The U.S. income and Social Security tax system is complex beyond imagining. It’s especially complex for U.S. citizens serving oversees as missionaries. Most accountants and lawyers are unfamiliar with these rules, less so for how they work together with the rules for ministers of the gospel.
I’ve earlier posted an outline laying out the tax rules for ministers here. This post is supplemented here. This is an effort to supplement that information as it applies to U.S. citizens who are missionaries in other countries.
Some, but not all, of the critical rules for US citizens working abroad are summarized at IRS Publication 54. The rules for ministers of the gospel may be found in IRS Publication 517. These two publications are well written and useful.
The following is just an introduction. You’ll need to study these publications as well before trying to fill out a tax return. And you’ll need a tax professional’s help for many of these issues.
U.S. citizens living abroad are subject to the same rules as U.S. citizens living in the U.S.—plus additional rules. They still have to file tax returns, estimates, and such just as though living in the U.S. However, the nation in which the missionary lives may also tax them and require them to file returns.
Missionaries are eligible for the same benefits that ministers receive when working on U.S. soil, such as the housing allowance exclusion from income. This assumes that they are “ministers of the gospel” as explained in IRS Publication 517. Short-term, volunteer missionaries, for example, would not meet this standard.
Missionaries who a ministers of the gospel are allowed to elect out of Social Security, as may any other minister of the gospel. However, I don’t think Church of Christ ministers can truthfully take the required oath. See this post. My view is none too popular, but no one has offered me a counter-argument yet.
A missionary may be considered an employee or independent contractor for income tax purposes. He is always self-employed for FICA/SECA purposes if he is a minister of the gospel. (Employees pay FICA to fund their Social Security. Those who are self-employed pay SECA.) This is one of the most misunderstood rules in the tax code (which is saying a lot!) The law is inconsistent and makes no sense. Most tax professionals get this wrong. Most university professors advising students get this wrong.
A preacher is required to pay estimated Social Security taxes as a self-employed person. Located preachers working at their home congregations are almost always employees for all other purposes.
However, a missionary might be treated either way for non-Social Security purposes. Many churches consider them employees and file Forms W-2. Others consider them independent contractors and issue Forms 1099. In theory, the distinction would depend on who controls the missionary’s daily activities. But it also depends on other factors, such as the custom in that denomination, the terms of the contract, and the degree of control exercised by the sponsoring congregation.
If the missionary is subject to a local eldership or congregational leadership in his foreign country, he may actually be an employee of the foreign church.
In any event, the sponsoring church needs to carefully consider how it will treat this missionary and document that decision in a contract or letter of understanding. The missionary needs to know so he can plan accordingly. The decision affects many things, such as—
· The extent to which health insurance premiums are deductible
· Whether the missionary can (or must) participate in the sponsoring church’s health insurance or retirement plans
· Whether workers compensation laws or state unemployment insurance applies to the missionary.
· Whether the church is obligated to withhold income taxes.
· Independent contractors generally have no limit on their ability to deduct expenses, whereas employee-paid expenses are subject to the 2% of adjusted gross income limit (for employee business expenses) or the alternative minimum tax (which disallows itemized deductions).
There are a few countries that have tax treaties (binational Social Security agreements or totalization agreements) with the U.S. that make U.S. citizens subject solely to foreign social security taxes. These countries are listed in Publication 54. Generally, under these agreements, you will only be subject to social security taxes in the country where you are working. However, if you are temporarily sent to work in a foreign country, you generally can remain covered only by U.S. Social Security.
Of course, if the minister has opted out of Social Security, he remains opted out even in these countries. But the opt out is likely ineffective with respect to foreign taxation. Hence, a missionary may well still have to pay into a foreign social security system.
Notice that U.S. and foreign taxation often depend on national residence. This is typically governed by a tax treaty between the U.S. and the foreign nation. All tax treaties are available on the IRS web site. As a rule, living in a foreign country more than 6 months makes you a resident of that country for tax purposes, but check the treaty.
