Publication 517: Social Security and Other Information for Members of the Clergy and Religious Workers; Main Contents

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Table of Contents

Social Security Coverage

The services you perform in the exercise of your ministry are covered by social security and Medicare under SECA. Your earnings for these services are subject to self-employment tax (SE tax) unless one of the following applies.

You are a member of a religious order who has taken a vow of poverty.
You ask the Internal Revenue Service (IRS) for an exemption from SE tax for your services and the IRS approves your request. See Exemption From Self-Employment (SE) Tax, later.
You are subject only to the social security laws of a foreign country under the provisions of a social security agreement between the United States and that country. For more information, see Binational Social Security (Totalization) Agreements in Publication 54.

Your earnings that are not from the exercise of your ministry may be subject to social security tax under FICA or SECA according to the rules that apply to taxpayers in general. See Qualified Services, later.

Ministers

If you are a minister of a church, your earnings for the services you perform in your capacity as a minister are subject to SE tax unless you have requested and received an exemption. See Exemption From Self-Employment (SE) Tax, later. These earnings are subject to SE tax whether you are an employee of your church or a self-employed person under the common law rules. For the specific services covered, see Qualified Services, later.

Ministers Defined

Ministers are individuals who are duly ordained, commissioned, or licensed by a religious body constituting a church or church denomination. They are given the authority to conduct religious worship, perform sacerdotal functions, and administer ordinances or sacraments according to the prescribed tenets and practices of that church or denomination.

If a church or denomination ordains some ministers and licenses or commissions others, anyone licensed or commissioned must be able to perform substantially all the religious functions of an ordained minister to be treated as a minister for social security purposes.

Employment Status for Other Tax Purposes

Even though you are considered a self-employed individual in performing your ministerial services for social security tax purposes, you may be considered an employee for income tax or retirement plan purposes. For income tax or retirement plan purposes, some of your income may be considered self-employment income and other income may be considered wages.

Common-law employee. 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, see 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.

Example.

A church hires and pays you a salary to perform ministerial services subject to its control. Under the common-law rules, you are an employee of the church while performing those services.

Form SS-8. 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.

Members of Religious Orders

If you are a member of a religious order who has not taken a vow of poverty, your earnings for qualified services you performed as a member of the order are subject to SE tax. See Qualified Services, later. This does not apply if you have requested and received an exemption as discussed under Exemption From Self-Employment (SE) Tax, later.

Vow of poverty. 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.

Services covered under FICA at the election of the 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.

Services performed outside the order. 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:

Work for an organization outside your religious community, and
Perform work that is not required by, or done on behalf of, the order.

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

Rulings. 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 2005-1, which is published in Internal Revenue Bulletin 2005-1.

You can read this Revenue Procedure at most IRS offices or at “www.irs.gov/pub/irs-irbs/irb05-01.pdf. ”

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

Superintendent of Documents
P.O. Box 371954
Pittsburgh, PA 15250-7954.

Christian Science Practitioners and Readers

Your earnings from services you performed in your profession as a Christian Science practitioner or reader are generally subject to SE tax. However, you can request an exemption as discussed under Exemption From Self-Employment (SE) Tax, later.

Practitioners. 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.

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

Religious Workers (Church Employees)

If you are a religious worker (a church employee) and are not in one of the classes already discussed, your wages are generally subject to social security and Medicare tax (FICA) and not to SE tax. Some exceptions are discussed next.

Election To Exclude Church Employees From FICA Coverage

Churches and qualified church-controlled organizations (church organizations) that are opposed for religious reasons to the payment of social security and Medicare taxes can elect to exclude their employees from FICA coverage. If you are an employee of a church or church organization that makes this election and pays you $108.28 or more in wages, you must pay SE tax on those wages.

Churches and church organizations make this election by filing two copies of Form 8274, Certification by Churches and Qualified Church-Controlled Organizations Electing Exemption From Employer Social Security and Medicare Taxes. For more information about making this election, see Form 8274.

Table 2. The Self-Employment Tax Exemption Application and Approval Process

Who Can Apply	Ministers, Members of Religious Orders, and Christian Science Practitioners	Member of Recognized Religious Sect
How	File Form 4361	File Form 4029
When	File by the due date (including extensions) of your income tax return for the second tax year in which you had at least $400 of net earnings from self-employment (at least part from qualified services)	File anytime
Approval	If approved, you will receive an approved copy of Form 4361	If approved, you will receive an approved copy of Form 4029
Effective Date	For all tax years after 1967 in which you have at least $400 of net earnings from self-employment	First day of first quarter after the quarter in which Form 4029 was filed

Table 2. The Self-Employment Tax Exemption Application and Approval Process

Who Can Apply	Ministers, Members of Religious Orders, and Christian Science Practitioners	Member of Recognized Religious Sect
How	File Form 4361	File Form 4029
When	File by the due date (including extensions) of your income tax return for the second tax year in which you had at least $400 of net earnings from self-employment (at least part from qualified services)	File anytime
Approval	If approved, you will receive an approved copy of Form 4361	If approved, you will receive an approved copy of Form 4029
Effective Date	For all tax years after 1967 in which you have at least $400 of net earnings from self-employment	First day of first quarter after the quarter in which Form 4029 was filed

Election by Church Employees Who Are Opposed to Social Security and Medicare

You may be able to choose to be exempt from social security and Medicare taxes, including the SE tax, if you work for a church (or church-controlled non-profit division) that does not pay the employer's part of the social security tax on wages. You can make the choice if you are a member of a religious sect or division opposed to social security and Medicare. This exemption does not apply to your service, if any, as a minister of a church or as a member of a religious order.

