Churches and taxes have a very long history. Although churches haven't paid taxes since the founding of the United States in 1776, they weren't officially recognized as tax-exempt entities until 1894.
Churches do not pay property taxes on their buildings, and donations to any church are tax deductible for the donor. Churches are not allowed to withhold Social Security and Medicare (FICA) for ministers; it is up to the individual clergy member to make estimated tax payments to pay their FICA taxes.
The IRS publishes a 40-page document outlining the tax code for churches and religious institutions, and it can answer a lot of questions that clergy and other church leaders have about what a church does and does not need to do when it comes to taxes.
However, that guide does not prioritize money-saving tax strategies, which is what we want to provide in this post.
Strategy 1: The Accountable Plan
An accountable plan must be put in place by the church in order for ministers to receive tax free reimbursements for their job related out of pocket expenses.
Prior to the tax reform bill of 2018, it was the minister’s responsibility to ensure that their unreimbursed, out of pocket job expenses were claimed on their Schedule A (Itemized Deductions) when filing their annual tax return. Today, the church bears the burden of ensuring that their compensation packages are structured to provide ministers tax saving opportunities.
By offering an accountable plan, the church can determine the items for which the minister can receive tax free reimbursements. These items can include such things as books, mileage, lodging, meals, etc. However, it is critical that the church has a plan documented with the items that are eligible for reimbursement as this determination can not be made on a case by case scenario.
Strategy 2: Work Your Schedule C
Schedule C forms are used by independent contractors and sole proprietors to account for the net profit/loss at the end of a tax year. As a member of the clergy, you have dual tax status and are obligated to pay estimated tax payments as if you were an independent contractor.
This means that you are eligible to use a Schedule C form to report income earned and expenses incurred outside your regular church employment (such as weddings, funerals, speaking engagements, etc.). It is extremely important to track all your costs associated to these outside engagements to reduce your taxable income.
Strategy 3: Learn to use QSEHRA
QSEHRA stands for “qualified small employer health reimbursement arrangement.” Churches can implement this plan in place of traditional health benefits. It works in a similar manner to the accountable plan.
Essentially, the church establishes the QSEHRA and states what is eligible for tax free reimbursements. It is important for churches to consider the QSEHRA when establishing each ministers compensation package.
Please note: QSEHRA cannot be used just for one church employee. This must be implemented across the board for all full-time employees of the church.
Strategy 4: Retirement Planning
Smart retirement planning can reduce what you pay in taxes!
Utilizing an Individual Retirement Account (IRA), a minister can lower his income tax by taking advantage of the tax deduction available for contributions to a traditional IRA. Additionally, for those ministers who are at retirement age, the strategic use of funds held in tax deferred retirement accounts and after tax investment accounts can provide opportunities to minimize a clergy’s tax burden.
By working with a knowledgeable CPA and investment advisor, a minister will be able to enjoy the benefit of hard earned savings during retirement. It is important for clergy members to work with professionals to ensure that the retirement and investment funds are maximized while minimizing the minister’s tax liability.
Strategy 5: Calculate Your Housing Allowance
Pastor housing is something that is commonly misunderstood. Many think that it is exempt from ALL taxes; however, it is only exempt from income tax. It is still subject to Social Security/Medicare (FICA) taxes.
Furthermore, you must be sure to properly calculate your housing allowance. At the end of the year, if your housing allowance exceeds your allowable housing expenses, the difference must be reallocated to income and is subject to income taxes. This can become tricky once your house is paid off or if you own multiple homes.
How to Create a Smart Tax Planning Strategy for Pastors, Clergy & Churches
Because church tax law is both complicated and incredibly niche, there is a lot of bad advice out there. The internet is full of inaccurate, outdated, or flat-out wrong information. Whoever handles your taxes should not just be a tax expert, but also a church tax expert.
At Ascension, we understand this niche. We know about church tax law, the impacts of the 2018 tax bill on church and clergy taxes, and the best ways to reduce your tax obligation with careful planning and excellent knowledge.