State taxes. Whether a minister is subject to state income taxation generally depends on residence. Hence, temporary visits to a foreign nation does not prevent the minister’s home state from taxing his income. A permanent change in residence normally will. Obviously, whether a mission trip involves a change in residence is very fact specific.
Ministers who are employees are often subject to income tax withholdings. Again, the rules are inconsistent and confusing. At the federal level, the church is never obligated to withhold unless the minister voluntarily opts for withholding (by completing a Form W-4 and filing with his employing church). However, many states, including Alabama, require income tax withholding. It’s entirely possible that the minister may pay estimates at the federal level and be subject to withholding at the state level.
I always recommend that the church require the minister elect to have income taxes withheld at the federal level, as this keeps preachers from having to borrow on April 15 and puts them on a better budgeting process. In fact, they should over-withhold enough money to also cover their SECA obligations, thereby avoiding the need to file estimates.
Missionaries who are independent contractors for income tax purposes, of course, are not subject to withholding and must pay estimates.
Exchange rate issues. Missionaries generally get paid in U.S. dollars and spend money in local currency. However, local love offerings or support from a foreign church may be paid in foreign currency. This is all income and must be reported at the U.S. dollar equivalent.
Many sponsoring congregations forget that shifts in the exchange rate can be devastating to the missionaries they support, and they should be sensitive to the need to make appropriate adjustments when currency values fluctuate.
Missionaries married to nonresident aliens. If a U.S.-citizen missionary marries a nonresident alien, he’ll surely want to file a joint income tax return (lower tax rates). Publication 54 explains how to do this. It requires that the foreign spouse have a U.S. taxpayer number, which may require some effort to get.
Missionaries will usually qualify for the foreign earned income exclusion and housing exclusion or deduction. The foreign earned income exclusion is $82,400 (for 2006), which is quite a nice benefit on a missionary’s salary! To qualify, the missionary must have a foreign tax home, that is, he must not be a U.S. resident (check the tax treaty). He must have foreign earned income. And he must be either —
A U.S. citizen who is a bona fide resident of a foreign country or countries for an uninterrupted period that includes an entire tax year, or
A U.S citizen who is physically present in a foreign country or countries for at least 330 full days during any period of 12 consecutive months.
Most missionaries meet one of these standards.
Notice that the exclusion or deduction is not available for SECA purposes. It will be very common that a missionary owes no US income taxes but owes substantial SECA taxes.
If both spouses qualify for the exclusion, the earned income exclusion is doubled. A married couple could exclude a full $164,800 if both spouses are U.S. citizens, but they must separately qualify for the exclusion.
Notice that being a resident of a foreign country does not depend on actually being present every day. Rather, tax residence is where you work. The main distinction is whether you have permanently relocated or temporarily relocated. To some extent, the question is one of your state of mind, but this is tested based on objective behaviors, such as where you maintain a residence, where your wife and children live, and such. Most fulltime missionaries easily qualify under this test, even though they may spend some time in the U.S. to make reports, raise funds, and visit family.
Income is “foreign earned income” if it’s earned for services performed outside the U.S. even if the money is paid by a U.S. church.
It may be helpful for the missionary’s contract with his sponsoring church to specify how much of his income is earned for foreign mission work and how much for U.S. work. For example, it’s common for a church to ask its missionaries to spend time in the U.S. making reports to the congregation, perhaps even working on staff. Sometimes, the missionary is on vacation, and so his pay is still for work done in the foreign country. Or the missionary may be providing valuable services while in the U.S. Obviously, you want to avoid unnecessarily characterizing mission support as U.S.-based income to maximize the exclusion.
It’s important that the missionary not tell the foreign tax authorities that he’s a U.S. resident. You can’t have it both ways. An effort to avoid foreign taxes by claiming U.S. residence will defeat eligibility for the exclusion. Voting in the U.S. by absentee ballot is not a problem, as voting is based on citizenship, not residence — unless the missionary votes in a state election. Many states base voting rights on residence.
The exclusion applies only to earned income. Pensions from U.S.-based employment, Social Security benefits, gambling winnings, dividends, interest, and rent do not qualify.
