Church hasn't issued W-2

[LindaB]

I have a friend who, with her husband, started a church some years ago. They are both ordained ministers. In the early years she was doing regular W-2s but didn't like to do the 941s. She would go to the local IRS office to get the forms, and when she complained about having to do the quarterly reporting, they (IRS clerks) told her to issue 1099s instead. She is now convinced that pastor income should be reported on 1099s. I think she did 1099s for a few years. For at least 2007 and 2006 she did not do 1099s or W-2s. I think she and her husband are the only ones paid by the church.

I have a reasonable understanding of clergy income, and I've printed some info for her, including some of the recent posts from this message board.

My question is this: Can she do W-2s, including housing allowance, for 2006 and 2007? Or is the housing allowance out, since it was not set up before? I don't do W-2s or 1099s, so I really don't know anything about doing them late.

Thanks for any help!

[RitaB]

Linda, I feel your pain. I'm currently working on two pastors who did not receive W-2's myself. Just finished another one where the church treasurer prepared the W-2, but incorrectly, after me telling her last year to leave boxes 3 and 5 blank, and copying the example from Pub 517 for her.

Yes, it is too late on the housing allowance for 2006, 2007; it must be designated prior to payment. It is not too late to do something for today forward in 2008.

I would not prepare the W-2's for 2006 and 2007, just prepare the returns correctly. That's just me, I'm still feeling whipped, and I would have been more accomodating earlier in my career when I wasn't so jaded. ;-)

There are some great preparers on here that do lots more clergy returns that I. I'm sure you've found a couple of them on searches. I personally think Pub 517 is good. There is a mistake on a worksheet, #3 I think, if your clients file Form 4361.

[MAMalody]

If the only W-2's issued are to clergy, there is no F941 requirement.

As to the preparation of W-2s, I would recommend that proper W-2s be prepared. After all, that is the way is should be done. If they have already issued Form 1099 Misc, then I indicate to them that you can prepare the returns for them using those, however, in 2008 and future years they need to do W-2.

When you prepare the return, report the income on Schedule C and then back it off as

other expense". I usually use a statement like "Reported in error on 1099 Misc, should be W-2 income. See line 7 of Form 1040." Move the income and then prepare the return as if it was W-2 income.

The only thing left on the W-2 should be honorarium type income.

I believe the worksheet #4 is the one with the error in relation to the IRC 265 limitation.

Anyway, this is my two cents.

Mike

[LindaB]

Thanks RCooper and MAMalody.

So far she just gave me the amount paid written on a piece of paper. I started the return as if it were on a W-2 with housing allowance, came up with a balance due and filed an extension. The more I thought about it the more I thought we couldn't do the housing allowance 'after the fact.' I think I'll copy the return and change it so there is no housing allowance, then when I show her the difference maybe I can convince her to do it the right way.

While I was looking for info to print out for her, I found IRS pub. 1828 which I had never seen before. I think it's more intended for the people in churches rather than tax preparers, but there's a lot of good information in it. You guys might want to take a look at it.

Thanks again.

[RitaB]

You're welcome.

Mike is one of the those "most knowledgeable clergy tax return preparers". Listen to what he says.

Yes, I have a copy of Pub 1828; I like it, too!

[MAMalody]

Thanks RCooper and MAMalody.

So far she just gave me the amount paid written on a piece of paper. I started the return as if it were on a W-2 with housing allowance, came up with a balance due and filed an extension. The more I thought about it the more I thought we couldn't do the housing allowance 'after the fact.' I think I'll copy the return and change it so there is no housing allowance, then when I show her the difference maybe I can convince her to do it the right way.

While I was looking for info to print out for her, I found IRS pub. 1828 which I had never seen before. I think it's more intended for the people in churches rather than tax preparers, but there's a lot of good information in it. You guys might want to take a look at it.

Thanks again.

I thought in your first posting that these clients did not have a designated housing allowance. You sentence above makes me think that they simply do not have a W-2 with housing allowance on it. So to cover my bases:

1. Housing allowance is not required to be listed on the W-2. It is simply required to be designated prior to distribution.

2. If you actually, meant that there is no prior designated housing allowance, then you are correct, you do no give them any of the housing allowance benefits, it is all taxable income.

Mike

[RitaB]

I thought in your first posting that these clients did not have a designated housing allowance. You sentence above makes me think that they simply do not have a W-2 with housing allowance on it. So to cover my bases:

1. Housing allowance is not required to be listed on the W-2. It is simply required to be designated prior to distribution.

2. If you actually, meant that there is no prior designated housing allowance, then you are correct, you do no give them any of the housing allowance benefits, it is all taxable income.

Mike

I took it that way, too, Mike, cause Linda said the housing had not been "set up before."

