Publication 517 (2007), Social Security and Other Information for Members of the Clergy and Religious Workers

Publication 517 - Main Contents

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 (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, for social security tax purposes, you are considered a self-employed individual in performing your ministerial services, 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. Depending on all the facts and circumstances, under common-law rules you are considered either an employee or a self-employed person. 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 any of the FICA tax.

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 by Church To Exclude Their 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 2007-1, which is published in Internal Revenue Bulletin 2007-1.

You can read this Revenue Procedure at most IRS offices or at www.irs.gov/irb/2007-01_IRB/ar06.html.

To subscribe to the Bulletin, you can order it on the Internet at http://bookstore.gpo.gov/collections/subscriptions/index.jsp. 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 by Church To Exclude Their 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 during the tax year, you must pay SE tax on those wages.

Churches and church organizations make this election by filing two copies of Form 8274. 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	Members of Recognized Religious Sects
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 nonprofit 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 U.S. Virgin Islands, Guam, the CNMI, and American Samoa. If you are a resident of one of these U.S. possessions but not a U.S. citizen, for SE tax purposes you are treated the same as a citizen or resident alien of the United States. For information on figuring the tax, see Self-Employment Tax: Figuring Net Earnings, 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.

Generally, 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, Revocation of Exemption From Self-Employment Tax for Use by Ministers, Members of Religious Orders, and Christian Science Practitioners, 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 self-employment 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 2 years came from your services as a:

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

The 2 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 2007, has net self-employment earnings of $450 in 2007 and $500 in 2008. He must file his application for exemption by the due date, including extensions, for his 2008 income tax return. However, if Rev. Jaeger does not receive IRS approval for an exemption by April 15, 2009, his SE tax for 2008 is due by that date.

Example 2.

Rev. Louise Wolfe has $300 in net self-employment earnings as a minister in 2007, but earned more than $400 in both 2006 and 2008. She must file her application for exemption by the due date, including extensions, for her 2008 income tax return. However, if she does not receive IRS approval for an exemption by April 15, 2009, her SE tax for 2008 is due by that date.

Example 3.

In 2005, Rev. David Moss was ordained a minister and had $700 in net self-employment earnings as a minister. In 2006, he received $1,000 as a minister, but his related expenses were over $1,000. Therefore, he had no net self-employment earnings as a minister in 2006. Also in 2006, he opened a book store and had $8,000 in net self-employment earnings from the store. In 2007, he had net earnings of $1,500 as a minister and $10,000 net self-employment earnings from the store.

Rev. Moss had net earnings from self-employment in 2005 and 2007 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 2007 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 2004, had $400 or more in net self-employment earnings as a minister in both 2004 and 2007. She files an application for exemption on February 19, 2008. If an exemption is granted, it is effective for 2004 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 on both your wages and self-employment income.

Exception. If you received social security benefits or payments, or anyone else received these benefits or payments based on your wages or self-employment 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 below 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 self-employment 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.

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.

If you have an approved exemption from SE tax and for some reason that approved exemption ended, you must file a new Form 4029 if you subsequently meet the eligibility requirements, discussed earlier. See Effective date of exemption, below, for information on when the newly approved exemption would become effective.

If you have a previously approved exemption from SE tax and you change membership to another recognized religious sect, without any change to your eligibility requirements, then you do not need to file a new Form 4029.

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. For example, if you meet all eligibility requirements and file Form 4029 by January 31, 2008, and your exemption is approved, it will become effective on April 1, 2008.

The exemption 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 Requesting Exemption—Form 4361, 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, enter “Form 4029” in the box marked “Other.” Do not make any entries in boxes 3, 4, 5, or 6.

Forms 941, 943, and 944. If both you and your employee have received approved Forms 4029, do not include these exempt wages on Form 941, Employer's QUARTERLY Federal Tax Return; Form 943, Employer's Annual Federal Tax Return for Agricultural Employees; or Form 944, Employer's ANNUAL Federal Tax Return.

On Form 941, check the box on line 4 and enter “Form 4029” in the empty space below the check box.

On Form 943, enter “Form 4029” to the right of the wage entry spaces on lines 2 and 4.

On Form 944, check the box on line 3 and enter “Form 4029” in the empty space below the check box.

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 self-employment income.

The following discussions provide more detailed information on qualified services of ministers, 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 (including the religious boards, societies, and other integral agencies of such organizations) 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 and Medicare tax withholding (not self-employment tax) under the rules that apply to employees 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, those 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 a qualified service.

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 employees 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.

