Self-employment tax is the biggest tax expense for members of the clergy (pastors, bishops, missionaries, priests, ministers etc). In this article, you will learn what is self-employment tax, why you must pay it, what earnings are included in this tax, and how to avoid expensive penalties and fees.
If you need expert assistance with preparing your tax return, please contact me or visit our Maineville, Ohio office at US-22 Suite 3, Maineville, OH 45039. I have clergy clients all over the world and would love to work with you.
What is self-employment tax
Self-employment tax, or SECA (named after the Self-Employment Contributions Act of 1954) is a percentage of a taxpayer’s self-employment income that contributes to social security and Medicare funds. As taxpayers contribute to these funds, they are earning credit towards use of the benefits in their retirement years. For taxpayers who are employed, these taxes are partly paid by employers, and partly paid by the employee. Because taxpayers who are self-employed do not have an outside employer, they are responsible for the entirety of the payments. The portion of earnings subject to the tax is 92.35%. The self-employment tax of 15.3% is then applied to the taxable earnings. 12.4% of wages pays into the social security fund, and 2.9% is allocated to the Medicare fund (hospital insurance)[2].
What sources of income are subject to self-employment tax?
The IRS is clear on what income is subject to the self-employment tax. All wages paid by the church, honorariums, payments for baptisms, weddings, and funerals, speaking engagements, and any housing or utility allowance (less pertinent deductible expenses) will be subject to SECA.
Why can’t my church just take it out of my W-2?
Churches cannot pay any portion of the self-employment tax for the clergy. Doing this puts the pastor at risk of being criminally charged with income tax evasion. The IRS is very clear on the rules (linked at the end of this article). Any payments erroneously made on the clergy’s behalf by the church must be added to wages on the clergy’s W-2 and reported as income. If the clergy elects to have a portion of his/her salary withheld for social security and Medicare tax purposes, s/he must make estimated tax payments[3].
Estimated Tax Payments: Not just for the rich and famous!
It is really heartbreaking to prepare a clergy tax return and discover that he or she did not make any estimated tax payments during the year. You may reason that this is fine, that you have set aside savings to pay the tax bill in bulk in April. However, the IRS is a “pay as you go” system: if you owe unpaid taxes and haven’t at least paid your previous year’s tax liability during the year, you will be charged expensive penalties! It can be frustrating to be stuck with a $5000 tax bill AND $350 in penalties and interest. The way to avoid this is to pay estimated taxes when the “quarterlies” are due: roughly 4/15, 6/15, 9/15 and 1/15. Write the IRS a check (and your state as well) and mail the payments well before those due dates. You can pay online with a credit card, but that costs you a 1% fee: I don’t recommend it. The wisest clients I have set money aside monthly for both state, local and federal taxes, and mail those quarterlies in on time.
How do I know how much to pay in estimated taxes?
If you are worried about paying the correct amount, use your total tax paid from the previous year as a guide. If you are making similar amounts of money year-to-year, divide the total tax liability by 4. Your tax preparer is able to generate estimated payment vouchers to accompany your tax payments in the mail. If your spouse gets a pay raise it may be wise to have him/her increase withholding just to be safe.
Did my tax preparer complete my taxes correctly last year?
Good question! The strip mall tax chains can really botch up clergy tax returns. In fact, it is not uncommon for me to have to go back and amend poorly prepared returns from previous years – and the clergy often owes penalties as well.
A properly prepared clergy W-2 will have wages in box 1, any voluntary federal income tax withholding in box 2 (although this is not required), and no entry in boxes 3, 4, 5 or 6. Housing allowance is reported in box 14. If a clergy receives a W-2 with social security withholding s/he should contact his/her church’s accountant and request that the W-2 be corrected.
Calculation of the SECA tax takes place on the long form SE[4] (Self-Employment tax calculation worksheet). The IRS does not impose federal income tax on a clergy’s housing allowance, but all earnings are added back together when calculating the self-employment tax. When figuring adjusted gross income on form 1040, self-employed individuals may deduct one-half of the self-employment tax. This deduction takes into consideration the fact that taxpayers who are not self-employed are only responsible for paying one-half of these taxes. By allowing for a 50% SECA tax deduction, it reduces the adjusted gross income that is subject to federal income tax.
For more detailed information regarding preparation of clergy tax, read IRS publication 517: Social Security and Other Information for Members of the Clergy and Religious Workers.
[1] Topic #554: Self Employment Tax. https://www.irs.gov/taxtopics/tc554 [2] Publication 517: Social Security and Other Information for Members of the Clergy and Religious Workers https://www.irs.gov/publications/p517 [3] IRS online payment page. https://www.irs.gov/payments [4] IRS schedule SE (1040) https://www.irs.gov/forms-pubs/about-schedule-se-form-1040