2019 Clergy Tax Return Preparation Guide for 2018 - MMBB Financial ...

 
2019 Clergy Tax
                           Return Preparation
                             Guide for 2018
                               Returns*
                      RICHARD R. HAMMAR, J.D., LL.M., CPA
                  SENIOR EDITOR, CHURCH LAW & TAX REPORT

ACKNOWLEDGEMENTS
Both the author and Christianity Today’s Church Law & Tax Team would like to thank CPA Elaine Sommerville and Attorney and CPA Frank
Sommerville for their assistance with reviewing the material in the Guide.
Copyright 2019 Christianity Today International. Clergy Tax Return Preparation Guide by Richard R. Hammar. Used with permission.
Published by
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Tel: 800.986.6222 Fax: 800.986.6782
This publication is intended to provide a timely, accurate, and authoritative discussion of tax reporting compliance, and the impact of recent
changes in the tax laws. It is not intended as a substitute for legal, accounting, or other professional advice. If legal, tax, or other expert assistance is
required, the services of a competent professional should be sought. Although we believe this book provides accurate information, there may be
changes resulting from IRS or judicial interpretations of the Tax Code, new tax regulations, or technical corrections that occurred after the printing
of this edition that are not reflected in the text.
*THIS GUIDE IS INTENDED FOR USE WITH MMBB U.S. BASED PLANS ONLY
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Clergy Tax Return Preparation Guide for 2018 Returns

                                       TABLE OF CONTENTS

SPECIAL SUPPLEMENT: ................................................................................................... E
CURRENT STATUS OF THE PARSONAGE AND HOUSING ALLOWANCE EXCLUSIONS

PART 1: INTRODUCTION.................................................................................................. 1
        How to use this guide....................................................................................................... 1
        Tax highlights for 2018...................................................................................................... 1
        Preliminary Questions....................................................................................................... 3

PART 2: SPECIAL RULES FOR MINISTERS.......................................................................... 4
        Who is a minister for federal tax purposes?.......................................................................... 4
        Are ministers employees or self-employed for federal tax purposes?........................................ 5
        Exemption from Social Security (self-employment) taxes...................................................... 6
        How do ministers pay their taxes?...................................................................................... 6

PART 3: STEP-BY-STEP TAX RETURN PREPARATION......................................................... 8
     TAX FORMS AND SCHEDULES.................................................................................... 8
     FORM 1040................................................................................................................. 9
        Step 1: Filing status.......................................................................................................... 9
        Step 2: Name and address.................................................................................................. 9
        Step 3: Dependents........................................................................................................... 9
        Step 4: Income................................................................................................................. 9
            Line 1. Wages, salaries, tips, etc...................................................................................... 9
                Housing Allowance....................................................................................... 11
                    Housing expenses to include in computing your housing allowance exclusion................. 12
            How much should a church designate as a housing allowance? ......................................... 14
            Section 403(b) plans.................................................................................................... 15
                    Contribution limits..................................................................................... 15
                    Minister’s housing allowance and contribution limits............................................. 15
                    Taxation of distributions from a 403(b) plan....................................................... 15
                    Salary reduction contributions (Section 402(g)).................................................... 16
                Qualified scholarships................................................................................... 16
                Sale or exchange of your principal residence.................................................... 16
        Line 2 Interest income: attach Schedule B if over $1,500........................................................ 17
        Line 3. Dividend income: attach schedule B if over $1,500..................................................... 17
        Lines 4a and 4b. IRA, pension, and annuity income.............................................................. 17
        Line 5. Social security benefits........................................................................................... 17
        Line 6. Total income......................................................................................................... 18
        Step 5: Adjustments to income........................................................................................... 18
            Line 7. Adjusted gross income...................................................................................... 18
            Line 7 Schedule 1 (Form 1040) line 27.
            One-half of self-employment tax................................................................................... 18
            Line 7 Schedule 1 (Form 1040) line 32.
            Payments to an Individual Retirement Account.............................................................. 19
        Step 6: Tax computation.................................................................................................... 20
Clergy Tax Return Preparation Guide for 2018 Returns

              Line 8. Itemized deduction or standard deduction........................................................... 20
              Line 11. Compute tax.................................................................................................. 20
          Step 7: Credits.................................................................................................................. 20
              Line 12a. Child tax credit............................................................................................. 21
              Line 12a Schedule 3 (Form 1040) Line 49.
              Credit for child and dependent care expenses................................................................. 21
              Line 12b Schedule 3 (Form 1040) line 51.
              Retirement savings contributions credit......................................................................... 21
          Step 8: Other taxes........................................................................................................... 22
              Line 14. Other taxes.................................................................................................... 22
          Step 9: Payments.............................................................................................................. 22
              Line 16. Federal income tax withheld............................................................................ 22
              Line 17 Schedule 5 (Form 1040) Line 66.
              2018 estimated tax payments........................................................................................ 22
              Line 17a. Earned income credit..................................................................................... 22
          Step 10: Refund or amount you owe................................................................................... 23
          Step 11: Sign here............................................................................................................. 23

OTHER FORMS AND SCHEDULES..................................................................................... 24
    SCHEDULE A.............................................................................................................. 24
       Step 1: Medical and dental expenses (lines 1–4).................................................................... 24
       Step 2: Taxes you paid (lines 5–7)........................................................................................ 24
       Step 3: Interest you paid (lines 8-10)................................................................................... 25
       Step 4: Gifts to charity (lines 11-14).................................................................................... 25
       Step 5: Casualty and theft losses (line 15)............................................................................. 27

    SCHEDULE B.............................................................................................................. 28
       Step 1: Interest income (lines 1–4)...................................................................................... 28
       Step 2: Dividend income (lines 5–6).................................................................................... 28
       Step 3: Foreign accounts and foreign trusts (lines 7-8)........................................................... 28

    SCHEDULE C.............................................................................................................. 28
       Step 1: Introduction.......................................................................................................... 28
       Step 2: Income (lines 1–7).................................................................................................. 28
       Step 3: Expenses (lines 8–27).............................................................................................. 28

    SCHEDULE C-EZ........................................................................................................ 29
    SCHEDULE SE............................................................................................................ 29
       Step 1: Section A (line 2)................................................................................................... 30
       Step 2: Section A (line 4)................................................................................................... 30
       Step 3: Section A (line 5)................................................................................................... 30

