A Chemistry Conversation with Brad Wooten
Brad is the owner of Wooten, CPA. He has had a decade of doing work for faith-based organizations. In this conversation, Brad shares some of the ins and outs of filing taxes as a minister.
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Matt Steen: Well hey, it's Matt Steen, Co-Founder of Chemistry Staffing, and this is another Chemistry conversation. Today, this is going to be the most exciting conversation that we've had ever since we've launched this because today we are talking pastoral taxes. I can feel the excitement beginning to rise. Joining me today is Brad Wooten. Brad is the owner of Wooten CPA. Brad's got over a decade of accountancy work. he works primarily with ministry-minded folks, whether they're missionaries, working a parachurch, whether they're pastors. He does a great deal of tax work in the ministry area and kind of builds on some of the work that he did. He worked at Campus Crusade for quite some time, and this is kind of his niche. What I was hoping to do was to spend some time picking Brad's brain and say, hey, this is what we need to be thinking about as far as ministry and pastor's taxes and what all that means for us. So Brad, first of all, thanks for jumping in, man.
Brad Wooten: Yeah, thanks Matt. Appreciate you inviting me to come and do this. It's a great opportunity. I love talking about this and helping pastors out because unfortunately I see a lot of them get mixed up in this sometimes and do things wrong. It's great being able to help out with this.
Matt Steen: Well that right there tells us that this is the right guy to have the conversation with because Brad likes talking about taxes in ministry. So I think you are probably one in five people in all the world. So anyhow. So Brad, here we are. We're at the time of the year. Taxes are at top of mind. So let's talk a little bit about what pastors need to be thinking through when it comes to their own tax situation. It's a little bit different. There's self-employment tax, and there's housing allowance, and there's Schedule C's and who knows what else. That's why I send all my taxes to you so you know what's going on. What do we need to be thinking about?
Brad Wooten: That's perfect. Like I said, there's a couple times during the year that people think about their taxes. Right at year end is usually a big one, and when they sit down to do their tax returns. So there's a couple of things that I actually tell everyone, whether they're a pastor or not, and I'll run through those real quick for you. The first one, kind of what you just said, is, when are you thinking about these things? If you're sitting down and you're thinking about how can I minimize my taxes or increase my refund when you sit down to do the actual tax return, it's too late for 99% of your tax strategies. You need to be thinking of it during the year. And so right now, yearend, a lot of people trying to do things before that calendar rolls over to January 1st because at that point you lose a lot of things. So for instance, you can still contribute to a deductible IRA if you qualify up until April 15th when you do the tax return, but the majority of those things that are going to help you out, you need to do during the tax year, not when you're sitting down to do your taxes with the guy in his office or when you're doing it at home on Turbo Tax or whatever. That's a big one is don't wait until it's too late. Do it during the year. The next one I tell people is forget about your refund. It's not about your refund. We can manipulate your refund all we want by increasing withholding or making estimated tax payments. What you care about is, what's the actual amount of income tax that you're paying. We want to get that number as low as possible. And then if we reduce your withholding, then your refund might be smaller, but we're minimizing the actual dollars that you guys are paying in taxes. That's what we want to pay attention to.
Matt Steen: And that way you actually have more to spend during the year instead of a vacation check that you get back in like June.
Brad Wooten: That's right. If you want a nice, big refund, we can pump up your withholding all you want. It has nothing to do with the work I'm doing, but we can get you a nice refund. And that's what drives me crazy about some of the marketing gimmicks. You know, "Get your maximum refund," "Get your best refund here," and they do it as if they're the only ones that can get you the maximum refund. But what I tell people is, the tax return is a basic math problem. It's adding up your income and subtracting a couple of deductions, doing some multiplication, and you get a number. So again, if you're doing tax planning while you're doing the return, those numbers are already set. That math problem's already figured, and if you go to one tax returner to another and they give you a different refund, a lot of times that's because one of them did something wrong, not because they had a better strategy. There's a little bit of strategy you can still do at that point, but a lot of times at that point that stuff's already set, so it's a basic math problem at that point. The last one that I tell everyone is, know what's in your return. I get it. You don't understand taxes. You don't know what's going on. There's a lot of forms, there's a lot of numbers, sometimes the same numbers on multiple places. And it's like, how is this all working together? I'm just going to give it to the guy to do it. I'd tell you, that's why I'm here, but I sit down with people and I still go through the return because you need a basic understanding of what's in there. You need to feel comfortable with what's in there because when you sign the return, even with a preparer, even with a CPA, you're still the one ultimately responsible for that. This was actually the first year where I saw one that I was 99.9% sure the preparer just fraudulently put information in there to get a larger return for the person. So you need to know at a basic level what's in there and feel comfortable with it, whether you know how to prepare the taxes or not. So that's kind of those general things. We'll jump into some specific clergy tips here too. So one of those that I tell people is, what makes it so complicated is that dual status, right? So that dual status is, you are an employee as a missionary or a pastor. Typically you are an employee for employment law purposes and for income tax purposes, and that's why you get a W-2. But you're self-employed for social security and Medicare. So you're not in FICA, you're in SECA as a self-employed individual, strictly for social security and Medicare purposes. And that's where if you go to a tax preparer who's not familiar with clergy members, you're going to hand them a W-2, and they're going to, "This W-2's messed up, it's not right" and then might try to do something that doesn't make any sense. So that's why you get that funny look on your W-2.
