paid the date of the charge. $_____________
Store Credit Card:  Expenses are considered to be paid as the credit card payments are made. $_____________

The following form may be used to help a pastor determine what amount of his salary he would like designated as housing allowance.  Always overestimate, the amount a pastor cannot justify as being spent will be declared as income. It is important to keep accurate records of expenditures. The housing allowance can be amended in mid­year, but the housing allowance is never retroactive.

Name of church  __________________________________________________

Position held _____________________________________________________

Housing allowance for the coming year of 20___. I expect to incur the following expenses to rent or otherwise provide a home. I understand that my actual expenses are what I will deduct on my next year’s tax return, and I will not be allowed to deduct any expenses not estimated and designated officially.

Amount Item
Rent or payments on purchase of a house including
down payment, principal payments, interest, taxes,
and improvements
$_____________
Furnishings and appliances $_____________
Utilities $_____________
Other housing expenses (cleaning supplies, etc.) $_____________
Miscellaneous repairs $_____________
Total $_____________

Signature__________________________________

Date ________________

When a pastor lives in a church owned parsonage its value is considered a part of his housing allowance and is automatically free from income tax*.  In addition, a pastor does not pay federal income tax on that portion of his cash income which is considered to be his housing allowance.

*Housing allowance (parsonage value, utilities paid by the church and designated cash portion) is always subject to social security and Medicare taxes.

A pastor who lives in a church owned parsonage has 2 parts to his housing allowance.

Part One: The first part is a value that he receives and not a part of his cash salary.  It includes the fair market rental value of the parsonage and any utilities which are paid by the church.

Part Two: The second part is the portion of his cash salary which is designated as housing allowance.  This part continues to be paid to the pastor along with his regular salary.  The pastor keeps track of his own personal housing expenses and is able to exclude one of the following amounts, whichever is less.

1. The amount of the pastor’s cash salary which is designated by the church to be considered housing allowance.

2. The amount actually spent (see below: What expenses are included in the housing allowance?)

Many pastors living in a church owned parsonage do not have any of their cash salary designated as housing allowance and do not take advantage of this benefit.

How do you determine the fair market rental value of the parsonage?

Because a pastor must pay self-employment tax (Social Security and Medicare) on his housing allowance, it is important that you set a conservative yet reasonable value.  While good stewardship would suggest a more conservative figure, it would be wrong to understate the value.  Churches are responsible for determining the fair market rental value of the parsonage but generally the church and pastor work together to arrive at this figure.  There are many elements to consider in setting a fair market rental value, such as condition, location, current demand and economic conditions and you may wish to consult a realtor or appraiser.

What expenses are included in the housing allowance?

The following expenses, when paid by the pastor, are included in part two of his housing allowance.

1.  Improvement, repairs, and upkeep. This includes a room addition, new roof, fence, sod, swimming pool, garage, refrigerator repair, etc.

2.  Furnishings and appliances. Including dish washer, TV, personal computer, pool table, piano, dishes, blender, lawnmower, etc.

3.  Decorator items. Such as rugs, curtains, pictures, plants, knick knacks, wallpaper, paint, towels, bedding, etc.

4.  Utilities. Electric, garbage, water, telephone (not business), cable TV, internet, gas, water softener rental, etc.

5.  Miscellaneous. This would include cleaning supplies, light bulbs, dry cleaning of drapes, carpet cleaning, landscape tools, garden hose, etc..

For over 24 years I have advised churches to get out of the parsonage business. I think it is very important to get a pastor into his own home as soon as possible for many reasons.

  • Retirement – owning a home at retirement is a key ingredient to retirement planning.
  • Security – for his family, particularly his wife. Privacy – they can decorate how they want -it’s home.
  • I think it tends to add to longevity – the family feels more attached to the community because there’s a stronger sense of belonging.
  • Tax purposes – income tax law provides for generous benefits to the pastor who is buying his own home. Federal and state income taxes are greatly reduced and sometimes eliminated due to the housing allowance and double deduction for mortgage interest and real estate taxes. (Unfortunately, it has no affect on the pastor’s most burdensome tax, his self-employment tax.)

The church sells the parsonage to the pastor. The pastor assumes the balance of the mortgage and signs a note for the difference between the selling price and mortgage balance, to be paid with or without interest at a future date, or when residence is sold.

The Pastor purchases a home through Conventional Financing. The down payment is acquired from the sell of the parsonage to be repaid with or without interest at a future date or when residence is sold.

There are three ways this can be accomplished:

1) The church purchases the home and sells it to the Pastor on land contract using the church assets as collateral. 100% financing is not unusual*.

2) The Pastor purchases a home through Conventional Financing. If the church cannot supply the down payment, it can be acquired from individuals (i.e. church members) with interest* and principal payments deferred, but interest accruing* until home can be refinanced (i.e. after five years when Pastor can afford larger mortgage payments).

3) A building program can be timely. More bonds can be sold or additional financing secured to be used as a loan to the Pastor for the purpose of buying his home.