Missionaries may also qualify for a foreign housing exclusion. However, as the missionary will also qualify for the housing allowance for ministers, the point is largely moot. You can exclude the same income only once.
Less clear is whether the missionary may claim the deduction for foreign housing, available for self-employed (for income tax purposes) workers outside the U.S. The housing allowance for ministers does not prevent the deduction for home mortgage interest and property taxes, despite the double benefit that results. I can find no authority either way regarding the foreign housing deduction. Publications 517 and 54 do not address the potential double benefit. However, for most missionaries, the point is moot as the foreign earned income exclusion will usually exceed their income without regard to this benefit.
The IRS has just (1-6-2009) released a summary of the foreign housing exclusion.
Foreign property taxes are deductible. Other foreign taxes, such as a VAT, are not deductible. But the taxes are not deductible against SECA, which may be the only US tax the missionary owes, anyway.
Tax treaties may provide other benefits. The U.S. has tax treaties with many, but not all, other countries. These often define whether the foreign country may tax you and what credits you may take. Treaties override the Internal Revenue Code when inconsistent. All the treaties are available at the IRS web site.
Let’s take the Romanian tax treaty for example.
Article 3(2) defines “fiscal residence” based on an individual’s “permanent home.” Clearly, a tourist or short-term missionary remains a U.S. fiscal resident. However, a missionary who buys a house or is a long-time resident of Romania will be a Romanian fiscal resident.
Article 14 deals with income from independent personal services. The first question is one of residence. If the missionary is a resident of Romania, Romania may tax his income earned in Romania and in the U.S. The U.S. may only tax U.S. based services if the missionary is physically present in the U.S. for more than 183 days or maintains a permanent establishment in the U.S. from which the income is generated. If the missionary opens a coffee shop in the U.S. for 10 days, he owes U.S. taxes on the income. However, he should be exempt if he’s only visiting his sponsoring church to give a report.
However, if the missionary is an employee of his sponsoring church, Article 15 applies. For an employee of U.S. church, services performed in the U.S. for that church will likely be taxable to the U.S. (and not subject to the foreign earned income exclusion).
Notice that tax treaties typically deal with income taxation and not self-employment tax or FICA. See below regarding totalization agreements.
Rev. Rul. 62-113. A church may rely on Rev. Rul. 62-113, which treats housing, travel, and food costs as tax free to the missionary if he is otherwise working for free. However, if the missionary has any income derived from services as a missionary, this exclusion likely does not work.
A short-term missionary, visiting the Bahamas for two weeks to do mission work, may well volunteer services and yet receive a few thousand dollars of support to pay for the trip. To the extent these funds are used to pay out-of-pocket expenses, the support is tax free to the missionary. However, this should be governed by an “accountable plan,” that is, the sponsoring church should require receipts and such to demonstrate that the money actually went to legitimate expenses.
This assumes a volunteer missionary. If the missionary is getting paid for his work, then the rules for independent contractors or employees kick in. At this point, donations made to his effort will be treated as income.
Gift vs. income. As suggested earlier, it can sometimes be tricky to distinguish a gift from income. If an individual writes a check to a missionary to help support his work, it’s income, unless limited to paying for expenses and the use of the money is accounted for. If the missionary is required to use the money to buy Bibles to give to potential converts, then the money is a gift to the potential converts. If the missionary may use the money in any way he sees fit, including keeping it for himself, it’s income.
If the missionary’s car breaks and the church buys him a car to allow him to continue in the mission field, the car is income unless it’s owned by the church. In that case, the missionary has income to the extent he uses the car for personal use, just the same as if a bank let’s its president have a company car for mixed business and personal use.
Fortunately, the foreign earned income exclusion covers a lot of tax grayness, and often avoids any need to sort these metaphysical issues out. Just be careful to stay within the $82,400 limit, taking into account all benefits provided—housing, cars, and such.