Pat Brown and Chris 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.

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

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

Pat's services are not duties required by the order. Her earnings are subject to social security and Medicare tax under FICA and to federal income tax.

Chris' services are considered duties required by the order. He is acting as an agent of the order and not as an employee of a third party. He 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.

Self-Employment Tax: Figuring Net Earnings

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.
Nonfarm optional method.

You may find Worksheets 1 through 4 helpful in figuring your net earnings from self-employment. Blank worksheets are in the back of this publication, after the Comprehensive Example .

Regular Method

Most people use the regular method. Under this method, 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, subtract your allowable business deductions and multiply the difference by 92.35% (.9235). 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 92.35% (.9235). Do not reduce your wages by any business deductions when making this computation. Use Schedule SE (Form 1040), Section B, 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.

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 $39,000 as a full-time minister. The $39,000 includes $5,000 that is designated as a rental allowance to pay utilities. His church owns a parsonage that has a fair rental value of $12,000 per year. Pastor Adams is given the use of the parsonage. He is not exempt from SE tax. He must include $51,000 ($39,000 plus $12,000) 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 $51,000 of which $17,000 ($5,000 plus $12,000) 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 serving abroad and living in a foreign country.

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

Example.

Paul Jones was the minister of a U.S. church in Mexico. He earned $35,000 in that position and was able to exclude it all for income tax purposes under the foreign earned income exclusion. However, Mr. Jones must include $35,000 when figuring net earnings from self-employment.

Specified U.S. possessions. The exclusion from gross income for amounts derived from American Samoa or Puerto Rico does not apply in computing net earnings from self-employment. Also see Residents of Puerto Rico, the U.S. 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), Section A, line 2, or Section B, line 2. Attach an explanation.

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 all three of the 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 and report the combined total in box 1 of your Form W-2. You can deduct your related expenses (for SE tax 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 self-employment 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 self-employment income of the spouse having the agreement.

Maximum Earnings Subject to SE Tax

For 2007, the maximum net earnings from self-employment subject to social security (old age, survivors, and disability insurance) tax is $97,500 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	Two-thirds of your gross nonfarm income.
More than $2,400	$1,600.

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

More information. For more information on the nonfarm optional method, see Publication 334 and the Schedule SE (Form ) instructions.

Income Tax: Income and Expenses

Some income and expense items are treated the same for both 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, earnings 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 Self-Employment Tax: Figuring Net Earnings.

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 salary 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 earnings. 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. The church allows her to use a parsonage that has an annual fair rental value of $24,000. The church pays her an annual salary of $67,000, of which $7,500 is designated for utility costs. Her actual utility costs during the year were $7,000.

For income tax purposes, Rev. Baker excludes $31,000 from gross income ($24,000 fair rental value of the parsonage plus $7,000 from the allowance for utility costs). She will report $60,000 ($59,500 salary plus $500 of unused utility allowance). Her income for SE tax purposes, however, is $91,000 ($67,000 salary + $24,000 fair rental value of the parsonage).

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

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 salary,
The fair rental value of the home plus utilities, or
The amount actually used to provide a home.

Include in the total on Form 1040, line 7. On the dotted line next to line 7, enter “Excess allowance” and the amount.

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. However, these expenses can be deducted only as itemized deductions on Schedule A (Form 1040).

Retired ministers. If you are a retired minister, you can 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. In Publication 525, see Faculty lodging in the discussion on meals and lodging under Fringe Benefits .

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.

Earnings—Members of Religious Orders

Your earnings 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 earnings for services performed as an agent of the order and in the exercise of duties required by the order, and
Renounces the earnings and gives them 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.

However, any of your employee business expenses that are allocable to tax-free income will not be deductible (discussed next).

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 (tax-free) portion of expenses related to Rev. Ashford's ministerial salary is figured as follows:

($10,000 ÷ $40,000) x $3,500 = $875

The nondeductible (tax-free) 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 attachments prepared for the Comprehensive Example, later. Following the example, you will find blank worksheets for your own use.

Health Insurance Costs of Self-Employed Ministers

If you are self-employed, you may be able to deduct the amount you paid in 2007 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 29. See the instructions for Form 1040 to figure your 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 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 6 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, on Form 1040, line 27.

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 wages or salary. However, your salary generally is not subject to federal income tax withholding if both of 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 salary 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 may need to make estimated tax payments 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 SE 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, 2008. 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 chapter 2 of Publication 505, Tax Withholding and Estimated Tax.