Also, the church didn't issue anything (no 1099, no W-2, no nuttin') for 2006, 2007 which also made me assume, perhaps wrongly, that no housing allowance had been designated. As I look at it from another point of view, I could be wrong.

I will be encouraging my two pastors' churches (both new clients, both needed extenstions, etc.) that didn't do W-2's to prepare the W-2's going forward. I will even show them how to prepare the W-2's. Didn't want to leave the impression that I was not concerned with doing things properly. When I read my earlier post, it kinda looks that way.

[Daune/CA]

They need to have the church accept a reimbursement policy to cover their expenses, and then those are not shown on the W-2 or 1099. If filing to take these expenses on the Sch A, they would lose 2% of AGI as non-deductible expenses. Also, elect to have some of salary designated as Furnishings Allowance, when doing the Housing Allowance.

[OldJack]

As to the preparation of W-2s, I would recommend that proper W-2s be prepared. After all, that is the way is should be done. ..........however, in 2008 and future years they need to do W-2.

Anyway, this is my two cents.

Mike

I think Mike and I have disagreed before on this issue of pastors being issued W2's instead of 1099's. If the pastor agrees that he is an employee of the church, then I would issue a W2. However, many pastors do not count themselves as employees. I know the IRS publications read as though a W2 should be issued but that is not a requirement if the pastor does not meet the employee definition. I cite the famous case of James T. Alford and Freda Alford in the United States Court of Appeals FOR THE EIGHTH CIRCUIT, No. 96-3287. The Alfords were ordained ministers of the Assemblies of God Church. The IRS declared them employees and the 8th circuit court of appeals in 1997 determined they were not. This case was also because the Alfords had business expenses to deduct on Sch-C that the IRS was disallowing as a result of employee status.

[JohnH]

This is a conversation I've had with clergy members from time-to-time, and I believe there's a chance those who insist on using Schedule C may someday find that they shot themselves in the foot on this issue. If there continues to be controversy over their dual status, at some point Congress might step in and clarfiy the issue. If than happens and everything goes on the table, an unfortunate side effect could be the elimination of the tax-favored treatment of the H&U allowance as a part of the process, and possibly loss of the ability to treat retirement contributions as pre-tax benefits. Given that for most ministers the value of these benefits far outweighs the ability to use Schedule C, and since a properly documented accountable reimbursement plan completely negates the benefits of using Schedule C anyhow, they could easily find themselves winning the battle but losing the war.

When I encounter a minister who wants to focus on using Schedule C for reporting their primary source of income, I encourage them to spend their time more constructively. First they should be sure their H&U allowance is set well above their actual requirements, and secondly they should work with their Finance Committee to establish an accountable plan, even if it means a salary reduction of approximately the same amount. Thinking about the potential downside, I do everything I can to discourage their even thinking in terms of Schedule C, except for honoraria and other related secondary income sources.

[OldJack]

When I encounter a minister who wants to focus on using Schedule C for reporting their primary source of income, I encourage them to spend their time more constructively.

That is a ridiculous statement or tax position. I suppose you also encourage all self-employed taxpayers to go get themselves a job? :wacko:

[JohnH]

Jack: No, I don't think it's ridiculous at all. Clerrgy enjoy a special tax status that is very unique among all other self-employed persons. Part of being a professional is properly applying the ability to make distinctions. I know from many of your posts that you have that ability, so I'd expect you to use it with clergy in the same manner you'd use it with any other special class of taxpayer.

But thanks for the other suggestion. Now that I actually think about it, I have SOME Schedule C clients that I should be encouraging to get a real job. I may start working on that angle next tax season.

[OldJack]

Jack: No, I don't think it's ridiculous at all. Clerrgy enjoy a special tax status that is very unique among all other self-employed persons. Part of being a professional is proeprly applying the ability to make distinctions.

Part of being a tax professional is properly preparing and representing the taxpayers position. It is not the tax professionals place to oppose the taxpayers position unless it is in violation of the rules and regulations. Professional advice and opinion is appropriate but should not mislead the taxpayer into thinking such advice or opinion is law or regulation requiring the taxpayer to take a position that is not correct or justified.

I am not aware of any "threat" by congress to diminish the special tax laws for clergy and a tax professional should not manufacture such a threat in the minds of the taxpayer. Tax returns should be prepared according to actual facts and deductions allowed under the tax laws. So called "Red flag" items should still be deducted if they are deductible under the laws since a tax professional should be ready for audit the moment (s)he signs a tax return. Clergy should take advantage of any and all tax rules without concern that if they so do they might shoot themselves in the foot. A clergy taxpayer has a right to claim any tax law the same as would any taxpayer where a particular law would apply in their favor. A tax professional could be subject to malpractice if (s)he advises clients to not follow tax laws because if following the law it would lead to a lower tax.

