As part of my tax preparation practice in Lake Nona, a community within Orlando, FL "the City Beautiful", I serve many pastors, missionaries, and clergy members. Whether you are here in Florida or anywhere else in the country, your unique tax return is the same when it comes to MHA and self-employment income (SECA).
Retirement planning is a major topic for any taxpayer. Should I put money into my employer plan or an outside IRA? Should I designate it as ROTH or regular contributions? What's the difference? Which will save me more in taxes?
Just about anyone can defer taxes by contributing to an employer sponsored plan through payroll deductions, but clergy who are self employed for purposes of social security and medicare can save taxes permanently by doing this.
Why is this specific to clergy (pastors, missionaries, etc.)? It is because of the minister housing allowance, self employment taxes, and the difference between a 403b "church plan" and a 401k plan.
First, generally speaking, ROTH contributions are not deductible now, but the distributions, including earnings, are tax free in retirement (if all other qualifications are met). Ordinary (pre-tax) contributions are deductible now (or excluded from taxable income if deferred through payroll), but the distributions are subject to income tax when withdrawn.
For a typical W2 employee who is in the 10% tax bracket, deferring $5,000 into a 401k will save $500 in income taxes now. They will still pay social security and medicare tax on the $5,000, which is withheld from their paycheck.
For a clergy member who is self employed for purposes of social security and medicare and in the 10% tax bracket, deferring $5,000 into their 403b will save the same $500 in income taxes now plus an additional $700 in social security and medicare taxes due to the way their wages are reported. When the money comes out of the 403b in retirement it will be subject to income taxes, but in most circumstances should not be subject to SE tax. Furthermore, in most situations, some of your 403b distributions in retirement can be designated MHA and therefore would be "income tax free" then as well. In many situations, this allows a traditional 403b contribution to be tax free now, tax free in retirement when distributed, and never subject to social security and medicare tax.
Therefore, even a clergy member who already has enough deductions and/or tax credits to otherwise pay $0 in income tax could still benefit from contributing to a 403b on a pre-tax basis.
There are many factors to consider in a situation like this. This may not result in the best tax outcome for you given your unique circumstances. You need to discuss this with a tax professional who can advise you based on your particular goals and situation.
If you or someone you know is a pastor, missionary, or other clergy member and need help from a CPA with experience in this area, please contact me at (407) 243-8678 or brad@wootencpa.com or schedule an appointment.
-Brad
I enjoy helping individuals with tax preparation and tax planning as well as offering tax help to individuals dealing with tax debt, IRS liens, IRS levies, Wage Garnishments, etc. I also service businesses (including nonprofits and churches) by providing tax preparation and tax planning as well as consulting for accounting, bookkeeping, and other finance related questions. I live in Orlando, FL, but I serve clients all across the country. Schedule an appointment if you need assistance and take a look at the resource page.
6900 Tavistock Lakes Blvd Ste 400
Orlando, FL 32827
(407) 243-8678
Serving clients in Orlando, Lake Nona, Altamonte Springs, Apopka, Azalea Park, Celebration, Hunters Creek, Lake Buena Vista, Lake Hart, St Cloud, Winter Garden, Winter Park and via the latest technology remotely around the country.
*The blog posts (as well as the YouTube channel) are my personal opinions and thoughts about a wide range of topics. They are not meant to apply to individuals specifically and should never be relied on as tax or investment advice. You should contact a professional for specific advice before taking action.