My first minister client - some questions

Technical topics regarding tax preparation.
#1
chris  
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One of my long time clients is retiring from his corporate job and going into ministry along with his wife who is already retired. He is 61 and she is 58. He plans on starting to collect SSA benefits starting next year. She will, but much later. She has a great pension from the school district where she taught.

They will each get income from the church and it will total $70K for both of them. A decent one-family small house around here rents four around $3000/mth and figure another $500/mth for utilities.

I'm thinking I should do the following. I would appreciate any advice or suggestions:

- Have the church set housing allowance at $30K for each of them (which I know is too high)
- Have them both submit a 4361 to ask to be excluded from FICA taxaes

(EDIT): ok, I think the 4361 is out of the question, I did not realize the full implications until I looked at the form. If the client is going to be receiving social security then there's no way he can in good faith sign that form. So I think my question is not limited to the housing allowance configuration.

Reasoning is, first the high housing allowance gives flexibility to dial down at tax time and convert some to normal income, if needed. Second, since they are both retired and banked well enough into SSA, then the opt-out (if approved) will not hurt them.

Am I thinking the right way about this?
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#2
JAD  
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Hi Chris, is any of this helpful?

viewtopic.php?f=8&t=3662&p=53746&hilit=church#p53746

I can't respond to your specific questions because I haven't dealt with this at all since 2014, when I posted. My client remains uncompensated. But maybe my post at least helps get the discussion going for you.

Also, of course, tax reform may have changed the rules.
 

#3
MWPXYZ  
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I can't see the advantage of overstating the Housing Allowance. Perhaps they have not yet obtained a stable housing situation and 2018 costs are unknown?

Estimated payments for 2018 would be based on the best estimate of actual income and/or prior year tax liability, irrespective of the stated amount of the Housing Allowance, I think.
 

#4
KarenF  
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I prepare several clergy returns. Housing allowance would include rent, mortgage and real estate taxes paid, property insurance, utilities, furnishings and appliances, repairs, maintenance etc. A lot of my clients overestimate a little in case something unexpected comes up. There's no harm in doing that as long as they understand they would owe tax and likely SE tax on any overage and to make sure they're covered for penalty purposes.

Also, who will be the minister? From what you wrote, it sounds like husband only. In order to claim the housing allowance, he (and the wife if also claiming) would need to be licensed, ordained or commissioned by the religious body. If it's just the husband, then he is the only one who could claim the housing allowance. But he could claim the housing allowance for all of their housing expenses.
 

#5
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In this scenario, is it a good idea to claim SS benefits at age 62? Sounds like he'd be paying a lot of it back.
 

#6
JR1  
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Take a look at this, very comprehensive article. In good conscience, yes, he can file for exemption on his ministry earnings while receiving benefits from his real world work. Makes perfect sense. That he believes the church should care for its own is not in conflict over that.

I’m a Minister–How Should I Get Paid?

Clergy pay is one of the more complex areas of the law, and for many accountants who don’t handle a lot of pastors and pastoral employees, it can be frustrating to understand. There are a few key issues to address: Who is a minister? The SS system. Reimbursements. Housing. Reporting. Retirement. As succinctly as I can:

Who is a minister? A minister is determined to be someone who is licensed, commissioned, or ordained, and meets any two of the following: leads worship, administers sacraments, is considered a spiritual leader, or is administering or managing affairs of the church or organization. Many churches and orgs have a checklist or policy to help determine who, within their body, qualifies as a minister.

The Social Security system. One of the most important decisions you’ll make as a minister is whether you want to be covered in the SS system or not. You have two years after taking a new position in a church to make that determination and file with the IRS for exemption if you choose. The financial benefit is obvious-you control your retirement money instead of the government, and will return 6-10 times what you’d have through the government system. Ministers are the only people other than teachers and government workers who have the opportunity to dodge SS. But this is not an inherently financial decision. It’s a moral decision.

