Not even a massive dose of aspirin could help Pastor Williams' violent headache that dreadful evening. It was April 15. In fact, it was April 15 and three quarters, and he was apparently no nearer to having his Form 1 040 completed and ready to mail than when he'd started work on it early that morning.
When his many hours of struggle and calculation resulted in the horrifying realization that he owed more than $3,000 to the IRS, the headache was the least of his symptoms. We will quietly close the door on the events that conclude this episode.
In another city, a month earlier, Pastor Smith sat down at his desk during a rare free evening. He carefully assembled his IRS Federal income tax booklet, the family's W-2 forms, and the folder in which he kept all receipts that applied to tax records.
Making slow but steady use of his pocket calculator, Pastor Smith worked through the calculations necessary to complete his 1040 and accompanying forms within a few hours. After checking his calculations, he cheerfully informed his wife that they owed only an additional $24 to the IRS, and that the family could afford shakes at McDonald's to celebrate!
What was it that made Pastor Smith's evening so much less devastating? The men had very similar income and expenses, but the key ingredients of preparation, organization, and anticipation saved the day for Pastor Smith.
The minister's tax return is one of the more complicated individual returns in the tax business. Several factors contribute to this, including the sometimes odd method of payment and the unique deductions allowed to the minister (the parsonage allowance in particular). Add to this the fact that although ministers are responsible to pay their own self-employment (Social Security) tax, no tax is withheld from their salaries, and the problem grows even more complex.
Many ministers dread income tax time more than annual fund-raising projects, and all too often what we dread we handle by procrastination.
Several things could contribute toward making April 15 a less-traumatic date on the ecclesiastical calendar. Books on the nitty-gritty of preparing a personal return can help a lot. Probably the best of these are the IRS booklet that is mailed to every prior-year taxpayer, and the small tax manual * for ministers that many employing organizations provide for their ministers. But preparing a good tax return starts long before April 15.
As a matter of fact, preparation for the tax year should begin on the first of January fifteen months before the April when the tax is due. Using a simple filing device such as an accordion file, begin saving receipts and checks that might have a significant bearing on the tax return. (A home computer can also keep these records well. Be sure to save the receipts as backup records, though.)
Tax returns are divided into two parts: one section concerned with income, and the other with expenses. So a filing method for tax data should include records for these two categories.
Income will include check stubs from the employing organization, from any spousal income, interest recorded on bank statements, and dividends from stock or utility companies. A note should be included to record income from funerals, weddings, or speaking honorariums. Any regular year-end bonus is also taxable income. But a gift from the congregation, such as for a birthday or Christmas, need not be reported as income.
Another item of income to which serious thought should be given is that from the sale of any item that has been depreciated. This income must be included in the tax return as either a gain or loss, and in many situations it may be a gain. This is because the original "basis" (or cost) of the item must be reduced by any depreciation allowed throughout the years of use.
For example, suppose you purchased a desk in mid-1978 for $500 and gave it a useful life (for tax purposes) of ten years. If you deducted $50 per year as depreciation through mid-1984, you depreciated the desk's value by $300. So now, instead of taking the cost of the desk as $500, the cost can only be considered $200 ($500 minus the $300 depreciation). If you sell the desk for $275, you will have a long-term capital gain of $75 ($275 sale price less $200 basis). The $75 is reportable on Schedule D and will require an accompanying Form 4797, Part III, to report correctly.
If an item used in the business of ministry has been totally depreciated before being sold, it retains no basis. Any payment you receive for it is a capital gain.
Trading items in on like items constitutes a nontaxable exchange and (in most cases) does not have to be reported.
Expenses can include both business and personal expenditures. Business expenses include mileage and travel (a log book is almost mandatory); office supplies; subscriptions and books; professional organization dues; moving; and costs of purchasing equipment used in business. Personal expenses include medical (to a limited extent); taxes; interest on loans, credit cards, and mortgages; contributions; extreme casualty (theft, fire, or accident) loss; and a few miscellaneous items such as safe deposit boxes and union dues.
After setting up and consistently maintaining a careful recordkeeping system, the most important thing affecting a pleasant tax filing is keeping up with estimated tax payments! When filing the prior year's tax return, an estimate should immediately be made as to the amount of next year's income. If your salary for the coming year will not change significantly, you can estimate payments based on the past year's return. But don't forget to make allowance for increased Social Security tax and any outside income.
On-time estimated tax payments make good sense for more than one reason. First of all, it's the law. Also, it's much easier to find $300 at widely distributed times of the year than to come up with $ 1,200 or $ 1,500 on April 15 (these being very optimistic figures indeed!).
Underpayment or nonpayment of estimated taxes is also costly, because it automatically means a penalty that is figured by variable interest rates determined by prevailing bank interest rates throughout the year.
Many ministerial wives are working just to help with taxes, and one of the biggest helps is to have an extra-large amount of tax withheld from their salaries. This can be easily accomplished if the spouse files with no exemptions. This will also be helpful on any State tax due. Since much of the Federal tax due is self-employment tax, which is not a tax item in State returns, most ministers do not have a serious problem with their State taxes. A spouse with average income can usually provide enough State tax withholding.
Ministerial tax planning may also include careful investments, although not many ministerial incomes have much left over to invest.
One investment that could have a significant tax effect is an IRA account. You can open an IRA whether you are covered by a retirement plan with your employer or not. Don't let the $2,000- a-year upper limit frighten you. An IRA can be started for as little money as you can afford to invest in it. An investment of $500 per year with 10 percent interest will yield a retirement fund at the end of twenty years of $32,000. Withdrawn at the rate of $200 a month after retirement, this would provide a nice supplement to other retirement income for about fifteen years. The present advantage is that current income is reduced by the amount contributed to an IRA and none of the interest it generates is taxable. (The distributions taken out after retirement are taxable, but presumably income by that time will be lower, and the tax on the IRA distributions will be at a lower rate.)
