The tax law makes certain exceptions for the clergy, but otherwise, the basic rules are the same as they are for any other taxpayer. If you’re a religious leader – for example, a minister, priest, rabbi or imam – any gifts you receive from congregation members are exempt from tax, but amounts that constitute compensation are taxable.
A pastor in a new case, Felton, TC Memo 2018-168, 10/10/18, learned this the hard way.
Background: A licensed, commissioned or ordained minister is generally the common law employee of the church, denomination or organization that employs him or her to provide ministerial services. However, there are some exceptions, such as traveling evangelists, who are considered to be independent contractors.
In either event, all earnings – including wages, offerings and fees received for performing marriages, baptisms, funerals, etc. – are subject to federal income tax. Also, even if a clergy member is a common law employee, amounts received from congregation members are usually treated as self-employment earnings.
Other special rules may apply to amounts paid to men and women of the cloth. For instance, if a congregation provides a housing allowance to its religious leader, the value is generally excluded from tax under Section 107 of the tax code.
In the case at hand, a pastor and his wife established a church in St. Paul, MN, in 2000. The pastor testified at trial that he preached at the church for 13 years without a salary, although the executive board authorized one for him in two of those years.
So what did the couple live on? The facts show they had the following four separate sources of income during the tax years in question:
- Weekly payments by congregation members made to the church that were placed in white envelopes with a designation on the outside that some or all of the money inside was for pastoral compensation;
- Income from counseling and speaking engagements performed through a personal service corporation (PSC);
- A housing allowance; and
- Weekly payments from congregation members made directly to the pastor that were placed in blue envelopes and labeled as “pastoral gifts.”
Eventually, the IRS investigated the couple, who had not filed personal tax returns. They subsequently reported the donations placed in the white envelopes as self-employment income on Schedule C. But they didn’t report the housing allowance as well as about $250,000 in pastoral gifts included in the blue envelopes.
The IRS agreed the housing allowance was exempt from tax, but it challenged the tax treatment for the amounts labeled as pastoral gifts in the blue envelopes. With neither side giving in, the case went to the Tax Court.
Tax gospel: The judge in this matter listed four factors used to distinguish taxable payments from gifts:
(1) Whether the payments were objectively provided in exchange for services;
(2) Whether the minister or church officers specifically solicited the payments;
(3) Whether the payments were part of a routinized and structured program; and
(4) The amounts of the payments compared to the minister’s salary.
Accordingly, the judge ruled that payments were made in exchange for services and were part of a routine and structured program. Additionally, the payments far exceeded the amounts usually paid to ministers for services. Therefore, the “gifts” the pastor received in the blue envelopes counted as taxable compensation.
Moral of the story: No one is above the tax law – not even the clergy. Know all the ins and outs of the rules, or you could be led astray.
About Ken Berry
Ken Berry, Esq., is a nationally known writer and editor specializing in tax, financial, and legal matters. During his long career, he has served as managing editor of a publisher of content-based marketing tools and vice president of an online continuing education company. As a freelance writer, Ken has authored thousands of articles for a wide variety of newsletters, magazines, and other periodicals.