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Irs efile 2. Irs efile   Depreciation of Rental Property Table of Contents The BasicsWhat Rental Property Can Be Depreciated? When Does Depreciation Begin and End? Depreciation Methods Basis of Depreciable Property Claiming the Special Depreciation Allowance MACRS DepreciationDepreciation Systems Property Classes Under GDS Recovery Periods Under GDS Conventions Figuring Your Depreciation Deduction Figuring MACRS Depreciation Under ADS Claiming the Correct Amount of Depreciation You recover the cost of income producing property through yearly tax deductions. Irs efile You do this by depreciating the property; that is, by deducting some of the cost each year on your tax return. Irs efile Three factors determine how much depreciation you can deduct each year: (1) your basis in the property, (2) the recovery period for the property, and (3) the depreciation method used. Irs efile You cannot simply deduct your mortgage or principal payments, or the cost of furniture, fixtures and equipment, as an expense. Irs efile You can deduct depreciation only on the part of your property used for rental purposes. Irs efile Depreciation reduces your basis for figuring gain or loss on a later sale or exchange. Irs efile You may have to use Form 4562 to figure and report your depreciation. Irs efile See Which Forms To Use in chapter 3. Irs efile Also see Publication 946. Irs efile Section 179 deduction. Irs efile   The section 179 deduction is a means of recovering part or all of the cost of certain qualifying property in the year you place the property in service. Irs efile This deduction is not allowed for property used in connection with residential rental property. Irs efile See chapter 2 of Publication 946. Irs efile Alternative minimum tax (AMT). Irs efile   If you use accelerated depreciation, you may be subject to the AMT. Irs efile Accelerated depreciation allows you to deduct more depreciation earlier in the recovery period than you could deduct using a straight line method (same deduction each year). Irs efile   The prescribed depreciation methods for rental real estate are not accelerated, so the depreciation deduction is not adjusted for the AMT. Irs efile However, accelerated methods are generally used for other property connected with rental activities (for example, appliances and wall-to-wall carpeting). Irs efile   To find out if you are subject to the AMT, see the Instructions for Form 6251. Irs efile The Basics The following section discusses the information you will need to have about the rental property and the decisions to be made before figuring your depreciation deduction. Irs efile What Rental Property Can Be Depreciated? You can depreciate your property if it meets all the following requirements. Irs efile You own the property. Irs efile You use the property in your business or income-producing activity (such as rental property). Irs efile The property has a determinable useful life. Irs efile The property is expected to last more than one year. Irs efile Property you own. Irs efile   To claim depreciation, you usually must be the owner of the property. Irs efile You are considered as owning property even if it is subject to a debt. Irs efile Rented property. Irs efile   Generally, if you pay rent for property, you cannot depreciate that property. Irs efile Usually, only the owner can depreciate it. Irs efile However, if you make permanent improvements to leased property, you may be able to depreciate the improvements. Irs efile See Additions or improvements to property , later in this chapter, under Recovery Periods Under GDS. Irs efile Cooperative apartments. Irs efile   If you are a tenant-stockholder in a cooperative housing corporation and rent your cooperative apartment to others, you can deduct depreciation on your stock in the corporation. Irs efile See chapter 4, Special Situations. Irs efile Property having a determinable useful life. Irs efile   To be depreciable, your property must have a determinable useful life. Irs efile This means that it must be something that wears out, decays, gets used up, becomes obsolete, or loses its value from natural causes. Irs efile What Rental Property Cannot Be Depreciated? Certain property cannot be depreciated. Irs efile This includes land and certain excepted property. Irs efile Land. Irs efile   You cannot depreciate the cost of land because land generally does not wear out, become obsolete, or get used up. Irs efile But if it does, the loss is accounted for upon disposition. Irs efile The costs of clearing, grading, planting, and landscaping are usually all part of the cost of land and cannot be depreciated. Irs efile   Although you cannot depreciate land, you can depreciate certain land preparation costs, such as landscaping costs, incurred in preparing land for business use. Irs efile These costs must be so closely associated with other depreciable property that you can determine a life for them along with the life of the associated