Under common law rules, you are considered either an employee or a self-employed person depending on all the facts and circumstances. Generally, you are an employee if your employer has the legal right to control both what you do and how you do it, even if you have considerable discretion and freedom of action. For more information about the common-law rules, get Publication 15–A, Employer's Supplemental Tax Guide.

If you are employed by a congregation for a salary, you are generally a common-law employee and income from the exercise of your ministry is considered wages for income tax purposes. However, amounts received directly from members of the congregation, such as fees for performing marriages, baptisms, or other personal services, are considered self-employment income.

If you are not certain whether you are an employee or a self-employed person, you can get a determination from the IRS by filing Form SS–8.

If you are a member of a religious order who has taken a vow of poverty, you are exempt from paying SE tax on your earnings for qualified services (defined later) you perform as an agent of your church or its agencies. For income tax purposes, the earnings are tax free to you. Your earnings are considered the income of the religious order.

Even if you have taken a vow of poverty, the services you perform for your church or its agencies may be covered under social security. Your services are covered if your order, or an autonomous subdivision of the order, elects social security coverage for its current and future vow-of-poverty members.

The order or subdivision elects coverage by filing Form SS–16. It can elect coverage for certain vow-of-poverty members for a retroactive period of up to 20 calendar quarters before the quarter in which it files the certificate. If the election is made, the order or subdivision pays both the employer's and employee's share of the tax. You do not pay.

Even if you are a member of a religious order who has taken a vow of poverty and are required to turn over to the order amounts you earn, your earnings are subject to federal income tax withholding and employment (FICA) tax if you:

In this case, you are considered an employee of that outside organization. You may, however, be able to take a charitable deduction for the amount you turn over to the order. See Publication 526, Charitable Contributions.

Lay employees generally are covered by social security. However, see Election To Exclude Church Employees From FICA Coverage, later, under Religious Workers.

Organizations and individuals may request rulings from the IRS on whether they are religious orders, or members of a religious order, respectively, for FICA tax, SE tax, and federal income tax withholding purposes. To request a ruling, follow the procedures in Revenue Procedure 2002–1, which is published in Internal Revenue Bulletin 2002–1.

You can read this Revenue Procedure at most IRS offices or, if you have a personal computer, visit the IRS on the Internet at www.irs.gov/ind_info/bullet.html.

To subscribe to the Bulletin, you can order it on the Internet at http://bookstore.gpo.
gov/irs. You also can write to:

Christian Science practitioners are members in good standing of the Mother Church, The First Church of Christ Scientist, in Boston, Massachusetts, who practice healing according to the teachings of Christian Science. Christian Science practitioners are specifically exempted from licensing by state laws.

Some Christian Science practitioners also are Christian Science teachers or lecturers. Income from teaching or lecturing is considered the same as income from their work as practitioners.

Christian Science readers are considered the same as ordained, commissioned, or licensed ministers.

Residents of Puerto Rico, the Virgin Islands, Guam, the Commonwealth of the Northern Mariana Islands, and American Samoa, who are not U.S. citizens, are treated the same as citizens or resident aliens of the United States for SE tax purposes. For information on figuring the tax, see Figuring Net Earnings From Self-Employment for SE Tax, later.

You cannot be exempt from SE tax if you made one of the following elections to be covered under social security. These elections are irrevocable.

Table 2 briefly summarizes the procedure for requesting exemption from the SE tax. More detailed explanations follow.

To request exemption from SE tax, file Form 4361 in triplicate (original and two copies) with the IRS.

The IRS will return to you a copy of the Form 4361 that you filed indicating whether your exemption has been approved. If it is approved, keep the approved copy in your permanent records.

File Form 4361 by the date your income tax return is due, including extensions, for the second tax year in which you have net earnings from self-employment of at least $400. This rule applies if any part of your net earnings for each of the two years came from your services as a:

The two years do not have to be consecutive tax years.

The approval process can take some time, so you should file Form 4361 as soon as possible.

The right to file an application for exemption ends with an individual's death. A surviving spouse, executor, or administrator cannot file an exemption application for a deceased clergy member.

