Clergy Status—Employee or Self-Employed

By Richard R. Hammar, J.D., LL.M., CPA

© Copyright 1991, 1997 by Church Law & Tax Report.  All rights reserved.  This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is provided 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. Church Law & Tax Report, PO Box 1098, Matthews, NC 28106. Reference codes: m25 m24 m68 m63

It is often necessary to determine whether a minister is an employee or self--employed. The following paragraphs will illustrate the importance of this distinction.

Social security taxes are collected under two separate tax systems. Under the Federal Insurance Contributions Act (FICA)¹, half the tax is paid by the employee and the other half is paid by the employer. Under the Self--Employment Contributions Act² the total tax is paid by the self--employed person. Which method applies to a minister who is not exempt from social security coverage?³ See Social Security for Ministers.

The Self--Employment Contributions Act provides that a “duly ordained, commissioned, or licensed minister of a church in the exercise of his ministry” is to be treated as self--employed for purposes of social security⁴ even if he or she is considered to be an employee for income tax or other purposes.

The Federal Insurance Contributions Act provides that the term employment does not include “service performed by a duly ordained, commissioned, or licensed minister of a church in the exercise of his ministry.”⁵

In summary, ministers who perform services on behalf of a church are treated as self--employed individuals under the social security laws, though the Self--Employment Contributions Act suggests that in other contexts it may be more appropriate to characterize them as employees.

Beginning in 1978, the IRS began making statements that were interpreted by some to require ministers to report their income taxes as employees. For example, in Revenue Ruling 80--110, the IRS held that a minister who is “an employee of a church” may not deduct unreimbursed business expenses on Schedule C but rather must use Schedule A.⁶ In Publication 517 (“Social Security for Members of the Clergy and Religious Workers”), the IRS lists a comprehensive example demonstrating how a minister who is “an employee of the church” should report his income and business deductions. These pronouncements led some tax advisers to conclude that the IRS now views all ministers serving local churches as employees rather than as self--employed. Reliance has also been placed on section 3401(a)(9) of the Internal Revenue Code which states that ministers who are employees of a church are exempt from tax withholding.  

This author has always taken the position that the IRS pronouncements mentioned above merely stated the appropriate manner of reporting income and deductions if employee status was assumed, and were not IRS directives requiring all ministers to report their taxes as employees. IRS Publication 517 recognizes that ministers who are employees of their churches may be self--employed with respect to certain services (e.g., baptisms, marriages, funerals). Furthermore, no one seriously questions that full--time evangelists are self--employed for income tax purposes. It is therefore difficult to support sweeping generalizations that all ministers are employees for income tax purposes.  Publication 517 also states that a minister “may be treated as an employee” for income tax purposes, and that the common law rules (discussed below) apply in determining whether a particular minister is an employee or a self--employed person for income tax purposes.  This language certainly is not consistent with the conclusion that all clergy must report their federal income taxes as employees.

The best approach to this issue is to treat ministers as employees only if they satisfy the common law employee test adopted by the Treasury Department:

Generally the relationship of employer and employee exists when the person for whom services are performed has the right to control and direct the individual who performs the services, not only as to the result to be accomplished by the work but also as to the details and means by which that result is accomplished.  That is, an employee is subject to the will and control of the employer not only as to what shall be done but how it shall be done.  In this connection, it is not necessary that the employer actually direct or control the manner in which the services are performed; it is sufficient if he has the right to do so. The right to discharge is also an important factor indicating that the person possessing that right is an employer. Other factors characteristic of an employer, but not necessarily present in every case, are the furnishing of tools and the furnishing of a place to work to the individual who performs the services.  In general, if an individual is subject to the control or direction of another merely as to the result to be accomplished by the work and not as to the means and methods for accomplishing the result, he is not an employee.⁷

Determining a particular minister's status under this somewhat ambiguous test is often difficult. In 1987, the IRS developed a list of twenty criteria to be used “as an aid in determining whether an individual is an employee under the common law rules.”⁸  The criteria were “developed based on an examination of cases and rulings considering whether an individual is an employee.”  The IRS cautioned, “The degree of importance of each factor varies depending on the occupation and the factual context in which the services are performed,” and that “if the relationship of employer and employee exists, the designation or description of the relationship by the parties as anything other than that of employer and employee is immaterial.”  The twenty criteria are set forth below.