*In the past loans in excess of $10,000 would require interest be assessed. However the IRS no longer requires interest be assessed for a pastor with less than $1,000 of investment income (interest, dividends, capital gains, etc.) on loans not exceeding $100,000 (IRC 7872(d)).   If the pastor has more than $999 of investment income, interest must be assessed on loans over $10,000.  You need an interest rate, which is equivalent to the federal discount rate.

Many churches help their pastors get into a home by providing money for a down payment.  These funds can be a taxable gift and become taxable income in the year they are received and may be designated as housing allowance OR the funds can be considered a loan to the pastor.  Churches that “loan” money to their pastor need to be aware of several things.

1.      In the past loans in excess of $10,000 would require interest be assessed. However the IRS no longer requires interest* be assessed on a loan of less than $100,000 for a pastor with less than $1,001 of investment income (interest, dividends, capital gains, etc.).   If the pastor has more than $1,000 of investment income, interest must be assessed on loans over $10,000.  You need an interest rate, which is equivalent to the federal discount rate.  There are two ways to assess interest:

  • METHOD 1–CANNOT BE DESIGNATED HOUSING ALLOWANCE Multiple the amount of the loan by the interest rate and add that amount to the pastor’s wages on his W-2.  No money actually changes hands.  (Example:  $15,000 x 3% = $450.  The church would add $450 to block 1 of the W-2.)  Because the pastor never actually makes an interest payment to the church the interest payment may not be housing allowance.
  • METHOD 2-CAN BE DESIGNATED HOUSING ALLOWANCE Multiple the amount of the loan by the interest rate and add that amount to the pastor’s income as housing allowance in block 14 of the pastor’s W-2.  This increases the pastor’s total income by $450.  (Example:  $15,000 x 3% = $450)   Using a salary reduction the pastor pays the interest back to the church each pay period.   (Divide $450 by the number of pay periods.  $450 divided by 12 = $37.50.  If there are 12 pay periods per year the pastor would have $37.50 deducted from each paycheck to pay the interest due to the church.)  The advantage to this method is that the interest payment may be designated housing allowance as long as the loan is secured by the home.

2.      There is no such thing as a “contract” for forgiveness either written or verbal.  (When such a contract exists the IRS would recognize the entire contracted amount to be income in the year of the contract.)  Churches who wish to give their pastor’s a loan are free to do so.  If after a year or several years they wish to forgive all or a portion of the loan they may do so (but they cannot forgive the loan via a contract).  The forgiven amount becomes taxable income in the year forgiven (and it may be designated housing allowance if the loan is secured by the home), however the church may not make an agreement to forgive an amount in future years.

3.      The loan needs to be secured by the home.This is necessary in order for any interest payments, loan payments or future forgiven amounts to be considered housing allowance and to be deductible as mortgage interest on Schedule A.

*IRS Code Sec. 7872(d)

Retirement

Hanging up the phone the pastor had a knot growing in the pit of his stomach as he had just been informed that his life savings had been lost by a friend in an investment.  Hindsight started to overwhelm him, he had some doubts when he did it but the trust factor had taken over.  Now he was questioning his judgment, and rightly so.  How does he tell his wife that at retirement age their savings are gone, the IRA is gone, and the home that just 2 years ago was debt free is now mortgaged to the hilt?

What is sad is that the above story is true, having recently happened to a pastor friend of mine.  Is this story an exception?  I would like to say yes, but I can’t.  In my 36 years of ministry this story has repeated itself many times over.  The results have been devastating to the family and with virtually no time in their working life to recover financially.

Is God sovereign?  Of course.  Will the Lord take care of their needs? Yes, and this family knew that.  When I met with them, they were fully trusting that the Lord would provide.  And He will.  In fact he already has.

The church’s response was immediate.  The Lord worked in the hearts of the board and congregation in a very special way.  The love and affection expressed to him and his family was overwhelming.  As of this writing the church has provided immediate financial help and a provision in the budget which provides for a long-term retirement benefit for him and his wife.   Was this required by the congregation?  No.  Was it the right thing to do?  Absolutely and I believe the Lord will richly bless the church for their care and generosity.  Will the pastor have to earn income in his retirement?  Yes, and the Lord will provide here also.  His pastoral and counseling skills will allow him to continue working in an area he loves.  Isn’t God good?

Are there lessons to be learned from this pastor’s experience?  Yes.  Let me list some:

Personal Stewardship – This pastor obviously got himself into a situation that was beyond his area of expertise:

