Tax Planning Moves for Ministers
Church leaders are in a unique position to help their ministers and church body utilize unique tax rules to reduce tax bills and increase the usage of funds in more advantageous ways. This post outlines four tax planning moves that are beneficial for church leaders to be aware of to help their staff avoid paying unnecessary taxes and also to council church donors on how to give in the most effective manner and potentially raise donation amounts as a result.
Minister Housing Allowance
As a working minister, a portion of your salary is eligible to be declared as a housing allowance and thereby exempt from federal income tax under Section 107 of the Internal Revenue Code. You are eligible for this tax treatment if you are a licensed, commissioned, or ordained by a church, convention, or association of churches.
The tax benefit of the allowance works as follows:
A minister earning a $60,000 salary as a single taxpayer would owe approximately $6,262 in federal taxes. If $25,000 of that salary was designated as and qualified for the minister housing allowance that would reduce their taxable income to $35,000 and subsequently reduce the ministers tax bill to $2,515 resulting in a tax savings of $3,747.
The housing allowance is established by the church prior to each calendar year and must be used by the minister for housing related expenses to qualify for the tax treatment (excess funds not used become taxable). While there is no list of expenses provided by the IRS, reasonable household expenses include down payment for a home, mortgage and home equity line of credit payments, property taxes, HOA fees, furnishings and appliances, repairs, yardwork, and home improvements. As an added tax advantage for those that itemize their taxes – the mortgage interest that is paid can be deducted even though tax free funds are being used to cover the mortgage.
Once retired, a minister can use their 403(b) to continue to receive the housing allowance tax treatment. Assuming they are over the age of 59.5, the minister can take pre-tax funds from their 403(b) tax free to use towards housing related expenses. While there may be reasons to move some funds to an IRA post-retirement – such as the Qualified Charitable Distribution outlined later – it is prudent to account for this tax break before rolling funds over.
Gifting Appreciated Stock
Tithing is a common practice for ministers and the church body to give to a religious or otherwise charitable organization. While there can be a tax benefit for those that itemize their taxes to gift cash, the tax break can be supercharged for those that gift appreciated stock instead.
As a 501(c)3 organization, churches do not have to pay capital gains taxes on the sale of appreciated securities whereas individuals do. By gifting the appreciated stock before selling an individual can avoid the capital gains tax and either raise their cost basis in the security, by purchasing new shares, or diversify out of the investment, by using cash to purchase other investments.
Example: Jane would like to make a gift to her church of $30,000 to go towards the renovation of the church offices. She has $30,000 in cash and $30,000 in Apple stock with a cost basis of $10,000. If she sold the Apple stock she would owe capital gains taxes of $3,000 but instead Jane chooses to gift the appreciated Apple stock to the church who can then sell the stock with no tax implication. Jane then uses the $30,000 in cash she already had to purchase back the Apple stock which now has a cost basis of $30,000. If Jane is in the 22% tax bracket and itemizes her taxes she will save $4,400 in income taxes while avoiding a $3,000 capital gains for a total tax savings of $7,400.
With the standard deduction raised following the Tax Cuts and Jobs Act to $25,100 for Married individuals filing a jointly, a common strategy for those that can’t typically itemize their deductions is to bunch charitable giving to get over that threshold in a single year. Individuals looking to gift a large amount with no immediate destination for the full gift can utilize a Donor Advised Fund. By gifting appreciated securities to this fund, they can avoid the capital gains taxes and get the charitable deduction for the gift and then continue to invest the funds until they decide to grant the funds to another charitable organization.
Qualified Charitable Distribution
Once in retirement, it is less likely at an individual is generating a sufficient amount of itemized deductions to benefit from the charitable tax deduction. Those individuals can utilize the qualified charitable distribution to give charitably, get an income tax deduction, and reduce their required minimum distribution simultaneously.
The way that this is done is by gifting directly from their IRA account to their church or other charitable organization. Note – this must be done from an IRA and therefore someone looking to utilize this benefit and the minister housing allowance would need to split their funds between a 403(b) and IRA.
A retiree looking to do this must be over the age of 70.5 and must have the check made payable directly to the charitable institution. As long as these requirements are met they can gift up to $100,000 tax free while also counting those funds towards their required minimum distribution, if applicable.
Example: Donna would like to gift $10,000 to her church this year. She is 74 and has a required minimum distribution of $35,000 for 2023. By making the gift as a QCD she can take the $10,000 out of her IRA tax free and will only be required to take a required minimum distribution of the remaining $25,000. If Donna is in the 22% tax bracket and could not otherwise deduct her charitable giving then this strategy would save her $2,200 in taxes.
Accountable Reimbursement Plan
Following the Tax Cuts and Jobs Act introduced in 2017, employees can no longer deduct business related expenses. Through the use of an accountable reimbursement plan these individuals can pay for expenses tied to ministry related expenses and be reimbursed tax free. These expenses include:
- Auto mileage
- Travel – including transportation, lodging, and meals
- Conferences and workshops
- Continuing education
- Books, subscriptions, and software
- Entertainment – if ministry related
A minister or eligible church employee who incurs and tracks these expenses could then be reimbursed by the church for those that qualify tax free from the accountable reimbursement plan. Requirements on these plans, including who can use them and what expenses can be reimbursed are outlined in IRS Publication 463.
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Disclosure: The foregoing information has been obtained from sources considered to be reliable, but we do not guarantee that it is accurate or complete, it is not a statement of all available data necessary for making an investment decision, and it does not constitute a recommendation. Any opinions are those of author and not necessarily those of Raymond James.
This case study is for illustrative purposes only. Individual cases will vary. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Prior to making any investment decision, you should consult with your financial advisor about your individual situation. This is a hypothetical illustration and is not intended to reflect the actual performance of any particular security.
Please note, changes in tax laws may occur at any time and could have a substantial impact upon each person’s situation. While we are familiar with the tax provisions of the issues presented herein, as Financial Advisors of RJFS, we are not qualified to render advice on tax or legal matters. You should discuss tax or legal matters with the appropriate professional.
Donors are urged to consult their attorneys, accountants or tax advisors with respect to questions relating to the deductibility of various types of contributions to a Donor-Advised Fund for federal and state tax purposes.
RMD’s are generally subject to federal income tax and may be subject to state taxes. Consult your tax advisor to assess your situation.
