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Effect of parsonage allowance on self-employment tax and on Sec. 265.

An individual is considered a "minister" if duly ordained, commissioned or licensed by a religious body constituting a "church" or church denomination (or, if appropriate, substituting comparable religious designations for minister and church). Sec. 3121(b)(8)(A) generally exempts ministers from FICA tax.

On the other hand, Sec. 1402(a)(8) treats ministers as self-employed for self-employment (SE) tax purposes - unless an irrevocable election is made on Form 4361, Application for Exemption From Self-Employment Tax for Use by Ministers, Members of Religious Orders and Christian Science Practitioners, to be exempt from SE tax because of religious beliefs (pursuant to Sec. 1402(e)). This exemption applies only to income derived from performing services as a minister. Thus, if a minister earns income from other endeavors, the exemption does not apply.

Sec. 107 allows ministers to exclude from gross income, for income tax purposes, a reasonable amount for the rental value of a home, including utilities, furnished to them as part of their compensation or the rental allowance (commonly called a parsonage allowance), to the extent this allowance is used by them to rent or otherwise provide a home. Regs. Sec. 1.107-1(b) requires parsonage allowances to be designated in advance by the employing church or other qualified organization.

An easy error to make on ministers' returns is to not add the excluded amount back to SE income in computing the SE tax - as required by Sec. 1402(a)(8). Even though Sec. 107 excludes such amount for computing income tax, it is not exempt from SE tax.

Rev. Rul. 83-3 precluded deductions for home mortgage interest and real estate taxes allocable to parsonage allowances excluded from gross income. However, this ruling was reversed by the enactment of Sec. 265(a)(6) in the Tax Reform Act of 1986. Nevertheless, Sec. 265 still requires ministers to prorate business expenses related to ministerial compensation, based on the relationship of excluded income to total income earned as a minister. For example, if a minister receives a $12,000 parsonage allowance and $48,000 of other compensation, the disallowance percentage would be 20% ($12,000 [divided by] ($12,000 + $48,000)). Therefore, if this minister's total business expenses were $10,000, $2,000 would not be deductible.
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Article Details
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Author:Whiteaker, Stephen C.
Publication:The Tax Adviser
Article Type:Brief Article
Date:May 1, 1994
Words:374
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