  • Pastors should be very cautious about investing with people in their congregations, it can easily become a catch 22 situation.  If he’s not satisfied with the handling of his account how can he make a change without offending a member of his church?
  • Pastors need to ask questions or seek counsel from someone with no conflict of interest who has expertise in that area.
  • Listen to the counsel!!
  • People who delay their retirement planning until later in life are more vulnerable to the “get rich quick” scenarios.  Will Rogers once said “I’m not as concerned with the return on my money as I am the return of my money”.
  • Pastors are not trained to be investors (not many people are).  They do not have the time to do the homework, make sure the investment vehicle is sound, has a strong measure of safety, and is managed by competent investors with a track record of experience.  A pastor in his 50’s or 60’s does not have time to recover if he makes a mistake.
  1. When possible the church needs to get the pastor into his own home.  The first pre-requisite of retirement is to have a home paid for at retirement.  (Not to ignore the security issue, privacy, longevity and tax advantages which are also benefits to owning his own home.)
  2. The church should help him fund his retirement plan with the goal of his receiving 80% of his take home pay from Social Security and his retirement plan at retirement.
  3. To accomplish the above he needs to begin funding his retirement as early as possible, it should at least begin by age 40 with $4,000 per year, increasing annually to meet the desired results.  If he has opted out of Social Security his plan needs to be more aggressive.
  4. The 403-b family of plans is the most advantageous of retirement plans for pastors.  The contribution can be up to 100% of income with a maximum of $16,500 per year (22,000 if he is age 50 or older).  In addition, if he has been in the ministry for 15 years, he can add a $15,000 lifetime make-up at a maximum rate of $3,000 per year.  The distinct advantages of the 403-b is the church makes the deposit (which can be from salary or in addition to salary), the amount deposited is exempt from the self-employment tax, and the distributions are eligible for the housing allowance at retirement.  Pastors should not be in IRA’s and rarely Roth IRA’s.

Answers to Common Questions:

  • I recommend the 403-b plan because IRA’s do not have the characteristics for pastors as does the 403-b.  That is the Social Security tax savings and the housing allowance feature explained in “4” above.
  • I am not aware of any disadvantages to the 403-b pension plan.
  • The 403-b can be invested into the same vehicles as any pension plan.  Bonds, stocks and etc. an experienced broker will counsel you based on your objective.
  • The 403-b catch-up is for pastors who have been in the ministry for 15 years (not necessarily with the same church).  The life time catch-up maximum is $15,000, the annual catch-up maximum is $3,000.
  • Contributions to the 403-b pension plan must be made by December 31 of the year in question.  Whereas an IRA contribution can be made up to April 15th of the following year.
  • The Roth IRA should only be used by pastors who have opted out of Social Security and pay no federal income tax, or by pastors who are maximizing their 403-b contributions and want to set aside an additional amount.

Stewardship principles require each of us to be responsible with the resources and families he has entrusted to our care.  A suggested procedure is to assign two board members to review the needs of the staff annually and make recommendations to the full board for consideration.  When it comes to our pastors we should take I Corinthians 9:14 and I Timothy 5:17 very seriously.  Good planning can prevent the kind of sad experiences that occur far too often in the lives of these precious servants.

The 403-b family of plans is the most advantageous of retirement plans for pastors.  For the following reasons a 403-b is more beneficial than an IRA:

  • The contribution limits are higher.

The contribution can be up to 100% of income with a 2015 maximum of $18,000 per year (24,000 if he is age 50 or older).  In addition, if he has been in the ministry for 15 years, he can add a $15,000 lifetime make-up at a maximum rate of $3,000 per year.

  • You do not pay SE tax on 403-b contributions.

The church makes the deposit (which can be from salary or in addition to salary) directly to the 403-b and the amount deposited is exempt from tax, including the self-employment tax.  Monies contributed to an IRA can be exempt from federal income tax but NOT self-employment tax.

  • Distributions can be designated as housing allowance.

Once you begin to receive distributions from your 403-b (generally when you retire) the distributions can be designated as housing allowance.  Then any amounts you use to pay housing expenses would not be taxable.

Questioning where to go to establish a 403-b?

In summary:

You pay self-employment tax on contributions you make to a traditional IRA.  You pay federal income tax on distributions.You pay self-employment tax and federal income tax on contributions you make to a Roth IRA.You never pay taxes on 403-b contributions.  You pay no taxes on 403-b distributions that are used for housing expenses.  You only pay federal income taxes on 403-b distributions which are NOT used for housing expenses.

For a pastor, why is a 403-b pension plan better than an IRA?

There are three main reasons for using a 403-b pension plan instead of an IRA:

1) The church makes the deposit which can be from salary or in addition to salary and the amount deposited is exempt from the self-employment tax,

2) the contribution limits are much higher than the contribution limits of an IRA and there is a catch-up provision for pastors who have been in the ministry for 15 years, and

3) when you retire the distributions you receive from your 403-b can be designated as housing allowance. The 403-b can be invested into the same vehicles as any pension plan (i.e. stocks, bonds, etc).

How do you establish a 403-b pension plan?

Simply contact any reputable investment agency such as Merrill Lynch, Dean Witter, etc.  Find an investment counselor that you want to work with and tell him you want to set up a 403-b pension plan.  Your investment counselor will give you the name and address where the church should direct the contributions.  Beginning January 1, 2009, churches are required to have a “plan document” for your 403-b plan.  The “plan document” is a lengthy and detailed document.  Because of the many details that need to be included, the document will need to be mostly written by your investment agency.  This requirement is making it difficult for some pastors to find an investment agency willing to set up their 403-b.  You should find an investment agency to set up a 403-b for you without requiring you to hire a TPA (third party administrator).  We recommend two investment agencies.  Either one of these will be able to get your plan document up and running.  These two agencies are also able to designate your housing allowance for you once you begin to receive distributions from the 403-b.

GuideStone can set up a 403-b for you if you have $50,000 in assets.  This can be transferred from existing investments.  They have an onboarding fee of $500 if you have less than $150,000 in assets.