    FORM 2106................................................................................................................. 30
PART 4: COMPREHENSIVE EXAMPLES AND FORMS........................................................... 31
    EXAMPLE ONE: SENIOR MINISTER............................................................................. 31
    EXAMPLE TWO: RETIRED MINISTER. . ......................................................................... 43
Special Supplement

         SPECIAL SUPPLEMENT:
 CURRENT STATUS OF THE PARSONAGE AND
    HOUSING ALLOWANCE EXCLUSIONS
    On November 22, 2013, federal district court judge                The plaintiffs here have never been denied the parsonage
Barbara Crabb of the District Court for the Western                   exemption because they have never requested it; therefore,
District of Wisconsin struck down the ministerial housing             they have suffered no injury.”
allowance as an unconstitutional preference for religion.                 It suggested that this deficiency could be overcome if
Freedom From Religion Foundation, Inc., v. Lew, 983 F. Supp.          the FFRF’s officers filed tax returns claiming a housing
2d 1051 (W.D. Wis. 2013). The ruling was in response                  allowance that was later rejected by the IRS in an audit:
to a lawsuit brought by the Freedom From Religion                     “The plaintiffs could have sought the exemption by
Foundation (FFRF) and two of its officers challenging                 excluding their housing allowances from their reported
the constitutionality of the housing allowance and the                income on their tax returns and then petitioning the
parsonage exclusion. The federal government, which                    Tax Court if the IRS were to disallow the exclusion.
defended the housing allowance, since it is a federal statute,        Alternatively, they could have . . . paid income tax on their
asked the court to dismiss the lawsuit on the ground that             housing allowance, claimed refunds from the IRS, and
the plaintiffs lacked standing to pursue their claim in               then sued if the IRS rejected or failed to act upon their
federal court.                                                        claims.”
    Standing is a constitutional requirement of any plaintiff             The FFRF responded to the appeals court’s ruling by
in a federal case and generally means that a plaintiff must           designating a housing allowance for two of its officers.The
have suffered some direct injury as a result of a challenged          officers reported their allowances as taxable income on
law. The Wisconsin court concluded that the plaintiffs had            their tax returns and thereafter filed amended tax returns
standing on the ground that they would have been denied               seeking a refund of the income taxes paid on the amounts
a housing allowance exclusion had they claimed one on                 of their designated housing allowances. FFRF claims
their tax return. The government appealed this ruling to              that in 2015 the IRS denied the refunds sought by its
a federal appeals court—the Seventh Circuit Court of                  officers (one of whom had died and was represented by
Appeals in Chicago.                                                   her executor).
    On November 13, 2014, the appeals court issued its                    Having endeavored to correct the standing problem,
ruling reversing the Wisconsin court’s decision. Freedom              the FFRF renewed its legal challenge to the housing
From Religion Foundation, Inc., v. Lew, 773 F.3d 815 (7th             allowance in the federal district court in Wisconsin,
Cir. 2014). It concluded that the plaintiffs lacked standing          where the litigation began. On October 6, 2017, judge
to pursue their challenge to the housing allowance. The               Crabb again ruled that the ministerial housing allowance
plaintiffs had asserted that they had standing due to their           is an unconstitutional preference for religion. Gaylor v.
“injury” of being denied a tax-free housing allowance                 Mnuchin, (W.D. Wis. 2017). Judge Crabb observed: “[The
should they claim one on their tax returns. But the appeals           housing allowance] violates the establishment clause
court refused to base standing on theoretical injury. It              because it does not have a secular purpose or effect and
concluded: “Only a person that has been denied such a                 because a reasonable observer would view the statute as
benefit can be deemed to have suffered cognizable injury.             an endorsement of religion.” The government promptly

                                                                 E
Special Supplement

appealed this ruling to the Seventh Circuit Court of                      3. Many churches will want to increase ministers’
Appeals in Chicago. A ruling by the Seventh Circuit                          compensation to offset the adverse financial
Court of Appeals ordinarily would apply only to ministers                    impact. Thousands of ministers have purchased
in that circuit, which includes the states of Illinois, Indiana,             a home, and obtained a mortgage loan, on the
and Wisconsin. But Judge Crabb issued an injunction                          assumption that the housing allowance would
requiring the IRS to disallow the housing allowance                          continue to be available as it has for more than
on all tax returns filed by ministers. Judge Crab delayed                    a half century. The sudden elimination of this tax
the effective date of the injunction for 180 days after a                    benefit will immediately thrust many clergy into a
final ruling in the case. In effect, the ruling will become a                dire financial position with a mortgage loan based
national precedent if affirmed by the appellate court and                    on a tax benefit that no longer is available. Many
U.S. Supreme Court, if applicable.                                           church leaders will want to reduce the impact of
    What should churches and clergy do now? Consider                         such a predicament by increasing compensation.
the following steps:                                                         Such an increase could be phased out over a period
                                                                             of years to minimize the impact on the church.
    1. Monitor developments.
                                                                          4. Ministers who are considering the purchase of
    2. Many ministers will experience an immediate                           a new home should not base the amount and
       increase in income taxes. As a result, they should be                 affordability of a home mortgage loan on the
       prepared to increase their quarterly estimated tax                    availability of a housing allowance exclusion unless
       payments to reflect the increase in income taxes                      and until the courts conclusively uphold the
       in order to avoid an underpayment penalty. Note                       constitutionality of the allowance.
       that there will be no effect on self-employment
       taxes for which the housing allowance is not tax-                  5. The fair rental value of church-provided parsonages
       exempt.                                                               remains a nontaxable benefit, for now.

                                                                   F
Clergy Tax Return Preparation Guide for 2018 Returns

                                                                               new and lower brackets (10%, 12%, 22%, 24%,
PART 1                                                                         32%, 35%, and 37%).