You can make this choice by filing Form 4029. See Requesting exemption — Form 4029, later, under Members of Recognized Religious Sects.

U.S. Citizens and Resident and Nonresident Aliens

To be covered under the SE tax provisions (SECA), individuals generally must be citizens or resident aliens of the United States. Nonresident aliens are not covered under SECA.

To determine your alien status, see Publication 519, U.S. Tax Guide for Aliens.

Residents of Puerto Rico, the Virgin Islands, Guam, the CNMI, and American Samoa. Residents of Puerto Rico, the Virgin Islands, Guam, the Commonwealth of the Northern Mariana Islands (CNMI), 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.

Exemption From Self-Employment (SE) Tax

You can request an exemption from SE tax if you are one of the following.

A minister.
A member of a religious order who has not taken a vow of poverty.
A Christian Science practitioner.
A member of a recognized religious sect.

Members of religious orders who have taken a vow of poverty are exempt from paying SE tax, as discussed earlier under Members of Religious Orders. They do not have to request the exemption.

Who cannot be exempt? 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.

You elected to be covered under social security by filing Form 2031, Waiver Certificate For Use By Ministers, Certain Members of Religious Orders, and Christian Science, for your 1986, 1987, 2000, or 2001 tax year.
You elected before 1968 to be covered under social security for your ministerial services.

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

If you are a minister, member of a religious order, or Christian Science practitioner, an approved exemption only applies to earnings you receive for qualified services, discussed later. It does not apply to any other SE income.

Ministers, Members of Religious Orders, and Christian Science Practitioners

To claim the exemption from SE tax, you must meet all of the following conditions.

You file Form 4361, described later under Requesting exemption — Form 4361.
You are conscientiously opposed to public insurance because of your individual religious considerations (not because of your general conscience), or you are opposed because of the principles of your religious denomination.
You file for other than economic reasons.
You inform the ordaining, commissioning, or licensing body of your church or order that you are opposed to public insurance if you are a minister or a member of a religious order (other than a vow-of-poverty member). This requirement does not apply to Christian Science practitioners.
You establish that the organization that ordained, commissioned, or licensed you, or your religious order, is a tax-exempt religious organization.
You establish that the organization is a church or a convention or association of churches.
You did not make an election discussed earlier under Who cannot be exempt.
You sign and return the statement the IRS mails to you to certify that you are requesting an exemption based on the grounds listed on the statement.

Requesting exemption — Form 4361. 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.

When to file. 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:

Minister,
Member of a religious order, or
Christian Science practitioner.

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.

Example 1.

Rev. Lawrence Jaeger, a clergyman ordained in 2004, has net earnings of $450 in 2004 and $500 in 2005. He must file his application for exemption by the due date, including extensions, for his 2005 income tax return. However, if Rev. Jaeger does not receive IRS approval for an exemption by April 17, 2006, his SE tax for 2005 is due by that date.

Example 2.

Rev. Louise Wolfe has $300 in net earnings as a minister in 2004, but earned more than $400 in both 2003 and 2005. She must file her application for exemption by the due date, including extensions, for her 2005 income tax return. However, if she does not receive IRS approval for an exemption by April 17, 2006, her SE tax for 2005 is due by that date.

Example 3.

In 2002, Rev. David Moss was ordained a minister and had $700 in net earnings as a minister. In 2003, he received $1,000 as a minister, but his related expenses were over $1,000. Therefore, he had no net earnings as a minister in 2003. Also in 2003, he opened a book store and had $8,000 in net self-employment earnings from the store. In 2004, he had net earnings of $1,500 as a minister and $10,000 net SE earnings from the store.

Rev. Moss had net earnings from self-employment in 2002 and 2004 that were $400 or more each year, and part of the earnings in each of those years was for his services as a minister, so he must file his application for exemption by the due date, including extensions, for his 2004 income tax return.

Death of individual. 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.

Effective date of exemption. 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.

Example.

Rev. Trudy Austin, ordained in 2003, had $400 or more in net earnings as a minister in both 2003 and 2004. She files an application for exemption on February 18, 2005. If an exemption is granted, it is effective for 2003 and the following years.

Refunds of SE tax. 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.

Members of Recognized Religious Sects

If you are a member of a recognized religious sect, or a division of a recognized religious sect, you can apply for an exemption from payment of social security and Medicare taxes.

Exception. 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.

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

You must file Form 4029, discussed later under Requesting exemption — Form 4029.
As a follower of the established teachings of the sect or division, you must be conscientiously opposed to accepting benefits of any private or public insurance that makes payments for death, disability, old age, retirement, or medical care, or provides services for medical care.
You must waive all rights to receive any social security payment or benefit and agree that no benefits or payments will be made to anyone else based on your wages and SE income.
The Commissioner of Social Security must determine that:
1. Your sect or division has the established teachings as in (2) above,
2. It is the practice, and has been for a substantial period of time, for members of the sect or division to provide for their dependent members in a manner that is reasonable in view of the members' general level of living, and
3. The sect or division has existed at all times since December 31, 1950.

