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October 15, 2013

Neglecting to "Render Unto Caesar"

Failure to file income tax returns can get new ministers into hot water.

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Ministers—especially new ones—often fail to file income tax returns. It's a common problem, because churches are not required to withhold either income taxes or Social Security taxes from the wages of ministers who are performing ministerial services. This occurrence takes place for two main reasons:

• Ministers are classified as self-employed by the tax code for Social Security purposes (they pay the self-employment tax in lieu of having Social Security and Medicare taxes withheld from their wages by their employing church), and

• The tax code exempts the wages of ministers from income tax withholding.

Unless they elect voluntary tax withholding, ministers are required to prepay their federal income taxes and self-employment taxes using the estimated tax procedure. This requires the minister to estimate his or her income taxes and self-employment taxes for the year and pay one-fourth of this amount quarterly.

The problem is that few seminaries inform students of their obligation to prepay their taxes using the estimated tax procedure. Many new ministers assume that their church will operate like a secular employer and withhold these taxes. When they realize that nothing is being withheld, pastors may rationalize their failure to pay taxes or file tax returns (e.g., "ministers must be exempt from taxes" or "I probably am not earning enough to trigger withholding"). This leads to nonpayment of taxes and, in many cases, to a failure to file a tax return.

In time, some of these ministers realize that they owe back taxes, but they are unsure how to proceed. Thankfully, there are preventative and restorative measures you can take. Consider the following points pertaining to clerical income tax procedures:

• If a tax return is not filed by the due date (including extensions), a taxpayer may be subject to the failure-to-file penalty unless reasonable cause exists.

• Taxpayers who did not pay their tax liability in full by the due date of the return (excluding extensions) may also be subject to the failure-to-pay penalty unless reasonable cause exists.

• Interest is charged on taxes not paid by the due date. Interest is also charged on penalties.

• Ministers who have not filed one or more tax returns should consult with a CPA or tax attorney to determine whether taxes are owed, and if so, what options are available. Taxpayers who owe taxes, but are financially unable to pay them, may qualify for assistance in making payments through either an installment agreement or an offer in compromise. Discuss these options with your tax adviser.

• There is no penalty for failure to file if you are due a refund, but a return claiming a refund has to be filed within three years of its due date for a refund to be allowed.

• After the expiration of the three-year window, the refund statute prevents the issuance of a refund check and the application of any credits, including overpayments of estimated or withholding taxes, to other tax years that are underpaid.

• The statute of limitations for the IRS to assess and collect any outstanding balances does not start until a return has been filed. In other words, there is no statute of limitations for assessing and collecting the tax if no return has been filed.

Church leaders should discuss tax filing requirements with every new minister, especially those who are recent seminary graduates. Leaders need to ask pastors questions like, "How do you plan to pay your income taxes and self-employment taxes? Through voluntary withholding? The estimated tax procedure?" If the latter, provide them with a current copy of IRS Form 1040-ES (including the instructions). This is the form used to compute estimated taxes. It also includes payment vouchers that are used with each quarterly tax payment.

Check out the Essential Guide to Law and Tax for New Ministers eBook for key legal and tax information for new pastors.

For a comprehensive treatment of income tax policies for ministers for 2013, refer to chapter 1 of the 2013 Church & Clergy Tax Guide. Subscribe to Richard Hammar's Essential Reminders free e-newsletter to alert you weekly to important tax deadlines.

Related Tags: church tax, failure to file, federal income tax, pastor, pastoral tax, Richard Hammar, tax, voluntary withholding

Comments

It's often even worse, as pastors have a two year window to decide if they are going to elect out of social security on their salary as a minister. If they miss this window, or if they choose not to elect out, then they are required to pay the self-employment tax (SECA) rather than 1/2 of self employment tax with the employer paying the other half (FICA). And even if the amount of income tax due is minimal (often the case with ministers, since there is no income tax on the housing allowance), the self-employment tax, which is due on the entire amount paid, including the housing allowance, can quickly mount up. The amount due for several years worth of SECA is likely to be far in excess of the minister's disposable income.

Clergy taxation is not thoroughly understood by many [most?] CPAs. It is an area of specialty. Clergy, and ministry leaders, should seek out tax preparers who have specialized in this area. Our practice files many amended returns for clergy who have previously used CPAs who do not understand this area of tax practice.

The big problem I find is that many churches treat ministers as regular employees. This may go on for several years. Then amended payroll tax returns and W-2s, and individual returns of the minister's all must be amended. This can be expensive to fix.

We need better training of church treasurer's and bookkeepers.

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