(1) Instructions. A person who is required to comply with instructions about when, where, and how to work is ordinarily an employee.

(2) Training. Training of a person by an experienced employee or by other means is a factor of control and indicates that the worker is an employee.

(3) Integration. Integration of a person's services into the business operations generally shows that the person is subject to direction and control and accordingly is an employee.

(4) Services rendered personally. If the services must be rendered personally by the  individual employed, it suggests an employer--employee relationship.  Self--employed status is indicated when an individual has the right to hire a substitute without the employer's knowledge.

(5) Hiring, supervising, and paying assistants. Hiring, supervising, and payment of assistants by the employer generally indicates that all workers on the job are employees. Self--employed persons generally hire, supervise, and pay their own assistants.

(6) Continuing relationship. The existence of a continuing relationship between an individual and the organization for whom the individual performs services is a factor tending to indicate the existence of an employer--employee relationship.

(7) Set hours of work. The establishment of set hours of work by the employer is a factor indicating control and accordingly the existence of an employer--employee relationship. Self--employed persons are “masters of their own time.”

(8) Full time required. If the worker must devote full time to the business of the employer, he or she ordinarily will be an employee. A self--employed person on the other hand may choose for whom and when to work.

(9) Doing work on employer's premises. Doing the work on the employer's premises may indicate that the worker is an employee, especially if the work could be done elsewhere.

(10) Order or sequence of work.  If a worker must perform services in an order or sequence set by the organization for whom he or she performs services, this indicates that the worker is an employee.

(11) Oral or written reports. A requirement that workers submit regular oral or written reports to the employer is indicative of an employer--employee relationship.

(12) Payment by hour, week, month. An employee usually is paid by the hour, week, or month, whereas a self--employed person usually is paid by the job on a lump sum basis (although the lump sum may be paid in intervals in some cases).

(13) Payment of business expenses. Payment by the employer of the worker's business or travel expenses suggests that the worker is an employee. Self--employed persons usually are paid on a job basis and take care of their own business and travel expenses.

(14) Furnishing of tools and materials. The furnishing of tools and materials by the employer indicates an employer--employee relationship. Self--employed persons ordinarily provide their own tools and materials.

(15) Significant investment. The furnishing of all necessary facilities (equipment and premises) by the employer suggests that the worker is an employee.

(16) Realization of profit or loss. Workers who are in a position to realize a profit or suffer a loss as a result of their services generally are self--employed, while employees ordinarily are not in such a position.

(17) Working for more than one firm at a time. A person who works for a number of persons or organizations at the same time is usually self--employed.

(18) Making services available to the general public. Workers who make their services available to the general public are usually self--employed.  Individuals ordinarily hold their services out to the public by having their own offices and assistants, hanging out a “shingle” in front of their office, holding a business license, and by advertising in newspapers and telephone directories.

(19) Right to discharge. The right to discharge is an important factor in indicating that the person possessing the right is an employer. Self--employed persons ordinarily cannot be fired as long as they produce results which measure up to their contract specifications.

(20) Right to terminate. An employee ordinarily has the right to end the relationship with the employer at any time he or she wishes without incurring liability. A self--employed person usually agrees to complete a specific job and is responsible for its satisfactory completion or is legally obligated to make good for failure to complete the job.

Another factor, not mentioned in the above list, is the parties' own characterization of their relationship. For example, if a church and its minister enter into a written contract that specifically characterizes the minister as self--employed, this would be an additional factor to consider. Keep in mind that such a document by itself, as the IRS observed in Revenue Ruling 87--41, will have little if any relevance and will never result in a minister being characterized as self--employed if he or she failed the “common law employee test” or a majority of the twenty criteria.  It is merely one factor that will be considered, but one that could be given considerable weight in a close case. Of course, a church  will  offset the effect of such a characterization by issuing its minister a W--2 instead of a 1099--MISC form at the end of each year.