GuideStone Financial Services
2401 Cedar Springs Road
Dallas, Texas 75201-1498
Dixie Beard, CRPC®
Director – Business Development
Retirement Institutional Investment New Business
Registered Representative
214-720-4661 Office
1-866-692-6327 Fax
Dixie.Beard@GuideStone.org

Envoy Financial can set up a 403-b for you even if you do not have any start-up funds. Their set up fees are approximately $600.

Envoy Financial
4194 Royal Pine Drive
Colorado Springs, CO 80920-1556
Timothy A. Struck, CRPS
Director of Retirement Plan Consulting
888.879.1376 ext. 217
EnvoyFinancial.com
tstruck@envoyfinancial.com

As of the 2002 tax year the voluntary contribution limit has increased to the smaller of:  1) 100% of income or 2) the amount from the table below.

Tax Year Maximum Contribution Max Contribution Age 50+
2009 16,500 22,000
2010 16,500 22,000
2011 16,500 22,000
2012 17,000 22,500
2013 17,500 23,000
2014 17,500 23,000

There is also a catch-up provision for pastors who have been in the ministry for 15 years or longer.  An additional $15,000 can be contributed at a rate not to exceed $3,000 a year.  This would limit your yearly contributions to the smaller of:  1) 100% of your includible compensation or 2) the amount from the table below plus $3,000.You may wish to refer to IRS Publication 571 for additional information regarding contribution limits and for general information regarding the 403(b).

If your 403b is with a religious annuity board like GuideStone Financial Services or Envoy Financial, they will designate your housing allowance for you.  If your 403b is with a secular investment agency such as Vanguard, Fidelity, TD Ameritrade, etc. then include the following in the business meeting minutes of the church or board:

According to the provision in income tax law, a retired minister of the Gospel is not subject to federal income tax on ministerial retirement distributions designated as housing allowance to the extent that it is used to provide a home.

Resolved that Pastor ____________ is to receive 403-b distributions for the year 20___.  100% of this amount is hereby designated as housing allowance.

Resolved that as long as Pastor ____________ is receiving 403-b distributions 100% of these distributions will be designated housing allowance for all future years until modified.

Date_______________
Signature_________________________

The names of the individuals making the motion and seconding it should be included.  You can designate 100% of the distributions as housing allowance, but the housing allowance is always limited to out of pocket costs in providing a home.  The housing allowance designation should be renewed in writing each year.

Note:  For IRS documentation regarding designating a portion of a minister’s pension as housing allowance refer to IRS Publication 517 (page 8, “Retired Ministers”).

According to Revenue Ruling 55-422 payment(s) to a retired pastor may be considered non-taxable gifts because of the close personal relationship that exists between a minister and his congregation.  This is a unique provision which is not available in any other careers.  Payment(s) which are made out of gratitude and appreciation to a pastor who received appropriate compensation while employed can be considered non-taxable.  In order for the payment(s) to the retired pastor to be considered non-taxable gifts it is important that the following conditions are true.

  • The pastor is not expected to perform any services in exchange for the payment(s). (This does not mean the pastor cannot voluntarily teach or serve as any other member would.)
  • The payment(s) are not part of a plan or agreement entered into before retirement.
  • The payments are based on the pastor’s need and the church’s ability to pay.

It is important that the church does not enter into a binding agreement or contract with the pastor because the payments must be based on the church’s ability pay. A contract would need to be honored regardless of the church’s financial ability.

Medical Benefits

Mandatory
In a nutshell the new law states that all Americans will be required to obtain health insurance with “minimum essential benefits” OR pay a penalty. (“Minimum essential benefits” is a catch phrase the government is using to describe what qualifies as coverage. If your policy does not meet the government’s minimum requirements then you will be considered to be uninsured.) There are 2 exceptions:
1. Those who are members of a religious sect (such as Amish or Old Order Mennonites). I will not dwell on this since it does not apply to clergy in our circles.
2. Those who are members of a health care sharing ministry such as Samaritan Ministries, Medi-Share, and Christian Healthcare Ministries.

HSA
When an employee has a qualified HDHP (high-deductible health plan) churches can make tax free contributions to the employee’s HSA. For more information see IRS publication 969 http://www.irs.gov/pub/irs-pdf/p969.pdf. The HDHP premium is not a tax free fringe benefit unless it is a group plan (ie. the employer has signed up with an insurance company to provide the HDHP to its employees as a “group”).

Marketplace
The Marketplace (state exchanges) is where the uninsured are able to go to obtain health insurance. These are the government websites you have heard so much about. Using an exchange a low income individual or family may qualify for a tax credit to help pay for their premium or they can choose to take a credit on the tax return instead.  If the church or employer reimburses this premium for an employee with a government subsidy, the marketplace will need to be notified as this could affect the subsidy.

Taxable Benefit
The new health care laws also affect the taxability of health insurance benefits. In short there are only two situations that qualify an employer to treat health insurance premiums as a tax free fringe benefit: 1. Provide a group health plan for its qualified employees OR
2. Use a Health Reimbursement Arrangement (HRA).