An approved exemption is effective for all tax years after 1967 in which you have $400 or more of net earnings from self-employment and any part of the earnings is for services as a member of the clergy. Once the exemption is approved, it is irrevocable.

If, after receiving an approved Form 4361, you find that you overpaid SE tax, you can file a claim for refund on Form 1040X before the period of limitations ends. This is generally within 3 years from the date you filed the return or within 2 years from the date you paid the tax, whichever is later. A return you filed, or tax you paid, before the due date is considered to have been filed or paid on the due date.

If you file a claim after the 3-year period but within 2 years from the time you paid the tax, the credit or refund will not be more than the tax you paid within the 2 years immediately before you file the claim.

If you received social security benefits or payments, or anyone else received these benefits or payments based on your wages or SE income, you cannot apply. However, if you pay your benefits back, you may be considered for exemption. Contact your local Social Security office to find out the amount to be paid back.

To claim this exemption from SE tax, all the following requirements must be met.

If you have previously received approval for exemption from SE tax, you are considered to have met the requirements and do not need to apply for this exemption.

To request the exemption, file Form 4029 in triplicate with the Social Security Administration at the address shown on the form. The sect or division must complete part of the form.

The IRS will return to you a copy of the Form 4029 that you filed indicating whether your exemption has been approved. If it is approved, keep the approved copy in your permanent records.

You can file Form 4029 at any time.

An approved exemption generally is effective on the first day of the first quarter after the quarter in which Form 4029 is filed. It does not apply to any tax year beginning before you meet the eligibility requirements discussed earlier.

The exemption will end if you fail to meet the eligibility requirements or if the Commissioner of Social Security determines that the sect or division fails to meet them. You must notify the IRS within 60 days if you are no longer a member of the religious group, or if you no longer follow the established teachings of this group. The exemption will end on the date you notify the IRS.

For information on requesting refunds, see Ministers, Members of Religious Orders, and Christian Science Practitioners, earlier.

If you have an approved Form 4029 and you have an employee who has an approved Form 4029, do not report wages you paid to the employee as social security and Medicare wages.

If you have an employee who does not have an approved Form 4029, you must withhold the employee's share of social security and Medicare taxes and pay the employer's share.

When preparing a Form W–2 for an employee with an approved Form 4029, write “Form 4029” in the box marked Other. Do not make any entries in box 3, 4, 5, or 6.

Do not include these exempt wages on Form 941, Employer's Quarterly Federal Tax Return, or on Form 943, Employer's Annual Tax Return for Agricultural Employees, if you have received an approved Form 4029.

On Form 941, write “Form 4029” to the left of the entry spaces on the lines for Taxable social security wages, Taxable social security tips, and Taxable Medicare wages and tips. Check the box on line 8 to show that the wages are not subject to these taxes.

On Form 943, write “Form 4029” to the left of the entry spaces on the lines for Total wages subject to social security tax, and Total wages subject to Medicare tax.

An approved exemption from FICA becomes effective on the first day of the first calendar quarter after the quarter in which Form 4029 is filed. The exemption will end on the last day of the calendar quarter before the quarter in which the employer, employee, sect, or division fails to meet the requirements.

Your services for a nonreligious organization are qualified services if the services are assigned or designated by your church. Assigned or designated services qualify even if they do not involve performing sacerdotal functions or conducting religious worship.

If your services are not assigned or designated by your church, they are qualified services only if they involve performing sacerdotal functions or conducting religious worship.

Income from services that are not qualified services is generally subject to social security tax withholding (not self-employment tax) under the rules that apply to workers in general. The following are not qualified services.

Writing religious books or articles is considered to be in the exercise of your ministry and is considered qualified services.

This rule also applies to members of religious orders and to Christian Science practitioners.

Ordinarily, if your services are not considered directed or required of you by the order, you and the outside party for whom you work are considered employee and employer. In this case, your earnings from the services are taxed under the rules that apply to workers in general, not under the rules for services provided as agent for the order. This is true even if you have taken a vow of poverty.

