Taxable income (Federal and Social Security) The following are various types of income commonly found on a priest s tax filing:

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1 Diocese of Madison Policy for Priest Compensation Taxable income (Federal and Social Security) The following are various types of income commonly found on a priest s tax filing: A. Salary and Supplements All priests within the diocese have a base salary as promulgated by the Bishop of Madison. Any additional payments such as a Social Security Supplement are also taxable. A priest pays Federal income tax and Social Security tax on salary and salary supplements. B. Allowances: Car, Meal, and Education Allowances such as car, food, and education allowances represent additional salary and are taxable income to the recipient (priest). Clergy are commonly paid for certain expenses they incur in the course of performing their duties. The kinds of expenses that are commonly paid are travel, meals, entertainment, lodging, meeting registrations, and continuing education. Priests should receive an IRS Form W-2 from his residence parish reporting his taxable income, which includes salary, stipends, Social Security supplement, and the meal, car and education allowance. (Exception to Form W-2 - Religious Society Priests - please contact the Department of Parish and School Financial Services for these exceptional cases). Payments for business expenses are included in a priest s taxable income (on their IRS Form W-2) unless the payments are made through an accountable reimbursement plan. An accountable plan is one that: (1) Reimburses only those expenses that are substantiated, within 60 days of the expense being incurred, as to the amount, date, place, and business purpose of the expenses, and (2) Requires any excess reimbursements (reimbursements exceeding substantiated expenses) to be returned within 120 days. If a priest is paid a monthly allowance for travel, continuing education, or the like, but is not required to account for his expenses as indicated above, then the amounts paid must be added to his taxable income on IRS Form W-2, Box

2 C. Mass Stipends (Mass offering by a parishioner or other for loss of loved one or special intention) and Help-Out Fees When a payment is received by a priest for saying a Mass, it is the result of a performance for service rendered. Therefore, Mass stipends are earnings, subject to Federal and Social Security tax. Help-out fees are defined as an amount paid to a priest who is not assigned to a parish and/or celebrates Mass for a nearby parish. This includes hearing confessions, celebrating Mass, and any other service rendered in which a priest receives compensation (except for honoraria or stole fees see below). Like Mass stipends, help-out fees and weekend assistance are earnings subject to Federal income tax and Social Security tax. Parishes are required to issue Form MISC to priests who are not assigned to the parish and are paid help-out fees and Mass stipends of $600 or more in total during a calendar year. If a priest does not receive Form 1099-MISC for help-out fees and Mass stipends, he is responsible for reporting those amounts on his personal income tax return. However, standard mileage rate reimbursements paid to visiting priests are not subject to Federal income or Social Security tax. D. Honoraria (Stole) Fees (for services performed in his ministry: baptism, funeral, wedding, and speaking engagements) When a priest receives fees for the above services, and the parish allows him to retain the fees, it represents earnings subject to Federal and Social Security tax. If these fees are retained by the parish, then there would be no reporting of income, because the priest does not have constructive receipt. If priests receive the stole fees directly, parishes will have no amounts to report. If priests remit the stole fees to the parish and receive a portion of the stole fees back, then parishes should report these earnings on IRS Form W-2, Box 1. E. Professional Fees Professional fees are those classified as income earned for services performed outside normally assigned duties. Professional income usually comes from particular training or outside education which a priest acquired through extended education. Priests usually have a regular salary from a parish; in addition, they may be called to provide expertise in another area, such as in canon law. Usually, income arising from this specific expertise is paid on an outside contractor basis in which an IRS Form 1099-MISC would be issued. 22.2

3 F. Non-Ministry Related Earnings Non-ministry related earnings are those earnings which are from non-ministry work. When a priest performs services for an organization other than the Church or its agencies, those services may be subject to the same tax rules as wages earned by lay employees. A common non-ministry related earnings example would be a priest working for a college. The college would pay him for his services as a teacher and his paycheck would have Federal, State, and Social Security (FICA) taxes withheld. G. Value of Room and Board The fact that a parish can compensate a priest by providing him with tax-free housing is a major benefit. It is a limited benefit to only two classes of taxpayers, those being ordained clergy and military personnel. Although the value of a priest s housing, including room and board, is supposed to be free from income tax(es), it is not free from Social Security taxes, unless the priest is exempt form the Social Security system. Please note, all Diocese of Madison priests are required to be enrolled in the Social Security System, and therefore would be eligible for Medicare at the appropriate age. Further, room and board, or portions of it, can be subject to income taxes under certain circumstances, if it is not properly documented and paid. A minister s housing allowance, sometimes called a parsonage allowance or a rental allowance, is excludable from gross income for income tax purposes but not for self-employment tax purposes. If you are a minister and receive as part of your salary (for services as a minister) an amount officially designated as a rental allowance, you can exclude from gross income the lesser of the following amounts: the amount actually used to provide or rent a home the fair market rental value of the home (including furnishings, utilities, garage, etc.) the amount officially designated (in advance of payment) as a rental or housing allowance, or an amount which represents reasonable pay for your services The payments must be used in the year received. If, instead of a housing allowance, your congregation furnishes housing in-kind as pay for your services as a minister, you may exclude the value of the housing from income for income tax purposes, but you must include the fair market rental value of the housing in net earnings from self-employment for self-employment tax purposes. 22.3