INTRODUCTION                                                              ●●   Temporarily increases (through 2025) the basic
                                                                               standard deduction to $24,000 for married
                                                                               individuals filing a joint return, $18,000 for head-
    All references in this publication to line numbers on IRS
                                                                               of-household filers, and $12,000 for all other
forms are for the “draft” versions of the 2018 forms since the
                                                                               individuals.
final forms had not been released by the IRS as of the date of
publication.                                                                   The significantly increased standard deduction
                                                                               will reduce the number of persons who are able
                                                                               to itemize deductions on Schedule A (Form 1040)
                                                                               from 30 percent to as few as 5 percent of all
How to use this guide                                                          taxpayers. The result will be a significant decrease
    This book contains the basic information you need                          in the number of taxpayers who can claim a tax
to complete your 2018 federal income tax return. It gives                      deduction for contributions they make to churches
special attention to several forms and schedules and the                       and other charities.
sections of each form most relevant to ministers. The                     ●●   Modifies section 529 plans to allow such plans
companion resource—Federal Reporting Requirements—                             to distribute not more than $10,000 in expenses
helps churches comply with their federal tax reporting                         for tuition incurred during the taxable year in
requirements.                                                                  connection with the enrollment or attendance
   This guide is divided into the following                                    of the designated beneficiary at a public, private or
                                                                               religious elementary or secondary school.The new rules
sections:
                                                                               apply to distributions made after December 31,
        Part 1: Introduction—This section reviews tax                          2017. A “section 529 plan” (also known as a
    highlights for 2018 and presents several preliminary                       “qualified tuition plan”) is a plan operated by a
    questions you should consider before preparing your                        state or educational institution with tax advantages
    tax return.                                                                and potentially other incentives to make it easier to
        Part 2: Special Rules for Ministers—In this                            save for college and other post-secondary training
    section, you learn whether or not you are a minister                       for a designated beneficiary, such as a child or
    for tax purposes, whether you are an employee                              grandchild. The main tax advantage of a 529 plan
    or self-employed for both income tax and Social                            is that earnings are not subject to federal tax and
    Security purposes, and how you pay your taxes.                             generally are not subject to state tax when used for
                                                                               the qualified education expenses of the designated
        Part 3: Step-By-Step Tax Return Prepa-                                 beneficiary, such as tuition, fees, books, as well as
    ration—This section explains how to complete the                           room and board.
    most common tax forms and schedules for ministers.
                                                                          ●●   Repeals both the moving expense deduction,
        Part 4: Comprehensive Examples and                                     and the exclusion of employer reimbursements
    Sample Forms—This section shows a sample tax                               of moving expenses under an accountable
    return prepared for an ordained minister and spouse                        arrangement--except in the case of a member of
    and for a retired minister and spouse.                                     the Armed Forces of the United States on active
        Federal Reporting Requirements for Churches—                           duty who moves pursuant to a military order.
    This resource provides assistance to churches                              This provision is effective for taxable years 2018
    (especially treasurers and bookkeepers) in filing                          through 2025.
    federal tax forms.                                                    ●●   Under the Affordable Care Act (“Obamacare”)
                                                                               individuals must be covered by a health plan that
Tax highlights for 2018                                                        provides at least “minimum essential coverage”
1. The Tax Cuts and Jobs Act of 2017                                           or be subject to a penalty for failure to do so
                                                                               (commonly referred to as the “individual
    On December 22, 2017, President Donald Trump                               mandate”). For 2018, the penalty could be up to
signed into law the $1.5 trillion, 500-page Tax Cuts and                       $2,085 for a family, or $695 for an individual.The
Jobs Act of 2017. In brief, the Act amends the Internal                        Tax Cuts and Jobs Act reduces the amount of the
Revenue Code to reduce tax rates and modify credits                            ACA’s individual mandate to zero with respect to
and deductions for individuals and businesses.                                 health coverage status for months beginning after
    With respect to individuals, the bill:                                     December 31, 2018.
    ●●   Replaces the seven existing tax brackets (10%,                   ●●   Removes the deductions for personal exemptions
         15%, 25%, 28%, 33%, 35%, and 39.6%) with seven                        for taxable years 2018 through 2025. Under
                                                                 1
Clergy Tax Return Preparation Guide for 2018 Returns

     prior law, in determining taxable income,                                    ●●   work clothes and uniforms if required
     an individual reduced AGI by any personal                                         and not suitable for everyday use;
     exemption deductions and either the applicable                               ●●   malpractice insurance;
     standard deduction or itemized deductions.
     Personal exemptions generally were allowed                                   ●●   subscriptions to professional journals and
     for the taxpayer, the taxpayer’s spouse, and any                                  trade magazines related to the taxpayer’s
     dependents.                                                                       work; and
●●   Eliminates the deductions for miscellaneous                                  ●●   equipment and supplies used in the
     itemized deduction. Under prior law, individuals                                  taxpayer’s work.
     could claim itemized deductions for certain                           ✪✪ KEY POINT The new law temporarily
     miscellaneous expenses. Certain of these expenses                        changes the structure of the individual income
     were not deductible unless, in aggregate, they                           tax by modifying the rate structure so that
     exceeded two percent of the taxpayer’s adjusted                          the tax brackets are 10-percent, 12-percent,
     gross income. The deductions described below                             22-percent, 24-percent, 32-percent, 35-percent
     were subject to the aggregate two-percent floor:                         and 37-percent. The bill temporarily increases
     ◆◆   appraisal fees for a casualty loss or charitable                    the size of the standard deduction (for 2018 the
          contribution;                                                       standard deduction is $24,000 for joint filers,
                                                                              $18,000 for heads of household and $12,000 for
     ◆◆   casualty and theft losses from property used                        other filers), and temporarily eliminates personal
          in performing services as an employee;                              exemptions. These and several other provisions
     ◆◆   clerical help and office rent in caring for                         in the Act “sunset” for taxable years beginning
          investments;                                                        after 2025 unless extended by Congress.
     ◆◆   hobby expenses, but generally not more than                  2. Other tax changes of interest to
          hobby income;                                                   churches and church staff
     ◆◆   investment fees and expenses;                                    There were several tax developments in 2018 that
     ◆◆   safe deposit box rental fees, except for storing             will affect tax reporting by both ministers and churches
          jewelry and other personal effects;                          for 2018 and future years. Here is a rundown of some of
                                                                       the key provisions:
     ◆◆   trustee’s fees for an IRA, if separately billed
          and paid;                                                        a. You may be able to claim the earned income
                                                                              credit for 2018 if (1) you do not have a qualifying
     ◆◆   tax preparation expenses;                                           child and you earned less than $15,270 ($20,950
     ◆◆   job search expenses in the taxpayer’s present                       if married); (2) a qualifying child lived with you
          occupation;                                                         and you earned less than $40,320 ($46,010 if
                                                                              married filing jointly); (3) two qualifying children
     ◆◆   licenses and regulatory fees;                                       lived with you and you earned less than $45,802
     ◆◆   passport fees for a business trip;                                  ($51,492 if married filing jointly); or (4) three or
                                                                              more qualifying children lived with you and you
     ◆◆   tools and supplies used in the taxpayer’s work;
                                                                              earned less than $49,194 ($54,884 if married filing
     ◆◆   unreimbursed employee business expenses                             jointly). The maximum earned income credit
          (see below).                                                        for 2018 is (1) $519 with no qualifying child;
    Unreimbursed employee business expenses subject to                        (2) $3,461 with one qualifying child; (3) $5,716
the 2 percent AGI floor include such items as:                                with two qualifying children; and (4) $6,431 with
                                                                              three or more qualifying children.
          ●●   overnight out-of-town travel;
                                                                           b. For contributions in 2018 to a traditional IRA,
          ●●   local transportation;                                          the deduction phaseout range for an individual
          ●●   meals (subject to a 50 percent AGI floor);                     covered by a retirement plan at work begins at
                                                                              income of $101,000 for joint filers and $63,000
          ●●   entertainment (subject to a 50 percent
                                                                              for a single person or head of household. These
               AGI floor);
                                                                              are 2018 amounts that increase to $103,000 for
          ●●   home office expenses;                                          joint filers and $64,000 for a single person or
          ●●   business gifts;                                                head of household for 2019.