To figure your net earnings from self-employment (on Schedule SE (Form 1040)), include in gross income:

For the income tax treatment of items (2) and (4), see Income Tax: Income and Expenses, later.

Your net earnings from self-employment are determined without any foreign earned income exclusion or the foreign housing exclusion or deduction if you are a U.S. citizen or resident alien who is serving abroad and living in a foreign country.

For information on excluding foreign earned income or the foreign housing amount, get Publication 54.

The exclusion from gross income for amounts derived in Guam, American Samoa, or the Commonwealth of the Northern Mariana Islands does not apply in computing net earnings from self-employment. Also see Residents of Puerto Rico, the Virgin Islands, Guam, the CNMI, and American Samoa, earlier, under U.S. Citizens and Resident and Nonresident Aliens.

Do not include the following amounts in gross income when figuring your net earnings from self-employment.

When figuring your net earnings from self-employment, deduct all your nonemployee ministerial expenses. Also, deduct all your allowable unreimbursed trade or business expenses that you incur in performing ministerial services as a common-law employee of the church. Include this net amount on line 2 of Schedule SE (Form 1040).

These are qualified expenses you incurred while not working as a common-law employee of the church. They include expenses incurred in performing marriages and baptisms, and in delivering speeches.

If you received an advance, allowance, or reimbursement for your expenses, how you report this amount and your expenses depends on whether the reimbursement was paid to you under an accountable plan or a nonaccountable plan. If you are not sure if you are reimbursed from an accountable plan or a nonaccountable plan, ask your employer.

To be an accountable plan, your employer's reimbursement arrangement must include all three of the following rules.

Generally, if your expenses equal your reimbursement, you have no deduction and the reimbursement is not reported on your Form W–2. If your expenses are more than your reimbursement, you can deduct your excess expenses for SE tax and income tax purposes.

A nonaccountable plan is a reimbursement arrangement that does not meet at least one of the three rules listed under Accountable plans. In addition, even if your employer has an accountable plan, the following payments will be treated as being paid under a nonaccountable plan.

Your employer will combine any reimbursement paid to you under a nonaccountable plan with your wages, salary, or other compensation. Your employer will report the combined total in box 1 of your Form W–2. You can deduct your related expenses (for SE and income tax purposes) regardless of whether they are more than, less than, or equal to your reimbursement.

For more information on accountable and nonaccountable plans, get Publication 463, Travel, Entertainment, Gift, and Car Expenses.

The church or organization that employs you must officially designate the payment as a housing allowance before the payment is made. A definite amount must be designated. The amount of the housing allowance cannot be determined at a later date.

If you are employed and paid by a local congregation, a resolution by a national church agency of your denomination does not effectively designate a housing allowance for you. The local congregation must officially designate the part of your salary that is to be a housing allowance. However, a resolution of a national church agency can designate your housing allowance if you are directly employed by the agency. If no part has been officially designated, you must include your total salary in your income.

If you receive in your pay an amount officially designated as a rental allowance (including an amount to pay utility costs), you can exclude the allowance from your gross income if:

The amount you exclude cannot be more than the fair rental value of the home, including furnishings, plus the cost of utilities.

You can exclude from gross income the fair rental value of a house or parsonage, including utilities, furnished to you as part of your pay. However, the exclusion cannot be more than the reasonable pay for your services. If you pay for the utilities, you can exclude any allowance designated for utility costs, up to your actual cost.

If you own your home and you receive as part of your pay a housing or rental allowance, you may exclude from gross income the smallest of the following.

You must include in gross income the amount of any rental allowance that is more than the smallest of your reasonable pay, the fair rental value of the home plus utilities, or the amount actually used to provide a home.

Include the excess rental allowance on line 7 of Form 1040.

If you are a retired minister, you exclude from your gross income the rental value of a home (plus utilities) furnished to you by your church as a part of your pay for past services, or the part of your pension that was designated as a rental allowance. However, a minister's surviving spouse cannot exclude the rental value unless the rental value is for ministerial services he or she performs or performed.