4 The board (meals) portion is subject to specific qualifications for the IRS to consider it a tax-free benefit. There are three main requirements for tax-free status of board : 1. The meals must be consumed on the premises of the parish Meals mean meals -- not groceries and not a cash food allowance. On the premises of the parish simply means a rectory (or equivalent) -- not a private residence. 2. The meals are for the convenience of the parish This means there must be a bona-fide business reason for the priest to dine at the rectory. If the reason is that he is on call, then he should establish he answers such calls and that he can reasonably expect to respond to future calls. 3. The meals are required as part of the priest s working conditions This means that the priest has no choice in residence location. He must reside at the designated rectory as part of his assignment. If the priest fails any of the three tests above, the board represents taxable earnings to the priest both for Federal and Social Security tax purposes. Taxable income (Federal, not Social Security) A. Pension Benefits 1. Diocesan benefits Pension benefits are not earnings, according to IRS definition. Therefore, a priest does not pay Social Security tax on pension benefits. Pension benefits constitute income though and are subject to Federal income tax. 2. Social Security Social Security benefits are also not earnings, and therefore a priest does not pay Social Security tax on them. Social Security benefits may be taxed, though, in two other ways: a. Higher income priests -- Priests who earn over $25,000 (including one-half of Social Security benefits) begin to pay Federal income tax on Social Security benefits. b. Priests working and collecting Social Security benefits -- Priests who collect Social Security benefits should be aware that there are limits to the amount they can earn without losing some of their benefits. Earnings, for purposes of this limitation, are income 22.4

5 subject to Social Security tax. Please contact your tax advisor if there are questions. B. Investment and passive income (Interest and Dividend Income) Investment and passive income do not constitute earnings and are, therefore, not subject to Social Security tax but do constitute income subject to Federal income tax. Not all investment and passive income is subject to income tax, due to a variety of special tax rules. Again, please contact your tax advisor for details. Tax-free income A. Gifts Gifts are tax free; however, there is much to debate on what is considered a gift. Donative intent is the key in determining whether a payment is classified as a tax-free gift or as taxable. Tax-free gifts are motivated by love and affection, without regard to past, present, or future services rendered. Gifts, then, include: birthday, anniversary, going-away, and get-well-soon presents. A gift is not tax-deductible by the giver. Gifts paid from the parish funds to the priest are taxable to the priest and should be included as taxable income on IRS Form W-2. Taxable compensation is motivated by the performance of a service. It doesn t matter if a priest does not specify or request an amount and leaves it up to the donor. If the gift is a result of the service performed, it is classified by the IRS as taxable service rendered. Mass stipends are considered compensation for services rendered by the priest and are taxable. B. Reimbursements (with proper documentation) If a parish reimburses a priest after-the-fact, the priest incurs the expense and requests payment from the parish. In this case, the parish must deal with two rules. For the reimbursement to be tax-free: There must be a (business) ministry connection and There must be proper substantiation If a priest incurs an expense which is for the direct benefit of the parish (business connection) and can prove it with a receipt (substantiation), the reimbursement qualifies as a tax-free reimbursement. Sometimes the reimbursement occurs in advance of the expense. For reimbursements made in advance, the parish needs to deal with two more rules in addition to the two aforementioned. For the reimbursement to be tax-free: 22.5

6 Excess amounts must be returned to the parish, and It must occur within a reasonable period of time If a parish gives a priest an advance, the priest must return any amounts not spent, reporting the amounts within 60 days, and returning any unused amounts within 120 days. Failure to comply with the returning of excess amounts will result in taxable earnings to the priest, subject to Federal income tax. 22.6