          ●●   dues to professional societies;                             c. The dollar limit on annual elective deferrals an
                                                                              individual may make to a 403(b) retirement plan is
          ●●   work-related education;                                        $18,500 for 2018. It increases to $19,000 for 2019.
                                                              2
Clergy Tax Return Preparation Guide for 2018 Returns

d. The catch-up contribution limit on elective                          for religion. This development is addressed fully
   deferrals to a 403(b) retirement plan for                            at the beginning of this text.
   individuals who had attained age 50 by the end                    k. A provision in the comprehensive tax reform
   of the year was $6,000 for 2018. It remains at                       legislation enacted by Congress in 2017 (the
   $6,000 for 2019.
                                                                        Tax Cuts and Jobs Act, or “TCJA”) imposes a
e. The IRS has announced that it will not issue                         tax (the unrelated business income tax) of 21
   private letter rulings addressing the question of                    percent on expenses associated with benefits
   “whether an individual is a minister of the gospel                   provided to employees through a qualified
   for federal tax purposes.” This means taxpayers                      transportation fringe benefit program as defined
   will not be able to obtain clarification from the                    by IRC Section 132(f). These benefits include
   IRS in a letter ruling on their status as a minister                 employer provided parking, mass transit passes
   for any one or more of the following matters:                        and commuter vans. Churches providing these
   (1) eligibility for a parsonage exclusion or                         benefits must file Form 990-T to report the costs
   housing allowance; (2) eligibility for exemption                     and the related tax. The provision of parking
   from self-employment taxes; (3) self-employed                        to employees may come through payment of
   status for Social Security; or (4) exemption of                      parking fees for employees or by provision of
   wages from income tax withholding. The IRS                           parking on the church’s premises. While there
   also has announced that it will not address                          has been much debate over the application of the
   “whether amounts distributed to a retired                            new law to on-site employer provided parking,
   minister from a pension or annuity plan should                       the current consensus is that the new tax applies
   be excludible from the minister’s gross income as                    to employers whose on-site parking provided to
   a parsonage allowance.”                                              employees has value because parking in the area
f. The standard business mileage rate was 54.5                          is only provided on a paid basis. The protest from
   cents per mile for business miles driven during                      nonprofit organizations, including churches, has
   2018. The standard business mileage rate for                         been great during 2018 and petitions have been
   2019 is 58 cents per mile.                                           submitted to Congress requesting repeal of the
                                                                        provision and several bills have been introduced
g. Recent tax law changes will result in lower taxes,                   to repeal the provision. However, until Congress
   and lower estimated tax payments, for many                           or the IRS provides relief, churches should
   taxpayers. Be sure your estimated tax calculations                   prepare to comply with the new law by reporting
   or withholdings take into account the most                           expenses associated with qualified transportation
   recent tax law changes.                                              fringe benefits on Form 990-T and paying
h. Many churches employ retired persons who                             the unrelated business income tax (21 percent)
   are receiving Social Security benefits. Persons                      on this income. Future developments will be
   younger than full retirement age may have                            reported on churchlawandtax.com.
   their Social Security retirement benefits cut if
   they earn more than a specified amount. Full                  PRELIMINARY QUESTIONS
   retirement age (the age at which you are entitled                Below are several questions you should consider
   to full retirement benefits) for persons born                 before preparing your 2018 federal tax return.
   in 1943–1954 is 66 years. If you are under full
   retirement age for the entire year, $1 is deducted               Q. Must ministers pay federal income taxes?
   from your benefit payments for every $2 you                      A. Yes. Ministers are not exempt from paying fed-
   earn above the annual limit. For 2019 that limit                    eral income taxes.
   is $17,640. In the year you reach full retirement                Q. How much income must I earn to be re-
   age, your monthly benefit payments are reduced                      quired to file a tax return?
   by $1 for every $3 you earn above a different                    A. Generally, ministers are required to file a fed-
   limit. For 2019 that limit is $46,920 $3,910 per                    eral income tax return if they have earnings of
   month) but only earnings before the month you                       $400 or more to report their self-employment
   reach full retirement age are counted.                              tax. Different rules apply to ministers who are
i. Will Congress give ministers another                                exempt from self-employment taxes.
   opportunity to revoke an exemption from Social
                                                                    Q. Can I use the simpler Forms 1040A
   Security? It does not look likely, at least for now.
                                                                       or 1040EZ rather than the standard
   No legislation is pending that would provide
                                                                       Form 1040?
   ministers with this option.
                                                                    A. All taxpayers use the newly redesigned
j. The housing allowance is being challenged in                        Form 1040 for 2018 and future years. Forms
   federal court as an unconstitutional preference                     1040A and 1040EZ no longer will be used.
                                                          3
Clergy Tax Return Preparation Guide for 2018 Returns

