The Tax Audit

The return address read “Internal Revenue Service.”

Oh, no. What does that mean?

I opened the envelope to read the summons. My wife and I were invited to meet with an IRS representative to discuss a tax return filed two years earlier. We were being audited.

File folder in hand, we arrived at the federal office building with enough time to sit in the waiting area a while. Finally, a young woman called our name and led us to her office. We sat in the chairs across the desk from her. I noticed splotchy red marks erupt on her face and neck as the questioning began. I wondered if my anxiety showed in any way.

Need to Know

There’s a lot to know about preparing a minister’s income tax return and a lot of ways to make a mistake. Pleading ignorance at an audit won’t erase the tax bill.

Where a person gets information about a minister’s tax situation is important. I talked with a recent college graduate who was told by a history professor that he should opt out of Social Security. I received similar counsel when I was his age, but that is not an option for a minister in the Church of the Nazarene. I’m glad now that I didn’t give that suggestion any consideration at the time. The Internet has increased the availability of vast quantities of information, including misinformation that can make life difficult.

Sometimes a volunteer treasurer asks a pastor for instruction on tax issues. Too often that results in the blind leading the blind. Income tax return preparation software may be difficult to navigate for such issues as housing allowance and self-employment tax calculations. I’ve even heard horror stories about professional tax preparers who have messed up a minister’s return. Income tax is a complicated subject with little correlation to the issues which occupy pastors the most. Sermon preparation is to tax preparation as the “Bread of Life” is to garlic toast. A pastor, however, must do both sermon prep and tax prep with integrity.

A pastor should know that a qualified ministry expense reimbursement plan set up by the church board provides tax advantages over including the expenses on Schedule A of his or her annual federal return. With benefits such as retirement plan contributions and health insurance premiums, for income tax purposes, it makes a difference who (the church of the minister) makes the payment. Then, there’s reporting ministerial housing with the required Schedule SE to declare the value received from living in a parsonage or the housing allowance.

Unless the minister voluntarily asks the church to withhold taxes, he or she must make regular estimated tax payments to the Federal government. There’s a penalty if a pastor waits until April 15 to make the payment for the previous year. States with an income tax will want estimated tax payments too. Some counties or cities have income taxes that must be calculated. Things can become a bit more complex for the minister who moves to a new pastoral assignment in a different state, since that may require filing income tax returns in two states for the year of the move.

Good documentation is essential with income taxes. A minister needs to devise a way that fits his or her lifestyle to keep records and receipts throughout the year.

That’s a lot to remember, but it is necessary for every pastor to know the basics of income taxes. Sufficient knowledge is unlikely to come through speed reading. Careful study of Pensions and Benefits memos is a good place to start. Then move on to documents from the IRS (see below for suggestions). Also, you might consult Dan Busby’s “Preparing Tax Returns for Clergy,” which was sent by P&B USA to every active Nazarene minister in January. If you come across something you don’t understand, find someone who will explain it to you.

Ultimately, as the taxpayer, the minister is responsible to keep precise records and prepare an accurate income tax return. If audited, you’ll be the one in the chair on the other side of the desk.

Vows Following the Tax Audit

At our tax audit, the first question totally surprised me. “Are you required to give this much to be employed at the church?”

“Give what?”

“Your charitable contributions. Does the church require you to contribute at a specified level as a condition of employment?”

“No. All contributions are voluntary.”

The auditor looked at the contribution receipts we used to prepare the income tax return. She thanked us for coming and ushered us back to the waiting area. That was it.

As I reflected on the experience, I resolved to understand income taxes well enough to accurately prepare the annual return. I want to be totally ready should we be audited again. And I vowed to continue generous living, even if it meant another conversation with an auditor.

Originally published by Pensions & Benefits USA.