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.

Requesting exemption — Form 4029. 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.

When to file. You can file Form 4029 at any time.

Effective date of exemption. 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.

Refunds of SE tax paid. To get a refund of any SE tax you paid while the exemption was in effect, file Form 1040X. For information on filing this form, see Refunds of SE tax under Ministers, Members of Religious Orders, and Christian Science Practitioners, earlier.

Exemption From FICA Taxes

Generally, under FICA, the employer and the employee each pay half of the social security and Medicare tax. Both the employee and the employer, if they meet the eligibility requirements discussed earlier, can apply to be exempt from their share of FICA taxes on wages paid by the employer to the employee.

A partnership in which each partner holds a religious exemption from social security and Medicare is an employer for this purpose.

If the employer's application is approved, the exemption will apply only to FICA taxes on wages paid to employees who also received an approval of identical applications.

Information for employers. 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.

Form W-2. 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 boxes 3, 4, 5, or 6.

Forms 941 and 943. Do not include these exempt wages on Form 941, Employer's Quarterly Federal Tax Return, or on Form 943, Employer's Annual Federal 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.

Effective date. 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.

Qualified Services

Qualified services, in general, are the services you perform in the exercise of your ministry or in the exercise of your duties as required by your religious order. Income you receive for performing qualified services is subject to SE tax unless you have an exemption as explained earlier. If you have an exemption, only the income you receive for performing qualified services is exempt. The exemption does not apply to any other SE income.

The following discussions provide more detailed information on qualified services of ministers, and members of religious orders, and Christian Science practitioners and readers.

Ministers

Most services you perform as a minister, priest, rabbi, etc., are qualified services. These services include:

Performing sacerdotal functions,
Conducting religious worship, and
Controlling, conducting, and maintaining religious organizations, boards, societies, and other integral agencies that are under the authority of a religious body that is a church or denomination.

You are considered to control, conduct, and maintain a religious organization if you direct, manage, or promote the organization's activities.

A religious organization is under the authority of a religious body that is a church or denomination if it is organized for and dedicated to carrying out the principles of a faith according to the requirements governing the creation of institutions of the faith.

Services for nonreligious organizations. 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.

Services that are not part of your ministry. 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.

Services you perform for nonreligious organizations other than the services stated earlier.
Services you perform as a duly ordained, commissioned, or licensed minister of a church as an employee of the United States, the District of Columbia, a foreign government, or any of their political subdivisions. This is true even if you are performing sacerdotal functions or conducting religious worship. (For example, if you perform services as a chaplain in the Armed Forces of the United States, the services are not qualified services.)
Services you perform in a government- owned and operated hospital. (These services are considered performed by a government employee, not by a minister as part of the ministry.) However, services that you perform at a church-related hospital or health and welfare institution, or a private nonprofit hospital, are considered to be part of the ministry and are considered qualified services.

Books or articles. 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.

Members of Religious Orders

Services you perform as a member of a religious order in the exercise of duties required by the order are qualified services. The services are qualified because you perform them as an agent of the order.

For example, if you are directed to perform services for another agency of the supervising church or an associated institution, you are considered to perform the services as an agent of the order.

However, if you are directed to work outside the order, the employment will not be considered a duty required by the order unless:

Your services are the kind that are ordinarily performed by members of the order, and
Your services are part of the duties that must be exercised for, or on behalf of, the religious order as its agent.

Effect of employee status. 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.

Example.

Mark Brown and Elizabeth Green are members of a religious order and have taken vows of poverty. They renounce all claims to their earnings. The earnings belong to the order.

Mark is a licensed attorney. The superiors of the order instructed him to get a job with a law firm. Mark joined a law firm as an employee and, as he requested, the firm made the salary payments directly to the order.

Elizabeth is a secretary. The superiors of the order instructed her to accept a job with the business office of the church that supervises the order. Elizabeth took the job and gave all her earnings to the order.

Mark's services are not duties required by the order. His earnings are subject to social security and Medicare tax under FICA and Federal income tax.

Elizabeth's services are considered duties required by the order. She is acting as an agent of the order and not as an employee of a third party. She does not include the earnings in gross income, and they are not subject to income tax withholding, social security and Medicare tax, or SE tax.

Christian Science Practitioners and Readers

The exemption from SE tax, discussed earlier, applies only to the services a Christian Science practitioner or reader performs in the exercise of his or her profession. If you do not have an exemption, amounts you receive for performing these qualified services are subject to SE tax.

Figuring Net Earnings From Self-Employment for SE Tax

There are two methods for figuring your net earnings from self-employment as a minister, member of a religious order, Christian Science practitioner, or church employee.

Regular method, or
Nonfarm optional method.

Regular Method

Most people use the regular method. Under this method, you figure your net earnings from self-employment by totaling your gross income for services you performed as a minister, a member of a religious order who has not taken a vow of poverty, or a Christian Science practitioner. Then, you subtract your allowable business deductions and multiply the difference by .9235 (92.35%). Use Schedule SE (Form 1040) to figure your net earnings and SE tax.

If you are an employee of a church that elected to exclude you from FICA coverage, figure net earnings by multiplying your church wages shown on Form W-2 by .9235. Do not reduce your wages by any business deductions when making this computation. Use Section B of Schedule SE (Form 1040), to figure your net earnings and SE tax.