One problem with an IRA is that the funds are relatively untouchable. There is a 10 percent penalty plus tax on any amount withdrawn before age 59 1/2, but calculations indicate that the tax savings may more than make up for the penalty imposed for withdrawing the money prematurely.
So your tax year has come to a conclusion, you have received all your necessary W-2's and 1099's, and are ready to prepare your return.
The best way to do a tax return is to handle one problem or entry or form at a time. Begin with income, the first source being wages.
It is important to note that the IRS now wishes ministerial income to be considered wages, and prefers the employing organization to issue a W-2 even though no taxes have been with held. Even if an organization has not so formalized the minister's income as to issue a W-2, the IRS still wants the income listed as wages on the 1040, rather than on Schedule C (Profit or Loss from Business or Profession).
List other income next. Calculate and attach each needed schedule in alphabetical order with the exception of Schedule A. All others down to W are source-of-income schedules.
Expenses fall into three categories: adjustments to income, deductions, and tax credits. Each reduces taxes in a different way.
Adjustments to income include business-related expenses such as moving, auto mileage, and out-of-town-over night travel expense. It also includes contributions to an IRA and the deduction for married couples when both work.
Whether or not you will have adjustments, particularly with moving expenses and auto mileage, depends on how the employing organization handles its reimbursement or non-reimbursement of your expenses. Most organizations will pay for an employee's moving expenses, then issue a W-2 listing the moving expenses as income. They will provide a worksheet, and often a copy of Form 3903 (Moving Expense Adjustment), showing exactly what they have reimbursed. You can use this copy with your return, or make your own. You may have some minor additional expenses, such as the driving of a second car to a new location and temporary living expenses for the first month. (If you rent for a month or longer while looking for a permanent place to live, you may deduct your first thirty days' rent and food expenses.)
It may be, though, that your employing organization covers all moving expenses but does not include any of the expense as taxable income to you. In this case, unless you have small additional expenses you will not have a moving expense adjustment.
The same conditions apply to a mileage allowance. If the mileage allowance is included as taxable income, all legitimate applicable expenses should be deducted as employee business expenses on Form 2106. Also included on this form are expenses for out-of-town travel, airline and other public transportation fares, meals, lodging, phone expenses while away from home, and laundry while away from home. Not included here would be local entertainment, business gifts, and other local business expenses.
Taxable income is next reduced on Schedule A, Itemized Deductions. This form covers all personal and family deductions in the categories of medical expenses, taxes, interest, contributions, casualty loss, and miscellaneous deductions. Miscellaneous deductions can include business costs such as telephone expenses, the purchase of equipment, subscriptions and books, organizational dues, and the purchase and cleaning of professional uniforms.
Deductions for professional clothing cannot be construed to include a business suit and dress shirts and ties. The only possible deduction related to these regular street clothes would be for laundry and dry-cleaning while on out-of-town business travel. Ministerial apparel that can be deducted as miscellaneous expense would be limited to the cost and cleaning of clerical robes or clerical-collared shirts.
A taxpayer's itemized deductions may reduce his taxable income only by the amount exceeding the "zero bracket amount." If the combined amount of all items is under the zero bracket amount, a minister will lose his deduction for miscellaneous local business expenses. This is not very likely to happen because most ministers can deduct a large sum for contributions.
Tax credits do not affect taxable income, but are applied to reduce the actual income tax itself. The ministerial family may be able to claim tax credits for child care when both parents are work ing or are full-time students. And they may be able to claim investment credit, which is a credit given for the purchase of equipment used in a business and depreciated. This includes the purchase of a new (or used) car, even if the "optional" method for calculating mileage is used. The equipment must be kept for three or more years--otherwise the investment credit will have to be recaptured (in other words, paid back!).
After reducing income tax by available tax credits, any additional taxes are added. This will generally include self-employment tax.
Calculate the self-employment tax in this way: From total wages deduct moving expenses and business expenses, including those listed in Schedule A, and add the parsonage allowance. This will yield your total self-employment income. The parsonage allowance may be a certain portion of wages that has been set aside at the first of the tax year by the employing organization as nontaxable. If the parsonage is owned by the church, the parsonage allowance will be the local fair-market value (what a similar house and furnishings would rent for in the same area plus utilities, certain maintenance expenses, and insurance). There is no place on Schedule SE for this calculation. If it can be fitted between lines, it can be included on the form.' Otherwise, attach a sheet of paper with the information to the Schedule SE, since this figure will not match any other figure on your return and the IRS may wonder how you reached it.
Multiply your total self-employment income by the year's self-employment tax rate to find your self-employment tax. Then add it to the other taxes on Form 1040.
If you planned well in January, the total tax will closely match the amounts withheld and paid by estimated payments through the year, and April 15 will not be a problem.
Should you find yourself owing considerably more money than you have available, do you have the option of filing for an extension of the due date for your return? No, you do not. You may use the extension of time to file only when there is a possibility that records are not complete. You must submit the total tax that you estimated to be due with the form.
Someone who finds himself unable to pay his taxes on time should send in the tax return by the date due anyway, with as much money as he can include, and an explanatory note. By doing this he will avoid the penalty for not filing a timely return. The IRS will be happy to send a schedule of payments including interest. And the interest is even deductible on Schedule A!
April 15 creeps inexorably upon us every year. A small amount of preparation, organization, and anticipation can make it pass with very little trauma.
* Minister's Guide for Income Tax. Published yearly and available from Prerau and Teitell, 375 ParkAve., Suite 3500, New York, New York 10022.