Matt Steen: Yeah, so unpack that a little bit. So not in FICA, but in SECA. So is this a benefit in all situations, or is this something that depends on the situation?
Brad Wooten: Yeah. So there are some things that can be a little beneficial. The downside is, of course, coming out of your pocket is both social security and Medicare, both halves of it. So typically it's a benefit to the employee, the company would pay half of that, and the employee would pay half of that out of their withholding. But when you're self-employed, the companies pay none and it's all coming out of your pocket. And so $70,000 to a pastor is a little bit less than $70,000 to a typical W-2 employee because you've got to pay that other 7% that typically the employer would pick up. So that's a downside. The other downside is making sure to do it right because you don't always necessarily have a Schedule C, which typically would flow into the SE form for self-employment income, but you're still going to have self-employment income, even though it doesn't look like you might would typically have that. The number one mistake that I see are, and you can actually as a pastor or missionary or clergy, you can opt out of SECA. There's some qualifications, there's a form to do that. Very few people are opting out now. Typically if they are older than 45, I would expect them to be opted out. If they're younger than 45, I would expect them to be opted in. And that just has to do with how the advice has changed through the years. But some of those who are older actually got back in when there was an opportunity to around early 2000's, late '90's I think when that happened and people opted back in. But the number one mistake is the MHA. Your minister's housing allowance. People, they know that their MHA is "tax free," but what they don't realize is MHA is income tax free, but it is still subject to self-employment tax. So you do have to pay self-employment tax on your housing allowance. And the first thing I look through is I flip to the SE form and I make sure that their SE income is higher than their income tax income because that tells me that they picked up the MHA for self-employment taxes. And a lot of times, they or a preparer who's not familiar with that won't do that, so they will underpay social security and Medicare, which is not the position you want to be in because that can be $5,000-10,000 on your return. That's the first thing that I jump to, that I look for. Other MHA issues actually are people who might claim too little or too much housing allowance. Your housing allowance has to be designated by your organization in order for you to be able to take it. It has to be designated before they pay it, and then it doesn't have to be designated on the W-2 actually, but 99.9% of the time it is. But it doesn't actually have to be on the W-2, but it does have to be designated in the minutes or something by the board of the church or whatever in order for it to qualify. So there's three numbers. There's that designated amount, which typically would be on your W-2. There's the actual expenses, your mortgage payments, your rent, utilities, furnishings for your house, landscaping, what you actually spent. And then there's a fair rental value. And a lot of times people won't look at all three of those numbers. They'll just say, "Here's what I spent" or, "Here's what's on my W-2," that's what I qualify for. The majority of times, you'll be okay with that number, but if you had a large renovation or large repair or a big down payment on your mortgage and you think, "Hey, I'm going to bump my MHA up to $16,000 this year because of this large expense," that would actually hurt you. It will hurt you if you take that because you didn't qualify for that much because that's when the fair minimum value might end up catching you. Because the fair minimum value is, what would your house rent for furnished. So if that number, if it's the lowest number, you're stuck with that number even if your W-2 amount is higher. So you're stuck with the lowest of those three numbers.
Matt Steen: And so, just to be clear, it's not the highest, it is the lowest.
Brad Wooten: It's the lowest.
Matt Steen: So regardless of what's going on, you go to that lowest number.
Brad Wooten: That's right.
Matt Steen: Something else that you said, it sounds like we need to be keeping receipts through the year, keeping track of how we're spending on that kind of thing. Probably worth having a spreadsheet of some sort that tracks this throughout the course of the year.
Brad Wooten: Yeah. I always tell people, more records is definitely better than too few records. You can't go back and recreate, but you can always toss out what you don't need later. And pretty much anything to maintain the home for your family is qualified in that - utilities, repairs, landscaping. A lot of times I'll tell people, like I said, keep records. But then sometimes you want to look at your tax returns because, for instance, there are staff where I've done it where they've got three kids, they've got a pretty good MHA number - maybe they live in California, New York, or something - and they're already paying zero income tax. Just based on basically their rent or mortgage plus utilities minus the fact that they have kids and they're getting the child tax credit, they're already paying no income tax. And so the three hours they spend adding up how much they spend on Windex throughout the year is a waste of time because it saved them no taxes. So there is sometimes where you're adding up things that you're not getting any additional benefit for it, so that's just a matter of looking at your return and knowing if you're going to get some benefit from that or not. And I also tell people that it's not a problem to have your MHA too high. If you have your MHA designated a little too low, you can never go back and get that extra kind of tax-free income, but if it's a little too high and your actual expenses are a little lower than what's designated, that's not a problem as long as you make sure that when you fill out the return you put in the right actual amount and the return is throwing the additional MHA back as taxable income. You would have paid taxes on it anyway, but you're just kind of kicking it back on the return, paying tax on it now. That's a better situation to be in than if it was designated too low and you can never go back and get that benefit.
