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Should I Report My
Income Taxes as an Employee or as Self-Employed?
Introduction
We now focus on the issue of employed status for income tax purposes.
Executive Summary
Most ministers should report their federal income taxes as
employees, because they will be considered employees under the tests
currently used by the IRS and the courts. Most clergy will be “better
off” reporting as employees, since (1) the value of various fringe
benefits will be excludable, including the cost of employer-paid health
insurance premiums on the life of the minister, (2) the risk of an IRS
audit is lower, and (3) reporting as an employee avoids
the additional taxes that often apply to self-employed
mnisters audited by the IRS and reclassified as employees.
Lesson
There are two ways for a minister
to report federal income taxes—as an employee or as a self-employed
person. What difference does it make, and which way should a minister
report? These are the issues addressed in this lesson for new ministers.
What difference does it make?
Whether ministers
should report their federal income taxes as an employee or as
self-employed, is a very good question for many reasons, including the
following:
(1) Reporting compensation.
Employees report their compensation on Form 1040 (line
7—wages). Self-employed persons report income and
expenses on Schedule C.
(2)
Adjusted gross income is higher for ministers who report their income
taxes as employees if they have unreimbursed or “nonaccountable”
reimbursed business expenses since these expenses are "below the line"
deductions that are claimed after adjusted gross income is computed.
Self-employed persons deduct business expenses in computing adjusted
gross income.
(3) W-2 or 1099? Ministers working
for a church should receive a Form W-2 each year if
they are employees, and a Form 1099-MISC if they are self-employed (and
receive at least $600 in compensation).
(4) Tax treatment of
fringe benefits. A few fringe benefits provided by the church to the minister are excludable from the minister’s income if he is an employee.
this would include things like medical insurance premiums paid by
the church; group term life insurance (up to
$50,000) provided by the church; amounts payable
to employees as sick pay, covering illness, accident, or disability; employer-sponsored “cafeteria plans”
providing employees the right to choose between receiving cash in lieu
of a variety
of fringe benefits.
(5) Audit risk. Self-employed
persons face a much higher risk of having their tax returns audited.
IRS data reveals that the their is less risk of under-reporting of
income from self employed parties than employees.
(6) You can be
reclassified by the IRS as an employee. Ministers who report their federal income
taxes as self-employed face a significant risk of additional taxes and
penalties if, after being audited by the IRS they are reclassified as employees.
This is because many ministers who report as self-employed deduct their unreimbursed expenses on Schedule C. If they are reclassified by the IRS as
employees, their business expense deduction will be allowable only as an
itemized deduction on Schedule A.
The primary disadvantage of
employee status is that most business expenses are deductible only as
itemized deductions on Schedule A (if you can't itemize them, you can't
deduct them), and they are deductible
only to the extent that they exceed 2% of adjusted gross income. But,
this “disadvantage” can be overcome simply by having your employing
church adopt an accountable reimbursement policy under which the church
reimburses you for those business expenses that you periodically
substantiate.
Employee or Self-Employed—What
Difference Does it Make?
|
Issue |
If an employee |
If self-employed |
How to decide if a
worker is an employee or self-employed |
|
social security |
• employer and
employee each pay FICA tax of 7.65% of employee wages (total tax of
15.3%)
• ministers are never employees with regard to their
ministerial duties (they do not pay FICA taxes)
• nonminister
church workers who are employees for income taxes are employees for
social security (unless church filed a timely waiver from FICA
taxes--in which case they are treated as self-employed for social
security) |
• pay 15.3%
self-employment tax
• use Schedule SE
(Form 1040)
• ministers
always are self-employed with regard to their ministerial duties
• nonminister
church workers who are self-employed for income taxes are
self-employed for social security |
use income tax tests |
|
income taxes |
• wages reported
by employer on W-2
• wages reported
by worker on line 7 (Form 1040)
• unreimbursed
and nonaccountable reimbursed expenses are deducted on Schedule A
(subject to 2% floor)
• low audit
risk
• some fringe
benefits (such as employer paid medical insurance premiums and
cafeteria plans) tax-free |
• income reported
by employer on 1099
• wages reported
by worker on Schedule C and line 12 (Form 1040)
• unreimbursed
and nonaccountable reimbursed expenses are deducted on Schedule C
• higher audit
risk
• some fringe
benefits (such as employer paid medical insurance premiums and
cafeteria plans) are taxable
• church issues
1099 (if annual compensation is $600 or more) |
IRS applies a 20 factor test, the Tax Court has
adopted various tests?all focus on the degree of "control" exercised
by the employer over the details of how the worker performs his or
her job |
Employee or self-employed?