property. Irs efile Example. Irs efile You built a new house to use as a rental and paid for grading, clearing, seeding, and planting bushes and trees. Irs efile Some of the bushes and trees were planted right next to the house, while others were planted around the outer border of the lot. Irs efile If you replace the house, you would have to destroy the bushes and trees right next to it. Irs efile These bushes and trees are closely associated with the house, so they have a determinable useful life. Irs efile Therefore, you can depreciate them. Irs efile Add your other land preparation costs to the basis of your land because they have no determinable life and you cannot depreciate them. Irs efile Excepted property. Irs efile   Even if the property meets all the requirements listed earlier under What Rental Property Can Be Depreciated , you cannot depreciate the following property. Irs efile Property placed in service and disposed of (or taken out of business use) in the same year. Irs efile Equipment used to build capital improvements. Irs efile You must add otherwise allowable depreciation on the equipment during the period of construction to the basis of your improvements. Irs efile For more information, see chapter 1 of Publication 946. Irs efile When Does Depreciation Begin and End? You begin to depreciate your rental property when you place it in service for the production of income. Irs efile You stop depreciating it either when you have fully recovered your cost or other basis, or when you retire it from service, whichever happens first. Irs efile Placed in Service You place property in service in a rental activity when it is ready and available for a specific use in that activity. Irs efile Even if you are not using the property, it is in service when it is ready and available for its specific use. Irs efile Example 1. Irs efile On November 22 of last year, you purchased a dishwasher for your rental property. Irs efile The appliance was delivered on December 7, but was not installed and ready for use until January 3 of this year. Irs efile Because the dishwasher was not ready for use last year, it is not considered placed in service until this year. Irs efile If the appliance had been installed and ready for use when it was delivered in December of last year, it would have been considered placed in service in December, even if it was not actually used until this year. Irs efile Example 2. Irs efile On April 6, you purchased a house to use as residential rental property. Irs efile You made extensive repairs to the house and had it ready for rent on July 5. Irs efile You began to advertise the house for rent in July and actually rented it beginning September 1. Irs efile The house is considered placed in service in July when it was ready and available for rent. Irs efile You can begin to depreciate the house in July. Irs efile Example 3. Irs efile You moved from your home in July. Irs efile During August and September you made several repairs to the house. Irs efile On October 1, you listed the property for rent with a real estate company, which rented it on December 1. Irs efile The property is considered placed in service on October 1, the date when it was available for rent. Irs efile Conversion to business use. Irs efile   If you place property in service in a personal activity, you cannot claim depreciation. Irs efile However, if you change the property's use to business or the production of income, you can begin to depreciate it at the time of the change. Irs efile You place the property in service for business or income-producing use on the date of the change. Irs efile Example. Irs efile You bought a house and used it as your personal home several years before you converted it to rental property. Irs efile Although its specific use was personal and no depreciation was allowable, you placed the home in service when you began using it as your home. Irs efile You can begin to claim depreciation in the year you converted it to rental property because at that time its use changed to the production of income. Irs efile Idle Property Continue to claim a deduction for depreciation on property used in your rental activity even if it is temporarily idle (not in use). Irs efile For example, if you must make repairs after a tenant moves out, you still depreciate the rental property during the time it is not available for rent. Irs efile Cost or Other Basis Fully Recovered You must stop depreciating property when the total of your yearly depreciation deductions equals your cost or other basis of your property. Irs efile For this purpose, your yearly depreciation deductions include any depreciation that you were allowed to claim, even if you did not claim it. Irs efile See Basis of Depreciable Property , later. Irs efile Retired From Service You stop depreciating property when you retire it from service, even if you have not fully recovered its cost or other basis. Irs efile You retire property from service when you permanently withdraw it from use in a