The United States Supreme Court has observed that

In determining whether a hired party is an employee under the general common law of agency, we consider the hiring party's right to control the manner and means by which the product is accomplished. Among the other factors relevant to this inquiry are the skill required; the source of the instrumentalities and tools; the location of the work; the duration of the relationship between the parties; whether the hiring party has the right to assign additional projects to the hired party; the extent of the hired party's discretion over when and how long to work; the method of payment; the hired party's role in hiring and paying assistants; whether the work is part of the regular business of the hiring party; whether the hiring party is in business; the provision of employee benefits; and the tax treatment of the hired party . . . . No one of these factors is determinative.⁹

There is no doubt that most ministers will be employees under the “common law employee test” discussed above.  However, such a conclusion is not automatic.  As has already been indicated, traveling evangelists ordinarily are self--employed, as are ministers of local congregations with respect to certain personal services rendered directly to church members (baptisms, marriages, funerals, etc.). Ministers of local congregations may be self--employed with respect to their services on behalf of the church as well, provided that they are not “employees” under the common law employee test.  The fact that such a conclusion is entirely possible is illustrated by a recent Tax Court ruling. In Cosby v. Commissioner,¹⁰ the Tax Court concluded that a Methodist minister was not an employee of his local church but rather was self--employed, and accordingly could report his church income and all business expenses on Schedule C.  The court acknowledged that the “common law employee test” had to be applied in reaching a determination as to the minister's status, and referred to most of the twenty criteria discussed above as helpful guidelines.  The court relied upon the following considerations in reaching its conclusion:  (1) the minister was “free to use his own methods and style in the day--to--day conduct of his activities” and was clearly “his own man and operated free from any substantial control”; (2) the procedures that existed for terminating the minister's  services did “not at all approximate the type of day--to--day supervision and control which is characteristic of an employer--employee relationship” and did not enable the church to “control or direct the details and means by which the desired result was to be accomplished”; (3) the minister's seminary education represented a substantial capital investment in his profession; (4) the minister's profession requires considerable skill; and (5) the minister and his church regarded him as self--employed rather than as an employee. The court observed that its conclusion was “bolstered by the fact that neither party, nor our own research, disclosed a single case in which a member of the clergy . . . was held to be an employee of either his or her local congregation or of the hierarchical structure of his or her denomination.” The Cosby decision was a “small tax court case,” meaning that it involved less than $10,000 and the taxpayer elected to pursue an expedited and simplified procedure authorized by section 7463 of the Internal Revenue Code. While small tax court cases are more quickly resolved, there is a trade--off—section 7463 specifies that “a decision entered in any case in which the proceedings are conducted under this section shall not be reviewed by any other court and shall not be treated as precedent for any other case.”  In other words, the decision of the Tax Court in the Cosby case was final, and it cannot be cited as precedent in other cases.  Obviously, this greatly limits the impact of the case.

In summary, a minister's reporting status for federal income tax purposes will be determined on the  basis of  the common  law employee test rather than on the basis of a conclusive presumption that all clergy are employees for federal income tax reporting purposes.

Finally, note the following additional considerations.

(1)  The IRS has a definite bias in favor of treating taxpayers as employees. The reason is simple—employees are subject to income tax withholding, and accordingly there is a much greater likelihood that a person's taxes will be paid if he or she is an employee rather than self--employed.  This consideration has no application to clergy, however, whose income is exempt by law from income tax withholding even if they are employees for income tax purposes.¹¹

(2) Generally, an employer is legally accountable for the misconduct of employees (but not the misconduct of self--employed persons). Most courts have reached the conclusion that clergy serving local churches are employees rather than self--employed for purposes of deciding whether or not the employing church is legally responsible for their conduct.  For example, a federal appeals court concluded that a Methodist church was legally responsible for the copyright infringement of a minister of music since “the only inference that reasonably can be drawn from the evidence is that in selecting and arranging the song . . . for use by the church choir [the minister] was engaged in the course and scope of his employment by the church.”¹² Many other cases have involved accidents involving motor vehicles driven by clergy in the course of church work.  Such cases support the treatment of clergy as employees for income tax purposes, since the legal considerations employed in determining whether or not a minister is an employee for church liability purposes are substantially the same as those used in determining whether or not a minister is an employee for income tax purposes. Note, however, that some courts have not agreed with these rulings. To illustrate, the Kansas Supreme Court concluded that a Catholic priest was self--employed for purposes of determining the legal liability of his diocese for his misconduct even though the diocese “followed the majority of dioceses in issuing a W--2 form to each priest.”¹³

(3) Ministers may obtain an official determination of their reporting status by filing a Form SS--8 with the IRS. This can be a time--consuming and involved process, however, and the IRS demonstrates a decidedly pro--employee bias in its rulings.  In other words, a minister wanting to report his or her income taxes as a self--employed person ordinarily will not be successful in obtaining IRS confirmation in response to an SS--8 application.

