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Clergy, Church & Law

Revoking an Exemption From Social Security

By Richard R. Hammar


Ministers soon may be given another window to revoke an exemption from self-employment taxes.

Many ministers have exempted themselves from social security by filing a timely application form (Form 4361) with the IRS. Unfortunately, many of these ministers were not eligible for the exemption. In recognition of this fact, and because of the large number of exempt ministers who wanted to rejoin the Social Security program to qualify for Medicare benefits, Congress gave ministers a brief window of time in 1977, and again in 1987, to revoke an exemption from self-employment (social security) tax. Few did so. Ministers soon may be given another window to revoke an exemption from self-employment taxes. It is important for exempt ministers to be aware of these developments so they are ready to respond quickly if another window is provided. The lesson of the 1977 and 1987 legislation is that the longer ministers wait to revoke an exemption, the less likely it is that they will do so. This article reviews the status of current legislative efforts, assesses the likelihood of success, and provides ministers with recommendations to consider.

QUALIFYING FOR EXEMPTION

Ministers are allowed by federal law to exempt themselves from self-employment taxes by filing a timely exemption application (Form 4361) with the IRS. To qualify for exemption, ministers must meet several requirements. Among other things, they must certify that they are opposed on the basis of religious convictions to the acceptance of public insurance benefits (including social security and Medicare) based on their ministerial services. The application must be filed by the due date of the federal tax return for the second year in which a minister has net earnings from self-employment of $400 or more, any part of which derives from the performance of services in the exercise of ministry.

REVOKING AN EXEMPTION FROM SOCIAL SECURITY

The tax code states that ministers who exempt themselves from self-employment taxes cannot revoke their exemption. The decision to become exempt from self-employment taxes is "irrevocable." Form 4361 itself warns that "once the application is approved, you cannot revoke it."

On two occasions in the past, Congress has enacted special legislation giving ministers a brief window of time to revoke an exemption from self-employment taxes.

The 1977 legislation

Congress allowed ministers who were exempt as of December 20, 1977, to revoke their exemption by the due date of their federal income tax return for 1977 (April 15, 1978) by filing a Form 4361-A.

The 1987 legislation


If enacted, this bill would allow ministers to revoke an exemption from social security by filing a form with the IRS by April 15, 2002.

The Tax Reform Act of 1986 gave exempt ministers another limited opportunity to revoke an exemption from self-employment taxes, by filing a Form 2031 with the IRS by the due date for their federal income tax return for 1987 (April 15, 1988). Congress provided this limited opportunity for ministers to revoke an exemption from self-employment taxes because of a recognition that many of these ministers did not qualify in the first place.

Ministers who revoked an exemption by April 15, 1988, did not become liable for self-employment taxes all the way back to the date of their original exemption. Rather, they were required to pay self-employment taxes effective January 1, 1986, or January 1, 1987. This meant, for example, that a minister who revoked an exemption by April 15, 1988, had to pay not only the first quarter’s estimated self-employment tax for 1988 by that date, but also (1) the entire social security tax liability for 1986 and 1987, or (2) the entire social security tax liability for 1987. The minister elected on the Form 2031 whether to pay taxes for both 1986 and 1987, or just for 1987.

Very few exempt ministers revoked their exemption. The reason is simple: Most ministers who were seriously considering revoking their exemption waited until the deadline, only to discover that revoking their exemption would make them liable for at least five quarters of self-employment tax. Even on a modest income, this was a crushing liability that few could afford.

RECENT DEVELOPMENTS


Remember that the longer you wait to revoke your exemption, the more back taxes you will have to pay.

In 1998, a bill was introduced in Congress that would have allowed ministers another opportunity to revoke an exemption from social security. The bill passed in the House of Representatives by a vote of 410 to 1, but the legislative session ended before the Senate could take action. An identical bill was introduced in Congress in 1999, and passage appears likely. If enacted, this bill would allow ministers to revoke an exemption from social security by filing a form with the IRS by April 15, 2002. Ministers can choose to revoke their exemption beginning either with year 2000 or year 2001. The bill specifies that ministers who revoke an exemption will not be permitted to apply for exemption at a later time. The decision to revoke an exemption is irrevocable.

