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Ask the Experts January 26, 2021
Self Employed Ministers’ 403(b) Contributions’ Effect on Compensation
Experts from Groom Law Group and Cammack Retirement Group answer questions concerning retirement plan administration and regulations.
Reported by Rebecca Moore
“We are a church denominational 403(b)(9) plan which has not elected to be covered by the Employee Retirement Income Security Act (ERISA). Our participants include self-employed ministers. In Publication 571, Tax-Sheltered Annuity Plans (403(b) Plans), the IRS instructs self-employed ministers that their includible compensation is net earnings from ministry minus contributions made to the retirement plan and the deductible portion of their self-employment tax. If the minister makes designated Roth or after-tax contributions to their 403(b) account do those contributions reduce includible compensation since these contributions do not reduce taxable income?”
Charles Filips, Kimberly Boberg, David Levine and David Powell, with Groom Law Group, and Michael A. Webb, vice president, Retirement Plan Services, Cammack Retirement Group, answer:
This can be a confusing issue, as there is no clear guidance since many of the rules addressing taxable compensation of self-employed ministers predate the time that Roth contributions were added to the Code. That said, we look to the Code and Treasury Regulations for direction here.
Treas. Reg. section 1.403(b)-2(b)(11) provides that “[i]ncludible compensation for a minister who is self-employed means the minister’s earned income as defined in section 401(c)(2) (computed without regard to section 911) for the most recent period that is a year of service.”
Code section 401(c)(2) essentially provides the rule for determining earned income when a sole proprietor participates in a 401(a) plan – i.e., you use “net earnings from self-employment (as defined in section 1402(a))”, which is generally the amount subject to Self-Employment Contributions Act (SECA) tax. Ministers, whether self-employed or not, generally pay SECA rather than FICA. Thus, we look to whether or not Roth contributions to a 403(b) plan are subject to SECA tax in the case of a self-employed minister.
Code section 1402(a)(2) provides that “[i]ncome which is excludable from gross income under any provision of subtitle A of the Internal Revenue Code is not taken into account in determining net earnings from self-employment except as otherwise provided in … §1.1402(a)-11, relating to ministers or members of religious orders….” Treas. Reg. section §1.1402(a)-11(a) provides for net earnings to be the gross income derived from self-employment “less the deductions attributable to such gross income.” Rev. Rul. 68-395 provides that the “portion of the ‘employer contributions’ by the church on behalf of its minister towards the purchase of the annuity contract described that does not exceed the ‘exclusion allowance’ determined under section 403(b)(2) of the Code is not to be taken into account in determining the minister’s net earnings from self-employment since this portion is an amount excludable from his gross income under section 403(b) of the Code.” (emphasis added) See also Rev. Rul. 78-6.
Consequently, since not excludable from gross income under Code section 403(b), Roth contributions by ministers would generally be part of net earnings from self-employment subject to SECA tax (unlike pre-tax elective deferrals by the same minister), and would thus appear to be included in includible compensation for 403(b) purposes, supporting a higher 415 limit. This would be consistent with the applicable regulations and is supported by IRS Publication 517, addressing the calculation of SECA for ministers, which provides that the retirement plan contribution exclusion from net earnings from self-employment only applies to those salary reduction contributions (elective deferrals) “that aren’t included in gross income.” It would also seem better policy, since treating the Roth 403(b) contribution as includible compensation for 415 limit purposes would seem more consistent with paying SECA and income tax on the contribution. However, the description in Pub. 571 could be read otherwise, and the IRS has not issued definitive guidance on the question.
NOTE: This feature is to provide general information only, does not constitute legal advice, and cannot be used or substituted for legal or tax advice.