Self-employment Tax

One of the unique tax rules that applies to pastors is that they are always self-employed for Social Security with regard to services performed in the exercise of their ministry. This is true even if they report their income taxes as employees. This means that pastors pay the so-called "self-employment tax" rather than "Social Security" and "Medicare" taxes paid by employees.

It is helpful to review how Social Security benefits are financed. In general, benefits are financed through two tax systems. Employees pay “Social Security” and “Medicare” taxes, which comprise 7.65% of an employee's wages. Employers match this amount, meaning that a total of 15.3% is paid for each employee. Self-employed persons pay the “self-employment tax,” which is 15.3% of net self-employment earnings. In other words, self-employed persons pay the same tax rate that is split between employers and employees. While self-employed persons receive special deductions to minimize the impact of this rule, they still pay substantially more than employees.

As noted before, pastors always are treated as self-employed for Social Security purposes with respect to service performed in the exercise of ministry. This means that they never pay “Social Security” or “Medicare” taxes with respect to such services. Rather, they pay the full self-employment tax (15.3%) — unless they have filed a timely application for exemption from self-employment taxes and have received written approval of their exemption from the IRS.

Because pastors pay far more self-employment taxes than the Social Security and Medicare taxes paid by a non-ministerial employee earning the same amount of income, many churches seek to reduce or eliminate the effect of this unfair treatment by paying some or all of their pastor's self-employment tax. In fact, research indicates that over half of all churches pay some or all of their senior pastor's self-employment tax. This is a very common fringe benefit, and so pastors and church treasurers should be familiar with the tax consequences of such an arrangement.

However, note that churches that agree to pay "half" of their pastor's self-employment taxes will have difficulty making this calculation since it will not be clear what “half” of their pastor's self-employment taxes will be until the pastor completes a Form 1040 following the end of the current year. Churches wanting to pay a specified portion of a minister’s self-employment tax should consider paying a fixed amount rather than “half” of the total self-employment tax liability. This will avoid the complexities involved in calculating “half” of a minister’s self-employment tax.

While it is perfectly appropriate for a church to pay some or all of a pastor's self-employment tax, church leaders should understand that any amount paid by the church must be treated as taxable income to the pastor. This means that any amount of a pastor's self-employment taxes paid by the church must be reported on the pastor's W-2, and the pastor must report this amount as taxable income on Form 1040.

The IRS addressed this very question in a ruling in which it concluded, "To the extent that the church pays any amount toward the minister's obligation for income tax or self-employment tax other than from the minister's salary, the minister is in receipt of additional income that is includible in his gross income and must be considered in determining his income tax and self-employment tax liability." IRS Publication 517 gives ministers the following advice, "If a church pays any amount toward your obligation for your income tax or self-employment tax, other than by withholding the amount from your salary, this amount is additional income to you and must be included in your gross income and self-employment income.”