Updated: Apr 11
Every pastor needs to pay his taxes, but there’s no requirement to leave Uncle Sam a tip!
As a pastor, you have several tax-saving opportunities that don’t apply to most people. If you understand these rules and use them to your advantage you could save yourself thousands in taxes.
Here are 5 strategies every pastor should consider…
1. Contribute to a 403(b) plan
A 403(b) is a lot like a 401(k) plan. But only non-profits can set up 403(b) plans. If your church doesn’t already have one of these set up then you need to strongly consider it.
Not only do these type of plans have a much higher contribution limits than IRAs or Roth IRAs, but they also offer some big tax advantages for pastors.
First of all, any contributions you make to your 403(b) account are tax-deductible for federal income taxes and they are not subject to Social Security/Medicare tax. Remember that pastors generally pay the full 15.3% Social Security/Medicare tax on their ministry income.
So hypothetically, let’s say a pastor is in the 22% tax bracket and pays the full 15.3% Social Security/Medicare tax on his income. If he contributes $5,000 to his 403(b) account he is saving 37.3% or $1,865 in taxes ($1,100 in income taxes and $765 in Social Security/Medicare taxes)!
While the money is invested inside the retirement account, the earnings and interest are not taxed. Instead, you are taxed when you withdraw the money from your retirement account.
But here’s where it gets even better for pastors. The IRS allows pastors to claim housing allowance even in retirement. This means if your church or denomination is continuing to compensate you (either through a pension or through funds contributed to a church-sponsored retirement account) then you can continue to claim a housing allowance from that money.
So again, hypothetically, let’s say a pastor has consistently saved in his 403(b) account and retires. And let’s say his church designates a $30,000/year housing allowance for him. He would then be able to withdraw up to $30,000 from his account and not pay any federal income taxes or Social Security/Medicare taxes on that withdrawal!
This essentially gives pastors a triple tax benefit on their retirement funds: no taxes on contributions, no taxes on growth while funds are inside the retirement account, and no taxes on the housing allowance withdrawals.
You can see how this approach is can be much more advantageous than other retirement account options. That’s why I encourage every pastor to talk to their tax professional and consider setting up a 403(b).
2. Maximize Your Housing Allowance
You are probably already aware that pastors are usually able to designate a portion of their income as housing allowance. However, you may not be familiar with the rules that tell you how much you can designate for your housing allowance.
The IRS states that your housing allowance amount must be the lowest of these three: the designated amount from the church, your actual housing expenses, or the fair market rental value of your home.
If you are a pastor eligible to claim housing allowance and have not done so, talk to your church immediately to get that set up! And if you are currently receiving housing allowance, check to make sure that you are getting the maximum allowable amount.
Why is claiming housing allowance a tax benefit? Because it not subject to federal income taxes (but it is still subject to Social Security/Medicare taxes).
For example, Pastor Smith is married with no dependents and has a salary of $70,000. The church does not designate any housing allowance and does not provide him with a parsonage.
Pastor Smith will have to pay income taxes on the full $70,000. After taking his standard deduction, he will owe $4,884 in income taxes.
But, if Pastor Smith’s church were to designate $30,000 as housing allowance and pay him a salary of $40,000, then he would still make the same amount of money but pay much less in income taxes.
Based on his new salary of $40,000, after taking his standard deduction, Pastor Smith would only owe $1,413 in income taxes (a difference of $3471)!
3. Set Up an Accountable Reimbursement Plan
Pastors can rack up a lot of work-related expenses through the year (conferences, travel, meals, books, etc).
Did you know that many of these items are reimbursable and will not count as taxable income?
Here’s how it works:
The church budgets an amount that they are willing to reimburse the pastor for his expenses.
As the pastor incurs eligible expenses he submits receipts and documents the details of the expenses. The church then reimburses him for those expenses separately from his regular compensation.
The reimbursement plan is a “use it or lose it” arrangement. This means any difference in the amount the church budgeted vs. how much was reimbursed is forfeited. (If the church budgets $5,000 and the pastor only submits $2,000 in expenses, he does not receive the $3,000 difference.)
If a pastor is self-employed (receives a 1099), he instead is able to write off his eligible expenses on his tax return and lower his tax liability. It’s important to keep receipts and documentation of all those expenses.
An accountable reimbursement plan can be a great added benefit a church can offer their pastor to help him offset his costs without adding to his tax bill.
4. Track Your Mileage
For 2023, the federal mileage deduction for ministry is 65.5 cents/mile. Depending on how much driving you do for your ministry work this can add up to a significant amount by the end of the year.
Keep in mind that your “commuting miles” between your home and the church are not eligible for the mileage deduction. But travel related to visiting members in the hospital or at their home, speaking engagements, conferences, etc. would be as long as they are for business purposes.
To make things easy, here’s a list of apps that you can use to track your mileage instead of having to write them down each time.
Tracking your mileage allows you to either be reimbursed directly from your church, or if self-employed, deduct the expense on your tax return to lower your tax bill.
5. Apply for Health Coverage Through Healthcare.gov
Small health insurance plans are very expensive. So most churches don’t offer them.
If you don’t have health insurance available through a job (or spouse’s job), then you are eligible to apply for coverage through the healthcare marketplace (healthcare.gov).
Depending on your income, you may be eligible for free coverage through Medicaid or CHIP. Or you may qualify for a tax credit that will offset your monthly premiums.
Results will vary because it all depends on your income, family size, state you live in, and plans available in your area. However, many pastors are able to get affordable coverage this way.
But here’s the big tax advantage that a lot of pastors don’t know about: you don’t have to include your housing allowance as part of your income when applying for coverage.
You see, your eligibility is based off of your MAGI (Modified Gross Adjusted Income). Housing allowance isn’t included in that figure. So you are more likely to qualify for cheaper coverage even though your total compensation is higher than the amount you are required to report.
This means you are more likely to qualify for free coverage (Medicaid or CHIP) or get a bigger tax credit to offset your monthly premium.
A lot of pastors just get a Health Sharing Plan and don’t even bother applying through the marketplace because they assume it will be too expensive. But with this special tax advantage you may actually be able to get much better coverage at a lower cost. That’s why I always encourage pastors to at least apply each year during open enrollment to see what type of plan they qualify for.
Important reminder: always consult with your tax professional when considering any of these steps. This is not tax advice, but rather areas of potential tax savings that you should be aware of.