There are three important developments to report concerning the coverage of church employees under the social security (FICA) system:

RECENT DEVELOPMENTS
Social Security

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There are three important developments to report concerning the coverage of church employees under the social security (FICA) system:

1. 鼦 federal appeals court recently rejected the contention of a local church that the current treatment of churches and church employees under the social security program amounts to a violation of the constitutional guaranty of religious freedom. Here are the facts. In 1983, Congress amended the Internal Revenue Code to make church employees subject, for the first time, to mandatory social security (FICA) taxation effective January 1, 1984. Congress later partially restored the previous exemption (retroactive to January 1, 1984) for any church that (1) was opposed for religious reasons to the payment of the employer's share of FICA taxes, and (2) irrevocably elected to exempt itself from social security taxation by filing a Form 8274 with the IRS no later than the day prior to the due date of the first employer's quarterly tax report (IRS Form 941) that the church was required to file after July 17, 1984. For churches with nonminister employees as of July 17, 1984, Form 8274 was due not later than October 30, 1984.

A timely election relieves a church of the obligation to pay the employer's share of FICA taxes (7.15% of employee wages in 1987), and relieves each nonminister employee of the obligation to pay the employee's share of FICA taxes (an additional 7.15% of wages in 1987). However, the employee is not relieved of all social security tax liability. On the contrary, the nonminister employees of an electing church are required to report and pay their social security taxes as self-employed individuals (the "self-employment tax"). And, this tax is significantly greater than the employee's share of FICA taxes. In 1987, for example, the self-employment tax rate is 12.3% of earnings. Therefore, a church employee receiving a salary of $10,000 in 1987 would pay $715 in FICA taxes if his or her church did not file an election on Form 8274 (the church would pay an additional $715). However, if the church filed the election to exempt itself from FICA taxes, the following consequences occur: (1) the church pays no FICA tax; (2) the employee pays no FICA tax; and (3) the employee must report and pay a self-employment tax liability of $1,230.

Many churches and church employees consider this situation unfair. Churches are free to exempt themselves from social security taxes, but only at the cost of significantly increasing the tax liability of their employees. In response, many electing churches have increased the salary of their employees to compensate for the increase in taxes. Of course, this leaves the church in essentially the same position as if it had not elected to be exempt--it in effect is paying social security taxes "indirectly." This dilemma, argued a Baptist church in Pennsylvania, unconstitutionally restricts the religious freedom of churches by forcing them (contrary to their religious convictions) to divert church resources away from religious and charitable functions in order to increase employee compensation (and thereby "indirectly" pay the social security tax). A federal appeals court rejected this contention. The court based its ruling on a 1982 Supreme Court decision that upheld the imposition of the social security tax to employees of Amish farmers though this directly violated the farmers' religious beliefs. The Supreme Court had observed that "tax systems could not function if denominations were allowed to challenge the tax systems because tax payments were spent in a manner that violates their religious belief." It concluded that the broad public interest in the maintenance of the federal tax systems was of such a high order that religious belief in conflict with the payment of the taxes provides no constitutional basis for resisting them. The appeals court found this precedent controlling in resolving the challenge to social security coverage of church employees.

The appeals court also rejected the church's argument that the taxation of church employees violates the first amendment's nonestablishment of religion clause by creating an "excessive entanglement" between church and state. It also rejected the claim that the Internal Revenue Code was impermissibly discriminatory in granting clergy an exemption from social security coverage but not churches or church employees. Bethel Baptist Church v. United States, 822 F.2d 1334 (3rd Cir. 1987).

2. The Tax Reform Act of 1986 permits churches that have elected to exempt themselves from the employer's share of FICA taxes by filing a timely Form 8274 to revoke their exemption. However, the Act did not specify how churches could revoke their exemption. Temporary regulations recently issued by the Treasury Department provide that churches can revoke their exemption (starting with any calendar quarter after December 31, 1986) by filing a Form 941 (employer's quarterly tax return) accompanied by full payment of social security taxes for that quarter. To illustrate, if a church with three employees elects in November of 1987 to revoke its previous election to be exempt from social security taxes, it should simply submit a Form 941 on or by January 31, 1988 (the deadline for filing a Form 941 for the fourth calendar quarter) along with the applicable FICA taxes for that quarter. Thereafter, the deposit rules described in the "Tax Calendar" feature of this newsletter will apply. Of course, if a church revokes its exemption, nonminister employees are no longer treated as self-employed for social security purposes, and accordingly should no longer file quarterly estimated tax payments (their FICA taxes will be withheld from their wages).

3. A number of churches having nonminister employees (e.g., an office secretary) apparently do not know whether or not they have elected to exempt themselves from the employer's share of social security (FICA) taxes by filing a timely Form 8274. Churches having nonminister employees as of July of 1984 had until October 30, 1984 to file the election. Churches not having nonminister employees in July of 1984 have until the day before the due date of their first quarterly employer's tax report (Form 941) to file the election. Ordinarily, this form is not required until a church hires a nonminister employee. The due dates for Form 941 are the last day of the month following the end of each calendar quarter (i.e., April 30, July 31, September 30, and January 31). Churches that filed a timely election but that nevertheless paid all employment taxes due from the effective date of their election through December 31, 1986 (a fairly common practice by churches that could not remember if they ever filed the election) are treated as if they never filed the election. Internal Revenue News Release IR-87-94.