Conclusions. It seems that treating the missionary as self-employed has some significant advantages and likely should be the standard rule. For example—
The missionary will rarely be subject to day-to-day oversight by his sponsoring congregation, and so this is likely the correct treatment.
The tax treaty may protect some U.S. income from U.S. taxation.
Expenses incurred in doing his work, such as travel, will be fully deductible without the 2% AGI limitation or AMT restrictions.
The church is exempted from all withholding obligations.
The missionary can still claim a housing allowance and a foreign earned income exclusion, and should generally owe no U.S. income taxes. He may even avoid U.S. taxation for services in the U.S. giving reports and such if his housing interest, property taxes, and other itemized deductions are high enough. Of course, it would be wise to minimize U.S. services as income earned while in the US does not qualify for the exclusion.
He will still be subject to US SECA, absent working in a country with a US totalization agreement.
However, the missionary will unquestionably become a fiscal resident of his foreign mission base. He must be prepared to report and pay foreign taxes. Romans 13 is quite clear on this point. In the absence of a totalization treaty, he may owe foreign social security taxes as well as US SECA. This would be particularly a risk if he were employed by a foreign congregation under foreign tax law.
He should likely receive his funds directly from the US sponsoring church or parachurch organization to reduce this risk — certainly not from the foreign congregation.
Several years ago, a number of U.S. citizen missionaries in Europe were caught by European authorities for not paying European taxes. They owed several years of back taxes, penalties, and interest. Of course, they couldn’t afford to pay the tax bill, and so their sponsoring churches had to cough up the money (which was income to missionaries, compounding the problem!) Sponsoring churches should make certain their missionaries are complying with local tax laws.
One alternative is to treat the missionary as on temporary assignment in the foreign country. If he avoids becoming a resident of the foreign country, the rules become quite different. He can likely deduct his travel and food costs as travel expenses if he is in the foreign country for less than 1 year. He may avoid foreign taxation. But he won’t qualify for the foreign earned income exclusion.
Before embarking on such a strategy, there are two areas to watch very closely. First, the tax treaty for that nation must be carefully studied. Merely being present in that country for over half a year may be enough to subject the missionary to foreign taxation. This will usually be the case. The missionary will have to spend more than half the year in the U.S. (or perhaps in another foreign nation).
Second, residency is a subtle, ephemeral concept and the IRS often litigates this question. There are quite a few published cases. Careful planning and thought would be required to avoid establishing foreign fiscal or tax residence for a long-term missionary. Even if he travels among three or more countries to avoid spending too much time in any one place, he’ll have to be a resident somewhere.
Remember that an IRS residency determination is presumed correct by the courts and the taxpayer has the burden of disproving the IRS’s position. Moreover, if you get too cute, you may be unable to disprove a residency assertion by a foreign taxing authority. The missionary could actually be found to be resident in multiple locations. If you leave the facts ambiguous, different courts may reach different results.
The scriptures are very clear that Christians are to pay their taxes. However, there is no sin in carefully planning to minimize the taxes owed. Be careful, however, as if a missionary goes several years without paying taxes owed to one or another country, the amount owed could be enormous.
Don’t let your missionary (or his widow) become a burden on the church. Missionaries may escape U.S. Social Security taxes, and so they will still need to save for retirement and have insurance against premature death and perhaps disability.
Social Security may be too expensive for what you get, but it never seems too expensive to a disabled employee or widow! Make sure the missionary takes care of his retirement and carries appropriate insurance. Of course, if the missionary declares himself a resident of his foreign land, he may well qualify under their social services network. Local laws vary greatly, however, so this needs to be carefully thought through.
Expatriation. Finally, a missionary with no plans to return to the US may want to consider expatriation — that is, surrendering his US citizenship to become a citizen of his new country. For most Americans, the idea of giving up US citizenship is, well, unAmerican, but it can be nearly essential for a missionary finding himself obligated for both US SECA and foreign social security taxes. And he may wish to become a citizen of his new homeland to qualify for government healthcare and retirement benefits there.
The rules are complex. Loss of citizenship is generally irreversible. An introduction to the rules is here.
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