Ministers or church leaders often ask our advice on how to figure the amount of the Social Security Allowance.  The IRS does not require churches to pay a Social Security Allowance to its minister staff and provide no guidance on how to structure it.  As a result, many churches have devised many ways to structure the Social Security Allowance.  While there is not a right or wrong way to do this, many churches make the calculation too complex and confusing.

First, we suggest that the amount be set at whatever the church would be paying in “Employer Social Security and Medicare Taxes” to a non-pastor staff member with that same level of pay.  This would be 7.65% of their total pay and would be paid to all ministers regardless of whether the minister has opted out of Social Security.

There is a compelling simplicity and a sense of fairness for a church to say:  “For all of our workers, we will pay a Social Security (and Medicare) amount equal to 7.65% of their total pay (up to the Social Security ceiling of $110,100).”  For non-pastors this comes in the form of the government-required employer contribution to Social Security and Medicare.  For pastors, it comes in the form of a Social Security Allowance equal to 7.65% of salary and housing.

While I totally understand the initial inclination to exclude pastors who are exempt from Social Security and to reduce the Social Security Allowance for ministers who are contributing to a 403(b) retirement account, I suggest that it might be more ‘fair’ and appropriate to not exclude exempt ministers and not reduce the Social Security Allowance for ministers who contribute to a 403(b) retirement account.

In making this suggestion, we are proposing that the church base the Social Security Allowance only on the worker’s total pay and on the current Social Security and Medicare tax rate for employers, rather than basing the Allowance on the minister’s actual Social Security tax liability.

This is an  important distinction.  The minister’s actual Social Security tax liability can be impacted by various other factors including un-reimbursed ministry expenses and the existence of income from other sources which could conceivably push some minister’s work income beyond the $110,100 Social Security ceiling, thus reducing the amount of Social Security tax that they pay on their church income.

In addition,

• paying a larger Social Security Allowance to ministers who do not contribute to their retirement account could appear to be a subtle bias toward having ministers not make 403(b) retirement contributions.
• Similarly, paying a Social Security Allowance to ministers to have not opted out, but withholding it from ministers who have opted out, could conceivable be seen as unfair by those who have opted out.

There is a practical reason for ignoring 403(b) retirement contributions when setting the amount of the Social Security Allowance:  The IRS allows employees to change the amount of their elective contributions to 403(b) from time to time.  Having to change the Social Security Allowance every time a minister changes their 403(b) contribution makes things unnecessarily complicated.

We realize that it sounds quite odd to suggest paying a Social Security Allowance to ministers who have opted out of Social Security!  My additional rationale for proposing that  is this:

Those ministers who have opted out of Social Security will need to invest in other programs (alternatives to Social Security) to make sure that they – and their families – are covered  for retirement, survivor benefits, and disability benefits.

Generally, the decision to opt out of Social Security significantly reduces the future benefits that those ministers will receive from Social Security.  As a result, we strongly advise ministers who have opted out of Social Security to set aside an amount comparable to what they would be paying in Social Security taxes, and use those comparable funds to pay for increased life insurance, dramatically increased retirement funding, and perhaps disability insurance

The Driscoll v. Commissioner Tax Court case where the court allowed the clergy housing allowance on the minister’s primary house PLUS his lake house has caused a bit of controversy that we’d like to address.

We are very familiar with the case and have been following it closely.  Remember that the IRS has appealed this case and has not acquiesced to the Tax Court decision.  We are anticipating a ruling from the Appeals Court sometime during 2012.

Because of that, our recommendation is to NOT rely on the Tax Court decision, but instead, wait for a ruling from the Appeals Court.  After the Appeals Court rules on this case, we will provide a complete analysis to anyone interested.

In the event a minister has a second house, we recommend that the employer designate a housing allowance in an amount that will cover the housing expenses of both homes in the event the Appeals Court rules in favor of the Taxpayer.  However, do not exclude from gross income the housing expenses of the second home until we complete our analysis of the Appeals Court decision.

The IRS recently provided the inflation-adjusted contribution limits for health savings accounts (HSAs) for 2010. HSAs allow taxpayers with high-deductible health insurance plans to set aside pretax dollars that can be withdrawn tax-free to pay unreimbursed medical expenses.

The 2010 contribution limit for individuals is $3,050; the limit for family coverage is $6,150. A catch-up contribution of an additional $1,000 is permitted for individuals who are 55 or older.

If you are retired and receive Social Security retirement benefits you may lose some or all of those benefits unless your “earned income” is below specified Earnings Ceilings.

For 2010 that amount is $14,160 for workers age 62 to 66. If you’re over age 66, you may earn as much as you want without losing any Social Security benefits. However, you may pay income tax on Social Security benefits as your income increases.  In the year that you turn 66 you’ll enjoy a higher earnings ceiling (of $37,680 in the year 2010).

Income counted toward the Earnings Ceiling would include:

Ministry Salary, Honoraria, Housing Allowance, Parsonage Rental Value, Social Security allowance paid by the church, other secular work income or any other income from work.

Income not counted toward that ceiling includes:

Interest and dividends, Pensions, IRA’s, TSA’s or Annuities, any rental income and capital gains.

Also, church payments that do not count towards the ceiling include medical insurance for the worker and family. (Medical expenses reimbursed under a properly established Medical Reimbursement Plan will typically cover out-of-pocket expenses, such as deductibles, co-insurance amounts, dental care and eyeglasses).  Payment of other ministry expenses such as automobile mileage, meals, entertainment, books, seminars, etc. also do not count.  Money set aside by the church for a “Rabbi Trust” or  church payments to a 403(b) Retirement Plan is also excludable from the Earnings Ceiling.

Any time we mention a 403 (b) retirement plan to pastors, we feel that  we must emphasize this:  If your 403(b) is a regular secular plan and not a denominational plan or the Clergy Advantage 403(b) Retirement Plan, we strongly recommend that you call us or attend our next  ”Tax Free Money for Ministers” webinar to see why this is so important. Click a date on the Home page under “Upcoming Events” to Register and see details.  There is no charge for ministers, pastors and/or their spouses.

Also note this potential pitfall:  If your church sets aside funds in a deferred compensation account in the church name to pay out in a later year, this must generally be treated as income in 2010, even if it’s not paid to you until 2011. We’ll elaborate on this if you need more information. There are two exceptions, already mentioned above: the 403(b) retirement plan and a Rabbi Trust, if done correctly.

For a great, detailed explanation of  Social Security benefits and strategies, you’re welcome to attend our “Transforming Social Security in a Winning Retirement Strategy” webinar on January 19. See “Upcoming Events” on the Home Page for details.  These webinars are free to all pastors and their spouses.