If you are a minister employed as a teacher or administrator by a church school, college, or university, you are performing ministerial services for purposes of the housing exclusion. However, if you perform services as a teacher or administrator on the faculty of a nonchurch college, you cannot exclude from your income a housing allowance or the value of a home that is provided to you.

If you live in faculty lodging as an employee of an educational institution or academic health center, all or part of the value of that lodging may be nontaxable under a different rule. See Faculty lodging in the discussion on meals and lodging under Fringe Benefits, in Publication 525.

If you serve as a minister of music or minister of education, or serve in an administrative or other function of your religious organization, but are not authorized to perform substantially all of the religious duties of an ordained minister in your church (even if you are commissioned as a minister of the gospel), the housing exclusion does not apply to you.

If you are a theological student serving a required internship as a part-time or assistant pastor, you cannot exclude a parsonage or rental allowance from your income unless you are ordained, commissioned, or licensed as a minister.

You can exclude a designated rental allowance from out-of-town churches if you meet all of the following requirements.

If you have a bona fide commission and your congregation employs you on a full-time basis to perform substantially all the religious functions of the Jewish faith, you can exclude a rental allowance from your gross income.

This rule does not apply to your deductions for home mortgage interest or real estate taxes on your home.

Figure the portion of your otherwise deductible expenses that you cannot deduct (because that portion must be allocated to tax-free income) by multiplying the expenses by the following fraction:

When figuring the allocation, include the income and expenses related to the ministerial duties you perform both as an employee and as a self-employed person.

Reduce your otherwise deductible expenses only in figuring your income tax, not your SE tax.

If you receive a tax-free rental or parsonage allowance and have ministerial expenses, attach a statement to your tax return. The statement must contain all of the following information.

See the statement prepared for the Comprehensive Example, later.

For more information about the self-employed health insurance deduction, see chapter 7 in Publication 535.

Even if your income was less than the amount shown above, you must file an income tax return on Form 1040, and attach a completed Schedule SE (Form 1040), if:

If you are liable for SE tax, you must file Schedule SE (Form 1040) with your return.

If you filed Form 4361 and received IRS approval not to be taxed on those earnings, and you do not have any other income subject to SE tax, do not file Schedule SE (Form 1040). Instead, write “Exempt—Form 4361” on Form 1040, line 56.

If you filed Form 4029 and received IRS approval not to be taxed on those earnings, and you do not have any other income subject to SE tax, do not file Schedule SE (Form 1040). Instead, write “Exempt—Form 4029” on Form 1040, line 56.

For more information on filing your return, including when and where to file it, see the instructions for Form 1040.

To set up a qualified retirement plan (also called a Keogh or H.R. 10 plan), a simplified employee pension (SEP) plan, or a SIMPLE plan, you must be self-employed.

The common-law rules determine whether you are an employee or a self-employed person for purposes of setting up a retirement plan. See Employment Status for Other Tax Purposes, earlier. This is true even if your pay for qualified services (discussed earlier) is subject to SE tax.

For example, if a congregation pays you a salary for performing qualified services, and you are subject to the congregation's control, you are a common-law employee. You are not a self-employed person for purposes of setting up a retirement plan. This is true even if your salary is subject to SE tax.

On the other hand, amounts received directly from members of the congregation, such as fees for performing marriages, baptisms, or other personal services that are reported on Schedule C or C–EZ, are earnings from self-employment for all tax purposes.

For more information on establishing a SEP, SIMPLE, or qualified retirement plan, get Publication 560, Retirement Plans for Small Business.

The traditional IRA and the Roth IRA are two individual retirement arrangements you can use to save money for your retirement. You generally are allowed to make contributions to either a traditional or a Roth IRA of up to $3,000 ($3,500 if you are age 50 or older) for 2002, or the amount of your pay, whichever is less. $3,000 ($3,500 if you are age 50 or older) is the most you can contribute for 2002 regardless of whether you contribute to one or both of these IRAs. Contributions to a traditional IRA may be deductible. Your deduction for contributions to your traditional IRA may be reduced or eliminated if you or your spouse is covered by an employer retirement plan (including, but not limited to a SEP or SIMPLE, or qualified retirement plan). Unlike contributions to a traditional IRA, contributions to a Roth IRA are not deductible. However, if you satisfy certain requirements, all earnings in the Roth IRA are tax free and neither your nondeductible contributions nor any earnings on them are taxable when you withdraw them.