(4) Some clergy insist on reporting their income taxes as self--employed for theological reasons. That is, they consider themselves to be under the control or authority of Jesus Christ rather than a local church or church board. Such persons feel that they would be compromising their biblical authority by reporting as an employee since it would amount to an acknowledgment of subordination to local church authority. Such a view, if corroborated by appropriate language in the church's charter or bylaws, might support self--employed status for income tax reporting purposes if in fact the church does not exercise meaningful control over the minister. Note, however, that an IRS auditor might well want to determine whether the church board agrees with the minister's claim that he or she is not subject to the control of the church or church board.

(5) Any discussion of the reporting status of clergy for federal income tax purposes would not be complete without a discussion of Revenue Procedure 85--18.  In Revenue Procedure 85--18, the IRS announced that employers who treated workers as self--employed for employment tax purposes (i.e., income tax withholding and FICA taxes) for prior periods could continue to do so as long as the following conditions were met: (1) a “reasonable basis” existed for not treating the workers as employees (court decisions, previous IRS audits, or long--standing custom); (2) workers in the same or in substantially similar positions were consistently treated as self--employed since 1977; and (3) all federal tax returns filed by the employer were consistent with the workers' treatment as self--employed (i.e., 1099s were issued rather than W--2s, and the workers' earnings were not reported on quarterly 941 forms).  This ruling has limited application to clergy, since they are not subject to “employment taxes.”  That is, they are exempt from income tax withholding (even if they report their income taxes as employees) and they never pay FICA taxes with respect to church employment.  It is possible that the IRS might use Revenue Procedure 85--18 as authority for challenging a minister's claim to be self--employed, if one or more of the three “conditions” specified in Revenue Procedure 85--18 were not met.  While such a possibility is remote, it is sufficient basis for churches whose clergy report their income taxes as self--employed to at least consider adhering to the conditions enumerated in Revenue Procedure 85--18.  This means that churches with self--employed clergy should (1) issue 1099--MISC forms rather than W--2s to such clergy, (2) exclude self--employed clergy compensation from quarterly 941 forms, and (3) treat all clergy in the same or substantially similar positions as self--employed.  

Example. Rev. P is a retired minister who serves as an interim minister for churches in a given geographical region that are temporarily in need of ministerial services. Rev. P typically spends no more than three months with any particular congregation, is given great freedom with respect to the duties he performs and the manner or method of performance, and is issued a 1099--MISC form by each church. These facts suggest that Rev. P could report his income and business expenses as a self--employed person on Schedule C.

Example. Rev. L is a minister of education at First Church.  She has a specific job description, her services are under the direct supervision and control of her senior pastor, she is issued a W--2 form each year, and she is required to follow prescribed methods in the performance of her duties.  These facts strongly suggest that Rev. L is an employee for income tax reporting purposes.

Example. Rev. G is senior minister at First Church. The church gives him wide latitude in deciding what duties to perform and in what manner.  Much of his work is performed off of church premises. He is issued a 1099--MISC form each year, and his work agreement with the church characterizes him as self--employed. Under these facts, the Tax Court's ruling in Cosby v. Commissioner (discussed above) suggests that Rev. G is free to report his income taxes as a self--employed person.

Example. Rev. M works in an administrative capacity for a church agency. Ordinarily, ministers who work in such a capacity will satisfy the definition of a common law employee since they are subject to a greater degree of control and supervision with respect to the details and performance of their duties, and accordingly should report their income taxes as employees.

Example. Rev. H is a youth minister at First Church. Ordinarily, ministers who work in such a capacity will satisfy the definition of a common law employee since they are subject to a greater degree of control and supervision with respect to the details and performance of their duties, and accordingly should report their income taxes as employees.

