5 Common Myths Surrounding Ministers' Taxes
Have you seen any of the recent H&R Block™ tax commercials with actor Jon Hamm on television? They are actually quite clever and entertaining. There is one particular commercial that stands out to me.
In the commercial, Jon Hamm is on a Hollywood set standing in front of a snack table. He illustrates the different ways in which a tax return can be completed using doughnuts from the snack table. While picking up several plain doughnuts Jon says,
“There are many right ways to fill out this tax return. The IRS will accept them all. One of them gets you the most money back. Isn’t that the one you want?”
He then proceeds to eat the doughnut covered in sprinkles.
The commercial is simple and straight to the point, and while I typically forget about most commercials I see on television, this one left me thinking. I do not know one person who would select a tax return that did not give the most money back. However, in order to choose the tax return that gets you the largest refund, the person preparing your taxes needs to know all of the tax breaks and benefits afforded to you.
This is especially true for ministers.
Minister have a unique tax status
While the Declaration of Independence may declare that “all men are created equal,” the tax code does not.
From our experience in assisting ministers with their tax returns, the ministers who end up owing taxes usually do so because of incorrect information received from another minister and, in some instances, a tax professional. Most ministers and standard tax professionals do not realize that ministers have a dual tax status according to IRS Publication 517.
While the Declaration of Independence may declare that “all men are created equal", the tax code does not.
What does that mean?
What this means is that a minister is an employee of the church for federal income tax purposes and self-employed for Social Security purposes. It is not uncommon for churches to misunderstand this rule when paying their ministers a salary.
The lack of understanding a minister’s dual tax status, along with the amount of misinformation surrounding ministerial compensation and ministerial taxes, is what often leads to ill-informed decisions that can be costly to a minister.
With that being said, I want to spend some time debunking five common myths surrounding ministers’ taxes that will help you make better, well-informed decisions for your taxes.
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5 myths surrounding ministers’ taxes
Myth 1: “Ministers do not have to pay income taxes.”
In reality, ministers are exempt from income tax withholding . . . not from having to pay income taxes.
Many ministers misunderstand the fact that their wages as a minister are not subject to income tax withholding. This leads to the false assumption that they do not have to pay income taxes. Not until it is too late, and costly, do they realize the gravity of their mistake.
Since ministers have a dual tax status, ministers are responsible to withhold and pay their own taxes. As a minister, you can pay your taxes in quarterly installments using Form 1040-ES. If you want your church to withhold and pay your income taxes like a nonministerial employee, you can do so, but you must enter into a voluntary withholding agreement with the church. For more information on entering into a voluntary withholding agreement, click on the article listed below.
Ministers are exempt from income tax withholding - not from having to pay income taxes.
(Recommended reading: “3 Common Mistakes Churches Make When Paying Pastors”)
Myth 2: “Love offerings are not taxable income.”
The confusion surrounding love offerings comes primarily because the term love offering implies a gift that is given because of love and respect for the recipient. In the giver's mind it may be a gift, while in the IRS's mind it is compensation. Herein lies the conflict.
Section 102(a) says, "Gross income does not include the value of property acquired by gift, bequest, devise, or inheritance." While the members of the church are truly giving a love offering as a gift, the IRS says it is taxable income because section 102(c)(1) says that "any amount transferred by or for an employer to, or for the benefit of, an employee" shall be treated as gross income.
While the law clearly says that a gift is tax free, the fact that the gift is given to the church and then given to the pastor or leader makes it 100% taxable because of section 102(c)(1). The law makes an exception for a gift given by the church to the pastor if it is under $25.00.
(Recommended reading: “Love Offerings--When They Are Taxable and When They Are Not”)
Myth 3: “If I do not have the exact figures for my deductions, then I can just round up or make a best faith estimate.”
Deductions should not be in round numbers. Inserting round numbers on a return tells the IRS that you are likely making them up and can increase your chances of being audited.
(Recommended reading: “Is Your Home Office Deduction Legal?”)
Myth 4: “If I owe taxes and file an extension, then I will not have to pay the taxes I owe until the extension is due.”
The truth is that all money owed to the IRS is due by the annual tax deadline. This year the tax deadline is April 18th, 2017. If you happen to owe taxes and fail to meet the April 18th deadline, then you will be penalized for each month that you are late (even if you have filed an extension using Form 4868).
In general, if you file a tax extension using Form 4868 and think that you may end up owing money for your taxes, it is better to pay the IRS an estimated amount by April 18th. If you happen to overpay, the IRS will reimburse you the amount you overpaid.
The truth is that all money owed to the IRS is due by the annual tax deadline.
Myth 5: “Any CPA is a good CPA for ministers.”
While there are many knowledgeable and well-intentioned CPAs, not all of them are familiar with the various caveats of taxes for ministers.
A CPA working on taxes for ministers should be well versed on the subject and be familiar with nonprofit tax law because many of the tax benefits afforded to a minister are directly tied to a minister’s ordination. In turn, a minister’s ordination is directly tied to the ordaining organization (church).
While there are many knowledgeable CPAs not all of them are familiar with the various caveats of ministers' taxes.
For example, IRS Publication 517 is dedicated to explaining various rules regarding the tax status of ministers, and within this publication it defines a minister as,
[I]ndividuals who are duly ordained, commissioned, or licensed by a religious body constituting a church or church denomination. Ministers have the authority to conduct religious worship, perform sacerdotal functions, and administer ordinances or sacraments according to the prescribed tenets and practices of that church or denomination [emphasis added].
With this definition in mind, your chosen CPA should have a working knowledge of nonprofit tax law and how it relates specifically to you as a minister.
(Recommended reading: “Are You Sure Your Ordination is Legal?” )
Utilize a tax service trusted by thousands of ministers
Over the years, we have served thousands of pastors with their personal income tax returns through our minister's tax service. Our experienced CPAs and tax department know how to best serve you and your tax needs.
With our minister’s tax return service, you can confidently know that you are taking advantage of every tax benefit available to you as a minister. I encourage you to give us a call at 877-494-4655 to find out more about how we are able to serve you.
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