Q. What records should I keep?                                                 apply to ministers. A CPA has completed a
A. You should keep all receipts, canceled checks,                              rigorous educational program and is subject
   and other evidence to prove amounts you claim                               to strict ethical requirements. However, the
   as deductions, exclusions or credits.                                       tax law is broad and complicated, so it should
                                                                               not be assumed that all CPAs are familiar
Q. What is the deadline for filing my federal
                                                                               with the unique rules applicable to ministers.
   income tax return?
A. The instructions to Form 1040 state that the                           ●●   Ask local tax professionals if they work with
   deadline for filing Form 1040 for the 2018 tax                              ministers and, if so, with how many.
   year is April 15, 2019. If you live in Maine or Mas-                   ●●   Ask local tax professionals a few questions
   sachusetts, you have until April 17, 2019, because                          to test their familiarity with ministers’ tax
   of the Patriots’ Day holiday (April 16, 2019).                              issues. For example, ask whether ministers
Q. What if I am unable to file my tax return                                   are employees or self-employed for Social
   by the deadline?                                                            Security.Anyone familiar with ministers’ taxes
A. You can obtain an automatic six-month exten-                                will know that ministers are self-employed
   sion (from April 15 to October 15, 2019) to file                            for Social Security with respect to their
   your 2018 Form 1040 if you file Form 4868                                   ministerial duties. Or, ask a tax professional
   by April 15, 2019 with the IRS service center                               if a minister’s church salary is subject to
   for your area. Your Form 1040 can be filed at                               income tax withholding. The answer is no,
   any time during the six-month extension pe-                                 and anyone familiar with ministers’ taxes
   riod. An extension only relieves you from the                               should be able to answer this question.
   obligation to file your return; it is not an extension
   of the obligation to pay your taxes.You must make
   an estimate of your tax for 2018 and pay the
   estimated tax with your Form 4868.
Q. Should I prepare my own tax return?
                                                                   PART 2
A. The answer depends on your ability and expe-
   rience in working with financial information
                                                                   SPECIAL RULES
   and in preparing tax returns. Keep in mind:                     FOR MINISTERS
   Ministers’ taxes present a number of unique
   rules, but these rules are not complex. Many
   ministers will be able to prepare their own tax                 Who is a minister for federal tax
   returns if they understand the unique rules                     purposes?
   that apply. These rules are summarized in this                      ✪✪ KEY POINT The IRS has its own criteria for
   document. Easily accessible tax software will                          determining who is a minister for tax purposes.
   also accommodate the unique rules applicable                           The criteria the IRS uses to determine who is
   to ministers, but it does not relieve a minister                       a minister are not necessarily the same as those
   from understanding the rules in order to accu-                         used by churches and denominations. Whether
   rately utilize the software. On the other hand,                        or not one qualifies as a minister for tax purposes
   if you experienced unusual events in 2018, such                        is a very important question, since special tax and
   as the sale or purchase of a home or the sale of                       reporting rules apply to ministers under federal
   other capital assets, it may be prudent to obtain                      tax law. These rules include:
   professional tax assistance. The IRS provides a
   service called Taxpayer Assistance, but it is not                      ●●   eligibility for housing allowances;
   liable in any way if its agents provide you with                       ●●   self-employed status for Social Security;
   incorrect answers to your questions. Free tax-
                                                                          ●●   exemption of wages from income tax
   payer publications are available from the IRS
                                                                               withholding (ministers use the quarterly
   and many of these are helpful to ministers.
                                                                               estimated tax procedure to pay their taxes,
ÂÂ RECOMMENDATION. If you need                                                 unless they elect voluntary withholding); and
   professional assistance, here are some tips that                       ●●   eligibility, under very limited circumstances,
   may help you find a competent tax professional:                             to exempt themselves from self-employment
    ●●   Ask other ministers in your community for                             taxes.
         their recommendations.                                        These special rules only apply to persons qualifying
    ●●   If possible, use a CPA who specializes in tax             as a minister and with respect to compensation received
         law and who is familiar with the rules that               in the exercise of ministerial services.
                                                            4
Clergy Tax Return Preparation Guide for 2018 Returns