The requirement in filing for exemption is your signing off that you conscientiously object to the government providing welfare/retirement benefits, and that the church should do this job. If you don’t believe that, you can’t realistically file the exemption and sleep well at night. It is important to note a couple other key things. Many who were in the SS system in ‘real jobs’ will still receive SS benefits upon retirement, even after filing for exemption as a minister. This is confirmed in the SS code section 1131.4 “The exemption applies only to net earnings from the exercise of the ministry. Once having filed a valid application for exemption, a minister cannot later acquire Social Security credit for earnings from these services. However, Social Security taxes will continue to be paid by any minister on any other self-employment income or covered wages.” Finally, and perhaps this should NOT be mentioned, while the exemption is irrevocable, meaning that you cannot change your mind once that two year period is up, you may have other opportunities to alter your position with SS. First, if you change churches, you have a new two year window open for a new decision. Second, historically, about every 15-20 years, SS opens the window to allow previously exempt ministers to come back into the system.

This has been used for abuse, as someone chooses to dodge the system for many years, and then, near retirement age, comes back in, pays SS taxes for a few years and qualifies for decent benefits. My job is to give you all the facts, though, so that you can make the right decision.

Reimbursements. The general rule is that you want to get reimbursed for expenses first. Then housing, then, taxable salary. Reimbursed expenses don’t show up on any tax form, ever. So maximizing these helps keep taxable income down, while the same amount of money changes hands between the church and the minister. Let’s say that the church can afford to pay $40,000 total to the minister per year. If he/she turns in cellphone, mileage, dues, library, travel, meals, and the like, or the church pays these directly, $5,000-10,000 per year can change hands legitimately without any tax to anyone. Of the $30-35,000 that remains, in many metro areas, that will handle the housing allowance nicely. We’ll discuss that in the next section. But housing isn’t subject to income taxes, so you can see that this $40,000 compensation program can be kept from income taxes entirely. It’s a nice benefit. But we start with those reimbursements. Maximize those, and then…

Housing. Apart from opting out of SS, housing is the best deal going for ministers. To put into perspective, think of the old parsonage that was near the church that was provided to the pastor and his family. Those don’t exist much anymore, and the housing allowance is the replacement for it. The pastor could live in the parsonage tax free. And in the same way, the housing allowance which replaces the parsonage, is tax free. What is housing? Well, it’s whatever it costs in your area to live in that parsonage. Costs to pay for it (the entire mortgage payment, not just interest), furnish it, maintain it, light and heat it, clean it…just about anything except for food and clothing! Limited to a fair rental value for a furnished home, so you can’t live in a mansion and take it. But from my experience, $20-40,000 perhaps is pretty usual.

Now, you have to keep records and prove that you spent that much, or it gets added back to income. And that housing allowance must be declared, usually at year end, board approved, prior to receiving any housing allowance the next year. So you need to know at all times what you’ve spent so that you can set the amount for the following year. There is one other thing to know about housing. While it avoids income tax, if you’ve chosen to remain in the SS system, it is subject to SS taxes. So while you may owe no income tax, we compute SS taxes on the housing amount.

Reporting. Generally, the rule is that a minister is a dual status worker-an employee of the church, yet considered self employed for tax filing. This makes it very confusing, and many churches and orgs get this wrong. A minister should be issued a W2, nearly always. BUT, there should be no withholding of any kind, or social security/medicare wages. So it’s a W2 with one figure in the wage box, and the housing amount shown in box 14 as info only. That’s it. On the pastor’s return, we pick up the wages in the usual place on the 1040, but use a Sch. C for any unreimbursed business expenses, and the SE form to compute all the SS tax on salary and housing.

Retirement. Finally, the main thing to know here is that housing and reimbursments cannot be used to determine retirement contributions or benefits. So if you manage to dodge taxable income entirely, you’ve also dodged the ability to deduct a retirement contribution. And we should note as strongly as possible that if you do choose to opt out of the SS system, you owe it to yourself and your family to take that same money and put it into retirement, disability and life insurance. One other thing of note, upon retirement, distributions can still qualify for housing exclusion, making the money tax free. Again, it’s entirely possible to make tax deductible contributions to retirement over the years, and then not have to include the benefits in income when drawn for housing. It really gets no better than that, except for the retirement benefits after death…!
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#7
chris  
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Thanks for all the pointers. I did read up some more and now understand that attempting to opt out of SSA is a possibility, based on income attached to ministry only.

Good point too on the "who is a minister" question. I think it will end up being just the husband. In which case they may just end up putting him on payroll and his wife continues to volunteer.

