Could one mistake be costing you thousands? | By Don Corder
If you are reading this, there is a good chance that you are either a pastor or a leader at a church that is led by a pastor. Most pastors know that, as a minister, they are authorized to take a tax-free housing allowance. Seems easy, right? Unfortunately, the IRS requires that you follow an inflexible process. If you deviate from it, you may be under-reporting your income and you could owe thousands in taxes, fines, and penalties.
A few years ago, The Provisum Group took on a client running a ministry that was on fire for God. This church was growing weekly with new members. Soon, it became more than the staff could handle. The church’s growth had outpaced its volunteer bookkeeper’s ability. As a result, the pastor engaged us to help him manage the books and payroll.
As we onboarded the church and set up their payroll, we noticed that the pastor was being treated on the payroll as an employee of the church. He was also receiving a housing allowance, which is obviously allowed. The problem was that the church was paying the employer’s portion of the pastor’s Social Security. If you do not see how this is a problem, you may want to pay close attention to the next paragraphs.
Social Security and Clergy Housing Allowance
Clergy can opt-out of Social Security within the first 24 months of ministerial employment. All the minister must do is submit an IRS form 4361. Whether you opt-out of Social Security or not, pastors who take a housing allowance are classified by the IRS as self-employed individuals. This means you must comply with the requirements of the Self-Employed Contributions Act. What does that mean?
If you are a pastor receiving a housing allowance and are planning on receiving Social Security (meaning you did not opt-out within your first 24 months of ministry), you MUST pay both the individual AND employer portions of the FICA tax. There is no flexibility in this. If you are receiving a housing allowance and your church is paying the employer’s portion of your FICA tax, the ministry’s payment of the employer portion of FICA is legally considered “income” to you. You must report it as such and pay the taxes accordingly.
Unfortunately, this pastor did not report as income the employer’s portion of his Social Security that the church paid. This means, in the seven years since he became pastor of that church, he had unknowingly under-reported his income to the IRS. Our calculations showed he owed tens of THOUSANDS of dollars in taxes, fines, and penalties for the past seven years. The only thing he could do was self-report this to the IRS and pray for leniency. Fortunately, he received a friendly and understanding agent who worked with him to waive the fines and penalties. The agent also helped set up a very manageable repayment plan. Fines and penalties aside, the pastor still had to pay the full amount in taxes on 7 years of the unreported income.
What do I do?
In 35 years of leading people and organizations, I have learned there is what you know and what you should know. Clergy compensation regulations are something every pastor or ministry leader who takes a housing allowance should know. This means, you may need to swallow hard and review your tax filings. You may be unfortunately surprised by what you find. If you are, pray for leniency and start paying. Anything is better than piling more taxes, fines, and penalties on what you may already owe.
If you need help with reviewing your forms or if you do not even know where to begin, give us a call at The Provisum Group. We can assist you with this process and can even help you with your books going forward. Click the link below to start the conversation.