Can I Have the Church Withhold My Taxes?

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

This lesson examines the topic of withholding taxes of ministerial employees. 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 B is an ordained minister who is currently employed as a church custodian. Since Pastor B is a minister, the church treasurer does not withhold federal income taxes from his wages. The church treasurer is correct in concluding that Pastor B's wages are not subject to income tax withholding.
   True or False
   
   
2. Wages paid to a minister for services performed in the exercise of ministry are not subject to federal income tax withholding.
   True or False
   
   
3. Pastor C is senior pastor of his church. He reports his federal income taxes as an employee. He requests voluntary withholding of his income taxes. The church treasurer assumes that if he withholds income taxes from Pastor C's wages, he is required to withhold Social Security and Medicare taxes. Is the church treasurer correct?
   True or False
   
   
4. Pastors who report their federal income taxes as employees and who request voluntary withholding may have an additional amount of income taxes withheld to cover their self-employment tax liability for the year.
   True or False
   
   

Executive Summary

Ministers are exempt from federal tax withholding, whether they report their income taxes as an employee or as self-employed. However, if they report their income taxes as an employee, they may request "voluntary withholding" of their income taxes and self-employment taxes by filing a Form W-4 with the church. A self-employed minister is free to enter into an "unofficial" withholding arrangement whereby the church withholds a portion of his or her compensation each week and deposits it in a church account, and then distributes the balance to the minister in advance of each quarterly estimated tax payment due date

Lesson

Overview

The federal income tax is a "pay as you go" tax. This means that you must pay your tax as you earn income during the year. There are two ways to do this--tax withholding and quarterly estimated tax payments. This lesson addresses tax withholding and its application to new ministers.

Most employers are required to withhold federal income taxes from employees’ wages as they are paid. But there are exceptions, including wages paid for "services performed by a duly ordained, commissioned, or licensed minister of a church in the exercise of his ministry." As a result, a church is not required to withhold income taxes from wages paid to ministers who report and pay their income taxes as employees. This exemption only applies to "services performed in the exercise of ministry."

Ministers who are self-employed for income tax purposes report and prepay their income taxes and social security taxes by means of the estimated tax procedure (discussed in the next lesson). Self-employed persons are not subject to tax withholding.

The IRS audit guidelines for ministers contain the following statement regarding the application of tax withholding to ministers: "Although they are generally considered employees under the common law rules, payment for services as a minister is considered income from self employment and is not subject to FICA taxes or income tax withholding (if the employer and employee agree, an election can be made to have income taxes withheld)." The IRS audit guidelines are used by IRS agents when auditing ministers.

Voluntary withholding

Ministers who report their income taxes as an employee can enter into a "voluntary" withholding arrangement with their church. Under such an arrangement, the church withholds federal income taxes from the minister’s wages just as it would for any nonminister employee. Some ministers find voluntary withholding attractive since it avoids the additional work and discipline associated with the estimated tax procedure.

How is a voluntary withholding arrangement initiated? A minister who elects to enter into a voluntary withholding arrangement with his or her church need only file a completed IRS Form W-4 (employee’s withholding allowance certificate) with the church. The filing of this form is deemed to be a request for voluntary withholding.

Voluntary withholding arrangements may be terminated at any time by either the church or minister, or by mutual consent of both. Alternatively, a minister can stipulate that the voluntary withholding arrangement terminates on a specified date. Of course, a voluntary withholding arrangement will affect the church’s quarterly Form 941 since the church will include the minister's withheld income taxes on line 3.

What about a minister’s self-employment taxes? Remember that ministers are always deemed to be self-employed for social security purposes with respect to services performed in the exercise of ministry. As a result, a church whose minister elects voluntary withholding is only obligated to withhold the minister’s federal income tax liability. The minister is still required to use the estimated tax procedure to report and prepay the self-employment tax (the social security tax on self-employed persons). Such a result is unsatisfactory since it still requires the minister to file quarterly estimated tax payments (Form 1040-ES).

Consider the following alternative. Ministers who report their income taxes as employees (and who are not exempt from social security) should consider filing an amended W-4 form (withholding allowance certificate) with their church, indicating on line 6 an additional amount of cash to be withheld from each pay period that will be sufficient to pay the estimated self-employment tax liability by the end of the year. IRS Publication 517 states that "if you perform your services as an employee of the church (under the common law rules), you may be able to enter into a voluntary withholding agreement with your employer, the church, to cover any income and self-employment tax that may be due."

A church whose minister has elected voluntary withholding (and who is not exempt from social security taxes) simply withholds an additional amount from each paycheck to cover the minister’s estimated self-employment tax liability for the year, and then reports this additional amount as additional income tax (not "Social Security" or "Medicare" tax) withheld on its quarterly 941 forms that are filed with the IRS as well as on the minister's W-2 form at the end of the year. The excess income tax withheld is a credit against tax that the minister claims on his or her federal income tax return (Form 1040), and is applied to the minister’s self-employment tax liability. Since any tax paid by voluntary withholding is deemed to be timely paid, a minister who pays self-employment taxes using this procedure will not be liable for any underpayment penalty assuming that a sufficient amount of taxes are in fact withheld. Ministers who report their income taxes as employees should consider the convenience of voluntary withholding with respect to both income taxes and self-employment taxes.

A self-employed minister is free to enter into an "unofficial" withholding arrangement whereby the church withholds a portion of his or her compensation each week and deposits it in a church account, and then distributes the balance to the minister in advance of each quarterly estimated tax payment due date. No W-4 forms should be used, and the "withholdings" are not reported on Form 941.

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