For more information on IRAs, get Publication 590.

Church employees, members of religious orders, and duly ordained, commissioned, or licensed ministers working as ministers or chaplains can participate in tax-sheltered annuity (403(b)) plans. For more information, see Publication 571, Tax-Sheltered Annuity Plans (403(b) Plans) For Employees of Public Schools and Certain Tax-Exempt Organizations.

You generally cannot deduct contributions to a tax-sheltered annuity (403(b)) plan on your tax return. However, an exception applies to your contributions if you are a minister or chaplain and, in the exercise of your ministry, you are either self-employed or employed by an organization that is not exempt from tax under section 501(c)(3) of the Internal Revenue Code and with that you do not share common religious bonds. If the exception applies, you can deduct your contributions to a 403(b) plan as explained below.

You may be able to take a tax credit for certain contributions you make to any of the retirement plans or IRAs discussed above. The amount of the credit is based on the contributions you make and your credit rate. The maximum contribution eligible for the credit is $2,000. The credit rate can be as low as 10% or as high as 50%, depending on your adjusted gross income. You figure the credit on Form 8880, Credit for Qualified Retirement Savings Contributions.

You cannot take the credit if any of the following apply.

When figuring adjusted gross income, you must add back any exclusion or deduction claimed for the year for:

For more information about the credit, see Publication 590.

Earned income includes your:

If you have earnings from qualified services that are exempt from SECA (have an approved Form 4361), amounts you received for performing ministerial duties as an employee are earned income. This includes wages, salaries, tips, and other taxable employee pay.

Amounts you received for nonemployee ministerial duties are not earned income. This includes fees for performing marriages and baptisms, and honoraria for delivering speeches.

If you had nonministerial duties, any net earnings from self-employment, minus one-half of your SE tax, and any pay received as an employee, is earned income.

Earned income includes your net earnings from self-employment plus any pay you received for nonministerial duties minus your Form 1040, line 29, amount for one-half of SE tax.

Your net earnings from self-employment include those net earnings from qualified services. See Figuring Net Earnings From Self-Employment for SE Tax, earlier. Net earnings also include net earnings from self-employment related to nonministerial duties.

If you have an approved Form 4029, all wages, salaries, tips, and other taxable employee compensation are earned income. Amounts you received as a self-employed individual are not earned income. Also, in figuring earned income, losses from Schedules C, C–EZ, or F cannot be subtracted from wages on line 7 of Form 1040.

For the detailed rules on this credit, get Publication 596. To figure the amount of your credit, you can either fill out a worksheet or have the IRS compute the credit for you. You may need to complete Schedule EIC and attach it to your tax return. For details on getting part of the credit added to your pay, get Form W–5, Earned Income Credit Advance Payment Certificate, from your employer or the IRS.

If you have attempted to deal with an IRS problem unsuccessfully, you should contact your Taxpayer Advocate.

The Taxpayer Advocate represents your interests and concerns within the IRS by protecting your rights and resolving problems that have not been fixed through normal channels. While Taxpayer Advocates cannot change the tax law or make a technical tax decision, they can clear up problems that resulted from previous contacts and ensure that your case is given a complete and impartial review.

To contact your Taxpayer Advocate:

For more information, see Publication 1546, The Taxpayer Advocate Service of the IRS.

To find out what services are available, get Publication 910, Guide to Free Tax Services. It contains a list of free tax publications and an index of tax topics. It also describes other free tax information services, including tax education and assistance programs and a list of TeleTax topics.

The church entered Rev. Michaels' $31,000 salary.

The church left this box blank because Rev. Michaels did not request federal income tax withholding.

Rev. Michaels is considered a self-employed person for purposes of social security and Medicare tax withholding, so the church left these boxes blank.