The following examples all assume that Senate Bill 331 will be enacted:

Example: Rev. D. opted out of social security in 1980 because he did not want to pay the self-employment tax. He now recognizes that he was not eligible for the exemption, and would like to revoke it. If Congress enacts the pending legislation, Rev. D. will be able to file a form with the IRS revoking his exemption. On this form, Rev. D. will designate whether he wants to revoke his exemption beginning with either the year 2000 or the year 2001.

Example: Same facts as the previous example. Rev. D. waits until September 1, 2002, to file his revocation form. He has waited too long. The form must be filed no later than April 15, 2002.


Since it is likely that congress will enact legislation giving ministers an opportunity to revoke an exemption from self-employment tax, ministers should be reviewing their options at this time.

Example: Assume that Rev. D. has net self-employment earnings of $50,000 in 2000 and 2001, including his church-designated housing allowance. Assume further that Congress enacts the pending legislation allowing ministers to revoke an exemption from self-employment taxes. Rev. D. waits until April 15, 2002, to decide whether to revoke his exemption. By delaying his decision, he now has two options: (1) Revoke his exemption beginning with the year 2000. He will be liable for back taxes to January 1, 2000—that is, for 2 years plus the first quarter of year 2002 self-employment taxes. This will amount to approximately $17,200 (multiply the 15.3 percent self-employment tax rate times 2 years of net self-employment earnings of $50,000, plus the first quarter of compensation for 2002). Obviously, this liability is so large that it is doubtful that Rev. D. will be able to afford it. (2) Revoke his exemption beginning with the year 2001. He will be liable for back taxes to January 1, 2001, or 1 year plus the first quarter of year 2002 self-employment taxes. This will amount to approximately $9,600 (multiply the 15.3 percent self-employment tax rate times 1 year of net self-employment earnings of $50,000, plus the first quarter of compensation for 2002). Obviously, this liability is also substantial, making it unlikely that Rev. D. will be able to afford revoking his exemption. The problem in this example is that Rev. D. waited too long to decide whether or not to revoke the exemption. The key point is this—the longer ministers delay in making this decision, the less likely they will be able to afford revoking their exemption.

Example: Assume that Rev. D. has net self-employment earnings of $50,000 in 2000 and 2001, including his church-designated housing allowance. Assume further that Congress enacts the pending legislation allowing ministers to revoke an exemption from self-employment taxes. Rev. D. learns of the new law, and decides to revoke his exemption immediately by filing a revocation form with the IRS in January of 2000. He designates on the form that he wants to revoke his exemption beginning with the year 2000. Rev. D. uses the quarterly estimated tax procedure to pay his taxes, and so he simply begins basing his quarterly estimates on both income taxes and self-employment taxes. This will increase his quarterly payments by approximately $1,900 (one-fourth of his annual self-employment tax, computed by multiplying net self-employment earnings of $50,000 times the self-employment tax rate of 15.3 percent). By making the decision to revoke the exemption early, Rev. D. is avoiding the problem of having to make large payments of back taxes. It is more likely that Rev. D. will be able to afford revoking his exemption in the event that he would like to do so.

RECOMMENDATIONS

There are several important considerations for ministers to note:

1. Nothing has been enacted, yet. No law giving ministers an opportunity to revoke an exemption from self-employment tax has been enacted yet. Ministers who would like to revoke an exemption should do nothing now—except to review their options and be prepared to act quickly if any of the pending bills become law.

2. Enactment is likely. It is very likely that Congress will enact legislation giving ministers an opportunity to revoke an exemption from self-employment tax.

3. Be prepared to act. Since it is likely that Congress will enact legislation giving ministers an opportunity to revoke an exemption from self-employment tax, ministers should be reviewing their options at this time. Here are some questions to ask:


Richard R. Hammar, J.D., LL.M., CPA, serves as legal counsel to The General Council of the Assemblies of God. A graduate of Harvard Law School, he is the author of over 30 books on legal and tax issues for churches and pastors. This article is excerpted from his bimonthly Church Law & Tax Report, Copyright 1999.

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