Income Tax Reporting for Clergy
The clergy are, for the most part, no different from anyone else in the eyes of the Internal Revenue Service -- they have to pay income taxes. (And I can tell you from personal experience they get audited!) However, Congress has seen fit to bestow certain advantages on the clergy. (Most states that have income taxes permit the same benefits. You should check the state rules with a local CPA or attorney familiar with the issues.) The most prominent benefit is the tax exemption for housing. These advantages not only change how the clergy computes income taxes, but how the income is reported at the end of the year. Many religious organizations report clergy compensation and benefits incorrectly, mostly because the rules use words in confusing ways.
The Internal Revenue Service summarizes most of the rules for the clergy in its Publication 517, Social Security and Other Information for Members of the Clergy and Religious Workers, which is available from your local IRS office, or on the IRS web site. While it is a good source of information, it is written from the IRS point of view. It is only a brief guide to the issues, and you should discuss your synagogue's situation with your own advisor.
The first question is whether the rabbi is an employee or an independent contractor. (The same rules apply to hazzanim, but for simplicity we will refer to rabbis to mean both.) Under IRS rules, an employee's activities are controlled by the employer; an independent contractor controls his/her own activities. As a general rule, if the rabbi works for one synagogue s/he is probably an employee; if the rabbi works for a number of synagogues, or holds a parttime pulpit, s/he may be an independent contractor.
While a rabbi is usually an employee of the synagogue, if the rabbi receives fees directly from congregants for rabbinic services s/he may also be an independent contractor. If the congregant pays the fees to the synagogue and the synagogue pays the rabbi, the fee is most likely part of the rabbi's salary.
The second question is whether the rabbi is receiving payment for rabbinic services. A rabbi who works for Microsoft as a programmer is not being paid for rabbinic services and is not eligible for a parsonage allowance from Microsoft. However, if that same Rabbi has a part-time pulpit, the synagogue can provide a parsonage or parsonage allowance.
At the end of the year, an employee receives a Statement of Wages and Taxes (Form W-2) from the employer. An independent contractor receives Form 1099-MISC. The synagogue should include salaries and wages, taxable fringe benefits (such as a car provided by the synagogue), nonaccountable expense allowances and all other taxable compensation in Box I - Wages, tips, other compensation of Form W-2. The parsonage is not included here.
The synagogue may not have to withhold federal income taxes from the rabbi's compensation. Many rabbis elect voluntary withholding (intentionally or not) and the amount withheld is reported in Box 2 of Form W2.
One of the words that is used in a confusing way is self-employed. A rabbi who is an independent contractor is self-employed for income tax purposes. But all Rabbis are considered self-employed for Social Security and Medicare taxes, so the synagogue does not have to withhold or report these taxes even if the rabbi is an employee and the synagogue withholds income taxes.
The rabbi does have to pay self-employment taxes, which are essentially the same as Social Security and Medicare. Some synagogues attach a statement to the W-2 that the employee is a rabbi and not subject to withholding.
Parsonage is subject to a different set of tax rules, so it is reported separately. The same rules apply whether the synagogue provides housing, provides a cash allowance in lieu of housing, or a combination of the two. In Publication 517, the IRS shows a sample W-2 with the parsonage reported in Box 14 with a description. Many synagogues report the parsonage in a separate statement attached to Form W-2. Some synagogues use a Form 1099 to report the parsonage this is only appropriate when the rabbi is an independent contractor (report the parsonage as nontaxable compensation on Form 1099 or an attached statement.)
The simplest situation is where the rabbi receives only a cash allowance for housing costs. The rabbi and the synagogue will agree on the amount of the allowance, and designate it in writing as a parsonage alowance before it is paid to the rabbi. The synagogue reports the amount of the cash payment properly designated as a parsonage allowance. A Board resolution, Board minutes, budget line, contract provision or a letter between the rabbi and the Board is probably enough; but, the designation only applies to payments after it is made.
If the synagogue provides a house instead of (or in addition to) a cash allowance, the fair rental value of the home and the costs of maintenance and upkeep paid by the synagogue are included in the parsonage amount reported on Form W-2 or Form 1099.
The Rabbi is responsible for reporting the parsonage amount on his/her tax return, and for establishing that a cash parsonage allowance was spent on qualifying costs. Any part of a cash parsonage allowance that was not spent on qualifying costs becomes taxable income to the rabbi.
A synagogue can provide housing benefits to a retired rabbi who served the congregation. This can also be either a home or a cash allowance, and qualifies for the parsonage exclusion. The IRS has not officially decided whether a retired rabbi can designate part of his retirement income as parsonage allowance, although for the time being they seem to permit it. The surviving spouse of a deceased rabbi is not eligible for parsonage benefits (unless she is also a rabbi); the fair rental value of the parsonage or the cash allowance paid is taxable income to the surviving spouse.
June 2001
