2011 Tax Saving Ideas for Pastors
By Mark Helland, CPA

I know it is hard to believe, but we are only a month away from the end of 2011 which means that the Christmas will be here before we know it. While shopping for Christmas gifts and all the other festivities of the season are at the top of everyone’s mind during this time of year, it is also a great time to take some proactive steps to reduce your income tax liability. Pastors especially have some key areas that allow for income tax saving opportunities which need to be carefully considered. Following are some tax-saving ideas that could make filing your income tax return a whole lot less painful this year.

Housing allowances for 2012 must be board designated.
While this is not necessarily a tax saving idea for the 2011 tax year, this is a critically important IRS compliance issue. Compensation that is considered to be a housing allowance must be designated by the Church board of trustees, in writing, prior to the end of the calendar year for the upcoming year. Failure to do so could result in the IRS reclassifying such amounts as wages if you were ever to be audited.

Have you used the full value of the housing allowances for housing expenses?
A common misconception is that the housing allowance is completely free of any form of income tax. Here is how taxation on the housing allowance works—for pastors who have not opted out of social security, the full value of the housing allowance is subject to self-employment tax (FICA and Medicare, both the employee and employer’s portion). For pastors who have opted out of social security, the housing allowance is not subject to self-employment tax. In either case the housing allowance is not subject to federal and state income taxes unless the housing allowance has not been used in full to pay for qualified housing related expenses. In other words, any portion of the housing allowance that has not been spent for qualified housing expenses will be subject to income taxes. So, now is the time to compare your total housing allowance with your qualified housing expenses for 2010 and make any additional housing expenditures prior to year end.

Consider energy efficient improvements to your home.
Many home improvements such as new windows and insulation still qualify for energy tax credits in 2011 (and 2011 is the expiration of most of these credits). As a follow up to the previous point, if you find that your housing allowance is in excess of your actual expenses, energy efficient improvements are a great area to explore. In effect, energy efficient improvements are a double whammy—you are able to shelter your housing allowance from income taxation and you get a tax credit for these improvements to your home. Not to mention, you may also save some money on utilities which is the point of these credits. However, the rules are complicated as to which items qualify, so contact our office for help before you make the investment.

Have you had enough tax withheld or paid via estimated tax payments?
Even though there is not a lot of time left in the year to rectify the situation if you haven’t had enough tax withheld, now is the time to make sure that you are on track. The key things that you want to accomplish here are to make sure that; (A) you won’t receive an unwelcome surprise at April 15th by having too little tax paid in and (B) you won’t be subject to any underpayment of tax penalties. Without getting into all of the detailed rules on underpayment penalties, as a general rule you need to make sure that your current year withholdings and/or estimated tax payments are equal to or greater than your previous year’s tax liability. It is not too late to boost your federal and/or state withholdings for the month of December or make a federal and/or state estimated tax payment.

Consider funding a health savings account.
Health savings accounts are one of the biggest “no-brainers” when it comes to reducing your income tax. If you have health insurance coverage under a “high-deductible” insurance plan, you may be eligible to establish a health savings account which essentially operates like a checking account with a debit card. The debit card can then be used to pay for qualified medical expenses. Ordinarily, only medical expenses in excess of a threshold of 7.5% of adjusted gross income (“AGI”) can be deducted. In effect, a health savings account makes these expenses deductible with a 0% of AGI threshold. Again, there are various limitations and rules for health savings accounts, so contact us for help on how to establish one.

Retirement plan contributions.
Even if your Church sponsors a retirement plan, you might still be able to contribute to other qualified retirement plans such as an IRA or SEP. If you are married and your spouse has earned income, there are many opportunities for additional retirement plan contributions to be made. The rules in this area are complex and will vary tremendously based upon individual situations. The key here is to be aware that you may be able to save more for retirement and reduce your tax liability at the same time.

Maximize your tax deductions before year end.
Most pastors who own their own homes are able to “itemize” their income tax deductions, as opposed to taking the standard deduction. Here are some additional ways to maximize those deductions and lower your taxes in the process:

–  Pay your January 2012 mortgage payment before the end of December 2011. This step serves to move an extra month of mortgage interest into 2011, thus increasing your itemized deductions. This is also a great way to pay more qualified housing expenses if you have not utilized your full housing allowance, as mentioned previously. To err on the side of caution, I would advise not just relying on a postmark and I would instead advise mailing the payment at least a week before the end of the year.

–  Consider whether or not you had any unreimbursed business expenses for 2011. Potential unreimbursed expenses for pastors could include mileage, dues, license fees, publications, etc. As long as such items were entirely for business purposes and were not reimbursed by your church, they are valid itemized deductions.

–  State tax withholdings and estimated tax payments are deductible for federal income tax purposes if you are able to itemize deductions. So, if you do need to make a state estimated tax payment for the fourth quarter, make sure to make the payment before the end of the year so that you can deduct the payment for 2011.

Locate your IRS form 4361 and approval documentation.
If you have previously made the election to opt out of social security, this is important documentation that you and your tax advisor should have on file in your permanent records. The IRS will not provide you with a copy of this documentation, so the only way to prove your election is to make sure that you have the documentation on hand. In our office, we retain both a hard copy and a scanned image of all Form 4361 documentation for our clients in order to prove the election that has been made.

Final Thought…

This is no means a comprehensive list but these are some key items that pastors need to consider before the end of the year. If you would like to receive an expanded list of tax saving ideas, send me an email at [email protected]. Our firm specializes in working with pastors, churches and non-profit organizations as well as preparing income tax returns for pastors. We would be honored to have the opportunity to work with you this tax season on any income tax or accounting need you might have.

This article is designed to provide accurate and authoritative information in regard to the subject matter covered. It is shared with the understanding that neither the author nor Tony Cooke Ministries is engaged in rendering legal, accounting, psychological, medical or other professional services. Laws and regulations are continually changing, and can vary according to location and time. No representation is made that the information herein is applicable for all locations and times. If legal advice or other expert assistance is required, the services of a competent professional person should be sought.