Who is a Minister for Federal Tax Purposes?

by Richard R. Hammar, J.D., LL.M., CPA
© Copyright 2005 by Christianity Today International/Church Law & Tax Report. All rights reserved.

Printable version of this lesson

Introduction

A number of federal tax laws have unique application to ministers. Some laws, such as the housing allowance, provide special tax benefits to ministers. Others have an impact on how a minister pays his or her taxes. A key point, however, is that the Internal Revenue Service has its own definition of who is a minister for tax purposes. All new ministers must determine if they fall under that definition in order to properly determine and report their federal income taxes. This lesson addresses that issue. The Executive Summary provides a concise review of the key points. Before we get started, test your knowledge by completing the following exercise.

Self-Assessment Exercise

Instructions Click on the correct answer for each of the following questions.

1. Pastor J is an ordained minister who serves as a minister of education at his church. He occasionally conducts worship services, but does not administer the sacraments. He does have management responsibility in his local church and at regional and national meetings of his denomination. His duties include overseeing the educational program of his church, occasional counseling, and hospital visitation. Pastor J is a "minister" for federal tax purposes.
   True or False
   
   
2. Pastor B is minister of music at her church. She is not ordained, commissioned, or licensed. Because she is directly involved in worship services, the church can treat her as a minister for federal tax purposes.
   True or False
   
   
3. Pastor R is a licensed minister who serves as the youth pastor at his church. He regularly performs sacerdotal duties and conducts religious worship. He is a minister for federal tax purposes.
   True or False
   
   
4. Pastor G is an ordained minister who resigned his pastoral position and temporaily is working for a "secular" employer. Since he is an ordained minister, he should be treated as a minister for tax purposes by his employer. This means that income taxes should not be withheld from his wages, and he should be treated as self-employed for Social Security.
   True or False
   
   
5. There are several special tax rules that apply to "ministers." These include the housing allowance, self-employed status for Social Security, and exemption of wages from income tax withholding.
   True or False
   
   

Executive Summary

"Ministers" are eligible for the following 5 special tax rules with respect to services they perform in the exercise of their ministry: the housing allowance; the parsonage exclusion; exemption from social security coverage (if several conditions are met); self-employed status for Social Security (if not exempt); and exemption from income tax withholding. In deciding if a person is a "minister" for federal tax purposes, the following five factors must be considered: (1) the person must be ordained, commissioned, or licensed; (2) administration of sacraments; (3) conduct of religious worship; (4) management responsibilities in the local church or a parent denomination; (5) considered to be a religious leader by the church or parent denomination. In general, the IRS and the courts require that a minister be ordained, commissioned, or licensed, and then they apply a "balancing test" with respect to the other four factors. The more of them that a person satisfies, the more likely that he or she will be deemed to be a minister for tax reporting purposes.

Lesson

There are five special tax rules that apply to ministers:

(1) ministers who own their home do not pay federal income taxes on the portion of their church compensation that is designated in advance by their church as a housing allowance to the extent that the allowance is used to pay for housing related expenses and does not exceed the annual rental value of the home

(2) ministers do not pay federal income taxes on the annual rental value of a parsonage provided by their church

(3) exemption from "self-employment taxes" (Social Security taxes paid by the self-employed) if several conditions are met

(4) self-employed status for Social Security

(5) exemption of wages from income tax withholding

Let’s illustrate the significance of this subject with an example. Assume that a church has an ordained senior minister, a licensed associate minister, an unordained youth minister, an unordained music minister, a business administrator, four office secretaries, and two custodians. How many of these persons are eligible for a housing allowance? How many should be treated as self-employed for Social Security and pay the self-employment tax rather than FICA taxes? How many are eligible for exemption from Social Security coverage (assuming they meet all of the other conditions)? How many are exempt from income tax withholding? In other words, which of these individuals should be treated as "ministers" for federal tax purposes? This lesson will address these questions.

Income tax regulations

All of the special tax rules summarized above are available only to ordained, commissioned, or licensed ministers of a church with respect to service performed in the exercise of ministry. This critical terminology is defined in the income tax regulations as follows: "Service performed by a minister in the exercise of his ministry includes the ministration of sacerdotal functions and the conduct of religious worship, and the control, conduct, and maintenance of religious organizations . . . under the authority of a religious body constituting a church or church denomination. . . . Services performed by a minister in the control, conduct, and maintenance of a religious organization relates to directing, managing, or promoting the activities of such organization."

To summarize, the five special rules summarized above apply to persons who satisfy two requirements:

• they must be a minister, and

• they must be engaged in the exercise of ministry

Court rulings

The leading case defining the term "minister" is a 1989 Tax Court case. Knight v. Commissioner, 92 T.C. 199 (1989). The court announced a new test for determining whether or not a particular individual is a minister. Under this test, the following 5 factors must be considered in deciding whether or not a person is a minister for federal tax reporting purposes: (1) does the individual administer the "sacraments", (2) does the individual conduct worship services, (3) does the individual perform services in the "control, conduct, or maintenance of a religious organization" under the authority of a church or religious denomination, (4) is the individual "ordained, commissioned, or licensed," and (5) is the individual considered to be a spiritual leader by his or her religious body? Only the fourth factor is required in all cases (the individual must be ordained, commissioned, or licensed). The remaining 4 factors need not all be present for a person to be considered a minister for tax purposes. The court did not say how many of the remaining 4 factors must be met. It merely observed that "failure to meet one or more of these factors must be weighed . . . in each case." The court concluded that the taxpayer in question was a minister despite the fact that he only satisfied 3 of the 5 factors.

