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 misled by inaccurate interpretations of the law by both the IRS and other law firms.

Please note that all of our legal authorities are cited at the bottom in the footnotes. This is not our opinion; it is based on a diligent reading and interpretation of the law by attorneys that are alums of Harvard, Georgetown, SMU, and Florida Levin. If you applied for exemption on Form 4361 and were denied, you can still be exempt with this legal position. Contact us to schedule a free consultation.

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 religious order or religious duties since every single employee in a church or religious organization contributes to the overall spiritual environment in which all members can 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] In other words, Treasury regulations specifically state that it is the policy of the IRS to not get into the business of what is and is not a "religious duty." If the employee was "directed or required to perform" the duty, the nature and extent are irrelevant; it's automatically deemed to be a "religious duty."

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. If you filed a Form 4361 and it was denied, contact our firm.

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.

Update 05/12/2021

During the course of discussions with the IRS on this matter, the IRS referenced a hanging provision that applies to Section 1402(c)(1)-(6) that reads: "The provisions of paragraph (4) or (5) shall not apply to service (other than service performed by a member of a religious order who has taken a vow of poverty as a member of such order) performed by an individual unless an exemption under subsection (e) is effective with respect to him." This begs the question: What is a Vow of Poverty?

Before I begin this discussion, it's important to note that it is our firm's position that to add a religious litmus test and "vow of poverty" requirement forces the judiciary to become the arbitrar of religious doctrine. In other words, is it really the role of the federal judiciary to determine what is and is not a "vow of poverty"? You can quickly see how this could be a non-justiciable issue; an issue that a federal judge would be entirely unwilling to touch. In fact, even if a federal judge felt comfortable making such a decision, it would very likely be overturned on appeal since it is not the province of the federal judiciary to interpret religious doctrine. Nevertheless, I digress for now and continue with examining the religious doctrine behind a "vow of poverty."

The Gospel of Luke, 18:18-30, tells a story of a ruler asking Christ what must be done to guarantee the inheritance of eternal life. Christ quotes several of the commandments, but then explains how difficult it is for someone who is rich to enter the kingdom of God. Christ suggests to the ruler that he must sell everything he owns, give it to the poor, and follow him. Christ then explains that this is the only thing that could possibly guarantee entrance into the kingdom of God.

While it is true that sacrificing all that you own will demonstrate a turning point in one’s life sufficient to satisfy God, the sacrifice of personal property is symbolic to demonstrate the meaninglessness of worldly possessions. For one cannot selflessly serve God while selfishly satisfying personal greed. The two are irreconcilable.

However, if one has wealth and possession but joyfully shares it with others instead of selfishly hoarding it, there is no personal greed or love of possessions that conflicts with the love for God. Thus, a vow of poverty can include a renunciation and repudiation of the socially acceptable attachment one would otherwise usually have to worldly possessions. Such a vow could also include a personal commitment to share any excess with those in need.

This is supported in the Book of Acts, 4:32-36, wherein a description is provided of a commune of apostles in which no one claimed private ownership of property, shared all they had, and even sold the land and houses they owned to donate to the leaders for distribution to those in need. They sold their land and houses because the commune offered communal shelter.

This was necessary in the early stages of the Church to build the foundations of modern Christianity. The leaders were men who had walked with Christ; who wouldn’t leave their world behind to follow that? Today, however, Christianity is well established. While such acts of entirely leaving behind regular life is still admirable, it is most definitely not necessary.

Should a vow be documented, signed under oath, or another formal method?

According to the Gospel of Matthew, 5:33-37, absolutely not. In that verse, Christ said, “Again, you have heard that it was said to the people long ago, ‘Do not break your oath, but fulfill to the Lord the vows you have made.’ But I tell you, do not swear an oath at all: either by heaven, for it is God’s throne; or by the earth, for it is his footstool; or by Jerusalem, for it is the city of the Great King. And do not swear by your head, for you cannot make even one hair white or black. All you need to say is simply ‘Yes’ or ‘No’; anything beyond this comes from the evil one.”

This is repeated in the Epistle of James, 5:12, “Above all, my brothers and sisters, do not swear, not by heaven or by earth or by anything else. All you need to say is a simple ‘Yes’ or ‘No.’ Otherwise you will be condemned.”

Formal vows and oaths are not only specifically prohibited by Christ in the Gospel of Matthew as well as generally in the Epistle of James; they are said to be from the evil one that will result in one being condemned.

Therefore, a “vow of poverty” is simply a personal solemn assertion in one’s soul to repudiate the societal norm of being attached to worldly possessions. For if you have no attachment to worldly possessions, nothing stands in your way to answering God’s call. If you have no attachment to worldly possessions, then, in your heart, you own nothing. Then, and only then, your heart will be filled only with the love of Christ and the people of this world that require his saving. Then, and only then, you can follow his command to save people’s souls. Then, and only then, will you be unhindered by selfishness and greed. Then, and only then, will His kingdom come because His will is being done, here on Earth as it is in Heaven.

If you believe this is and always has been your vow of poverty, then I ask you, as Christ commanded to us, to simply answer: yes or no. If you answered yes, you satisfy the "vow of poverty" condition. If you answered no, we can take the position that the "vow of poverty" condition is a constitutionally inappropriate religious litmus test that is non-justiciable without violating the First Amendment's requirement that Congress make no law recognizing an establishment of religion or inappropriately forcing the judiciary's hand in being the arbitrar of religious doctrine.

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Contact Our Firm

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.

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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, an esteemed 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.


[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. 1985); 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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