For the 'risk' of overestimating housing - isn't it possible to reclassify some of that as income, at tax time? Or once it's loaded into the w-2 in box 14 you have to leave it there?
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#8
JR1  
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When you overestimate housing, on the W2 worksheet is a box asking for the allowance, and what was spent. If spent is less, it's automatically added to line 7 on the 1040 with some verbage overprinted there. No biggie, and good work since they often don't know how much they'll spend. There's no penalty.

There will also be boxes to check about how to apply SS...either exempt, to wages, wages and housing...
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#9
KarenF  
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Come tax time, you ask your client what his actual housing related expenses were. If that number is more than the housing allowance on the W-2, then there's nothing to do, other than potentially adding the housing allowance amount and maybe even the W-2 box 1 earnings to Schedule SE. I've seen it reported a number of different ways. If his housing expenses were less than the allowance, then you have to include the difference as other income and make sure the Schedule SE is correct. Some employers withhold the ministers FICA and Medicare and pay half like a normal employee. That's not correct, but it happens all the time.

The correct way would be for the church to give the minister a W-2 and show only box 1 wages for the non-housing allowance pay. Then put the housing allowance in box 14. Then Schedule SE should report the box 1 wages, plus the housing allowance minus any out-of-pocket unreimbursed expenses (which should be reported on 2106 as unreimbursed employee business expenses). So you just have to look carefully at what the employer did and make sure in the end all the proper taxes have been paid.
 

#10
chris  
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Thanks for all the responses, much appreciated. New questions now come to mind:

1. For determining housing expenses, do we take actual expenses, or "typical/market" costs? For example, someone who owns a home outright may have lower actual expenses compared to someone renting. I thought I would just determine what the fair market rental would be for a typical home in our area, and use that as a starting point. Is that wrong?

2. If we have to use home-owner actual expenses, do you factor in depreciation?

3. Hopefully the church would run an accountable plan for expenses. I really don't expect there to be too many expenses (this is an "in-house" job) -- but if they don't have an accountable plan then starting in 2018 won't we lose the ability to have employee expenses via 2106?
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#11
JR1  
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1. Actual. Yes, it sucks once mortgage is paid.
2. No.
3. No, because they're dual status, so expenses would go on Sch. C. But still better to be reimbursed first to avoid wages/housing. Mileage, dues/subscriptions/conferences/library, meals, etc. are pretty typical. Phone. Any office expenses.
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#12
Lmaris  
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Be careful. At least one district court has ruled the housing allowance exemption to be unconstitutional: GAYLOR v. MNUCHIN, 120 AFTR 2d 2017-6841

Also make sure your client is willing to swear the reason they won't be paying SE taxes is because of deeply held religious beliefs to not receive SS & medicare benefits for their ministerial services, not just to avoid paying tax.
 

#13
JR1  
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Lmaris, that's a red herring. Madison, WI court that's the heart of socialist America. It will be overturned. Again. We've been there before.

And the 4361 covers the next issue precisely since that's exactly what you attest to.
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#14
chris  
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You guys are the best; thank you for answering my questions. I now feel like I'm equipped to lay out a game plan.
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#15
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I'm with Sumwun on this. If he is going to make that much income from the church, not sure if he should begin drawing social security.
 

#16
chris  
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SumwunLost is right! ...yes...the total comp package (including housing allowance) counts toward the earned income calc for SSA benefits, so before full retirement age he would not be able to collect SSA benefits.
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#17
JR1  
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He can collect, but has to return much of it and then pay tax on the rest. I'd suggest he wait until FRA.
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#18
Lmaris  
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JR1 wrote:Lmaris, that's a red herring. Madison, WI court that's the heart of socialist America. It will be overturned. Again. We've been there before.

And the 4361 covers the next issue precisely since that's exactly what you attest to.


If one is in that district, that is the current law, whether one considers it a red herring or not, until it is overturned. If one banks on it being overturned and it is not, you are exposed too.
 

#19
skip  
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Lmaris wrote:
If one is in that district, that is the current law, whether one considers it a red herring or not, until it is overturned. If one banks on it being overturned and it is not, you are exposed too.



My understanding is that the ruling has been suspended to give time for appeals to be filed. So it is not quite yet the “current law” in any district.
 

#20
skip  
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JR1 wrote: First, if you change churches, you have a new two year window open for a new decision. Second, historically, about every 15-20 years, SS opens the window to allow previously exempt ministers to come back into the system.


Can you give a source for this information? Google is my friend- but I must not be using the right combo of search terms!

Thanks!!
 

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