   ✎✎ EXAMPLE Rev. J is an ordained minister                                    will be an employee but will be self-employed
   employed by a church. In addition, he works a second job                     with regard to guest speaking appearances in
   for a secular employer. Assume that Rev. J qualifies as a                    other churches and services performed directly
   minister for federal tax purposes. Since his church duties                   for individual members (such as weddings and
   constitute services performed in the exercise of his ministry,               funerals).
   the church can designate a portion of his compensation as                ✎✎ EXAMPLE Rev. B is a minister at First Church.
   a housing allowance. However, the secular employer cannot                She is an employee for federal income tax reporting
   designate any portion of Rev. J’s compensation as a housing              purposes with respect to her church salary. However, she
   allowance, since this work would not be the exercise of                  is self-employed with respect to honoraria she receives for
   ministry.                                                                speaking in other churches and for compensation church
    According to the IRS, ministers are individuals who                     members give her for performing personal services such as
are duly ordained, commissioned, or licensed by a religious                 weddings and funerals. The church issues Rev. B a Form
body constituting a church or church denomination.They                      W-2 reporting her church salary. Rev. B reports this
are given the authority to conduct religious worship,                       amount as wages on line 1 of Form 1040. She reports
perform sacerdotal functions, and administer ordinances                     her compensation and expenses from the outside self-
or sacraments according to the tenets and practices of that                 employment activities on Schedule C.
church or denomination. If a church or denomination                         ✪✪ KEY POINT Most ministers will be better
ordains some ministers and licenses or commissions                             off financially being treated as employees, since
others, anyone licensed or commissioned must be able                           the value of various fringe benefits will be tax
to perform substantially all the religious functions of                        free, the risk of an IRS audit is substantially
an ordained minister to be treated as minister for tax                         lower, and reporting as an employee avoids the
purposes. See IRS Publication 517.                                             additional taxes and penalties that often apply to
                                                                               self-employed ministers who are audited by the
Are ministers employees or self-                                               IRS and reclassified as employees.
employed for federal tax purposes?
                                                                            ✪✪ KEY POINT Ministers and other church
   ✪✪ KEY POINT Most ministers are employees                                   staff members should carefully review their
      for federal income tax purposes under the tests                          Form W-2 to be sure it does not report more
      currently used by the IRS and the courts and                             income than was actually received or fails to
      should receive a Form W-2 from their church                              report taxable benefits provided by the church.
      reporting their taxable income. However,                                 If an error was made, the church should issue a
      ministers are self-employed for Social Security                          corrected tax form (Form W-2c).
      (with respect to services they perform in the
      exercise of their ministry).                                          The Tax Court Test. The United States Tax Court
                                                                        has created a seven-factor test for determining whether
    Ministers have a dual tax status. For federal income                a minister is an employee or self-employed for federal
taxes they ordinarily are employees, but for Social                     income tax reporting purposes. The test requires
Security they are self-employed with regard to services                 consideration of the following seven factors: (1) the
performed in the exercise of their ministry. These two                  degree of control exercised by the employer over the
rules are summarized below:                                             details of the work; (2) which party invests in the facilities
   1. Income taxes. For federal income tax reporting,                   used in the work; (3) the opportunity of the individual
      most ministers are employees under the tests                      for profit or loss; (4) whether or not the employer has
      currently used by the IRS. This means that they                   the right to discharge the individual; (5) whether the
      should receive a Form W-2 from their church at                    work is part of the employer’s regular business; (6) the
      the end of each year (rather than a Form 1099).                   permanency of the relationship; and (7) the relationship
      Formerly, it meant that they reported their                       the parties believe they are creating. Most ministers will
      employee business expenses on Schedule A                          be employees under this test.
      rather than on Schedule C. (The deduction for                         2. Social Security. The tax code treats ministers
      employee business expenses as Miscellaneous                              as self-employed for Social Security with respect
      Itemized Deductions on Schedule A is suspended                           to services performed in the exercise of their
      through 2025, so employee business expenses                              ministry—even if they report their income taxes
      are not deductible at this time.) A few ministers                        as an employee. This means that ministers must
      are self-employed, such as some Wandering                                pay self-employment taxes (Social Security taxes
      Ministers and some interim pastors. Also, many                           for the self-employed) unless they have filed a
      ministers who are employees of a local church are                        timely exemption application (Form 4361) that
      self-employed for other purposes. For example,                           has been approved by the IRS. As noted below,
      the minister of a local church almost always                             few ministers qualify for this exemption.
                                                                    5
Clergy Tax Return Preparation Guide for 2018 Returns

   ✪✪ KEY POINT While most ministers are                             their non-ministerial employment assuming that they
      employees for federal income tax reporting                     have worked enough quarters. Generally, 40 quarters
      purposes, they are self-employed for Social                    are required. Also, the Social Security Administration
      Security with respect to services they perform                 has informed the author of this text that ministers
      in the exercise of their ministry. This means that             who exempt themselves from self-employment taxes
      ministers are not subject to the employee’s share of           may qualify for Social Security benefits (including
      Social Security and Medicare taxes, even though                retirement and Medicare) on the basis of their spouse’s
      they report their income taxes as employees and                coverage, if the spouse had enough credits. However,
      receive a Form W-2 from their church. Rather,                  the amount of these benefits will be reduced by the so-
      they pay the self-employment tax (SECA).                       called “windfall elimination provision.” Contact a Social
                                                                     Security Administration office for details.
Exemption from Self-Employment                                           ✪✪ KEY POINT The amount of earnings
(Social Security) Taxes                                                     required for a quarter of coverage in 2019 is
     If ministers meet several requirements, they may                       $1,360. A quarter of coverage is the basic unit for
exempt themselves from self-employment taxes with                           determining whether a worker is insured under
respect to their ministerial earnings. Among other                          the Social Security program.
things, the exemption application (Form 4361) must be                    ✪✪ KEY POINT Ministers who work after they
submitted to the IRS within a limited time period. The                      retire must continue to pay Social Security on
deadline is the due date of the federal tax return for the                  their ministerial income and wages (unless they
second year in which a minister has net earnings from                       exempted themselves from Social Security as a
self-employment of $400 or more, any part of which                          minister and they are employed in a ministerial
comes from ministerial services. Further, the exemption                     capacity).
is available only to ministers who are opposed on the
basis of religious considerations to the acceptance                      ✪✪ KEY POINT In 1970, the IRS ruled
of benefits under the Social Security program (or                           that ministers who exempt themselves from
any other public insurance system that provides                             self-employment taxes solely on the basis of
retirement or medical benefits). A minister who files the                   economic considerations are not legally exempt.
exemption application may still purchase life insurance                     Revenue Ruling 70-197. The IRS concluded:
or participate in retirement programs administered by                       “The taxpayer filed the Form 4361 solely for
nongovernmental institutions (such as a life insurance                      economic considerations and not because he
company). Additionally, the exemption does not require                      was conscientiously opposed to, or because of
a minister to revoke all rights to Social Security benefits                 religious principles opposed to, the acceptance
earned through their participation in the system through                    of any public insurance of the type described on
secular employment.                                                         the form. Accordingly . . . the taxpayer did not
                                                                            qualify for the exemption since the Form 4361
   A minister’s opposition must be to accepting benefits                    filed solely for economic reasons is a nullity.”
under Social Security (or any other public insurance                        Ministers wanting to revoke an exemption from
program) which are related to services performed                            self-employment taxes should discuss this ruling
as a minister. Economic, or any other nonreligious                          with a tax professional.
considerations, are not a valid basis for the exemption,
nor is opposition to paying the self-employment tax.                 How do ministers pay their taxes?
    The exemption is only effective when it is approved                  ✪✪ KEY POINT Ministers must prepay their
by the IRS. Few ministers qualify for the exemption.                        income taxes and self-employment taxes
Many younger ministers opt out of Social Security                           using the estimated tax procedure, unless they
without realizing that they do not qualify for the                          have entered into a voluntary withholding
exemption. A decision to opt out of Social Security is                      arrangement with their church with respect to
irrevocable. Congress did provide ministers with a brief                    federal income tax only.
“window” of time to revoke an exemption by filing
Form 2031 with the IRS. This opportunity expired in                      As noted above, ministers’ wages are exempt from
2002 and has not been renewed.                                       federal income tax withholding.This means that a church
                                                                     does not have to withhold income taxes from a minister’s
    An exemption from self-employment taxes applies                  paycheck. And, since ministers are self-employed for
only to compensation for ministerial services. Ministers             Social Security with respect to their ministerial services,
who have exempted themselves from self-employment                    a church does not withhold the employee’s share of
taxes must pay Social Security taxes on any non-                     Social Security and Medicare taxes from a minister’s
ministerial compensation they receive. And, they                     wages. Ministers must prepay their income taxes and self-
remain eligible for Social Security benefits based on                employment taxes using the estimated tax procedure,
                                                              6
Clergy Tax Return Preparation Guide for 2018 Returns

