Ep 68 ~ Ways to reduce taxable income to Ministers

The Church Finance & Minister Tax Podcast- Church finances, Minister Taxes, Minister payroll, IRS Compliance

"In today's episode, we're exploring 'Ways to Reduce Taxable Income for Ministers.' Ministers often face unique tax challenges, balancing their roles as both employees and self-employed individuals. We'll uncover effective strategies to legally minimize taxable income, with a special focus on salary reduction agreements and the option to refuse part of one's salary. Whether you're a minister looking to optimize your tax situation or simply interested in the intricacies of clergy taxation, this episode is packed with valuable insights and practical advice. Let's get started!"

Episode Quote: "Today’s episode quote is by Amy Porterfield, a go-to expert for creating online and digital courses. Amy says, 'I don’t even realize how good it can get, but I’m willing to try and find out.'

Introduction: Believe it or not, as part of your church’s finance team, one of the top priorities is to help minimize the tax liability of the minister’s income. Many ministers are not well-versed in the U.S. Tax Code System and are also not finance gurus. They are there to share the Gospel and equip the members for the work of the Gospel. It’s up to the church treasurer, bookkeeper, personnel team, finance team, or whatever title you hold within your church, to take care of the finances, including the minister's compensation package.

Dual Status Explanation: Ministers have a unique dual status for tax purposes: they are considered employees for income tax purposes and self-employed for Social Security tax purposes. This dual status opens up specific strategies for reducing taxable income.

Pre-Tax Deductions: A pre-tax deduction is an amount subtracted from an employee's (minister's) gross income before taxes are calculated. This reduces the minister’s taxable income, thereby lowering the amount of income and SECA tax owed. Common examples include contributions to retirement plans (such as 403(b) plans), health insurance premiums, housing allowance, and even charitable contributions.

Retirement Contributions:

• Utilizing tax-advantaged retirement plans like 403(b) and IRAs can significantly reduce taxable income.
• In 2024, the most an employee can contribute to a 403(b) account out of salary is $23,000.
• Housing allowances should typically be excluded from compensation for retirement plans due to their special tax treatment.
• Example: If a minister receives a $20,000 tax-free housing allowance, this amount is excluded from gross income and not included in the compensation for retirement plans.

Housing Allowance:

• Explanation of the housing allowance exclusion and how to maximize this benefit.

Charitable Contributions:

• Donating part of the salary back to the church can provide tax benefits.
• Example Scenario: Suppose you are a minister receiving a salary of $50,000. You decide to donate $10,000 back to the church.
  • Verify the church’s status as a qualified organization under IRC §170(c)(2).
  • Write a check for $10,000 and ensure it is deposited into the church's account.
  • Obtain documentation such as a receipt from the church.
  • Report the donation on your tax return, deducting it on Schedule A (Form 1040) as a charitable contribution.

Refusal to Accept Full Salary:

• Definition: Refusal to accept full salary means a minister voluntarily chooses not to take a portion of their agreed-upon salary, reducing taxable income.

• Legal Basis: Treasury Regulation § 1.451-2(a) outlines the concept of constructive receipt of income.

• Impact on Taxable Income: If a minister specifies where the money should go, it remains taxable. If the minister has no expectation or intent to withdraw the money later and gives no direction on its use, it can be considered non-taxable.

• Example:

  • Pastor Gary, with an annual salary of $50,000, decides to refuse $10,000 with no intent of drawing it later and no direction on its use, reducing his taxable income to $40,000.
  • If Pastor Gary specifies the $10,000 to go to a specific fund, it becomes taxable income.

Steps to Properly Document a Refusal to Accept Full Salary:

1. Written Agreement:
   • Create a written agreement stating the agreed-upon salary and the portion refused.
   • Include the effective date and duration.
2. Board Approval:
   • Obtain approval from the church board and record it in the meeting minutes.
3. Amend Employment Contract:
   • Amend the minister's contract if necessary and ensure both parties sign it.
4. Payroll Adjustments:
   • Adjust payroll records to reflect the reduced salary.
5. Maintain Records:
   • Keep copies of all related documents for IRS review.
6. Annual Review:
   • Review the arrangement annually to confirm continuation or make adjustments.

• Example:
  • Pastor Gary agrees to refuse $10,000 of his $50,000 salary, with a written agreement and board approval. Payroll is adjusted, and all documents are filed. This arrangement is reviewed annually.

Conclusion: By understanding and utilizing these strategies—such as salary reduction agreements, housing allowances, charitable contributions, and the refusal to accept full salary—ministers can effectively reduce their taxable income. Proper documentation and adherence to IRS regulations are crucial to ensure compliance and maximize tax benefits.

Thank you for tuning in! If you have any questions or want to learn more, stay tuned for our next episode.

xo, Michelle Next Steps:

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