Ministers, rabbis, cantors, priests and other religious officials who work as leaders of religious organizations are entitled to have some of their income excluded from taxation. In particular, the amount spent on housing and furnishing the home is excluded from income taxation. This is called parsonage.
There are two components of a clergy person's compensation: the amount allocated to parsonage and the residual amount left over after the parsonage allocation (referred to as "non-parsonage" compensation in the remainder of this article). Each component has different tax liabilities.
Ministers, rabbis and cantors have a unique standing for tax purposes. For income tax purposes they are considered employees (and the rabbi, minister or cantor should have the customary income tax withholding and receive a W-2). In terms of Social Security and Medicare taxes they are deemed to be self-employed. This is a crucial distinction because being deemed self-employed requires the clergy person to essentially pay double for these taxes. In contrast, if a clergy person was categorized as a traditional employee their employer would be required to make matching Social Security and Medicare taxes.
Someone who is self-employed has to subsidize the missing employer contribution and pay the difference out of their own pocket. The self-employment tax is imposed on both the parsonage and the non-parsonage pieces of compensation. Some institutions will reimburse their minister for Social Security and Medicare taxes on either the non-parsonage or parsonage component of the minister's salary. If this occurs, the reimbursement is subject to both income tax and self-employment tax.
The illustration below identifies the types of taxes the minister has to pay based on whether the component of income is deemed parsonage or non-parsonage.
|Federal Income Tax||State Income Tax (if applicable)||City Income Tax (if applicable)||Self-Employment Tax (Federal obligation)|
Most churches and synagogues do not account for the self-employment tax obligation when determining withholding taxes and this typically leads to the minister, rabbi or cantor not withholding the appropriate amount of tax. To ensure the proper amount of tax is withheld, the clergy person should divide his total compensation (parsonage plus non-parsonage) by the number of pay periods and multiply by 15.3%. This is the additional amount that should be withheld for each pay period to fulfill the federal tax requirement. Clergy should inform the person in charge of their payroll withholding about the additional withholding amount that must be taken into consideration (if the religious entity is matching Social Security and Medicare taxes for part or all of the clergy person's compensation, please adjust accordingly).
Please note: The computation above slightly overestimates the tax obligation because it includes an adjustment for one-half of self-employment taxes.
If the minister, rabbi or cantor is not living in church or synagogue furnished housing, the annual cost of their home including furnishings, yard and utilities can be claimed. If the minister is living in a residence provided to him by his or her church then the market value of the home, furnishing, yard and utilities can be claimed.
While not an exhaustive list, here are some samples of items that may be included in parsonage tax deductions:
Not included as part of parsonage:
Ministers are limited to the lower of the following three valuations:
As long as the limitations on parsonage are followed, theoretically 100% of the minister's salary can be claimed as parsonage. In the case of a dual-minister couple (that is, where each spouse is an active member of the ministry and both are eligible for parsonage allowance) the combined parsonage cannot exceed the limitation on parsonage. That is, there is no "double counting." The same also applies in a situation where a minister, rabbi or cantor has multiple positions and each position entitles him or her to a parsonage claim.
Parsonage is not an automatic right. It must be awarded by the minister's employing organization. As such, it is crucial that the minister ensure that the organization is entitled to award a parsonage based on its tax exempt status. Churches, synagogues and other houses of worship are automatically granted this right by the Internal Revenue Service (IRS) even if they have not have officially registered the charity with the IRS.
Once it is established that the minister is eligible for parsonage, the formal awarding has to be made part of the church or synagogue records and included in the minutes of the board of directors or the equivalent. The minister, rabbi or cantor should also get this eligibility in writing for his or her records in the event of an audit.
It is a best practice for the minister, rabbi or cantor to reevaluate on an annual basis their budget for parsonage as the amount of money a person spends on his or her home may change as a result of a move to a larger or smaller home, renovations, major appliance purchases or the purchase of furniture. Since one of the limitations of parsonage is the amount of the parsonage declaration, we recommend slightly overestimating the parsonage designation. If the amount actually spent is less than the declaration of parsonage then the excess amount is subject to income taxes. However, this will prevent the minister from maximizing his or her parsonage allowance.
Ministers must be attentive to the amount designated for parsonage. This is why MEDOWS CPA has developed a separate area of practice for clergy taxes. We would be more than happy to answer any specific questions you have during the course of the year as well assisting you with the declaration of your parsonage allowance and the preparation of your personal income taxes to ease the complexity of clergy taxes.