HRA 
When a church has only one employee qualified to receive health insurance benefits then it is possible to use a One-Person Stand-Alone Health Reimbursement Arrangement (HRA) http://ssfoundation.net/pastors?qa_faqs=health-reimbursement-arrangement-hra to pay or reimburse the health insurance premium. This would be a tax-free fringe benefit.

When a church has more than one employee but fewer than 50 employees qualified to receive health insurance benefits then it is possible to use a Health Reimbursement Arrangement (HRA) http://ssfoundation.net/pastors?qa_faqs=health-reimbursement-arrangement-hra to pay or reimburse the health insurance premium.  All employees must be treated the same as this HRA is subject to strict discrimination laws.  This would be a tax-free fringe benefit.

When a church has 50 or more full-time employees (30 hours or more per week) a HRA can only be used when it is integrated with a group policy.

MRP
 A Medical Reimbursement Policy  http://ssfoundation.net/pastors?qa_faqs=medical-reimbursement-policy cannot be used to pay or reimburse health insurance premiums.  A MRP is limited.  $2,550 for 2016 and $2,600 for 2017.

Group Plan
Churches (employers) can provide health insurance as a tax free fringe benefit if they obtain a group health plan.  Because these plans are expensive there is a credit available to small employers.  You can get more details about this credit on the IRS website at:  http://www.irs.gov/uac/Small-Business-Health-Care-Tax-Credit-for-Small-Employers

*This information is provided to try to help you understand the basics.  For clarity this information has been simplified and condensed.  It should not be viewed as a comprehensive treatment of the subject.

What is a Medical Reimbursement Plan?

A Medical Reimbursement Plan can be an effective way for churches to provide medical care for their pastors and/or lay employees.  In order for a plan to be a legitimate Medical Reimbursement Plan the following criteria must be followed:

1.      Medical Reimbursement Plan’s are funded solely through salary reduction.

2.      A Medical Reimbursement Plan is a “use it or lose it” plan.  Unused funds cannot become salary or any other benefit.

3.      Non-discrimination rules apply and the plan must be made available to all employees who are full-time (30 hours or more per week).  Not all full-time employees are required to participate, but the plan should be available to all.

4.      Medical Reimbursement Plan’s may only be used to reimburse employees for medical care for themselves, their spouse or their dependents.

5.      Reimbursements can only be made for substantiated medical care expenses.

6.      Contributions are limited.  $2,550 for 2016 and $2,600 for 2017.

The benefits of an Medical Reimbursement Plan?

1.      Distributions of Medical Reimbursement Plan funds to reimburse or pay an employee’s medical expenses are not taxable for federal, state or self-employment.

 

Here is a sample Medical Reimbursement Policy which your church can adopt as their own. 

Note to churches:
Paragraph #4 can be omitted if immediate reimbursement is  available to the employee.
There are two paragraphs numbered "6".  The church must choose which paragraph 6 to use.  You can have a two and a half month grace period OR you can carry forward up to $500 but you cannot offer both.  This is an employer decision not an employee decision so you cannot offer your employee(s) the choice.

 

“Name of your Organization”

Medical Reimbursement Policy

In an effort to reduce the potential for added out-of-pocket health expenses to our full-time employees the “Name of your Organization” has seen fit to establish a Medical Reimbursement Plan (MRP). The Internal Revenue Service requires that certain conditions exist in order for a Medical Reimbursement plan to be considered non-taxable.  The Medical Reimbursement plan of the “Name of your Organization” will be subject to the following conditions:

1.      The Medical Reimbursement Plan will be available to all full-time employees of the “Name of your Organization”.

  • Participation is voluntary, not mandatory.

2.      The Medical Reimbursement Plan will be based on a voluntary salary reduction.

  • Employees wishing to participate must fill out a Voluntary Salary Reduction form (attached) and turn it into the bookkeeping office by December 1st.
  • The salary reduction will apply beginning January 1st  of the year following receipt of your Voluntary Salary Reduction form and ending December 31st or the last day of employment, whichever comes first.
  • New employees must turn in a Voluntary Salary Reduction form prior to receiving their first paycheck.

3.      You will be reimbursed for deductible out-of-pocket medical expenses.

  • Only out-of-pocket expenses that are not covered by a medical plan are eligible for reimbursement.
  • You may be reimbursed for Medical and Dental payments that would be includible on Schedule A of your Federal return if you were not reimbursed under this plan.  (See attached list of what is and what is not deductible).
  • You CANNOT be reimbursed without turning in receipts.  If you fail to obtain a receipt from your doctor, dentist or pharmacist, you will be unable to be reimbursed.

4.      You will be reimbursed as the funds become available through your payroll reduction.

  • If you elect to reduce your salary by $1300 a year so that you have $1300 available for Medical Reimbursements and you are paid year round, then $50 ($1300 divided by 26 pay periods) will be available to you for reimbursement each pay period.
  • This means that if you request a $100 reimbursement on January 5th and your first paycheck is written on January 7th, then $50 will be reimbursed on January 7th and $50 will be reimbursed on January 14th.
  • If you request a $100 reimbursement on January 18th, and you have had no previous requests for reimbursement, then you will be reimbursed the full $100.