If you have an approved exemption, or you are automatically exempt, do not include the income or deductions from qualified services in figuring your net earnings from self-employment.

For more information on net earnings from self-employment, see Publication 533.

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

Salaries and fees for your qualified services (discussed earlier),
Offerings you receive for marriages, baptisms, funerals, masses, etc.,
The value of meals and lodging provided to you, your spouse, and your dependents for your employer's convenience,
The fair rental value of a parsonage provided to you (including the cost of utilities that are furnished) and the rental allowance (including an amount for payment of utilities) paid to you, and
Any amount a church pays toward your income tax or SE tax, other than withholding the amount from your salary. This amount is also subject to income tax.

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

Example.

Pastor Roger Adams receives an annual salary of $16,500 as a full-time minister. The $16,500 includes $1,500 that is designated as a rental allowance to pay utilities. His church owns a parsonage that has a fair rental value of $5,200 per year. Pastor Adams is given the use of the parsonage. He is not exempt from SE tax. He must include $21,700 ($16,500 plus $5,200) when figuring net earnings from self-employment.

The results would be the same if, instead of the use of the parsonage and receipt of the rental allowance for utilities, Pastor Adams had received an annual salary of $21,700 of which $6,700 ($1,500 plus $5,200) per year was designated as a rental allowance.

Overseas duty. 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.

Example.

Paul Jones was the minister of a U.S. church in Mexico. He earned $22,000 and was able to exclude it all for income tax purposes under the foreign earned income exclusion. However, Mr. Jones must include $22,000 when figuring net earnings from self-employment.

Specified U.S. possessions. 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.

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

Offerings that others made to the church.
Contributions by your church to a tax-sheltered annuity plan set up for you, including any salary reduction contributions (elective deferrals), that are not included in your gross income.
Pension payments or retirement allowances you receive for your past qualified services.
The rental value of a parsonage or a parsonage allowance provided to you after you retire.

Allowable deductions. 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 Schedule SE (Form 1040), line 2.

Nonemployee ministerial expenses. 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.

Reimbursement arrangements. 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.

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

Your expenses must have a business connection — that is, you must have paid or incurred deductible expenses while performing services as an employee of your employer.
You must adequately account to your employer for these expenses within a reasonable period of time.
You must return any excess reimbursement or allowance within a reasonable period of time.

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.

Nonaccountable plan. 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.

Excess reimbursements you fail to return to your employer.
Reimbursement of nondeductible expenses related to your employer's business.

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, see Publication 463, Travel, Entertainment, Gift, and Car Expenses.

Husband and Wife Missionary Team

If a husband and wife are both duly ordained, commissioned, or licensed ministers of a church and have an agreement that each will perform specific services for which they are paid jointly or separately, they must divide the SE income according to the agreement.

If the agreement is with one spouse only and the other spouse is not paid for any specific duties, amounts received for their services are included in only the SE income of the spouse having the agreement.

Maximum Earnings Subject to SE Tax

For 2004, the maximum net earnings from self-employment subject to social security (old age, survivors, and disability insurance) tax is $87,900 minus any wages and tips you earned that were subject to social security tax. The tax rate for the social security part is 12.4%. In addition, all of your net earnings are subject to the Medicare (hospital insurance) part of the SE tax. This tax rate is 2.9%. The combined self-employment tax rate is 15.3%.

Nonfarm Optional Method

You may be able to use the nonfarm optional method for figuring your net earnings from self-employment. In general, the nonfarm optional method is intended to permit continued coverage for social security and Medicare purposes when your income for the tax year is low.

You may use the nonfarm optional method if you meet all the following tests.

You are self-employed on a regular basis. This means that your actual net earnings from self-employment were $400 or more in at least 2 of the 3 tax years before the one for which you use this method. The net earnings can be from either farm or nonfarm earnings or both.
You have used this method less than 5 years. (There is a 5-year lifetime limit.) The years do not have to be one after another.
Your net nonfarm profits were:
1. Less than $1,733, and
2. Less than 72.189% of your gross nonfarm income.

If you meet the three tests, use Table 3 to figure your net earnings from self-employment under the nonfarm optional method.

Table 3. Figuring Nonfarm Net Earnings

IF your gross nonfarm income is ...	THEN your net earnings are equal to ...
$2,400 or less	The greater of: Two-thirds of your gross nonfarm income, or Actual net earnings. ^*
More than $2,400	The greater of: $1,600, or Actual net earnings. ^*

^* If actual net earnings (defined below) are greater, you cannot use the nonfarm optional method.

Actual net earnings. Your actual net earnings are 92.35% of your total earnings subject to SE tax (multiply total earnings subject to SE tax by 92.35% (.9235) to get actual net earnings). Actual net earnings are equivalent to net earnings using the “Regular Method.”

More information. For more information on the nonfarm optional method, see Publication 533 and Schedule SE (Form 1040).

Income Tax: Income and Expenses

Some income and expense items are treated the same for income tax and SE tax purposes and some are treated differently.

Income Items

The tax treatment of offerings and fees, outside earnings, rental allowances, rental value of parsonage, pay of members of religious orders, and foreign earned income is discussed here.

