Any ordained minister (as defined by their denomination or elder board) is considered a “Duel Status employee”. This basically means that they are considered self-employed AND fully employed by the church. That said, an ordained minister is allowed to consider some of their income as a “housing allowance”. Historically, some churches offered a parsonage, but those are now fairly few and far between. For the purposes of this discussion, we’re going to assume that this is a standard ordained minister.
Most churches do not dictate the amount that a pastor can consider as housing allowance. Generally, churches provide the pastor with a total salary (total income or gross compensation) and then allow the pastor to determine how much of that total income is to be considered “housing allowance”. We actually have a worksheet that the pastor can use to determine the appropriate amount to consider “housing allowance”.
As an example, the church may determine that Pastor Ken’s total income is $75,000. After Pastor Ken fills out his housing allowance worksheet, he may determine that his annual qualified housing expenses equal $30,000. The church’s payroll department should be notified that Pastor Ken would like to allocate his total income to be regular wages, salary of $45,000 and housing allowance of $30,000.
The tax side then gets a little complicated.
The regular wages (usually labeled as “clergy wages” by payroll companies) of $45,000 in our example, is subject to income taxes (federal, state, local) and Self-employment tax (Self Employed social security and Medicare tax) while the housing allowance portion $30,000 is exempt from income taxes. However, the housing allowance is considered Self-Employment income and is subject to the Self-employment tax (SECA or Self-employment Contributions Act) currently set at 15.3%. SECA tax is the Social / Medicare tax that applies to self-employed individuals. As mentioned above, pastors are considered duel status – both an employee and self-employed and therefore pay into social security through the SECA tax. One thing to mention is that for non-ministerial staff, the church will pay ½ of the Social Security / Medicare (FICA) tax while the employee pays the other ½. However, for ordained ministers, the church is not allowed to pay that employee ½ and therefore the pastor is responsible for the full 15.3%.
The federal income tax is a pay as you go system. The taxes can be paid via payroll withholding or quarterly estimated payments or a combination of both. The bottom line is that both types of taxes discussed above – income tax and self-employment tax – need to be considered and paid throughout the year in order to avoid an underpayment penalty or interest due at the time of completing the tax return or filing for an extension. However, the payroll withholding process based upon an employee exemptions W-4 form only applies to the federal income tax system and will not incorporate a withholding amount related to the self-employment tax. Therefore, we think it is a good idea for pastors to have an additional amount (above the standard income tax table withholding rate) withheld from their paycheck to cover the self-employment tax that they’re likely going to have to pay when they complete their tax return. If not, it’s imperative that the pastor make quarterly estimated tax payments, otherwise, they will be subject to penalties and interest by the IRS.
Using our example, here is how the taxes are paid ::
Regular “clergy” Wages – $45,000
Federal Income Tax – Withheld from paycheck per pay period
State Income Tax – Withheld from paycheck per pay period
Local / etc. (where applicable) – Withheld from paycheck per pay period
Self-Employment Tax (SECA) – Quarterly estimated payments
Housing Allowance – $30,000
Federal Income Tax – Only paid on the unused portion, quarterly estimated payments
State Income Tax – Only paid on the unused portion, quarterly estimated payments
Local / etc. (where applicable) – Only paid on the unused portion, quarterly estimated payments.
Social Security / Medicare – Not Applicable
Self-Employment Tax (SECA) – quarterly estimated payments
Because this gets very complicated, we always recommend that pastors use a CPA to complete their tax return and determine the appropriate amount of periodic withholding or estimated payments to be made during the year. Of course, we can always help with this… we do lots of tax returns for pastors!