5.      The Medical Reimbursement Plan will be a use it or lose it plan.

  • You will lose any excess funds left in your Medical Reimbursement Plan at the end of the plan term.
  • Careful thought should be given not to over estimate the amount you wish to set aside for Medical Reimbursements as any funds left over cannot be redesignated as salary.
  • You may wish to buy eyeglasses or catch up on dental work prior to the plan end rather than lose any left over funds.

6.     The Medical Reimbursement Plan is limited to $2,550 for 2015 ($2,550 for 2016).

Paragraph 7 Option 1
7.      The Medical Reimbursement Plan will include a carry forward to the following year.

  • Up to $500 of left over funds in your Medical Reimbursement Plan will be carried forward to the following year's plan.
  • The amount carried forward will be the smaller of $500 or the amount remaining in your Medical Reimbursement Plan as of December 31st.
  • Any amounts over $500 remaining in your Medical Reimbursement Plan as of December 31st will be forfeited.

Paragraph 7 Option 2
7.      The Medical Reimbursement Plan will include a two and a half month grace period.

  • Funds remaining in your Medical Reimbursement Plan as of December 31st will be available until March 15th.
  • You may be reimbursed for expenses from your previous year's plan if funds are available and receipts and documentation are submitted by March 15th.
  • You may be reimbursed from your previous year's plan for expenses incurred through March 15th.

 

Here is a sample form for employees to fill out.

 

“Name of your Organization”

Request for Medical Reimbursement Plan

Voluntary Salary Reduction

Please set aside $_______________* of my salary for the calendar year of  20____ for a Medical Reimbursement Plan.  I understand that my salary for the calendar year will be reduced by the amount of $_______________* in order to make available funds for reimbursement of my deductible out-of-pocket Medical expenses.

___________________________________
Signature of Employee

I understand that participation in this program is not mandatory and I am participating voluntarily.________
Initial

I also understand that I will not be reimbursed if I do not submit proper receipts or documentation.________
Initial

I further understand that if I do not use all of the funds I will lose whatever funds are “left over” when the reimbursement period ends.________
Initial

* These two (2) amounts are the same.

Here are the qualified Medical and Dental Expenses.

 

Medical and Dental Expenses

Examples of Medical and Dental Payments You May Deduct

  • Prescription medicines or insulin.
  • Nonprescription medicines (including pain relievers, antacids, cold medicines and allergy drugs) obtained with a prescription.
  • Medical doctors, osteopathic doctors, dentists, eye doctors, podiatrists, chiropractors, psychiatrists, psychologists, physical therapists, occupational therapists, acupuncturists, and psychoanalysts (medical care only).
  • Medical examinations, X-ray and laboratory services, insulin treatment, and whirlpool baths your doctor ordered.
  • Nursing help (including your share of the employment taxes paid). If you paid someone to do both nursing and housework, you may deduct only the cost of the nursing help.
  • Hospital care (including meals and lodging), clinic costs, and lab fees.
  • Qualified long-term care services (see Pub. 502).
  • The supplemental part of Medicare insurance (Medicare B).
  • The premiums you pay for Medicare Part D insurance.
  • A program to stop smoking and for prescription medicines to alleviate nicotine withdrawal.
  • Medical treatment at a center for drug or alcohol addiction.
  • Medical aids such as eyeglasses, contact lenses, hearing aids, braces, crutches, wheelchairs, and guide dogs,  including the cost of maintaining them.
  • Surgery to improve vision including radial keratotomy or other laser eye surgery.
  • Lodging expenses (but not meals) while away from home to receive medical care in a hospital or a medical care facility related to a hospital. No more than $50 a night for each eligible person.
  • Ambulance service and other travel costs to get medical care. If you used your own car, you may claim what you spent for gas and oil to go to and from the place you received the care; or you may claim 17 cents a mile for 2017. Add parking and tolls to the amount you claim under either method.
  • The amount you can deduct for qualified long-term care insurance contracts (as defined in Pub. 502) depends on the age, at the end of the calendar year, or the person for whom the premiums were paid.  See chart below.

Untitled

Examples of Medical and Dental Payments You May Not Deduct

  • The cost of diet food.
  • Insurance premiums for medical and dental care, including premiums for long-term care contracts as defined in Pub. 502.
  • The basic cost of Medicare insurance (Medicare A).  If you were 65 or older but not entitled to social security benefits, you may deduct premiums you voluntarily paid for Medicare A coverage.
  • Cosmetic surgery unless it was necessary to improve a deformity related to a congenital abnormality, an injury from an accident or trauma, or a disfiguring disease.
  • Life insurance or income protection policies.
  • The Medicare tax on your wages and tips or the Medicare tax paid as part of the self-employment tax or household employment taxes.
  • Nursing care for a healthy baby.
  • Illegal operations or drugs.
  • Nonprescription drugs, vitamins and supplements.
  • Travel your doctor told you to take for rest or a change.
  • Funeral, burial, or cremation costs.

Whose Medical and Dental Expenses Can You Include?

You may include medical and dental bills you paid for:

  • Yourself and your spouse.
  • All dependents you claim on your return.
  • Your child whom you do not claim as a dependent because of the rules explained in Pub. 501 for children of divorced or separated parents.
  • Any person you could have claimed as a dependent on your return if that person had not received $4,050 or more of gross income or had not filed a joint return.