[JohnH]

If you re-read my original post, you'll find I didn't refer to a "threat". On the other hand, I recognized a real possibility. If you don't see it the same way that's OK by me. BTW, am I also on thin ice when I tell clients that depending upon the outcome of the next election they should probably expect their tax bill to increase in the future?

But back to the main point, I'm all in favor of clergy taking advantage of all tax rules. In fact I encourage them to take full advantage of the favorable treatment they enjoy. I just don't see persisting in using Schedule C as taking advantage of anything - it's actually counterproductive. When the IRS already has a stated position that the minister should be issued a W-2, then FAILING to advise them that they should make every effort to switch to W-2 reporting with an accountable reimbursement plan is not serving the client's best interests, IMO.

[OldJack]

I just don't see persisting in using Schedule C as taking advantage of anything - it's actually counterproductive. When the IRS already has a stated position that the minister should be issued a W-2, then FAILING to advise them that they should make every effort to switch to W-2 reporting with an accountable reimbursement plan is not serving the client's best interests, IMO.

I have never seen an IRS position statement that all ordained clergy are employees of a church. Your code cite would be most welcome. I have seen the IRS publication that clearly states that a Clergy that is an employee of a church should be reported on a W2. I have no disagreement with the IRS publication if the clergy is in fact, by IRS definition, an employee. I disagree with those tax professionals that automatically determine and declare that a clergy is an employee without following the definition of an employee for that specific clergy individual. Clergy tax situations are not all the same for all clergy just like you as a tax professional may be an employee when I am not.

As to reporting clergy income on Sch-C being counterproductive, that is incorrectly assuming that any and all clergy expenses can or will be reimbursed by the church. That is not always possible and/or should be possible. Why should the church reimburse the clergy for such things as personal owned books, reference material, and/or privately owned business equipment. Do you not like for your clergy clients to only pay the minimum tax they should rightfully owe?

If a clergy client is by IRS definition an independent contractor status under the rules why would you insist that the church issue a W2 when the clergy does not in fact qualify as an employee?

edit: I would point out that in the original post it said "I have a friend who, with her husband, started a church some years ago." although not the controlling issue it would appear that these ordained ministers were not "hired as employees of a church" unless their status has changed over the years.

[JohnH]

I understand your points, but as a practical matter I disagree with you in all but a handful of rare situations. If one of those unusual situations arose, I might follow your logic. But for the vast majority of ministers, Form W-2 with an accountable plan is best., hands down. That's my story and I'm stickin' to it.

[OldJack]

I think you are still missing my point. Its *not* about logic, the vast majority of ministers, or the rare situation, its about tax professionals classifying a taxpayer properly.. especially if the taxpayer is clearly stating that their classification is a 1099 self-employed person. You should not stick to your story and disregard the taxpayers claim unless you can clearly determine the taxpayer is wrong. It is not your tax return, it is that of the taxpayer. Your best advice would be to help the church determine if their clergy meets the requirements of an employee or is in fact not an employee. Its not your place to just tell them to issue a W2 because the vast majority of ministers are employees. That is not sticking to a story, rather it is like sticking your head in the sand.

[JohnH]

Jack:

One of us is twisting the other one's words. Maybe it's me, but I'll continue anyhow.

I didn't say that I would ALWAYS and under ALL CIRCUMSTANCES advise that a W-2 be issued. Maybe I didn't make that clear enough, but I'll pull my head out of the sand long enough to clarify. (Some people might suggest that my head is somewhere else, so thanks for not making THAT suggestion)

I wouldn't tell them to issue a W-2 "because the vast majority of minsters are employees". I would tell them to do so because the minister is in my opinion an employee. But common sense does tell me that in the vast majority of cases that's what I'd be telling them.

In the very rare case that this didn't apply, I'd tell them not to issue a W-2. Common sense also tells me that this will rarely happen.

Again, it's all about making the proper distinctions using one's professional judgement, and on that point I agree with you completely.

[OldJack]

I would tell them to do so because the minister is in my opinion an employee.

And I am sure that being the professional that you are, I know you would go through the IRS procedures of determining if this specific minister was or was not in fact an employee before you gave your opinion to the church. So therefore I agree that you are right. :)

[MAMalody]

I think Mike and I have disagreed before on this issue of pastors being issued W2's instead of 1099's. If the pastor agrees that he is an employee of the church, then I would issue a W2. However, many pastors do not count themselves as employees. I know the IRS publications read as though a W2 should be issued but that is not a requirement if the pastor does not meet the employee definition. I cite the famous case of James T. Alford and Freda Alford in the United States Court of Appeals FOR THE EIGHTH CIRCUIT, No. 96-3287. The Alfords were ordained ministers of the Assemblies of God Church. The IRS declared them employees and the 8th circuit court of appeals in 1997 determined they were not. This case was also because the Alfords had business expenses to deduct on Sch-C that the IRS was disallowing as a result of employee status.