unless they enter into a voluntary withholding                            You must send each payment to the IRS,
arrangement with their church. Estimated taxes must be                accompanied by one of the four payment vouchers
paid in quarterly installments. If your estimated tax paid            contained in Form 1040-ES. If enrolled in the EFTPS
for the current year is less than your actual tax, you may            system, all four payments may be prescheduled for
have to pay an underpayment penalty. You can amend                    automatic payment at the schedule dates.
your estimated tax payments during the year if your                        Step 4. After the close of 2018, compute your
circumstances change. For example, if your income or                  actual tax liability on Form 1040. Only then will you
deductions increase unexpectedly, you should refigure                 know your actual income, deductions, exclusions, and
your estimated tax liability for the year and amend your              credits. If you overpaid your estimated taxes (that is,
remaining quarterly payments accordingly or submit                    actual taxes computed on Form 1040 are less than all of
additional payments.                                                  your estimated tax payments plus any withholding), you
     You will need to make estimated tax payments for                 can elect to have the overpayment credited against your
2019 if you expect to owe at least $1,000 in tax for 2019             first 2019 quarterly estimated tax payment, or spread it
after subtracting your withholding and credits and if you             out in any way you choose among any or all of your
expect your withholding and credits to be less than the               next four quarterly installments. Alternatively, you can
smaller of (1) 90 percent of the tax to be shown on your              request a refund of the overpayment. If you underpaid
2019 tax return, or (2) 100 percent of the tax shown                  your estimated taxes (that is, your actual tax liability
on your 2018 tax return (110 percent if adjusted gross                exceeds the total of your estimated tax payments plus
income exceeds $150,000, or if married filing separately,             any withholding), you may have to pay a penalty.
more than $75,000). Your 2018 tax return must cover                       ✪✪ KEY POINT Ministers who report their
all 12 months.                                                               income taxes as employees can request that
    The four-step procedure for reporting and prepaying                      their employing church voluntarily withhold
estimated taxes for 2019 is summarized below.                                income taxes from their wages. Simply furnish
    Step 1. Estimated tax payments may be paid using                         the church with a completed W-4 (withholding
either of the following methods:                                             allowance certificate). Since ministers are not
                                                                             employees for Social Security with respect to
   ●●    Obtain a copy of IRS Form 1040ES for 2019                           ministerial compensation, the church does not
         before April 15, 2019. You can obtain forms                         withhold the employee’s share of Social Security
         by calling the IRS toll-free forms hotline at                       and Medicare taxes. However, ministers can
         800-TAX-FORM (800-829-3676), or from the                            request on Form W-4 (line 6) that an additional
         IRS website (irs.gov). If you paid estimated                        amount of income tax be withheld to cover
         taxes last year, you should receive a copy of your                  their estimated self-employment tax liability
         2019 Form 1040-ES in the mail with payment                          for the year. The excess income tax withheld
         vouchers preprinted with your name, address,                        is a credit that is applied against the minister’s
         and Social Security number; or                                      self-employment tax liability. Many churches
   ●●    Enroll in the Electronic Federal Tax Payment                        understandably withhold Social Security and
         System at www.eftps.gov and establish an online                     Medicare taxes in addition to income taxes for
         account to be used to submit payments.                              a minister who requests voluntary withholding.
                                                                             Such withholding must be reported as income
    Step 2. Compute your estimated tax for 2019                              tax withheld.
using the Form 1040-ES worksheet. Ministers’ quarterly
estimated tax payments should take into account both
income taxes and self-employment taxes.
    Step 3. Pay one-fourth of your total estimated
taxes for 2019 in each of four quarterly installments as
follows:

        FOR THE PERIOD                DUE DATE
        January 1–March 31            April 17, 2019
        April 1–May 31                June 17, 2019
        June 1–August 31              September
                                      16, 2019
        September 1–December 31       January 15, 2020

                                                              7
Clergy Tax Return Preparation Guide for 2018 Returns

                                                                                Business income is reported on Schedule
PART 3
                                                                           ●●