Example. You provided over half of your mother’s support but may not claim her as a dependent because she received wages of $4,050 during the tax year. You may include on line 1 any medical and dental expenses you paid during the tax year for your mother.

 

Note:  The Affordable Care Act appears to have affected the ability of some to use a MRP to pay for individual medical insurance premiums.  We are not experts in this area and you may need to seek counsel from some other source.

What is a Health Reimbursement Arrangement?

A Health Reimbursement Arrangement (HRA) can be an effective way for churches to provide medical care for their pastors and/or lay employees.  In order for a plan to be a legitimate HRA the following criteria must be followed:

  1. HRAs are funded solely by the employer and not through salary reduction.
  2. HRAs cannot be part of a cafeteria plan and must be treated as a separate issue.
  3. Non-discrimination rules apply and all employees who are full-time (30 hours or more per week) must receive the same benefit.
  4. HRAs may only be used to reimburse employees for medical care for themselves, their spouse or their dependents.
  5. Reimbursements can only be made for substantiated medical care expenses.

The benefits of an HRA?

  1. When there are less than 50 full-time (30 hours or more) employees, the church may reimburse the pastor/employee for medical insurance.  This may be especially helpful if the medical insurance provider will not accept a church check for payment of premiums.  Distributions from the HRA are limited to $4,950 for an individual and $10,000 for family.  The HRA can reimburse medical insurance premiums and other out-of-pocket medical expenses.
  2. Any “unused” funds can be carried forward to increase the reimbursement amount available in the following year.  The “use it or lose it” rule would not apply.
  3. Distributions of HRA funds to reimburse or pay an employee’s medical expenses are not taxable for federal, state or self-employment.

 

Here is a sample Health Reimbursement Arrangement which your church can adopt

 

“Name of your Organization”

Health Reimbursement Arrangement

In an effort to reduce the potential for added out-of-pocket health expenses to our full-time employees the “Name of your Organization” has seen fit to establish a Health Reimbursement Arrangement. The Internal Revenue Service requires that certain conditions exist in order for a Health Reimbursement Arrangement to be considered non-taxable.  The Health Reimbursement Arrangement of the “Name of your Organization” will be subject to the following conditions:

1.      The Health Reimbursement Arrangement will be provided to all full-time (at least 30 hours per week) employees of the “Name of your Organization”.

2.      The Health Reimbursement Arrangement will provide a yearly benefit.

  • Each employee will have “Amount to be made available” per “week/month/year” available.  For a total of “Amount to be made available” per year.
  • The HRA will begin the “first/second/third/etc” year of employment on January 1st  and ending on the last day of employment at which time any unused funds will be absorbed back into the general fund.
  • Amounts remaining in the HRA on December 31st of each year will be carried forward and added to the HRA for the following year.  (You can eliminate the option to carryforward remaining amounts or use the following option:  On December 31st of each year any remaining amounts up to $_____  will be carried forward to the HRA for the following year.)

3.      You will be reimbursed for deductible out-of-pocket medical expenses.

  • Only expenses that are not covered by a medical plan are eligible for reimbursement.
  • You may be reimbursed for Medical and Dental payments that would be includible on Schedule A of your Federal return if you were not reimbursed under this plan.  (See attached list of what is and what is not deductible).
  • You CANNOT be reimbursed without turning in receipts.  If you fail to obtain a receipt from your doctor, dentist or pharmacists, you will be unable to be reimbursed.

4.      The Health Reimbursement Arrangement will be available for the full-time employee who retires directly from our employment.

  • If you retire from our service and do not pursue new employment, the amount remaining in your HRA at the time of retirement will be available to you for reimbursement until the funds are used up.