If you perform your services as a common-law employee of the church and your salary 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 must file an income tax return for 2007 if your gross income was at least the amount shown in the third column of Table 4.

Table 4. 2007 Filing Requirements for Most Taxpayers

IF your filing status is ...	AND at the end of 2007 you were ...*
single	under age 65 65 or older	$8,750 10,050
married filing jointly***	under 65 (both spouses) 65 or older (one spouse) 65 or older (both spouses)	$17,500 18,550 19,600
married filing separately	any age	$3,400
head of household	under 65 65 or older	$11,250 12,550
qualifying widow(er) with dependent child	under 65 65 or older	$14,100 15,150

* If you were born on January 1, 1943, you are considered to be age 65 at the end of 2007.
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 2007.
*** If you did not live with your spouse at the end of 2007 (or on the date your spouse died) and your gross income was at least $3,400, 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 Self-Employment Tax: Figuring Net Earnings) 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 net earnings subject to SE tax, or
You had wages of $108.28 or more from an electing church or church-controlled organization (see Religious Workers (Church Employees), earlier, under Social Security Coverage).

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, enter “Exempt—Form 4361” on the dotted line next to Form 1040, line 58.

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, enter “Exempt—Form 4029” on the dotted line next to Form 1040, line 58.

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, under Social Security Coverage. This is true even if your compensation 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. Generally, your maximum contribution for 2007 to either of these plans (or to a combination of the two) is the smaller of your taxable compensation, or $4,000 ($5,000 if you are age 50 or older).

However, your contributions to a Roth IRA may be further limited if your adjusted gross income is above a certain amount. Roth IRA contributions are not deductible, but 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 withdrawn.

If you contribute to a traditional IRA, your deduction may be reduced or eliminated if you or your spouse is covered by an employer retirement plan (including, but not limited to, a SEP, SIMPLE, or qualified retirement plan).

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. If you are an employee, your employer may exclude allowable contributions to a 403(b) plan from your income. These contributions will not be included in your total wages on your Form W-2, but you will pay tax on distributions from your plan. Contributions made to a Roth contribution program, however, are not excludable from gross income, but qualified distributions from the plan are tax free.

An exception to the above applies 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 to you, 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 28.
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 36. Enter the amount of your deduction and “403(b)” on the dotted line next to line 36.

Retirement savings contributions credit. You may be able to take a tax credit of up to $1,000 (up to $2,000 if filing jointly) for certain contributions you make to any of the retirement plans or IRAs discussed above. The credit is based on the contributions you make and your credit rate. The credit rate can be as low as 10% or as high as 50%, depending on your adjusted gross income. 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, 1990.
You were a full-time student in 2007.
Someone, such as your parent(s), claims an exemption for you on his or her 2007 tax return.
Your adjusted gross income for 2007 is more than:
1. $52,000, if your filing status is married filing jointly.
2. $39,000, if your filing status is head of household.
3. $26,000, if your filing status is single, married filing separately, or qualifying widow(er) with dependent child.

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 of bona fide residents of American Samoa, and
Income of bona fide residents of 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 wages or salary instead of waiting until after the end of the year.

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

$12,590 or more ($14,590 or more if married filing jointly) and you do not have a qualifying child,
$33,241 or more ($35,241 or more if married filing jointly) and you have one qualifying child, or
$37,783 or more ($39,783 or more if 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 27, 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 (because you 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 compensation.

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 compensation 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 compensation you received for nonministerial duties minus your Form 1040, line 27, amount for one-half of SE tax.

Your net earnings from self-employment include those net earnings from qualified services. See Self-Employment Tax: Figuring Net Earnings, 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 Form 1040, line 7.

More information. For 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 wages or salary, 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 a $650 per month mortgage payment of principal and interest only. He paid $1,800 in real estate taxes for the year on the home. The church paid him $800 per month as his parsonage allowance (excluding utilities). The home's fair rental value for the year (excluding utilities) is $9,840. 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 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. He paid $87 for marriage and family booklets and drove his car 445 miles for business, mainly in connection with honoraria. Rev. Michaels used the standard mileage rate to figure his car expense, as follows.

445 miles × 48.5 cents = $216

These expenses total $303 ($216 + $87). However, he cannot deduct the part of his expenses allocable to his tax-free parsonage allowance.

First, Rev. Michaels uses Worksheet 1 (see page 20) to figure what percentage of his business expenses are not deductible. Then he completes Worksheet 2 (see page 21) to show that 23% (or $70) of his business expenses are not deductible because they are allocable to his tax-free allowance. He subtracts the $70 from the $303, enters the $232 difference on line 2, and adds a note at the bottom of the page to see the attached statement.

