SE Tax Exemption for Religious Organization Employees

by John Anthony Castro, J.D., LL.M.

Introduction

One question that comes up quite often for new clients that are employees of religious organizations is why they have to pay the self-employment tax on their church income.

The short answer is that you’ve been paying the self-employment tax because you’ve been getting bad tax advice, but the truth is that the entire tax community has been mislead by the IRS.

Background

The Internal Revenue Code (the “Code”) generally imposes social security and Medicare taxes on all salaries and wages.[1] However, there is a list of specifically enumerated exceptions, which includes salaries and wages “for services performed by a… member of a religious order in the exercise of duties required by such order.”[2] For non-legal terms, the U.S. Supreme Court has held that courts must defer to the plain meaning of a term as reflected in any American dictionary.[3] The plain meaning of the term “order” according to Merriam-Webster is “a group of people united in a formal way,” “any of the several grades of the Christian ministry,” and a “sociopolitical system.” This describes just about every church in America. The federal government does not have the authority to define what constitutes a religion, religious order, or religious duties since every single employee in a church or religious organization contributes to the spiritual environment upon which all members rely to freely exercise their faith.[4]

Social Security and Medicare Tax

The Federal Insurance Contributions Act was codified in Title 26 “Internal Revenue Code,” Subtitle C “Employment Taxes,” Chapter 21 “Federal Insurance Contributions Act,” Sections 3101-3128. Chapter 21 is divided into three subchapters. Subchapter A “Tax on the Employees” includes Sections 3101 and 3102 that discusses the social security and Medicare taxes imposed on the individual wage earner. Subchapter B “Tax on Employers” includes Sections 3111 and 3112 that discusses the social security and Medicare taxes imposed on organizations. Subchapter C “General Provisions” covers Sections 3121 through 3128 that discusses definitions and other matters.

Both the tax on the employee under Section 3101 and employer under Section 3111 only apply to wages, as defined in Section 3121(a), from employment, as defined in Section 3121(b). For those familiar with the practice of law, you never go by the plain meaning of a term if the statute references a particular section for a definition. You ignore the term altogether and strictly refer to the provision it references.

For wages, we turn to Section 3121(a) as required by Sections 3101 and 3111. In short, it includes everything. For employment, however, the term does not include “service performed… by a member of a religious order in the exercise of duties required by such order” unless the organization specifically elects to pay the social security and Medicare taxes imposed by Section 3111.[5]

Seems very straightforward. However, the confusion arises when a religious organization makes an election under Section 3121(w) if the “church or organization is opposed for religious reasons to the payment of the tax imposed under section 3111.” It is important to emphasize that the only effect that an organization’s election under Section 3121(w) is that it is also not considered “employment” under Section 3121(b)(8)(B). This, in effect, subjects the income to an analysis under Sections 1401 and 1402 to determine if it is subject to the self-employment tax.

Self-Employment Tax

Section 1401 imposes the self-employment tax on all “self-employment income.”[6] This tax is imposed on all “net earnings from self-employment” attributable to “any trade or business.”[7] For any member of a religious order, whether performing religious duties or not, there are special exclusions that are not counted as “net earnings from self-employment.”[8]

Thus, for the self-employment tax to be applicable, there must be net earnings from self-employment and those earnings must be attributable to a trade or business. If either of those two factors are missing, the self-employment tax does not apply.

The term “trade or business” is defined to specifically exclude “the performance of service by… a member of a religious order in the exercise of duties required by such order.”[9] Thus, being in the employ of a religious order and performing religious duties is not a trade or business to which Section 1401 applies.

The confusion stems from Section 1402(c)(2)(g) that specifically categorizes the “service performed in the employ of a church… if such church or organization has in effect an election” that exempts the organization from social security and Medicare taxes for religious reasons, as discussed above, as a “trade or business.” However, Section 1402(c)(4) is the exception to this rule, which means this only applies to all other employees of a religious organization not performing religious duties.