Example.  Rev. J has been the senior minister at First Church since 1981.  He reports his income taxes as a self--employed person on Schedule C (Form 1040).  First Church issues Rev. J a W--2 form at the end of each year, and includes his compensation on its quarterly 941 returns.  Rev. J's predecessor was Rev. Noble, who reported his income taxes as an employee.  The fact that the church issues Rev. J a W--2 form rather than a 1099--MISC, and includes his compensation on its quarterly employer's tax returns (941 forms), would probably result in a determination that he is an employee for income tax reporting purposes in the event that his return is audited by the IRS.  Further, while Revenue Procedure 85--18 is not directly relevant to clergy, it may support the conclusion that Rev. J should be treated as an employee.

Example. Rev. W has reported his federal income taxes as a self--employed person for many years. At the beginning of the current year, however, he decided to report his taxes as an employee. Accordingly, his employing church withheld FICA taxes from his pay throughout the current year, and in addition paid the employer's share of FICA taxes. Clergy are always deemed self--employed for social security purposes with respect to services performed in the exercise of their ministry, and accordingly they are never subject to FICA taxes with respect to such services. Rev. W's decision to report his income taxes as an employee did not change his self--employed status for social security purposes. The church erred in treating Rev. W as an employee for FICA purposes. He should have continued to pay the self--employment tax (the social security tax for self--employed persons).

Example. Rev. Y, senior minister of First Church, reports his income taxes as a self--employed person (using Schedule C). His church compensation for the current year was $25,000. In addition, the church paid the annual premium ($2,500) on a health insurance policy for Rev. Y and his family. Since Rev. Y considers himself to be self--employed for federal income tax reporting purposes, he is not eligible for the exclusion of employer--paid health insurance premiums. Accordingly, the church must list the full $2,500 premium as income on Rev. Y's Form 1099--MISC.

Example. Rev. O reports his income taxes as a self--employed person. He has $4,000 of business expenses in the current year that were not reimbursed by his church. He deducted all of them on Schedule C. He did not have enough expenses to itemize deductions on Schedule A. Rev. O is later audited by the IRS, and he is reclassified as an employee. He will not be able to deduct any of the $4,000 of business expenses since they are deductible, by an employee, only as an itemized deduction on Schedule A. This harsh result can be avoided by the church adopting an accountable reimbursement plan

Federal law permits an employer who establishes an employee retirement plan to obtain significant tax advantages for both itself and its employees by qualifying the plan.¹⁴ In general, these advantages include a tax deduction for the employer for all contributions it makes to the plan, deferral of tax on the employee's interest income, and the exclusion of contributions from the employee's income.¹⁵

In 1962, Congress enacted the Self--Employed Individuals' Retirement Act (also known as the Keogh Act of H.R. 10). The Act was designed to provide self--employed persons with the substantial tax benefits enjoyed by employees enrolled in qualified pension plans. This was accomplished by expanding the term employee for purposes of qualified employee pension plans to include most self--employed individuals.¹⁶ However, the IRS has determined that the expanded class of employees eligible for participation in qualified pension plans does not include those ministers who are common law employees.¹⁷

In general, the discussion contained in the preceding section dealing with income taxes is relevant in determining whether a particular minister is an employee or self--employed. Thus, a minister who satisfies the IRS definition of a common law employee is not eligible for participation in a self--employed individual's retirement plan (Keogh plan) with respect to income received from the church for such services. However, the IRS has determined¹⁸ that even those ministers who meet the definition of employee will be treated as self--employed with respect to income received directly from church members. As a result, a minister may create a Keogh plan and fund it with income received for performing marriages, baptisms, funerals, and other personal services.

In 1974 Congress enacted the Employee Retirement Income Security Act (ERISA). This law was intended to extend the tax benefits of qualified pension plans and Keogh plans to the many employees who were not covered by a qualified plan. Under ERISA, most employees not covered by a qualified plan are permitted to establish “individual retirement accounts” (IRAs). Ministers who satisfy the definition of a common law employee discussed in the preceding section dealing with income taxes may create individual retirement accounts and fund them with compensation received directly from a church. Ministers who report their church compensation as self--employment earnings may also fund an IRA with such earnings to the extent that annual contributions do not exceed the lesser of (1) the annual contribution ceiling for an IRA (currently $2,000, or $2,250 for a “spousal IRA”), or (2) the minister's net earnings from self--employment reduced by any Keogh plan contributions for the year.¹⁹