                                                                                C as in prior years, but is then posted to
                                                                                Schedule 1 of Form 1040 rather than line 12
STEP-BY-STEP                                                                    as in prior years.
TAX RETURN                                                                 ●●   Adjustments to income, reported on lines 23-
                                                                                36 of the 2017 Form 1040 are now reported
PREPARATION                                                                     on lines 23-36 of Schedule 1 (Form 1040).
                                                                           ●●   Schedule 2 (Form 1040) lists taxes that
                                                                                were reported on lines 45-47 in the 2017
TAX FORMS AND                                                                   Form 1040.
SCHEDULES                                                                  ●●   Schedule 3 (Form 1040) lists “nonrefundable
   This step-by-step analysis covers these forms and                            credits,” including credits for child and
schedules:                                                                      dependent care expenses and education
                                                                                credits that were reported on lines 48-55 in
     Form 1040 is the basic document you will use.                              the 2017 Form 1040.
It summarizes all of your tax information. Details are                     ●●   Schedule 4 (Form 1040) lists “other taxes”
reported on supplementary schedules and forms. Note                             (including the self-employment tax) reported
that the IRS has unveiled a new and redesigned Form                             on lines 57-64 in the 2017 Form 1040.
1040 that reflects the many tax law changes made by
the Tax Cuts and Jobs Act of 2017. The new 1040 –                          ●●   Schedule 5 (Form 1040) lists “other
about half the size of the current version -- replaces the                      payments,” including self-employment taxes
current Form 1040 as well as the Form 1040A and the                             that were reported on lines 65-75 in the
Form 1040EZ. The new Form 1040 is different from                                2017 Form 1040.
its predecessors in several ways including the following:               ✪✪ KEY POINT Some references in this Guide
   1. It is half the size of the previous Form 1040 and                    are to lines in the new Form 1040, but others
      consists of two half pages.                                          refer to lines in the new “schedules.” Be sure
                                                                           you distinguish between these terms to avoid
   2. Health care coverage (mandatory through 2018)                        confusion.
      is reported by checking a box on page 1 (it was
      reported on line 61 on the 2017 form).                           ,,CAUTION The IRS has announced that
                                                                         there may be additional changes to the 2018
   3. All personal exemptions were repealed after                        Form 1040 before it is finalized.
      2017 and so there is no way to claim them on
      the 2018 Form 1040.                                               Schedule A is for itemized deductions for medical
                                                                    and dental expenses, taxes, interest, certain disaster
   4. Some lines have been consolidated. For                        related casualty losses and charitable contributions.
      example, several items of income, capital gains,
      rental income, etc. are consolidated and reported                    NEW IN 2018 Beginning with tax year
      on Line 6.                                                           2018 no miscellaneous itemized deductions
                                                                           that formerly were subject to a 2% of
   5. Wages are now reported on line 1 (instead of                         adjusted gross income limitation are allowed.
      line 7 for the past several years).                                  This and other changes to Schedule A are
   6. Adjusted gross income is reported on line 7 and                      addressed later in this guide.
      without detail on the form (instead of line 37 for               Schedule B is for reporting dividend and interest
      the past several years).                                      income.
   7. The standard deduction is reported on line 8,                     Schedule C is for reporting your income and
      and is significantly larger than in 2017 ($12,000             expenses from business activities you conduct other
      for unmarried persons and $24,000 for married                 than in your capacity as an employee. Examples would
      persons filing jointly).                                      be fees received for guest speaking appearances in other
   8. Several credits are now reported on Schedule                  churches or fees received directly from members for
      3 and consolidated on line 12b (they were                     performing personal services, such as weddings and
      reported on separate lines in 2017).                          funerals.
   9. Many lines in the previous Form 1040 have been                   Schedule SE is for reporting Social Security taxes
      deleted and transferred to various schedules. In              due on your self-employment income. Ministers use this
      fact, the 79 lines on the 2017 Form 1040 have                 schedule since they are deemed self-employed for Social
      been reduced to 23, a reduction of more than 50               Security with respect to ministerial services (unless they
      lines. For example:                                           have obtained an approved Form 4361 from the IRS).
                                                             8
Clergy Tax Return Preparation Guide for 2018 Returns

    These forms and schedules, along with others, are                Step 3: Dependents
included in the illustrated example in Part 4 of this
guide. These forms and schedules are the ones most                       In the past taxpayers were allowed a personal
commonly used by ministers. These forms may be                       exemption for themselves and certain dependents.
obtained at certain local post offices or IRS office. Or,            All personal exemptions were repealed after 2017
you can obtain them by calling the IRS toll-free forms               and so they cannot be claimed on the 2018 Form
hotline at 800-TAX-FORM (800-829-3676). They also                    1040. However, it is still necessary to determine who
are available on the IRS website (irs.gov).                          qualifies as dependents and include them on the return.
                                                                     Dependents determine various credits, such as the child
                                                                     tax credit, as well as other tax related items such as
                                                                     educational credits, medical expenses, child care credit
                                                                     and earned income credit, just to name a few.
FORM 1040
                                                                     Step 4: Income
Step 1: Filing status                                                     Several items of income are reported on lines
    Select the appropriate filing status from the five               1 through 6 (including amounts carried over from
options listed in this section of the Form 1040.                     Schedule 1, lines 10-22). The most important of these
    In 2015, the United States Supreme Court ruled                   (for ministers) are discussed below.
that the right of same-sex couples to marry is part of                   ✪✪ KEY POINT Some items, such as the housing
the Fourteenth Amendment’s guarantees of due process                        allowance, are not reported as income. They are
and equal protection of the laws, and therefore any state                   called exclusions and are explained below.
law that in any way limits this right is unconstitutional
and void. Obergefell v. Hodges, 135 S. Ct. 2584 (2015).              Line 1.Wages, salaries, tips, etc.
The effect of the Court’s decision was to invalidate laws               As an employee, you should receive a Form W-2
and constitutional provisions in several states defining             from your church reporting your wages at the end of
marriage solely as a union between one man and one                   each year. Report this amount on line 1.
woman, and to treat same-sex marriages the same as
opposite-sex marriages for purposes of federal tax law.                  Determining church wages or salary. Besides a salary,
                                                                     ministers’ wages reported on Form W-2 may include
Step 2: Name and address                                             several other items; some items are:
    Print or type the information in the spaces provided.                1. Bonuses
If you are married filing a separate return, enter your                  2. The cost of sending a minister to the Holy Land
spouse’s name on line 3 instead of below your name.                         (if paid by the church)
If you filed a joint return for 2017 and you are filing a
                                                                         3. Most Christmas and special occasion offerings
joint return for 2018 with the same spouse, be sure to
enter your names and Social Security numbers in the                      4. Retirement gifts paid by a church
same order as on your 2017 return.                                       5. The portion of a minister’s self-employment tax
   If you plan to move after filing your return, use                        paid by a church
Form 8822 to notify the IRS of your new address.                         6. Personal use of a church-owned vehicle
    If you (or your spouse) changed your name because                    7. Purchases of church property for less than fair
of marriage, divorce, etc., be sure to report the change to                 market value
the Social Security Administration (SSA) before filing
your return. This prevents delays in processing your                     8. Business expense reimbursements under a
return and issuing refunds. It also safeguards your future                  nonaccountable plan
Social Security benefits. If a name change with the SSA                  9. Imputed cost of group term life insurance
has not been completed, the name on SSA file must be                        coverage (including death benefits under the
used in filing your tax return.                                             Benefits Plan) exceeding $50,000 and cost
   Enter your P.O. Box number only if your post office                      of coverage of spouse and dependents if over
does not deliver mail to your home.                                         $2,000 which is paid by the church
     If you want $3 to go to the presidential election                   10. Church reimbursements of a spouse’s travel
campaign fund, check the box labeled “you.” If you are                       expenses incurred while accompanying a
filing a joint return, your spouse can also have $3 go to                    minister on a business trip (unless the spouse’s
the fund (check “spouse”). If you check a box, your tax                      presence serves a legitimate business purpose
or refund will not change.                                                   and the spouse’s expenses are reimbursed under
                                                                             an accountable arrangement)
                                                              9
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