How does a housing allowance work and who is eligible?

Any ordained minister (as defined by their denomination or elder board) is considered a “Duel Status employee”.  This basically means that they are considered self-employed AND fully employed by the church. That said, an ordained minister is allowed to consider some of their income as a “housing allowance”.  Historically, some churches offered a parsonage, but those are now fairly few and far between.  For the purposes of this discussion, we’re going to assume that this is a standard ordained minister.

Most churches do not dictate the amount that a pastor can consider as housing allowance.  Generally, churches provide the pastor with a total salary (total income or gross compensation) and then allow the pastor to determine how much of that total income is to be considered “housing allowance”.  We actually have a worksheet that the pastor can use to determine the appropriate amount to consider “housing allowance”.

As an example, the church may determine that Pastor Ken’s total income is $75,000.  After Pastor Ken fills out his housing allowance worksheet, he may determine that his annual qualified housing expenses equal $30,000.  The church’s payroll department should be notified that Pastor Ken would like to allocate his total income to be regular wages, salary of $45,000 and housing allowance of $30,000.

The tax side then gets a little complicated.

The regular wages (usually labeled as “clergy wages” by payroll companies) of $45,000 in our example, is subject to income taxes (federal, state, local) and Self-employment tax (Self Employed social security and Medicare tax) while the housing allowance portion $30,000 is exempt from income taxes. However, the housing allowance is considered Self-Employment income and is subject to the Self-employment tax (SECA or Self-employment Contributions Act) currently set at 15.3%. SECA tax is the Social / Medicare tax that applies to self-employed individuals. As mentioned above, pastors are considered duel status – both an employee and self-employed and therefore pay into social security through the SECA tax.  One thing to mention is that for non-ministerial staff, the church will pay ½ of the Social Security / Medicare (FICA) tax while the employee pays the other ½.  However, for ordained ministers, the church is not allowed to pay that employee ½ and therefore the pastor is responsible for the full 15.3%.

The federal income tax is a pay as you go system. The taxes can be paid via payroll withholding or quarterly estimated payments or a combination of both. The bottom line is that both types of taxes discussed above – income tax and self-employment tax – need to be considered and paid throughout the year in order to avoid an underpayment penalty or interest due at the time of completing the tax return or filing for an extension. However, the payroll withholding process based upon an employee exemptions W-4 form only applies to the federal income tax system and will not incorporate a withholding amount related to the self-employment tax. Therefore, we think it is a good idea for pastors to have an additional amount (above the standard income tax table withholding rate) withheld from their paycheck to cover the self-employment tax that they’re likely going to have to pay when they complete their tax return.  If not, it’s imperative that the pastor make quarterly estimated tax payments, otherwise, they will be subject to penalties and interest by the IRS.

Using our example, here is how the taxes are paid ::

Regular “clergy” Wages – $45,000

Federal Income Tax – Withheld from paycheck per pay period

State Income Tax – Withheld from paycheck per pay period

Local / etc. (where applicable) – Withheld from paycheck per pay period

Self-Employment Tax (SECA) – Quarterly estimated payments

Housing Allowance – $30,000

Federal Income Tax – Only paid on the unused portion, quarterly estimated payments

State Income Tax – Only paid on the unused portion, quarterly estimated payments

Local / etc. (where applicable) – Only paid on the unused portion, quarterly estimated payments.

Social Security / Medicare – Not Applicable

Self-Employment Tax (SECA) – quarterly estimated payments

Because this gets very complicated, we always recommend that pastors use a CPA to complete their tax return and determine the appropriate amount of periodic withholding or estimated payments to be made during the year.  Of course, we can always help with this… we do lots of tax returns for pastors!

Hiring Forms

There are two sets of hiring forms:

  1. Hiring form W-9 for contractors.

  2. Hiring forms for regular employees.

Hiring Form W-9 for Contractors:

Form W-9 (request for taxpayer identification number and certificate) is the IRS form that needs to be completed by independent contractors. It is simple and essentially requests the contractor’s taxpayer identification number. Get this form.

For significant contractual jobs, we suggest that you sign an agreement with contractors describing the the work and the compensation arrangement.

Hiring Forms for Regular Employees:

Both part-time and full-time employees need to complete the following forms. These forms should be retained on file for each employee, as they are subject to government inspection at any time.

Form W-4 (employee’s withholding allowance certificate)—Each non-ordained employee must fill out a W-4, which authorizes the employer to withhold funds for federal and state taxes. Get this form.

Form I-9 (employment eligibility verification)—This form requests several forms of identification. Get this form.

State Employee’s Withholding Allowance Certificate—Nine states have no individual income tax on wages (Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington, and Wyoming). For all other states, each employee needs to complete a state withholding form unique to that state. This form is similar to the federal W-4 above. Your payroll processor can assist you in obtaining and completing the form particular to your state.

We encourage employers to have each employee fill out an employee information sheet. This asks for emergency contact info, personal contact info, etc. This is good for keeping a clean database of all your employee’s contact info.

Classifying Workers as an Employee or Independent Contractor

An individual’s classification as an employee or independent contractor determines an organization’s responsibility regarding FICA, income tax withholding, and employer benefit plans.  Misclassification can lead to significant penalties, so it is important to understand the difference.

Independent Contractors

Workers are classified as contractors if:

  • They normally set the order and sequence of work.

  • They set their hours of work.

  • They work for others at the same time.

  • They are paid by the job.

  • They furnish their own tools/equipment.

The following payments are usually classified as contract labor transactions:

  • Honorariums paid to guest speakers.