Finally, it is important to note that “tax--sheltered annuities” may be available only to clergy (and other church workers) who report their federal income taxes as employees (rather than as self--employed). A tax--sheltered annuity (more properly called a “section 403(b) plan”) is an excellent way for a tax--exempt church or religious organization to provide retirement benefits for some or all of its employees.  A Church can fund contributions through “elective deferrals” (binding and irrevocable salary reduction agreements entered into between a church and an employee before the corresponding services are performed, and lasting for at least one year) or through “nonelective deferrals” (voluntary employer contributions not funded through salary reduction agreements); the church also can make the program available to selected employees only. Contributions are not permitted out of compensation previously distributed to a participant. Whether an employee's annuity is funded through employer contributions or salary reductions, the employee's rights to the annuity must be nonforfeitable.

A tax--sheltered annuity may be purchased only for common law employees subject to the will and control of the employer regarding both the work to be done and the manner in which it is to be performed.²⁰ This is a significant limitation, for many ministers who report their income taxes as self--employed are currently participating in such plans. The negative consequences of such participation can be disastrous.  The good news is that in 1989 the IRS issued a private letter ruling announcing that both “employee” and self--employed clergy could participate in a 403(b) retirement program established by a major Protestant denomination.²¹ While the IRS did not explain its reasoning, a couple of considerations should be noted. Code section 414(e)(3)(B) (quoted by the IRS) defines the term employee to include “a duly ordained, commissioned, or licensed minister of a church in the exercise of his ministry, regardless of the source of his compensation.”  While section 414(e) does not pertain directly to tax--sheltered annuities (it contains a definition of a “church plan”), it could be argued, on the basis of consistency, that the same definition applies to section 403(b). Such a conclusion is strengthened by the fact that section 403(b) refers to section 414(e) on three occasions, and section 403(a)(3) specifically adopts section 401(c)(1) which includes self--employed persons within the definition of employees. Section 414(e) is the precursor of section 403(b)—it represented the first part of a two--part effort by Congress, in 1980 and 1982, to adapt the Code to the actual circumstances surrounding plans maintained by churches and church--related organizations.  In 1980, section 414(e) was amended to cover those church plans that were intended to be “qualified” under section 401(a) yet exempted from post--1974 qualification requirements.  In 1982, section 403(b)(9) was added to provide a place in the Code for annuity--type church plans that were not intended to be qualified plans under section 401(a).  Given this background, it is logical to conclude that if section 414(e) explicitly recognizes self--employed clergy to be “employees,” then the same result should apply under section 403(b).

One final point should be noted: federal law prohibits private letter rulings from being used as precedent in other cases. Accordingly, other churches and denominations cannot “rely” upon the recent IRS ruling to justify participation by self--employed clergy or church workers in their own 403(b) plans. However, the ruling is the first indication that the IRS may be willing to treat self--employed clergy and church workers as “employees” for purposes of 403(b) tax--sheltered annuities. Churches and denominations that utilize 403(b) retirement plans should consider seeking their own private letter ruling on the question of eligibility of self--employed clergy (and other church workers) to participate.

Under a related legal principle, the acts of an “agent” committed within the scope of an “agency relationship” are attributable to the “principal.” An agency relationship is similar to an employer--employee relationship, and it exists whenever two persons agree that one (the agent) will act on behalf of another (the principal) and be subject to the other's control.²² Many persons injured by the alleged conduct of a minister serving a local church have attempted to sue a parent religious denomination on the ground that the minister is an “agent” of the denomination. Clearly, local clergy ordinarily cannot be deemed “employees” of denominational organizations. But if a minister is found to be an agent of a denominational organization, then the organization will be legally responsible for the acts of the minister committed within the scope of the agency.

The applicability of numerous other federal and state statutes and regulations is dependent upon the existence of an employer--employee relationship. Some of the more important of these laws include the following: wage and hour legislation,²³ employment discrimination laws,²⁴ federal occupational safety and health legislation,²⁵ workers compensation,²⁶ and unemployment compensation.²⁷

Legal Definitions of a Minister

Who is a minister for Tax Purposes

Clergy Status—Ordained, Commisioned, or Licensed

Additional articles may also be found by searching Clergy-definition, Clergy-compensation, Social Security, and Retirement plans.