The #1 mistake for pastor or missionary tax returns
Updated: Sep 23, 2020
Minster's housing allowance is a fantastic benefit. A significant portion of your income is considered "tax free". That term, "tax free" can lead to some trouble though. What exactly DOES that mean? What does it NOT mean?
I see incorrect returns that are self-prepared using market leading software that "guarantees" maximum refunds and accurate returns. I see incorrect returns that are "professionally" prepared by national chain tax prep shops that boast the same marketing gimmicks. And occasionally I even see incorrect returns prepared by quality CPAs who are simply unfamiliar with the taxes of a clergy member (pastor, missionary, etc) who receives MHA.
So what's the big deal? And what is the #1 mistake I've seen?
The #1 mistake: Failing to pay self employment tax on the housing allowance. Wait, the housing allowance is "tax free" right? Remember I said that term can lead us into trouble. Yes, the housing allowance (within some qualifying limits) is "income tax free". It is NOT self-employment tax free. Of course, if you have filed the proper form to opt out of SE tax, then it doesn't matter either way.
So what's the big deal?
If your minister's housing allowance is $20,000 and your total pay is $50,000 then $30,000 is subject to income tax and $20,000 is not. The entire $50,000 is subject to self employment tax. No matter what software you use, I would be willing to bet money the software will not pick this up automatically. There will be additional input or a check box or something you have to do manually. This means, you have to be aware of this and double check for it. You cannot just key in the numbers and trust the program to get it right.
By failing to pick up the $20,000 on the SE form you have underpaid your social security and medicare liabilities by almost $3,000. Multiply this by 3 years plus interest and penalties and you have a tax bill well over $10,000 that the IRS could hit you with.
MHA should be reported in box 14 of your W2. It isn't a requirement, but I've never seen it not reported there. If this is your only self employment income, the amount subject to SE on the SE Form should be box 1 of your W2 plus the MHA amount in box 14. Double check this before you file! Every time.
My recommendation? Find a tax preparer who is familiar with pastor/clergy taxes. Don't just take their word for it. Ask them what their experience is. In my personal opinion, tax prep chain offices are fine for some things, but I personally wouldn't use them for this type of return. I personally wouldn't use an out of the box, self prep option either. It's difficult to preview the form, I've seen the correct box checked and the form still be wrong, plus they're time consuming. Not to mention their "guarantee"... there's no guarantee if you key something in wrong or answer a question incorrectly.
Read more about me. I enjoy helping individuals with their taxes, businesses (including nonprofits and churches) with tax or accounting and other finance related questions, and I also enjoy helping people resolve tax debt, liens, levies, or other tax help you may need. I live in Lake Nona in Orlando, Florida, but I serve clients all across the country. Schedule an appointment if you need assistance and take a look at the resource page.
*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.