  • Stipends (periodic payments) made to band members.

  • Honorariums and stipends seldom—if ever—have income tax withheld.

Contract labor payments are made at gross amount with no federal, state, or FICA withholding. It is the contractor’s responsibility to file and pay taxes.

If a contract agreement is for an extended period of time and/or for specific projects, we advise both the employer and the contractor to sign a written agreement describing the nature of the work and the compensation arrangement. A simple Contract Agreement is provided below.

Employees

Workers are classified as employees if:

  • They maintain continuous, standard hours of employment.

  • They are subject to dismissal.

  • They can quit at anytime without penalty.

  • They receive business-expense reimbursements.

  • They must follow the organization’s work instructions.

  • They receive on-the-job training.

  • They receive routine payments of regular amounts.

Generally, the individual is considered an employee if the organization has the legal right to control both the work and how it is done.

When a person is paid as a regular employee:

  • The employer withholds and pays all the necessary employee income taxes as required by the IRS. These taxes include federal income tax, state income tax, and FICA (social security and Medicare taxes).

  • The employer pays employer taxes, including FICA. (Churches are exempt from FUTA (federal unemployment) and SUI (state unemployment insurance) taxes.)

  • Your payroll processor will manage these calculations and transactions.

Full-time employees and part-time employees are defined by the required hours and earned benefits that are unique to each organization. We recommend hiring part-time employees for less than 30 hours per week.  Generally, the government mandates employers to provide comparable health insurance coverage to all employees who work at least 30 hours per week.   Health insurance carriers generally use the 30 hour per week threshold when determining health insurance eligibility as well.

Want to learn more about classifying your workers?  http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Independent-Contractor-Self-Employed-or-Employee

1099's

What is a 1099?

A 1099 is just like a W-2, but it’s for an independent contractor as opposed to an employee. It’s a way of telling the contractor AND the IRS how much the contractor got paid for the year. The IRS then compares the 1099 they get to what the contractor puts on their taxes.

What is the W-9?

A W-9 form is quick and simple. It requests basic information about the contractor that is readily accessible. Most contractors can complete the form on the spot.

If you or your organization is paying someone for any work, rent, or goods, regardless of how often they work or how old they are, have them fill out a W-9 form. Contractors need to complete the W-9 before you pay them.

Do we really need to fill out the W-9?

Yes. Um, it’s the law. We are glad to teach you about these issues prior to any legal consequences, and that’s part of our role in serving you. But here’s the bottom line: your people need to fill out the W-9s so your organization can be in compliance with the law. (The IRS isn’t always as kind as we are.)

Can’t we do it under the table?

Ummm… NO! We get the idea behind this. But in order to act with integrity, it is your responsibility to follow through with the laws related to paying people. An organization cannot maintain integrity if they are willing to assist people in avoiding taxes. It’s that simple: be honest.

But my child is only 16.

The IRS is not concerned with how old your honor student is. They want you to fill out the form.

But I am doing a favor to this business by not reporting my income.

If you’d like to help them out, then volunteer your time. Then they won’t have to pay you. But since they are paying you, go ahead and fill this out the form so can you get your money. It really is that simple.

But I am only going to do this job (project, whatever) once.

Think you have a short-term contractor? They’re not planning to do this task more than once? We can offer you loads of examples of how that statement was actually the beginning of a great relationship. The person will likely do the work once, and then word will spread about how great they are. They will start getting calls from other locations, departments, etc., and before you know it, they have passed the $600 threshold. Suddenly, you’ll be caught up during a busy time of year, and you’ll still have to track them down to get this form filled out. Just go ahead and have them fill it out now. ‘Cause they might be one stellar contractor who will turn out to make some serious cash.

Is there any way to work around this?

You can attract more volunteers! Perhaps you are paying someone to do tasks that could be completed by a volunteer instead? When people are looking to get involved and connected, they are willing to help out. As you broaden your volunteer base, you’ll have less W-9 forms to complete and less 1099′s to send.

By the way, paying someone in cash to avoid the W-9 is a no-go.

If you really want to skip this, then the other legal option is to withhold 28% of the payment, then fill out the W-4 form, add them to payroll, pay payroll taxes on them, and submit it that way. This seems like a poor option since the [now] employee will lose a large chunk of pay up front, and in the end, there is still a form to fill out.

Be smart. Fill out the W-9. Have we proved our point yet? ☺

When is the 1099 required?

ALL individuals not on payroll are subject to 1099 reporting.

Corporations with “Inc” in their name are NOT subject to 1099.

A company that has “LLC” in their name MUST fill out a W-9. They may (or may not) be subject to a 1099, but the only way for us to know is if they fill out the W-9.

A company that does not have “Inc” in their name could be a sole proprietor, and the company IS subject to 1099.

All legal fees ARE subject to 1099.

1099’s will only be issued when total payments for the year exceed the IRS threshold (currently $600).

When will the IRS get involved?

The IRS gets involved when the contractor makes $600 or more. At that point, the payroll provider (or accounts payable person) fills out a 1099 form and sends it to the contractor and the IRS. That contractor will then comply with the tax liability that is relevant to his/her situation.

Per IRS regulations, all of the 1099 forms must be submitted in a batch—all the forms at once. So, if your organization is late with your 1099 (they are due 1/31), you must pay a penalty to the IRS – per form! – even though it might have been only one W-9 holding it up. So, nobody wants to spend the month of January trying to track down W-9’s for a whole year of payments. It’s best to get the W-9 BEFORE you pay the contractor! Make it a requirement… Don’t pay any contractors until you receive a W9.