Rev. Michaels attaches Worksheets 1 and 2 to his return. This is part of his required statement, Attachment 1 (see pages 20 and 21).

Line 3. He enters his net profit of $3,768 on both line 3 and 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 2,521 business miles, which he reports in Part II. Then, he figures his car expense for his line 1 entry.

2,521 miles × 48.5 cents = $1,223

Line 4. He enters $231 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. After completing Worksheet 3 (see page 21), he finds that $334 (23%) of his employee business expenses are not deductible. He subtracts $334 from $1,454 and enters the result, $1,120, on line 6, adding a note at the bottom of the page about the attached statement. He also enters $1,120 on Schedule A (Form 1040), line 21.

Schedule A (Form 1040)

Rev. Michaels fills out Schedule A as explained here.

Line 6. Rev. Michaels deducts $1,800 in real estate taxes.

Line 10. He deducts $5,572 of home mortgage interest.

Line 16. Rev. and Mrs. Michaels contributed $4,800 in cash during the year to various qualifying charities. Each individual contribution was less than $250 and they have the required records for all donations.

Line 21. Rev. Michaels enters his unreimbursed employee business expenses from Form 2106-EZ, line 6.

Lines 25, 26, and 27. 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 29. The total of all the Michaels' itemized deductions is $12,586, which they enter here and on Form 1040, line 40.

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 and determines that 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, Worksheet 4, on page 22) that explains how he figures the amount ($44,044) to enter.

Line 4. He multiplies $44,044 by .9235 to get his net earnings from self-employment ($40,675).

Line 5. The amount on line 4 is less than $97,500, so Rev. Michaels multiplies the amount on line 4 ($40,675) by .153 to get his self-employment tax of $6,223. He enters that amount here and on Form 1040, line 58.

Line 6. Rev. Michaels multiplies the amount on line 5 by 50% (.5) to get his deduction for one-half of self-employment tax of $3,112. He enters that amount here and on Form 1040, line 27.

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, his excess allowance. 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 $3,768 from Schedule C-EZ, line 3.

Line 27. He enters $3,112, half his SE tax from Schedule SE, line 6.

Line 40. He enters the total itemized deductions from Schedule A, line 28.

Line 52. 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 $1000 credit on line 52.

Line 58. He enters the self-employment tax from Schedule SE, line 5.

Line 64. He enters the federal income tax withheld, as shown in box 2 of his Form W-2 from the college.

Line 65. He enters the $8,400 estimated tax payments he made for the year.

Line 75. He wants to have any overpayment of tax applied to his 2008 estimated tax.

Attachment 1

Attachment 1 (Worksheets 1, 2, and 3) shows the computation of expenses that are nondeductible because they are allocable to tax-free ministerial income and the allowance deductions.

Attachment 2

Attachment 2 (Worksheet 4) shows the computation of net self-employment income.

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Forms W-2, (2) for John E. Michaels

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

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Form 1040, page 2

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Schedule A (Form 1040)

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Schedule C–EZ (Form 1040)

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Schedule SE (Form 1040)

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Form 2106-EZ

Attachment 1—John E. Michaels011-00-2222

Worksheet 1. Figuring the Percentage of Tax-Free Income

Note. For each line, enter the appropriate amount in all boxes that are not shaded.

	Source of Income			(a) Taxable	(b) Tax-free	(c) Total
1	W-2 salary as a minister (from box 1 of Form W-2)	1		31,000		31,000
2	Gross income from weddings, baptisms, writing, lecturing, etc. (from line 1 of Schedule C or C-EZ)	2		4,000		4,000
Note. Complete either lines 3a-3e or lines 4a-4i.
•If your church provides you with a parsonage, complete lines 3a-3e.
•If, instead of providing a parsonage, your church provides you with a rental or parsonage allowance, complete lines 4a-4i.
3a	FRV* of parsonage provided by church	3a
b	Utility allowance, if any	3b
c	Actual expenses for utilities	3c
d	Enter the smaller of line 3b or 3c	3d
e	Excess utility allowance (subtract line 3d from line 3b)	3e
4a	Parsonage or rental allowance	4a	9,600
b	Utility allowance, if separate	4b	1,200
c	Total allowance (add lines 4a and 4b)	4c	10,800
d	Actual expenses for parsonage	4d	9,600
e	Actual expenses for utilities	4e	960
f	Total actual expenses for parsonage and utilities (add lines 4d and 4e)	4f	10,560
g	FRV* of home, plus the cost of utilities	4g	10,800
h	Enter the smaller of line 4c, 4f, or 4g	4h			10,560	10,560
i	Excess allowance (Subtract line 4h from line 4c)	4i		240		240
5	Ministerial income (for columns (a), (b), and (c), add lines 1 through 4i)	5		35,240	10,560	45,800
6	Percentage of tax-free income:	Total tax-free income$10,560 Total income$45,800			=	23%**

*FRV (Fair Rental Value): As determined objectively and between unrelated parties, what it would cost to rent a comparable home (including furnishings) in a similar location.