Offerings and Fees

If you are a member of the clergy, you must include in your income offerings and fees you receive for marriages, baptisms, funerals, masses, etc., in addition to your salary. If the offering is made to the religious institution, it is not taxable to you.

Outside Earnings

If you are a member of a religious organization and you give your outside earnings to the organization, you still must include the earnings in your income. However, you may be entitled to a charitable contribution deduction for the amount paid to the organization. For more information see Publication 526.

Exclusion of Rental Allowance and Fair Rental Value of a Parsonage

Ordained, commissioned, or licensed ministers of the gospel may be able to exclude the rental allowance or fair rental value of a parsonage that is provided to them as pay for their services. Services include:

Qualified services, discussed earlier,
Administrative duties and teaching at theological seminaries, and
The ordinary duties of a minister performed as an employee of the United States (other than as a chaplain in the Armed Forces), a state, possession, political subdivision, or the District of Columbia.

This exclusion applies only for income tax purposes. It does not apply for SE tax purposes, as discussed earlier under Figuring Net Earnings From Self-Employment for SE Tax.

Designation requirement. 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.

Rental allowances. 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 is used to provide or rent a home, and
The amount is not more than reasonable pay for your services.

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

Fair rental value of parsonage. 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.

Example.

Rev. Joanna Baker is a full-time minister at the Central Mission Church. The church allows her to use the parsonage that has an annual fair rental value of $4,800. The church pays her an annual salary of $13,200, of which $1,200 is designated for utility costs. Her utility costs during the year were $1,000.

For income tax purposes, Rev. Baker excludes $5,800 from gross income (the fair rental value of the parsonage plus $1,000 from the allowance for utility costs). She will report $12,200 ($12,000 salary and $200 of unused utility allowance). Her income for SE tax purposes, however, is $18,000 ($13,200 salary + $4,800 fair rental value of the parsonage).

Home ownership. 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.

The amount actually used to provide a home,
The amount officially designated as a rental allowance, or
The fair rental value of the home, including furnishings, utilities, garage, etc.

Excess rental allowance. 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 Form 1040, line 7.

You may deduct the home mortgage interest and real estate taxes you pay on your home even though all or part of the mortgage is paid with funds you get through a tax-free rental or parsonage allowance.

Retired ministers. 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.

Teachers or administrators. 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.

Theological students. 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.

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

You are an ordained minister.
You perform qualified services at churches located away from your community.
You actually use the rental allowance to maintain your permanent home.

Cantors. 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.

Pay—Members of Religious Orders

Your pay may be exempt from both income tax and SE tax if you are a member of a religious order who:

Has taken a vow of poverty,
Receives pay for services performed as an agent of the order and in the exercise of duties required by the order, and
Renounces the pay and gives it to the order.

See Members of Religious Orders, earlier, under Social Security Coverage.

Foreign Earned Income

Certain income may be exempt from income tax if you work in a foreign country or in a specified U.S. possession. Publication 54 discusses the foreign earned income exclusion. Publication 570, Tax Guide for Individuals With Income From U.S. Possessions, covers the rules for taxpayers with income from U.S. possessions. You can get these free publications from the Internal Revenue Service or from most U.S. Embassies or consulates.

Expense Items

The tax treatment of ministerial trade or business expenses, expenses allocable to tax-free income, and health insurance costs is discussed here.

Ministerial Trade or Business Expenses as an Employee

When you figure your income tax, you must itemize your deductions on Schedule A (Form 1040) to claim allowable deductions for ministerial trade or business expenses incurred while working as an employee. You also may have to file Form 2106, Employee Business Expenses (or Form 2106-EZ, Unreimbursed Employee Business Expenses).

These expenses are claimed as miscellaneous itemized deductions and are subject to the 2%-of-adjusted-gross-income (AGI) limit. See Publication 529 for more information on this limit.

Additionally, these expenses may have to be reduced by the amount that is allocable to tax-free income (discussed next) before being limited by the 2% AGI limit.

Expenses Allocable to Tax-Free Income

If you receive a rental or parsonage allowance that is exempt from income tax (tax free), you must allocate a portion of the expenses of operating your ministry to that tax-free income. You cannot deduct the portion of your expenses that is allocated to your tax-free rental or parsonage allowance.

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

Figuring the allocation. 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:

	Tax free rental or parsonage allowance
	All income (taxable and tax-free) earned from your ministry

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.

Example.

Rev. Charles Ashford received $40,000 in ministerial earnings consisting of a $28,000 salary for ministerial services, $2,000 for weddings and baptisms, and a $10,000 tax-free parsonage allowance. He incurred $4,000 of unreimbursed expenses connected with his ministerial earnings. $3,500 of the $4,000 is related to his ministerial salary, and $500 is related to the weddings and baptisms he performed as a self-employed person.

The nondeductible portion of expenses related to Rev. Ashford's ministerial salary is figured as follows:

($10,000 ÷ $40,000) x $3,500 = $875

The nondeductible portion of expenses related to Rev. Ashford's wedding and baptism income is figured as follows:

($10,000 ÷ $40,000) x $500 = $125

Required statement. 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.

A list of each item of taxable ministerial income by source (such as wages, salary, weddings, baptisms, etc.) plus the amount.
A list of each item of tax-free ministerial income by source (parsonage allowance) plus the amount.
A list of each item of otherwise deductible ministerial expenses plus the amount.
How you figured the nondeductible part of your otherwise deductible expenses.
A statement that the other deductions claimed on your tax return are not allocable to your tax-free income.