trade or business or from use in the production of income because of any of the following events. Irs efile You sell or exchange the property. Irs efile You convert the property to personal use. Irs efile You abandon the property. Irs efile The property is destroyed. Irs efile Depreciation Methods Generally, you must use the Modified Accelerated Cost Recovery System (MACRS) to depreciate residential rental property placed in service after 1986. Irs efile If you placed rental property in service before 1987, you are using one of the following methods. Irs efile ACRS (Accelerated Cost Recovery System) for property placed in service after 1980 but before 1987. Irs efile Straight line or declining balance method over the useful life of property placed in service before 1981. Irs efile See MACRS Depreciation , later, for more information. Irs efile Rental property placed in service before 2013. Irs efile   Continue to use the same method of figuring depreciation that you used in the past. Irs efile Use of real property changed. Irs efile   Generally, you must use MACRS to depreciate real property that you acquired for personal use before 1987 and changed to business or income-producing use after 1986. Irs efile This includes your residence that you changed to rental use. Irs efile See Property Owned or Used in 1986 in Publication 946, chapter 1, for those situations in which MACRS is not allowed. Irs efile Improvements made after 1986. Irs efile   Treat an improvement made after 1986 to property you placed in service before 1987 as separate depreciable property. Irs efile As a result, you can depreciate that improvement as separate property under MACRS if it is the type of property that otherwise qualifies for MACRS depreciation. Irs efile For more information about improvements, see Additions or improvements to property , later in this chapter under Recovery Periods Under GDS. Irs efile This publication discusses MACRS depreciation only. Irs efile If you need information about depreciating property placed in service before 1987, see Publication 534. Irs efile Basis of Depreciable Property The basis of property used in a rental activity is generally its adjusted basis when you place it in service in that activity. Irs efile This is its cost or other basis when you acquired it, adjusted for certain items occurring before you place it in service in the rental activity. Irs efile If you depreciate your property under MACRS, you may also have to reduce your basis by certain deductions and credits with respect to the property. Irs efile Basis and adjusted basis are explained in the following discussions. Irs efile If you used the property for personal purposes before changing it to rental use, its basis for depreciation is the lesser of its adjusted basis or its fair market value when you change it to rental use. Irs efile See Basis of Property Changed to Rental Use in chapter 4. Irs efile Cost Basis The basis of property you buy is usually its cost. Irs efile The cost is the amount you pay for it in cash, in debt obligation, in other property, or in services. Irs efile Your cost also includes amounts you pay for: Sales tax charged on the purchase (but see Exception next), Freight charges to obtain the property, and Installation and testing charges. Irs efile Exception. Irs efile   If you deducted state and local general sales taxes as an itemized deduction on Schedule A (Form 1040), do not include those sales taxes as part of your cost basis. Irs efile Such taxes were deductible before 1987 and after 2003. Irs efile Loans with low or no interest. Irs efile   If you buy property on any time-payment plan that charges little or no interest, the basis of your property is your stated purchase price, less the amount considered to be unstated interest. Irs efile See Unstated Interest and Original Issue Discount (OID) in Publication 537, Installment Sales. Irs efile Real property. Irs efile   If you buy real property, such as a building and land, certain fees and other expenses you pay are part of your cost basis in the property. Irs efile Real estate taxes. Irs efile   If you buy real property and agree to pay real estate taxes on it that were owed by the seller and the seller does not reimburse you, the taxes you pay are treated as part of your basis in the property. Irs efile You cannot deduct them as taxes paid. Irs efile   If you reimburse the seller for real estate taxes the seller paid for you, you can usually deduct that amount. Irs efile Do not include that amount in your basis in the property. Irs efile Settlement fees and other costs. Irs efile   The following settlement fees and closing costs for buying the property are part of your basis in the property. Irs efile Abstract fees. Irs efile Charges for installing utility services. Irs efile Legal fees. Irs efile Recording fees. Irs efile Surveys. Irs efile Transfer taxes. Irs efile Title insurance. Irs efile Any amounts the seller owes that you agree to pay, such as back taxes or interest, recording or