The church entered Rev. Michaels' total parsonage and utilities allowance for the year and identified them.

The college entered Rev. Michaels' $3,400 salary.

The college withheld $272 in federal income tax on Rev. Michaels' behalf.

As an employee of the college, Rev. Michaels is subject to social security and Medicare withholding on his full salary from the college.

The college withheld $210.80 in social security taxes.

The college withheld $49.30 in Medicare taxes.

Rev. Michaels reports the $4,000 from weddings, baptisms, and honoraria.

Rev. Michaels reports his expenses related to the line 1 amount. The total consisted of $87 for marriage and family booklets and $174 for 477 miles of business use of his car, mainly in connection with honoraria. Rev. Michaels used the standard mileage rate to figure his car expense. He multiplied the standard mileage rate of 36.5 cents by 477 miles to get $174.

These expenses total $261 ($174 + $87). However, he cannot deduct the part of his expenses allocable to his tax-free parsonage allowance. He attaches the required statement, Attachment 1 (shown later) to his return showing that 23% (or $60) of his business expenses are not deductible because they are allocable to that allowance. He subtracts the $60 from the $261 and enters the $201 difference on line 2.

He enters his net profit of $3,799 both on line 3 and on Form 1040, line 12.

Rev. Michaels fills out these lines to report information about his car.

Before completing line 1, Rev. Michaels fills out Part II because he used his car for church business. His records show that he drove 2,708 business miles, which he reports in Part II. On line 1, he multiplies 2,708 miles by the mileage rate of 36.5 cents for the year. The result is $988.

He enters $219 for his professional publications and booklets.

Before entering the total expenses on line 6, Rev. Michaels must reduce them by the amount allocable to his tax-free parsonage allowance. On the required Attachment 1 (shown later), he shows that 23% (or $278) of his employee business expenses are not deductible because they are allocable to the tax-free parsonage allowance. He subtracts $278 from $1,207 and enters the result, $929, on line 6. He also enters $929 on line 20 of Schedule A (Form 1040).

Rev. Michaels deducts $1,750 in real estate taxes.

He deducts $6,810 of home mortgage interest.

Rev. and Mrs. Michaels contributed $4,800 in cash during the year to various qualifying charities. Each individual contribution was less than $250.

Rev. Michaels enters his unreimbursed employee business expenses from Form 2106–EZ, line 6.

He can deduct only the part of his employee business expenses that exceeds 2% of his adjusted gross income. He fills out these lines to figure the amount he can deduct.

The total of all the Michaels' itemized deductions is $13,583, which they enter on line 28 and on Form 1040, line 38.

Rev. Michaels attaches a statement (see Attachment 2, later) that explains how he figures the amount ($44,332) to enter.

He multiplies $44,332 by .9235 to get his net earnings from self-employment ($40,941).

The amount on line 4 is less than $84,900, so Rev. Michaels multiplies the amount on line 4 ($40,941) by .153 to get his self-employment tax of $6,264. He enters that amount here and on Form 1040, line 56.

Rev. Michaels multiplies the amount on line 5 by .5 to get his deduction for one-half of self-employment tax of $3,132. He enters that amount here and on Form 1040, line 29.

Rev. Michaels reports $34,640. This amount is the total of his $31,000 church salary, $3,400 college salary, and $240, the excess of his utility allowance over his utility costs. The two salaries were reported to him in box 1 of the Forms W–2 he received.

He reports his net profit of $3,799 from Schedule C–EZ, line 3.

He enters $3,132, half his SE tax from Schedule SE, line 6.

He enters the total itemized deductions from Schedule A, line 28.

The Michaels can take the child tax credit for their daughter, Jennifer. Rev. Michaels figures the credit by completing the Child Tax Credit Worksheet (not shown) in the instructions for Form 1040. He enters the $600 credit on line 50.

He enters the self-employment tax from Schedule SE, line 5.

He enters the federal income tax shown in box 2 of his Form W–2 from the college.

He enters the $8,400 estimated tax payments he made for the year.