See the statement prepared for the Comprehensive Example, later.

Health Insurance Costs of Self-Employed Ministers

If you are self-employed, you may be able to deduct the amount you paid in 2004 for medical and dental insurance and qualified long-term care insurance for you, your spouse, and your dependents.

If you qualify, you can take this deduction as an adjustment to income on Form 1040, line 31. There is a worksheet in the instructions for Form 1040 that you can use to figure this deduction.

The following special rules apply to the self-employed health insurance deduction.

The expenses taken into account for purposes of this deduction are not allowed as a medical expense deduction on Schedule A.
The deduction is not allowed for any month you are eligible to participate in a subsidized plan of your (or your spouse's) employer.
The deduction is not used to reduce your net earnings for your SE tax.
The deduction cannot exceed your net earnings from the business under which the insurance plan is established. Your net earnings under this rule do not include the income you earned as a common-law employee (discussed earlier) of a church.

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

Deduction for SE Tax

You can deduct one-half of your SE tax in figuring adjusted gross income. This is an income tax deduction only, and you deduct it on Form 1040, line 30.

This is not a deduction in figuring net earnings from self-employment subject to SE tax.

Income Tax Withholding and Estimated Tax

The federal income tax is a pay-as-you-go tax. You must pay the tax as you earn or receive income during the year. An employee usually has income tax withheld from his or her pay. However, your pay generally is not subject to federal income tax withholding if both the following conditions apply.

You are a duly ordained, commissioned, or licensed minister, a member of a religious order (who has not taken a vow of poverty), or a Christian Science practitioner.
Your pay is for qualified services (see Qualified Services, earlier).

If your salary is not subject to withholding, or if you do not pay enough tax through withholding, you might have to pay estimated tax to avoid penalties for not paying enough tax as you earn your income.

You generally must make estimated tax payments if you expect to owe taxes, including self-employment tax, of $1,000 or more, when you file your return.

Determine your estimated tax by using the worksheet in Form 1040-ES. Then, using the Form 1040-ES payment voucher, pay the entire estimated tax or the first installment by April 15, 2005. The April 15 date applies whether or not your tax home and your abode are outside the United States and Puerto Rico. For more information see Publication 505, Tax Withholding and Estimated Tax.

If you perform your services as a common-law employee of the church and your pay is not subject to income tax withholding, you can enter into a voluntary withholding agreement with the church to cover any income and SE tax that may be due.

Filing Your Return

You have to file an income tax return for 2004 if your gross income was at least the amount shown in the third column of Table 4.

Table 4. Who Must File

IF your filing status is . . .	AND at the end of 2004 you were* . . .
Single	under age 65 65 or older	$7,950 9,150
Married filing jointly***	under 65 (both spouses) 65 or older (one spouse) 65 or older (both spouses)	$15,900 16,850 17,800
Married filing separately	any age	$3,100
Head of household	under 65 65 or older	$10,250 11,450
Qualifying widow(er) with dependent child	under 65 65 or older	$12,800 13,750
* If you were born on January 1, 1940, you are considered to be age 65 at the end of 2004.
Gross income means all income you received in the form of money, goods, property, and services that is not exempt from tax, including any income from sources outside the United States (even if you may exclude part or all of it). Do not** include social security benefits unless you are married filing a separate return and you lived with your spouse at any time in 2004.
*** If you did not live with your spouse at the end of 2004 (or on the date your spouse died) and your gross income was at least $3,100 you must file a return regardless of your age.

Table 4. Who Must File

IF your filing status is . . .	AND at the end of 2004 you were* . . .
Single	under age 65 65 or older	$7,950 9,150
Married filing jointly***	under 65 (both spouses) 65 or older (one spouse) 65 or older (both spouses)	$15,900 16,850 17,800
Married filing separately	any age	$3,100
Head of household	under 65 65 or older	$10,250 11,450
Qualifying widow(er) with dependent child	under 65 65 or older	$12,800 13,750
* If you were born on January 1, 1940, you are considered to be age 65 at the end of 2004.
Gross income means all income you received in the form of money, goods, property, and services that is not exempt from tax, including any income from sources outside the United States (even if you may exclude part or all of it). Do not** include social security benefits unless you are married filing a separate return and you lived with your spouse at any time in 2004.
*** If you did not live with your spouse at the end of 2004 (or on the date your spouse died) and your gross income was at least $3,100 you must file a return regardless of your age.

Additional requirements. Even if your income was less than the amount shown in Table 4, you must file an income tax return on Form 1040, and attach a completed Schedule SE (Form 1040), if:

You are not exempt from SE tax, and you have net earnings from self-employment (discussed earlier under Figuring Net Earnings From Self-Employment for SE Tax) of $400 or more in the tax year,
You are exempt from SE tax on earnings from qualified services and you have $400 or more of other earnings subject to SE tax, or
You had wages of $108.28 or more from an electing church or church-controlled organization (discussed earlier under Religious Workers (Church Employees)).

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

Exemption from SE tax. 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 57.

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 57.

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

Retirement Savings Arrangements

Retirement savings arrangements are plans that offer you a tax-favored way to save for your retirement. You generally can deduct your contributions to the plan. Your contributions and the earnings on them are not taxed until they are distributed.