mortgage fees, charges for improvements or repairs, and sales commissions. Irs efile   The following are settlement fees and closing costs you cannot include in your basis in the property. Irs efile Fire insurance premiums. Irs efile Rent or other charges relating to occupancy of the property before closing. Irs efile Charges connected with getting or refinancing a loan, such as: Points (discount points, loan origination fees), Mortgage insurance premiums, Loan assumption fees, Cost of a credit report, and Fees for an appraisal required by a lender. Irs efile   Also, do not include amounts placed in escrow for the future payment of items such as taxes and insurance. Irs efile Assumption of a mortgage. Irs efile   If you buy property and become liable for an existing mortgage on the property, your basis is the amount you pay for the property plus the amount remaining to be paid on the mortgage. Irs efile Example. Irs efile You buy a building for $60,000 cash and assume a mortgage of $240,000 on it. Irs efile Your basis is $300,000. Irs efile Separating cost of land and buildings. Irs efile   If you buy buildings and your cost includes the cost of the land on which they stand, you must divide the cost between the land and the buildings to figure the basis for depreciation of the buildings. Irs efile The part of the cost that you allocate to each asset is the ratio of the fair market value of that asset to the fair market value of the whole property at the time you buy it. Irs efile   If you are not certain of the fair market values of the land and the buildings, you can divide the cost between them based on their assessed values for real estate tax purposes. Irs efile Example. Irs efile You buy a house and land for $200,000. Irs efile The purchase contract does not specify how much of the purchase price is for the house and how much is for the land. Irs efile The latest real estate tax assessment on the property was based on an assessed value of $160,000, of which $136,000 was for the house and $24,000 was for the land. Irs efile You can allocate 85% ($136,000 ÷ $160,000) of the purchase price to the house and 15% ($24,000 ÷ $160,000) of the purchase price to the land. Irs efile Your basis in the house is $170,000 (85% of $200,000) and your basis in the land is $30,000 (15% of $200,000). Irs efile Basis Other Than Cost You cannot use cost as a basis for property that you received: In return for services you performed; In an exchange for other property; As a gift; From your spouse, or from your former spouse as the result of a divorce; or As an inheritance. Irs efile If you received property in one of these ways, see Publication 551 for information on how to figure your basis. Irs efile Adjusted Basis To figure your property's basis for depreciation, you may have to make certain adjustments (increases and decreases) to the basis of the property for events occurring between the time you acquired the property and the time you placed it in service for business or the production of income. Irs efile The result of these adjustments to the basis is the adjusted basis. Irs efile Increases to basis. Irs efile   You must increase the basis of any property by the cost of all items properly added to a capital account. Irs efile These include the following. Irs efile The cost of any additions or improvements made before placing your property into service as a rental that have a useful life of more than 1 year. Irs efile Amounts spent after a casualty to restore the damaged property. Irs efile The cost of extending utility service lines to the property. Irs efile Legal fees, such as the cost of defending and perfecting title, or settling zoning issues. Irs efile Additions or improvements. Irs efile   Add to the basis of your property the amount an addition or improvement actually cost you, including any amount you borrowed to make the addition or improvement. Irs efile This includes all direct costs, such as material and labor, but does not include your own labor. Irs efile It also includes all expenses related to the addition or improvement. Irs efile   For example, if you had an architect draw up plans for remodeling your property, the architect's fee is a part of the cost of the remodeling. Irs efile Or, if you had your lot surveyed to put up a fence, the cost of the survey is a part of the cost of the fence. Irs efile   Keep separate accounts for depreciable additions or improvements made after you place the property in service in your rental activity. Irs efile For information on depreciating additions or improvements, see Additions or improvements to property , later in this chapter, under Recovery Periods Under GDS. Irs efile    The cost of landscaping improvements is usually treated as an addition to the basis of the land, which is not depreciable. Irs efile However, see What Rental Property Cannot Be Depreciated, earlier. Irs efile Assessments for local improvements. Irs efile   Assessments for items which tend to increase the value of property, such as