** This percentage of your ministerial expenses will not be deductible. Use Worksheets 2 and 3 to figure your allowable deductions.

Attachment 1—John E. Michaels011-00-2222 (continued)

Worksheet 2. Figuring the Allowable Deduction for Schedule C or C-EZ Expenses

1	Percentage of expenses that are nondeductible (from Worksheet 1, line 6): 23%
2	Business use of car: 445 miles × 48.5¢ (.485)	2		216
3	Meals and entertainment: $ × 50% (.50)	3
4	Other expenses (list item and amount)
a	Marriage and family booklets	4a	87
b		4b
c		4c
d		4d
e		4e
f	Total other expenses (add lines 4a through 4e)	4f		87
5	Total Schedule C or C-EZ expenses (add lines 2, 3, and 4f)	5		303
6	Nondeductible part of Schedule C or C-EZ expenses (multiply line 5 by the percent in line 1)	6		70
7	Deduction allowed.* Subtract line 6 from line 5. Enter the result here and on Schedule C, line 27, or Schedule C-EZ, line 2.	7		232

* None of the other deductions claimed in this return are allocable to tax-free income.

Worksheet 3. Figuring the Allowable Deduction for Form 2106 or 2106-EZ Expenses

1	Percentage of expenses that are nondeductible (from Worksheet 1, line 6): 23%
2	Use of car for church business: 2,521 miles × 48.5¢ (.485)	2		1,223
3	Meals and entertainment: $____________ × 50% (.50)	3
4	Other expenses (list item and amount)
a	Professional publications and booklets	4a	231
b		4b
c		4c
d		4d
e		4e
f	Total other expenses (add lines 4a through 4e)	4f		231
5	Total Form 2106 or 2106-EZ expenses (add lines 2, 3, and 4f)	5		1,454
6	Reimbursement not included in box 1 of Form W-2	6
7	Total unreimbursed Form 2106 or 2106-EZ expenses (subtract line 6 from line 5)	7		1,454
8	Nondeductible part of Form 2106 or 2106-EZ expenses (multiply line 7 by the percent in line 1)	8		334
9	Ministerial employee business expense deduction allowed.* Subtract line 8 from line 7. Enter the result here and on Form 2106, line 10, or Form 2106-EZ, line 6.	9		1,120

* None of the other deductions claimed in this return are allocable to tax-free income.

Attachment 2—John E. Michaels011-00-2222

Worksheet 4. Figuring Net Self-Employment Income for Schedule SE (Form 1040)

1	W-2 salary as a minister (from box 1 of Form W-2)	1		31,000
2	Net profit from Schedule C, line 31, or Schedule C-EZ, line 3	2		3,768
3a	Parsonage allowance (from Worksheet 1, line 3a or 4a)	3a	9,600
b	Utility allowance (from Worksheet 1, line 3b or 4b)	3b	1,200
c	Total allowance (add lines 3a and 3b)	3c		10,800
4	Add lines 1, 2, and 3c	4		45,568
5	Schedule C or C-EZ expenses allocable to tax-free income (from Worksheet 2, line 6)	5	70
6	Unreimbursed ministerial employee business expenses (from Worksheet 3, line 7)	6	1,454
7	Total business expenses not deducted in lines 1 and 2 above (add lines 5 and 6)	7		1,524
8	Net self-employment income. Subtract line 7 from line 4. Enter here and on Schedule SE, Section A, line 2, or Section B, line 2.	8		44,044

Worksheets

These worksheets are provided to help you figure your taxable ministerial income, your allowable deductions, and your net self-employment income.

Worksheet 1. Figuring the Percentage of Tax-Free Income

Note. For each line, enter the appropriate amount in all boxes that are not shaded.