The IRS and the courts have
a large number of tests to determine whether a minister is
an employee or self-employed for federal income tax reporting purposes.
However, there are three simple rules that will resolve most cases.
• Senior ministers employed by a
multi-staff church will almost always be treated as employees by the IRS
for federal income tax reporting purposes.
• Associate ministers (e.g.,
youth, music) will almost always be treated as employees by the IRS for
federal income tax reporting purposes.
• Ministers who are the
only paid worker at smaller churches may be self-employed for federal
income tax reporting purposes depending on the level of control
exercised by the church board or congregation over how they perform
their duties.
For those of you wanting a more
detailed explanation, a table summarizes every IRS and court ruling
addressing this issue.
Are Ministers Employees or
Self-Employed for Federal Income Tax Reporting Purposes? A Summary of
All Cases and Rulings
|
Case |
Test |
Conclusion |
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IRS Letter Ruling 9825002 (1998) |
applied 7 factor test adopted in the Weber case (see
below) |
denominational official was an employee |
|
Alford v. United States, 116 F.3d 334 (8th Cir. 1997) |
(1) the hiring party's right to control the manner
and means by which the product is accomplished; (2) the skill
required; (3) the source of the instrumentalities and tools; (4) the
location of the work; (5) the duration of the relationship between
the parties; 6) whether the hiring party has the right to assign
additional projects to the hired party; (7) the extent of the hired
party's discretion over when and how long to work; (8) the method of
payment; (9) the hired party's role in hiring and paying assistants;
(10) whether the work is part of the regular business of the hiring
party; (11) whether the hiring party is in business; (12) the
provision of employee benefits |
Assemblies of God minister who served as sole
employee of a small church was self-employed |
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Radde v. Commissioner, T.C. Memo. 1997?490 (1997) |
applied 7 factor test adopted in the Weber case (see
below) |
Methodist minister was an employee |
|
Greene v. Commissioner, T.C. Memo. 1996?531 (1996) |
applied an 8 factor test, which included all 7
factors in the Weber case (see below), plus an inquiry into whether
fringe benefits provided by the employer are "typical" of those
provided to employees |
Assemblies of God foreign missionary was
self-employed |
|
Weber v. Commissioner, 103 T.C. 378 (1994), aff'd 60
F.3d 1104 (4th Cir. 1995) |
(1) the degree of control exercised by the employer
over the details of the work; (2) which party invests in the
facilities used in the work; (3) the opportunity of the individual
for profit or loss; (4) whether or not the employer has the right to
discharge the individual; (5) whether the work is part of the
employer's regular business; (6) the permanency of the relationship;
(7) the relationship the parties believe they are creating |
Methodist minister was an employee |
|
Shelley v. Commissioner, T.C. Memo. 1994?432 (1994) |
applied 7 factor test adopted in the Weber case (see
above) |
Pentecostal Holiness minister was self-employed |
|
IRS Letter Ruling 9825002 (1998) |
applied 7 factor test adopted in the Weber case (see
above) |
denominational official was an employee |
|
IRS Letter Ruling 9414022 (1994) |
applied the 20 factor test of Revenue Ruling 87-41:
(1) employees must comply with employer instructions; (2) employees
more likely to be trained; (3) employees' work is integral part of
employer's business; (4) self-employed workers hire and pay
substitutes; (5) self-employed workers hire and pay assistants; (6)
employees have continuing relationship with employer; (7) employees
work set hours; (8) employees more likely to work full time; (9)
employees do work on employer's premises; (10) employees do work in
sequence set by employer; (11) employees submit oral or written
reports; (12) employees paid by hour or week, self-employed by the
job; (13) employees more likely to have business expenses reimbursed
by employer; (14) self-employed provide their own tools and
materials; (15) employees use equipment and facilities provided by
employer; (16) self-employed may realize profit or loss; (17)
self-employed work for more than one employer at same time; (18)
self-employed advertise their services to the public; (19) employees
can be dismissed; (20) employees can quit at any time
|
youth minister was an employee |
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IRS Letter Ruling 8333107 (1983) |
applied the "common law" employee test in the income
tax regulations, which states that "generally the relationship of
employer and employee exists when the person for whom services are
performed has the right to control and direct the individual who
performs the services, not only as to the result to be accomplished
by the work but also as to the details and means by which that
result is accomplished" |
associate minister was an employee |
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