streets and sidewalks, must be added to the basis of the property. Irs efile For example, if your city installs curbing on the street in front of your house, and assesses you and your neighbors for its cost, you must add the assessment to the basis of your property. Irs efile Also add the cost of legal fees paid to obtain a decrease in an assessment levied against property to pay for local improvements. Irs efile You cannot deduct these items as taxes or depreciate them. Irs efile    However, you can deduct as taxes, charges or assessments for maintenance, repairs, or interest charges related to the improvements. Irs efile Do not add them to your basis in the property. Irs efile Deducting vs. Irs efile capitalizing costs. Irs efile   Do not add to your basis costs you can deduct as current expenses. Irs efile However, there are certain costs you can choose either to deduct or to capitalize. Irs efile If you capitalize these costs, include them in your basis. Irs efile If you deduct them, do not include them in your basis. Irs efile   The costs you may choose to deduct or capitalize include carrying charges, such as interest and taxes, that you must pay to own property. Irs efile   For more information about deducting or capitalizing costs and how to make the election, see Carrying Charges in Publication 535, chapter 7. Irs efile Decreases to basis. Irs efile   You must decrease the basis of your property by any items that represent a return of your cost. Irs efile These include the following. Irs efile Insurance or other payment you receive as the result of a casualty or theft loss. Irs efile Casualty loss not covered by insurance for which you took a deduction. Irs efile Amount(s) you receive for granting an easement. Irs efile Residential energy credits you were allowed before 1986, or after 2005, if you added the cost of the energy items to the basis of your home. Irs efile Exclusion from income of subsidies for energy conservation measures. Irs efile Special depreciation allowance claimed on qualified property. Irs efile Depreciation you deducted, or could have deducted, on your tax returns under the method of depreciation you chose. Irs efile If you did not deduct enough or deducted too much in any year, see Depreciation under Decreases to Basis in Publication 551. Irs efile   If your rental property was previously used as your main home, you must also decrease the basis by the following. Irs efile Gain you postponed from the sale of your main home before May 7, 1997, if the replacement home was converted to your rental property. Irs efile District of Columbia first-time homebuyer credit allowed on the purchase of your main home after August 4, 1997 and before January 1, 2012. Irs efile Amount of qualified principal residence indebtedness discharged on or after January 1, 2007. Irs efile Claiming the Special Depreciation Allowance For 2013, your residential rental property may qualify for a special depreciation allowance. Irs efile This allowance is figured before you figure your regular depreciation deduction. Irs efile See Publication 946, chapter 3, for details. Irs efile Also see the Instructions for Form 4562, Line 14. Irs efile If you qualify for, but choose not to take, a special depreciation allowance, you must attach a statement to your return. Irs efile The details of this election are in Publication 946, chapter 3, and the Instructions for Form 4562, Line 14. Irs efile MACRS Depreciation Most business and investment property placed in service after 1986 is depreciated using MACRS. Irs efile This section explains how to determine which MACRS depreciation system applies to your property. Irs efile It also discusses other information you need to know before you can figure depreciation under MACRS. Irs efile This information includes the property's: Recovery class, Applicable recovery period, Convention, Placed-in-service date, Basis for depreciation, and Depreciation method. Irs efile Depreciation Systems MACRS consists of two systems that determine how you depreciate your property—the General Depreciation System (GDS) and the Alternative Depreciation System (ADS). Irs efile You must use GDS unless you are specifically required by law to use ADS or you elect to use ADS. Irs efile Excluded Property You cannot use MACRS for certain personal property (such as furniture or appliances) placed in service in your rental property in 2013 if it had been previously placed in service before 1987 when MACRS became effective. Irs efile In most cases, personal property is excluded from MACRS if you (or a person related to you) owned or used it in 1986 or if your tenant is a person (or someone related to the person) who owned or used it in 1986. Irs efile However, the property is not excluded if your 2013 deduction under MACRS (using a half-year convention) is less than the deduction you would have under ACRS. Irs efile For more information, see What Method Can You Use To Depreciate Your Property? in Publication 946, chapter 1. Irs efile Electing ADS If