Retirement plans for the self-employed. 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, see Publication 560, Retirement Plans for Small Business.

Individual retirement arrangements (IRAs). 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 2004, 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 2004 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, see Publication 590.

Tax-sheltered annuity plans. 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.

Deducting contributions to tax-sheltered annuity plans. 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. If the exception applies, you can deduct your contributions to a 403(b) plan as explained next.

If you are self-employed, deduct your contributions on Form 1040, line 32.
If you are not self-employed and your employer does not exclude your contributions from your earned income, deduct your contributions on Form 1040, line 35. Write “403(b)” on the dotted line next to line 35.

Retirement savings contributions credit. 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.

You were born after January 1, 1987.
You were a full-time student in 2004.
Someone, such as your parent(s), claims an exemption for you on his or her 2004 tax return.
Your adjusted gross income for 2004 is more than:
1. $25,000, if your filing status is single, married filing separately, or qualifying widow(er) with dependent child.
2. $37,500, if your filing status is head of household.
3. $50,000, if your filing status is married filing jointly.

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

Foreign earned income,
Foreign housing costs,
Income for bona fide residents of American Samoa, and
Income from Puerto Rico.

More information. For more information about the credit, see Publication 590.

Earned Income Credit

The earned income credit is a credit for certain people who work. If you qualify for it, the earned income credit reduces the tax you owe. Even if you do not owe tax, you can get a refund of the credit. Also, you may be able to get part of the credit added to your pay instead of waiting until after the end of the year.

You cannot take the credit if your earned income (or adjusted gross income) is:

$11,490 or more ($12,490 or more for married filing jointly) and you do not have a qualifying child,
$30,338 or more ($31,338 or more for married filing jointly) and you have one qualifying child, or
$34,458 or more ($35,458 or more for married filing jointly) and you have more than one qualifying child.

Earned income. Earned income includes your:

Wages, salaries, tips, and
Net earnings from self-employment minus the amount you claimed (or should have claimed) on Form 1040, line 30, for one-half of your SE tax.

Earned income for a minister with an approved Form 4361. 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 for a minister whose income from qualified services is not exempt from SECA. Earned income includes your net earnings from self-employment plus any pay you received for nonministerial duties minus your Form 1040, line 30, 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.

Earned income for a member of a recognized religious sect with an approved Form 4029. 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.

More information. For the detailed rules on this credit, see 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.

Comprehensive Example

Rev. John Michaels is the minister of the First United Church. He is married and has one child. The child is considered a qualifying child for the child tax credit. Mrs. Michaels is not employed outside the home. Rev. Michaels is a common-law employee of the church, and he has not applied for an exemption from SE tax.

The church paid Rev. Michaels a salary of $31,000. In addition, as a self-employed person, he earned $4,000 during the year for weddings, baptisms, and honoraria. He made estimated tax payments during the year totaling $8,400. He taught a course at the local community college, for which he was paid $3,400.

Rev. Michaels owns a home next to the church. He makes an $800 per month mortgage payment of principal and interest only. The church paid him $800 per month as his parsonage allowance (excluding utilities). The home's fair rental value is $900 per month. The utility bills for the year totaled $960. The church paid him $100 per month designated as an allowance for utility costs.

The parts of Rev. and Mrs. Michaels' income tax return are explained in the order they are completed. They are illustrated in the order that the Rev. Michaels will assemble the return to send it to the IRS.

Form W-2 From Church

The church completed its Form W-2 for Rev. Michaels as follows:

Box 1. The church entered Rev. Michaels' $31,000 salary.

Box 2. The church left this box blank because Rev. Michaels did not request federal income tax withholding.

Boxes 3 through 6. Rev. Michaels is considered a self-employed person for purposes of social security and Medicare tax withholding, so the church left these boxes blank.

Box 14. The church entered Rev. Michaels' total parsonage and utilities allowance for the year and identified them.

Form W-2 From College

The community college gave Rev. Michaels a Form W-2 that showed the following.

Box 1. The college entered Rev. Michaels' $3,400 salary.

Box 2. The college withheld $272 in federal income tax on Rev. Michaels' behalf.

Boxes 3 and 5. As an employee of the college, Rev. Michaels is subject to social security and Medicare withholding on his full salary from the college.

Box 4. The college withheld $210.80 in social security taxes.

Box 6. The college withheld $49.30 in Medicare taxes.

Schedule C-EZ (Form 1040)

Some of Rev. Michaels' entries on Schedule C-EZ are explained here.

Line 1. Rev. Michaels reports the $4,000 from weddings, baptisms, and honoraria.

Line 2. Rev. Michaels reports his expenses related to the line 1 amount. The total consisted of $87 for marriage and family booklets and $172 for 459 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 37.5 cents by 459 miles to get $172.

These expenses total $259 ($172 + $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 $259 and enters the $199 difference on line 2.

Line 3. He enters his net profit of $3,801 both on line 3 and on Form 1040, line 12.

Lines 4 through 8b. Rev. Michaels fills out these lines to report information about his car.

Form 2106-EZ

Rev. Michaels fills out Form 2106-EZ to report the unreimbursed business expenses he had as a common-law employee of First United Church.