Matt Steen: Right, right, that makes total sense. I want to circle back to something that you said. Going back to, so your minister housing allowance is something that needs to be declared annually, needs to be in your board's minutes, that kind of thing. And typically, this is something that an elder board, or whatever the church's polity is, is determining right around this time of year. January is typically when that board meeting happens, maybe December at some churches, where they're setting this for the next year. So anything that a church board member that's listening to this needs to be thinking about as they go into their January board meeting?
Brad Wooten: Yeah. I would say the biggest things are, one, it has to be in those minutes so you want to document it somewhere. In the board minutes would be the perfect place to do that. Or if it's not necessarily a board, maybe it's elders... however you document it, you want to make sure it's documented so it's seeing that it was set as minister's housing allowance ahead of time before the money was paid. You can't go in December 28, 2020 and say, "What we already paid you was MHA." You have to do it ahead of time before it was paid. And along with that, I would just say, again, be generous in that because it's better to pay a little bit more in MHA than to underpay MHA. Go to your pastors and ask them how much they're actually spending and find out and make sure that you're giving them that full benefit because it obviously doesn't affect the church's budget or hurt him. It just helps your pastor if you get that number correct.
Matt Steen: Great, great. So Brad, thank you so much. That's really helpful. Appreciate you sharing some of your thoughts on this and helping set our pastors up to stay out of tax prison next year. If people want to find you, where should they look?
Brad Wooten: You can find me, it's just wootencpa.com. You can get to my Facebook and my YouTube. I have a lot of videos on YouTube just helping people understand these things. I have a YouTube video on how to do pastor taxes. I walk through the actual tax return. So that's a pretty well-liked video on YouTube from what I've seen. You can check those out. You can get to those from my webpage, again wootencpa.com. And just kind of some teasers here, the last couple of things. Retirement planning for a pastor, actually this is one I've thought of more recently where typically when you don't have taxable income, you might put money into a Roth because you're not getting a deduction for that. But if you're paying no income tax, it makes sense to put it into a Roth anyway. But pastors, because they don't pay the FICA and Medicare through their payroll, they can actually avoid paying social security and Medicare on traditional contributions to a 403-B to their church. And so even though they're not getting income tax savings on a traditional contribution there, they would still save the 15.3% employment tax and actually never have to pay that because in retirement you still qualify for minister's housing allowance at that time too.
Matt Steen: And to be clear on that, that's only with 403-B. That's not the traditional 401-K. 403-B has to be set up either through your church or your denomination or whatever.
Brad Wooten: Yeah, that's right. Typically the church would be, because it's a non-profit it would be a 403-B instead of a 401-K. And in order to qualify for a minister's housing allowance in retirement, it, again, has to be designated, so something for board members to remember is retirement pastors and designating that amount. I've seen some missionary organizations where they just blanket designate the full amount and then it's up to the retired missionary to figure out how much they actually qualify for. But that's a big benefit in retirement, coming from a 403-B that you want to make sure you don't miss out on. And then the last one, Schedule C. Some pastors Schedule C's. But if you're a W-2 employee, for the income tax purposes you don't qualify for the home office. Which is a big one this year. I've been telling this to pastors and other W-2 employees. I know you worked from home a lot in 2020, everyone did, but if you're a W-2 employee, you don't actually qualify for home office expenses. Now, a pastor who might have a Schedule C as well for things such as funerals or weddings that were done outside of the church - now if that runs through the church, that's being paid through your W-2, but if it's outside of that, then you might have a Schedule C and you might actually be able to qualify for some home office expenses for that in that situation.
Matt Steen: That's great, that's great. Brad, again, thank you so much. We'll link off to Brad's site and to some other helpful content that he's sharing with us down below. Any final words of wisdom that you have for us?
Brad Wooten: No, that's it. Like I said, I tell people, you want to understand what's in that return at a basic level. You want to look through it every now again. Don't just blind trust the person. Ask questions. Ask your tax returner questions. That's the best way. Read people. You're in ministry, you know how to read people. Just like buying a used car, you don't want to just blanket trust somebody, but read the person, make sure you feel comfortable with them, and make sure they're giving you the time. A lot of CPAs just don't give you time anymore, and that was why I really wanted to get back into practice was to take that time to help people understand it. Not just do a form, which I do, but to have them understand what's going on when I do it for them.
Matt Steen: That's great, thanks so much Brad.
Brad Wooten: Thanks Matt.