you choose, you can use the ADS method for most property. Irs efile Under ADS, you use the straight line method of depreciation. Irs efile The election of ADS for one item in a class of property generally applies to all property in that class that is placed in service during the tax year of the election. Irs efile However, the election applies on a property-by-property basis for residential rental property and nonresidential real property. Irs efile If you choose to use ADS for your residential rental property, the election must be made in the first year the property is placed in service. Irs efile Once you make this election, you can never revoke it. Irs efile For property placed in service during 2013, you make the election to use ADS by entering the depreciation on Form 4562, Part III, Section C, line 20c. Irs efile Property Classes Under GDS Each item of property that can be depreciated under MACRS is assigned to a property class, determined by its class life. Irs efile The property class generally determines the depreciation method, recovery period, and convention. Irs efile The property classes under GDS are: 3-year property, 5-year property, 7-year property, 10-year property, 15-year property, 20-year property, Nonresidential real property, and Residential rental property. Irs efile Under MACRS, property that you placed in service during 2013 in your rental activities generally falls into one of the following classes. Irs efile 5-year property. Irs efile This class includes computers and peripheral equipment, office machinery (typewriters, calculators, copiers, etc. Irs efile ), automobiles, and light trucks. Irs efile This class also includes appliances, carpeting, furniture, etc. Irs efile , used in a residential rental real estate activity. Irs efile Depreciation on automobiles, other property used for transportation, computers and related peripheral equipment, and property of a type generally used for entertainment, recreation, or amusement is limited. Irs efile See chapter 5 of Publication 946. Irs efile 7-year property. Irs efile This class includes office furniture and equipment (desks, file cabinets, etc. Irs efile ). Irs efile This class also includes any property that does not have a class life and that has not been designated by law as being in any other class. Irs efile 15-year property. Irs efile This class includes roads, fences, and shrubbery (if depreciable). Irs efile Residential rental property. Irs efile This class includes any real property that is a rental building or structure (including a mobile home) for which 80% or more of the gross rental income for the tax year is from dwelling units. Irs efile It does not include a unit in a hotel, motel, inn, or other establishment where more than half of the units are used on a transient basis. Irs efile If you live in any part of the building or structure, the gross rental income includes the fair rental value of the part you live in. Irs efile The other property classes do not generally apply to property used in rental activities. Irs efile These classes are not discussed in this publication. Irs efile See Publication 946 for more information. Irs efile Recovery Periods Under GDS The recovery period of property is the number of years over which you recover its cost or other basis. Irs efile The recovery periods are generally longer under ADS than GDS. Irs efile The recovery period of property depends on its property class. Irs efile Under GDS, the recovery period of an asset is generally the same as its property class. Irs efile Class lives and recovery periods for most assets are listed in Appendix B of Publication 946. Irs efile See Table 2-1 for recovery periods of property commonly used in residential rental activities. Irs efile Qualified Indian reservation property. Irs efile   Shorter recovery periods are provided under MACRS for qualified Indian reservation property placed in service on Indian reservations. Irs efile For more information, see chapter 4 of Publication 946. Irs efile Additions or improvements to property. Irs efile   Treat additions or improvements you make to your depreciable rental property as separate property items for depreciation purposes. Irs efile   The property class and recovery period of the addition or improvement is the one that would apply to the original property if you had placed it in service at the same time as the addition or improvement. Irs efile   The recovery period for an addition or improvement to property begins on the later of: The date the addition or improvement is placed in service, or The date the property to which the addition or improvement was made is placed in service. Irs efile Example. Irs efile You own a residential rental house that you have been renting since 1986 and depreciating under ACRS. Irs efile You built an addition onto the house and placed it in service in 2013. Irs efile You must use MACRS for the addition. Irs efile Under GDS, the addition is depreciated as residential rental property over 27. Irs efile 