Are Ministers Employees?

For tax purposes, you may not want to be self-employed. Michael Weber, a United Methodist minister from Stonewall, North Carolina, deducted computer equipment and books as business expenses on his 1988 tax return–under Schedule C, for self-employed workers.

The IRS argued that Weber was a church employee, not a self-employed worker, and so those expenses could be listed only on Schedule A and only if they exceeded 2 percent of his adjusted gross income. A Federal Court judge ruled in favor of the IRS, thus turning Weber (and nearly all of the 20,000 United Methodist clergy supervised by a bishop) from self-employed professional into employee.

The ruling is a landmark case that may affect other denominations. LEADERSHIP asked J. David Epstein, an attorney specializing in tax law for clergy, to discuss the tax implications of filing as a church employee.

For years, many accountants have advised ministers that they should receive 1099s (for self-employed workers) instead of W-2s (for employees). While this may be a radical statement to some folks, in my opinion the 1099 strategy is flawed:

* It greatly raises your risk of being audited–by perhaps four or five times. From discussions I have had with an IRS official, I believe that ministers who use a 1099 rather than a W-2 are going to face a greatly stepped-up audit rate, and they will be targeted for more detailed audits.

In fact, the IRS has already developed an “audit technique guide” for ministers (and certain other professions) and may be selecting some clergy returns for the Taxpayer Compliance Measurement Program. The TCMP audits certain returns line by line. By using a W-2 you bypass this increased risk.

* Use of a 1099 limits or cuts off some benefits you could otherwise receive, such as medical expense reimbursements.

* With a W-2, you can use voluntary withholding, and have the church pay all your income taxes as a taxable fringe benefit. While you pay tax on the benefit, it’s a lot cheaper than paying the tax itself. This strategy, when set up correctly in conjunction with an accountable reimbursement plan and other tax-free fringe benefits, will result in the lowest tax due on the minister’s return and the lowest chance of any IRS challenge.

Some ministers believe they are giving up their independence by receiving a W-2 as a church employee. In my view, you are actually gaining freedom from IRS challenges, and your tax bill is likely to go down.

While 1099s have a place in reporting honorariums for guest speaking or other services, the use of a 1099 for a minister’s regular salary, in my view, raises the potential for tax problems.