Line 1. Before completing line 1, Rev. Michaels fills out Part II because he used his car for church business. His records show that he drove 2,600 business miles, which he reports in Part II. On line 1, he multiplies 2,600 miles by the mileage rate of 37.5 cents for the year. The result is $975.

Line 4. He enters $219 for his professional publications and booklets.

Line 6. 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 $275) of his employee business expenses are not deductible because they are allocable to the tax-free parsonage allowance. He subtracts $275 from $1,194 and enters the result, $919, on line 6. He also enters $919 on line 20 of Schedule A (Form 1040).

Schedule A (Form 1040)

Rev. Michaels fills out Schedule A as explained here.

Line 6. Rev. Michaels deducts $1,750 in real estate taxes.

Line 10. He deducts $6,810 of home mortgage interest.

Line 15. Rev. and Mrs. Michaels contributed $4,800 in cash during the year to various qualifying charities. Each individual contribution was less than $250.

Line 20. Rev. Michaels enters his unreimbursed employee business expenses from Form 2106-EZ, line 6.

Lines 24, 25, and 26. 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.

Line 28. The total of all the Michaels' itemized deductions is $13,573, which they enter on line 28 and on Form 1040, line 39.

Schedule SE (Form 1040)

After Rev. Michaels prepares Schedule C-EZ and Form 2106-EZ, he fills out Schedule SE (Form 1040). He reads the chart on page 1 of the schedule which tells him he can use Section A—Short Schedule SE to figure his self-employment tax. Rev. Michaels is a minister, so his salary from the church is not considered church employee income. Thus, he does not have to use Section B—Long Schedule SE. He fills out the following lines in Section A.

Line 2. Rev. Michaels attaches a statement (see Attachment 2, later) that explains how he figures the amount ($44,347) to enter.

Line 4. He multiplies $44,347 by .9235 to get his net earnings from self-employment ($40,954).

Line 5. The amount on line 4 is less than $87,900, so Rev. Michaels multiplies the amount on line 4 ($40,954) by .153 to get his self-employment tax of $6,266. He enters that amount here and on Form 1040, line 57.

Line 6. Rev. Michaels multiplies the amount on line 5 by .5 to get his deduction for one-half of self-employment tax of $3,133. He enters that amount here and on Form 1040, line 30.

Form 1040

After Rev. Michaels prepares Form 2106-EZ and the other schedules, he fills out Form 1040. He files a joint return with his wife. First he fills out the address area and completes the appropriate lines for his filing status and exemptions. Then, he fills out the rest of the form as follows:

Line 7. 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.

Line 12. He reports his net profit of $3,801 from Schedule C-EZ, line 3.

Line 30. He enters $3,133, half his SE tax from Schedule SE, line 6.

Line 39. He enters the total itemized deductions from Schedule A, line 28.

Line 51. 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. Because he did not receive an advance payment of the child tax credit, he enters the full $1000 credit on line 51.

Line 57. He enters the self-employment tax from Schedule SE, line 5.

Line 63. He enters the federal income tax shown in box 2 of his Form W-2 from the college.

Line 64. He enters the $8,400 estimated tax payments he made for the year.

Forms W–2, (2) for John E. Michaels

Form 1040, page 1 for John E. and Susan R. Michaels

Form 1040, page 2

Schedule A (Form 1040)

Schedule C–EZ (Form 1040)

Schedule SE (Form 1040)

Form 2106–EZ

Attachment 1. Computation of expenses, allocable to tax-free ministerial income, that are nondeductible

					Taxable		Tax-Free		Total
Salary as a minister				$	31,000			$	31,000
Parsonage allowance–Mortgage ($800 x 12)						$	9,600		9,600
	Utilities ($100 x 12)	$	1,200
Minus actual costs			-960				960		960
Excess utilities		$	240		240				240
Gross income from weddings, baptisms, and honoraria					4,000				4,000
Ministerial income				$	35,240	$	10,560	$	45,800
Percentage of nondeductible expenses: $10,560 ÷ $45,800 = 23%


Marriage and family booklets	$	87
Business use of car: (459 miles x 37.5¢)		172
Unadjusted Schedule C-EZ expense	$	259
Minus: Nondeductible part of Schedule C-EZ expenses (23% x $259)		-60
Schedule C-EZ deductions (line 2)	$	199

Form 2106-EZ — Employee Business Expense Deduction Computation
	Car expenses for church business: (2,600 miles x 37.5¢)	$	975
	Publications and booklets		219
	Unadjusted Form 2106-EZ expenses (line 1 plus line 4)	$	1,194
	Minus: Nondeductible part of Form 2106-EZ expenses (23% x 1,194)		-275
	Employee business expense deduction — Form 2106-EZ line 6	$	919
None of the other deductions claimed in the return are allocable to tax-free income.

Attachment 2. Attachment to Schedule SE (Form 1040)


	Church wages				$	31,000
	Parsonage allowance–Mortgage		$	9,600
		Utilities		1,200		10,800
	Net profit from Schedule C-EZ					3,801
					$	45,601
Less:
	Schedule C-EZ expenses allocable to tax-free income		$	60
	Ministerial employee business expenses (unadjusted Form 2106-EZ expenses (line 1 plus line 4))			1,194		1,254
	Net Self-Employment Income Schedule SE, Section A, line 2				$	44,347