You would happen to be in the 8th federal circuit, would you? That is the only place this case is somewhat uniformly used and accepted. That is not the case elsewhere.

It is interesting to note about the above case:

1. The Assembly of God national organization's recommendation is to disregared the Alford decision and to acept the employer/employee realations when the facts and circumstances support it.

2. It is unusal for a pastor to provide his own furniture etc.

Another court case you may want to read is Weber v. Commissioner, 103 TC 378, 386 or Radde v. Commissioner, TC Memo 1997-490 and PL 9825002. I must admit, however, that these are not determinitative cases either. As a side note it is interesting to me that these case all seem to be in the same time window, geographically diverse with opposing opinions. Oh well, that 's what makes court cases.

Interestingly enough, it has never been a choice on whether you are self-employed or a common law employee, it has always been a matter of law. I believe that is why the "20 Common Law Rules" are used. I do admit there can be some ambiguity here in there application and interpretation and there appears to be an employee bias. Don't we use these rules to make these determinations all the time on hobby vs self-employed, well, sort of. We simply apply the facts and circumstances to arrive at the best decision we can. In doing this, I have found that only about 2-3% of the ministers fall truly into the self-employed category. (Probably the 12 or 7 factor test would be better applied here due to the "employee slant" of the 20 factor test.)

Other issues:

To be eligible for "Tax Free" fringe benefits such as medical insurance, group term life insurance, etc., an individual must be a common law employee. Hypothetically, if a minister could be considered as an independent contractor and use Schedule C for reporting salary and expenses, he would have to report as taxable income the value of any fringe benefits provided by a payor.

With a properly constructed compensation package and an accountable reimbursement policy, a minister (common law employee) does not lose any of the perceived benefits of a Schedule C.

Until the Small Business Job Protection Act of 1996, a "self-employed" minister was not able to make contributions to a 403( TSA per RR 66-274. While this is prior to the Alford case, it is interesting to note that Congress had to get involved to give the "self employed" minister this ability.

I am not aware of any clergy audit, where this has been a question, that has not come down on the side of being a common law employee. Some of these were audited by friends of mine, so I know there was good representation. In fact, I gave them the court cases that would be called into question, including Alford, and they lost, even in appeals. I don't think any of them went to court.

While I can't find any information on it today, about few years ago the IRS had a project proposed to audit about 5,000 pastors specifically on this issue. It was never funded by Congress. That is one of the reasons there is a MSSP on clergy.

In my judgment, if you are going to advise a pastor to use Schedule C or not disuade him from it, you must review the real risks for him, even if there is only a 2% chance of audit.

There is more that could be said or other cases available that muddy the water, but we cannot ignore the clear direction the IRS is going with somewhat general support of the majority of court cases.

This is my nickel's worth.

Mike

[OldJack]

You would happen to be in the 8th federal circuit, would you? That is the only place this case is somewhat uniformly used and accepted. That is not the case elsewhere.

As a matter of fact I do practice in the 8th federal circuit district.

Interestingly enough, it has never been a choice on whether you are self-employed or a common law employee, it has always been a matter of law. I believe that is why the "20 Common Law Rules" are used. I do admit there can be some ambiguity here in there application and interpretation and there appears to be an employee bias. Don't we use these rules to make these determinations all the time on hobby vs self-employed, well, sort of. We simply apply the facts and circumstances to arrive at the best decision we can. In doing this, I have found that only about 2-3% of the ministers fall truly into the self-employed category. (Probably the 12 or 7 factor test would be better applied here due to the "employee slant" of the 20 factor test.)

That is exactly the point. The tax professional must determine if the individual is by law an employee or not. I agree that with many church organizations all ministers would without doubt be employees and it would not be necessary to look further than the national organization. However, my experience has been with the type of ordained minister as mentioned in this post where they started the church themselves and/or clearly claim that they are only an employee of God. I have known of several churches (and had one such minister client) where the "church deacons" tried to fire the minister and were unsuccessful causing the deacons to leave the church and in some cases to split into two churches. I know of one such country church where there are 2 church buildings with 2 ministers on the same church lot.

Other issues:

To be eligible for "Tax Free" fringe benefits such as medical insurance, group term life insurance, etc., an individual must be a common law employee. Hypothetically, if a minister could be considered as an independent contractor and use Schedule C for reporting salary and expenses, he would have to report as taxable income the value of any fringe benefits provided by a payer.

In many small communities the non denominational country church (or some loose church organization such as the various Baptists churches) can't afford to have employees let alone pay fringe benefits. The pastor is lucky if the plate offering is enough to buy his groceries and pay the church electric bill. These ministers mentioned in the original post would appear to be a small church where the church is in reality the ministers. I doubt if they are worried about fringe benefits being taxable. I don't think some such ministers would take it very kindly if you or the IRS told them they were employees rather than they were answering the call of God.