	Source of Income		(a) Taxable	(b) Tax-free	(c) Total
1	W-2 salary as a minister (from box 1 of Form W-2)	1
2	Gross income from weddings, baptisms, writing, lecturing, etc. (from line 1 of Schedule C or C-EZ)	2
Note. Complete either lines 3a-3e or lines 4a-4i.
•If your church provides you with a parsonage, complete lines 3a-3e.
•If, instead of providing a parsonage, your church provides you with a rental or parsonage allowance, complete lines 4a-4i.
3a	FRV* of parsonage provided by church	3a
b	Utility allowance, if any	3b
c	Actual expenses for utilities	3c
d	Enter the smaller of line 3b or 3c	3d
e	Excess utility allowance (subtract line 3d from line 3b)	3e
4a	Parsonage or rental allowance	4a
b	Utility allowance, if separate	4b
c	Total allowance (add lines 4a and 4b)	4c
d	Actual expenses for parsonage	4d
e	Actual expenses for utilities	4e
f	Total actual expenses for parsonage and utilities (add lines 4d and 4e)	4f
g	FRV* of home, plus the cost of utilities	4g
h	Enter the smaller of line 4c, 4f, or 4g	4h
i	Excess allowance (Subtract line 4h from line 4c)	4i
5	Ministerial income (for columns (a), (b), and (c), add lines 1 through 4i)	5
6	Percentage of tax-free income:	Total tax-free income $ Total income$		=	%**

*FRV (Fair Rental Value): As determined objectively and between unrelated parties, what it would cost to rent a comparable home (including furnishings) in a similar location.

** This percentage of your ministerial expenses will not be deductible. Use Worksheets 2 and 3 to figure your allowable deductions.

Worksheet 2. Figuring the Allowable Deduction for Schedule C or C-EZ Expenses

1	Percentage of expenses that are nondeductible (from Worksheet 1, line 6): %
2	Business use of car: miles × 48.5¢ (.485)	2
3	Meals and entertainment: $ ____________ × 50% (.50)	3
4	Other expenses (list item and amount)
a		4a
b		4b
c		4c
d		4d
e		4e
f	Total other expenses (add lines 4a through 4e)	4f
5	Total Schedule C or C-EZ expenses (add lines 2, 3, and 4f)	5
6	Nondeductible part of Schedule C or C-EZ expenses (multiply line 5 by the percent in line 1)	6
7	Deduction allowed.* Subtract line 6 from line 5. Enter the result here and on Schedule C, line 27, or Schedule C-EZ, line 2.	7

* None of the other deductions claimed in this return are allocable to tax-free income.

Worksheet 3. Figuring the Allowable Deduction for Form 2106 or 2106-EZ Expenses

1	Percentage of expenses that are nondeductible (from Worksheet 1, line 6): %
2	Use of car for church business: miles × 48.5¢ (.485)	2
3	Meals and entertainment: $____________ × 50% (.50)	3
4	Other expenses (list item and amount)
a		4a
b		4b
c		4c
d		4d
e		4e
f	Total other expenses (add lines 4a through 4e)	4f
5	Total Form 2106 or 2106-EZ expenses (add lines 2, 3, and 4f)	5
6	Reimbursement not included in box 1 of Form W-2	6
7	Total unreimbursed Form 2106 or 2106-EZ expenses (subtract line 6 from line 5)	7
8	Nondeductible part of Form 2106 or 2106-EZ expenses (multiply line 7 by the percent in line 1)	8
9	Ministerial employee business expense deduction allowed.* Subtract line 8 from line 7. Enter the result here and on Form 2106, line 10, or Form 2106-EZ, line 6.	9

* None of the other deductions claimed in this return are allocable to tax-free income.

Worksheet 4. Figuring Net Self-Employment Income for Schedule SE (Form 1040)

1	W-2 salary as a minister (from box 1 of Form W-2)	1
2	Net profit from Schedule C, line 31, or Schedule C-EZ, line 3	2
3a	Parsonage allowance (from Worksheet 1, line 3a or 4a)	3a
b	Utility allowance (from Worksheet 1, line 3b or 4b)	3b
c	Total allowance (add lines 3a and 3b)	3c
4	Add lines 1, 2, and 3c	4
5	Schedule C or C-EZ expenses allocable to tax-free income (from Worksheet 2, line 6)	5
6	Unreimbursed ministerial employee business expenses (from Worksheet 3, line 7)	6
7	Total business expenses not deducted in lines 1 and 2 above (add lines 5 and 6)	7
8	Net self-employment income. Subtract line 7 from line 4. Enter here and on Schedule SE, Section A, line 2, or Section B, line 2.	8