It may reasonably be assumed, however, that persons who claim to be "ministers" solely on the basis of the final 3 factors mentioned in the Knight case will not be deemed ministers by the IRS or the courts unless they can demonstrate that they are entitled to ministerial status on the basis of other considerations. After all, if a church is willing to ordain its bookkeeper and secretary, these persons could argue that they satisfy the final 3 factors in the Knight case (management responsibilities, ordination, and a "religious leader"). There is no doubt that the IRS and the courts will not accept such a conclusion. Considerations that suggest ministerial status, even if the first 2 Knight factors are not satisfied, would include (1) ordination to the pastoral ministry, and actual pastoral experience in the past, and (2) formal theological training.

IRS audit guidelines for ministers

In 1995 the IRS released audit guidelines for its agents to follow when auditing ministers. The guidelines cover a range of issues, including the definition of the term "minister" for federal tax purposes. The guidelines provide IRS agents with the following assistance in defining the critical term "minister":

• The income tax regulations require that an individual be a "duly ordained, commissioned, or licensed minister of a church."

• The Tax Court, in Salkov v. Commissioner, 46 T.C. 190 (1966), ruled that the phrase "duly ordained, commissioned, or licensed minister of a church" must be interpreted "disjunctively." By this it meant that a person qualifies as a minister for tax purposes if he or she meets any of these three categories. Ordained status, therefore, is not required.

• The guidelines add that "[t]he duties performed by the individual are also important to the initial determination whether he or she is a duly ordained, commissioned, or licensed minister. Because religious disciplines vary in their formal procedures for these designations, whether an individual is duly ordained, commissioned, or licensed depends on these facts and circumstances."

• The guidelines, in commenting on the Knight case, note:

The petitioner argued that he was not formally ordained as a minister and could not administer church sacraments or participate in church government. Thus, he could not be a minister subject to [self-employment taxes]. The court rejected this view, and looked at all the facts. In concluding that he was a licensed minister, it cited the facts that he was licensed by the church, he conducted worship services, and he was considered by the church to be a spiritual leader.

• The guidelines also review a 1968 Tax Court case:

A "minister of education" in a Baptist church was not a "duly ordained, commissioned, or licensed" minister for purposes of [eligibility for a housing allowance]. The petitioner held a Master’s Degree in Religious Education from a Baptist Theological Seminary, but was not ordained. Although his church "commissioned" him after he assumed the position, the court interpreted the commissioning to be for tax purposes, as it did not result in any change in duties. Most significant, however, was the court’s analysis of petitioner’s duties or rather, the duties he did not perform. He did not officiate at Baptisms or the Lord’s Supper, two Ordinances that closely resembled sacraments, nor did he preside over or preach at worship services. The court concluded that the evidence did not establish that the prescribed duties of a minister of education were equivalent to the duties of a Baptist minister. Lawrence v. Commissioner, 50 T.C. 494 (1968).

Other considerations

In deciding if a person is a minister for federal tax purposes, there are a few additional points to consider:

(1) ordained, licensed, or commissioned by one's employing church

Many churches have a long tradition of ordaining, licensing, or commissioning ministers. But in other cases, a local church only recently has ordained, licensed, or commissioned a minister for the first time, usually to qualify the person for a housing allowance. It is far from certain that the IRS would recognize this person as a minister for tax purposes, especially if (1) the charter or bylaws of the church do not specifically authorize such a practice; (2) the person has no formal theological training; (3) the church is affiliated with a denomination that ordains, licenses, or commissions ministers, and the denomination does not recognize the ministerial status of persons who are credentialed by local congregations; or (4) the person's duties are not changed after being ordained, licensed, or commissioned. The Lawrence case (summarized above) should be reviewed in this context.

(2) "better off" for tax purposes

It is not necessarily true that a church worker will be "better off" for tax purposes by becoming a minister. In many cases, a person actually will pay more taxes after being ordained, licensed, or commissioned. By becoming a minister, one will have the "benefit" of a housing allowance exclusion in computing his federal income taxes. On the other hand, the Social Security tax rate increases from 7.65% (the employee’s share of FICA taxes) to 15.3% (the self-employment tax). In other words, whether or not he or she will be "better off" for tax purposes depends on whether the housing allowance exclusion offsets the additional Social Security taxes. As a result, church workers should not assume that they automatically will be "better off" for tax purposes if their church ordains, commissions, or licenses them. In many cases, they will not be.

This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is sold with the understanding that the publisher is not engaged in rendering legal, accounting, or other professional service. If legal advice or other expert assistance is required, the services of a competent professional person should be sought. "From a Declaration of Principles jointly adopted by a Committee of the American Bar Association and a Committee of Publishers and Associations."

Copyright and Restrictions