Thus, the application for exemption under Section 1402(e) only applies to individuals that are not statutorily exempt. For example, any employee of a religious organization that has claimed a 3121(w) election is considered to be self-employed by operation of 1402(c)(2)(g); however, if that organization is a religious order and the employee is actually exercising religious duties, then the exemption stands under Section 1402(c)(4). Only the employees not exercising religious duties must apply for an exemption under Section 1402(e).[10] However, it is nearly impossible for any duty to not qualify since Treasury regulations specifically state that the “nature or extent of such service is immaterial so long as it is a service which he is directed or required to perform.”[11]

Therefore, a taxpayer employed by a religious organization need not consider the application for exemption on IRS Form 4029 or Form 4361 since they are statutorily exempt.

Conclusion

It’s our firm’s position every member of a religious organization is performing duties required by the religious organization, especially for those specifically tasked with proselytizing. As such, the employees are exempt from both the employee share of social security and Medicare taxes under Section 3101 as well as the self-employment tax under Section 1401.

Furthermore, by operation of Section 1402(c)(4), employees of religious organizations performing duties required by the religious organization are exempt from the Section 1402(e) application requirement.

Next Steps

If you have previously paid or currently are paying self-employment tax on earnings from a religious organization, contact our firm today to schedule a free consultation. We can recover the tax from the IRS going up to 3 years back. We have already secured amended refunds for several dozen clients. The IRS has acquiesced to our legal position.

Schedule a free consultation now. Click here!


About the Author

John Anthony Castro, J.D., LL.M., is the Managing Partner of Castro & Co., the author of International Taxation in Plain English, a graduate of Georgetown University Law Center in Washington DC, an OPM Fellow at Harvard Business School, and an internationally recognized tax attorney with offices in New York, Los Angeles, Washington DC, Miami, and Dallas.

To provide feedback on this article or suggest an idea for a future article, please contact Tiffany Michelle Hunt, J.D., LL.M., Director of Tax Planning at Castro & Co., at T.Hunt@CastroAndCo.com.


[1] See IRC § 3401.

[2] IRC § 3401(a)(9).

[3] See U.S. v. Home Concrete & Supply, 132 S. Ct. 1836 (2012); also see Intermountain v. C.I.R., 134 T.C. 211 (2010) (If a Court rules that a statute is unambiguous and thus forecloses any “gaps,” Treasury regulations cannot fill-in any gaps and are thus not entitled to Chevron judicial deference); Dominion Res., Inc. v. U.S., 681 F.3d 1313 (Fed. Cir. 2012) (regulations cannot exceed the unambiguously expressed intent of Congress).

[4] See St. Joseph Farms v. C.I.R., 85 T.C. 9 (1985), nonacq. recommended by AOD-1986-45 (July 28, 1986), and nonacq. (Dec. 31, 1986); but see Eighth St. Baptist Church. v. U.S., 295 F. Supp. 1400 (D. Kan. 1969); Rev. Proc. 91-20 (this revenue procedure insultingly sets a standard akin to a cult rather than a traditional religious organization); De La Salle Inst. v. U.S., 195 F. Supp. 891 (N.D. Cal. 1961); Kelley v. C.I.R., 62 T.C. 131 (1974); Estate of Callaghan v. C.I.R., 33 T.C. 870 (1960).

[5] IRC § 3121(b)(8)(A) ; also see Treas. Reg. § 31.3121(b)(8)-1(d).

[6] IRC § 1401(a).

[7] IRC § 1402(a).

[8] IRC § 1402(a)(8).

[9] IRC § 1402(c)(4); also see Treas. Reg. § 1.1402(c)-5(d)(3).

[10] See Bethel Baptist Church v. U.S., 822 F.2d 1334 (3d Cir. 1987) (church employees may have standing under the Equal Protection Clause to bring suit to invalidate this provision).

[11] Treas. Reg. § 31.3401(a)(9)-1. However, there are still outdated authorities contradicting this regulation. See Hogan v. U.S., 57 A.F.T.R.2d 86-338 (D.Me.); also see Rev. Ruls. 55-242, 57-129, 28-550, 79-132. Nevertheless, there are an equal amount of more recent revenue rulings that support the regulations. See Rev Ruls. 77-290, 78-229, 80-332.

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