Examples of Medical and Dental Payments You May Be Reimbursed For

  • Insurance premiums for medical and dental care, including premiums for qualified long-term care contracts as defined in Pub. 502.
  • Prescription medicines or insulin.
  • Nonprescription medicines (including pain relievers, antacids, cold medicines and allergy drugs) obtained with a prescription.
  • Medical doctors, osteopathic doctors, dentists, eye doctors, podiatrists, chiropractors, psychiatrists, psychologists, physical therapists, occupational therapists, acupuncturists, and psychoanalysts (medical care only).
  • Medical examinations, X-ray and laboratory services, insulin treatment, and whirlpool baths your doctor ordered.
  • Nursing help (including your share of the employment taxes paid). If you paid someone to do both nursing and housework, you may be reimbursed for only the cost of the nursing help.
  • Hospital care (including meals and lodging), clinic costs, and lab fees.
  • Qualified long-term care services (see Pub. 502).
  • The supplemental part of Medicare insurance (Medicare B).
  • The premiums you pay for Medicare Part D insurance.
  • A program to stop smoking and for prescription medicines to alleviate nicotine withdrawal.
  • Medical treatment at a center for drug or alcohol addiction.
  • Medical aids such as eyeglasses, contact lenses, hearing aids, braces, crutches, wheelchairs, and guide dogs,  including the cost of maintaining them.
  • Surgery to improve vision including radial keratotomy or other laser eye surgery.
  • Lodging expenses (but not meals) while away from home to receive medical care in a hospital or a medical care facility related to a hospital. No more than $50 a night for each eligible person.
  • Ambulance service and other travel costs to get medical care. If you used your own car, you may claim what you spent for gas and oil to go to and from the place you received the care; or you may claim 17 cents a mile for 2017. Add parking and tolls to the amount you claim under either method.
  • The amount you can deduct for qualified long-term care insurance contracts (as defined in Pub. 502) depends on the age, at the end of the calendar year, or the person for whom the premiums were paid.  See chart below.
  • UntitledExamples of Medical and Dental Payments You May Not Deduct
  • The cost of diet food.
  • Insurance premiums for medical and dental care (when you have more than 50 full-time employees) also, premiums for long-term care contracts as defined in Pub. 502.
  • Cosmetic surgery unless it was necessary to improve a deformity related to a congenital abnormality, an injury from an accident or trauma, or a disfiguring disease.
  • Life insurance or income protection policies.
  • The Medicare tax on your wages and tips or the Medicare tax paid as part of the self-employment tax or household employment taxes.
  • Nursing care for a healthy baby.
  • Illegal operations or drugs.
  • Nonprescription drugs, vitamins and supplements.
  • Travel your doctor told you to take for rest or a change.
  • Funeral, burial, or cremation costs.

Whose Medical and Dental Expenses Can You Include?

You may include medical and dental bills you paid for:

  • Yourself and your spouse.
  • All dependents you claim on your return.
  • Your child whom you do not claim as a dependent because of the rules explained in Pub. 501 for children of divorced or separated parents.
  • Any person you could have claimed as a dependent on your return if that person had not received $4,050 or more of gross income or had not filed a joint return.

Example. You provided over half of your mother’s support but may not claim her as a dependent because she received wages of $4,050 during the tax year. You may include on line 1 any medical and dental expenses you paid during the tax year for your mother.

What is a Health Savings Account?

An HSA is a savings account for setting aside tax-free funds to be used for non-covered medical expenses.  With an HSA you may choose individual coverage or family coverage.

How do I establish an HSA?

Any insurance company or bank* can be an HSA trustee or custodian.  Also, any other person approved to be a trustee or custodian of IRAs or Archer MSAs is automatically approved to be the trustee or custodian of an HSA.

Can I have both an HSA and Health Reimbursement Arrangement or Medical Reimbursement Policy?

You cannot have both an HSA and HRA nor can you have both an HSA and MRP.  The only exception to this is if you have a "limited purpose" HRA or MRP.  Limited purpose would mean that the expense account would cover only dental and/or vision expenses but NOT medical expenses.

Who qualifies to contribute to an HSA?

An individual is eligible to establish an HSA as long as the following 3 conditions are met:

1.      the individual is covered under a high-deductible health plan and

2.      the individual is not covered by any other health plan that is not a high-deductible health plan and

3.      the individual is not eligible to receive Medicare (usually has not reached age 65).

The employee or the employer may make the contributions to an HSA.  Employer contributions must be comparable for all employees with comparable coverage.

What qualifies as a high-deductible health plan?

For 2016 a high-deductible health plan would be a plan with an annual deductible of at least $1,300 ($1,300 for 2017) for individual coverage, but not more than $6,550 ($6,550 for 2017).  For family coverage a high deductible health plan would be a plan with an annual deductible of at least $2,600 ($2,600 for 2017) and not more than $13,100 ($13,100 for 2017).

What are the contribution limits?

For 2016 the maximum contribution for individual coverage would be $3,350 ($3,400 for 2017).  For family cover the maximum would be $6,750 ($6,750 for 2017).  In addition, for those ages 55 to 65 there is a catch-up contribution.  See chart below.

Year Add’l Catch-up Contribution
2007 $800
2008 $900
2009 - 2017 $1,000

What about tax treatment?

For dual-status ministers any individual contributions would be taxable for Self-employment purposes but not taxable for federal income tax.  Employer contributions would eliminate the Self-employment tax but are subject to discrimination rules.  Employer contributions would need to be the same for all comparable employees.

What are the advantages and/or disadvantages?

Some advantages of the HSA are that:

  • You don't pay taxes on money going into your HSA.
  • It is portable from church to church because it is managed by a third party other than the church so the account is yours even if you change jobs.
  • Funds can be used for non-covered out of pocket medical expenses until depleted.
  • Any unused money at the end of the year rolls over to the next year so the account will build if you do not have medical expenses.
  • After the age of 65 you can withdraw funds for non-medical expenses without penalty.

Some disadvantages are:

  • The cost of administering it with a third party.
  • The accompanying high deductible insurance requirement.
  • Stiff penalties for withdrawing the funds for non-medical expenses before the age of 65.

Additional Information:

http://www.irs.ustreas.gov/pub/irs-pdf/p969.pdf

 
Attention: Tax Law is subject to interpretation. Please be advised that the material contained on this Web site is for information only and is not intended to be a substitute for professional legal advice. The Stewardship Services Foundation endeavors to update the information on this site on a regular basis, but cannot guarantee its accuracy at all times.