5 years. Irs efile Table 2-1. Irs efile MACRS Recovery Periods for Property Used in Rental Activities   MACRS Recovery Period   Type of Property General Depreciation System Alternative Depreciation System   Computers and their peripheral equipment 5 years 5 years   Office machinery, such as: Typewriters Calculators Copiers 5 years 6 years   Automobiles 5 years 5 years   Light trucks 5 years 5 years   Appliances, such as: Stoves Refrigerators 5 years 9 years   Carpets 5 years 9 years   Furniture used in rental property 5 years 9 years   Office furniture and equipment, such as: Desks Files 7 years 10 years   Any property that does not have a class life and that has not been designated by law as being in any other class 7 years 12 years   Roads 15 years 20 years   Shrubbery 15 years 20 years   Fences 15 years 20 years   Residential rental property (buildings or structures) and structural components such as furnaces, waterpipes, venting, etc. Irs efile 27. Irs efile 5 years 40 years   Additions and improvements, such as a new roof The same recovery period as that of the property to which the addition or improvement is made, determined as if the property were placed in service at the same time as the addition or improvement. Irs efile   Conventions A convention is a method established under MACRS to set the beginning and end of the recovery period. Irs efile The convention you use determines the number of months for which you can claim depreciation in the year you place property in service and in the year you dispose of the property. Irs efile Mid-month convention. Irs efile    A mid-month convention is used for all residential rental property and nonresidential real property. Irs efile Under this convention, you treat all property placed in service, or disposed of, during any month as placed in service, or disposed of, at the midpoint of that month. Irs efile Mid-quarter convention. Irs efile   A mid-quarter convention must be used if the mid-month convention does not apply and the total depreciable basis of MACRS property placed in service in the last 3 months of a tax year (excluding nonresidential real property, residential rental property, and property placed in service and disposed of in the same year) is more than 40% of the total basis of all such property you place in service during the year. Irs efile   Under this convention, you treat all property placed in service, or disposed of, during any quarter of a tax year as placed in service, or disposed of, at the midpoint of the quarter. Irs efile Example. Irs efile During the tax year, Tom Martin purchased the following items to use in his rental property. Irs efile He elects not to claim the special depreciation allowance discussed earlier. Irs efile A dishwasher for $400 that he placed in service in January. Irs efile Used furniture for $100 that he placed in service in September. Irs efile A refrigerator for $800 that he placed in service in October. Irs efile Tom uses the calendar year as his tax year. Irs efile The total basis of all property placed in service that year is $1,300. Irs efile The $800 basis of the refrigerator placed in service during the last 3 months of his tax year exceeds $520 (40% × $1,300). Irs efile Tom must use the mid-quarter convention instead of the half-year convention for all three items. Irs efile Half-year convention. Irs efile    The half-year convention is used if neither the mid-quarter convention nor the mid-month convention applies. Irs efile Under this convention, you treat all property placed in service, or disposed of, during a tax year as placed in service, or disposed of, at the midpoint of that tax year. Irs efile   If this convention applies, you deduct a half year of depreciation for the first year and the last year that you depreciate the property. Irs efile You deduct a full year of depreciation for any other year during the recovery period. Irs efile Figuring Your Depreciation Deduction You can figure your MACRS depreciation deduction in one of two ways. Irs efile The deduction is substantially the same both ways. Irs efile You can either: Actually compute the deduction using the depreciation method and convention that apply over the recovery period of the property, or Use the percentage from the MACRS percentage tables. Irs efile In this publication we will use the percentage tables. Irs efile For instructions on how to compute the deduction, see chapter 4 of Publication 946. Irs efile Residential rental property. Irs efile   You must use the straight line method and a mid-month convention for residential rental property. Irs efile In the first year that you claim depreciation for residential rental property, you can claim depreciation only for the number of months the property is in use, and you must use the mid-month convention (explained under Conventions , earlier). Irs efile 5-, 7-, or 15-year property. Irs efile   For property in the 5- or 7-year class, use the 200% declining balance method and a half-year convention. Irs efile However, in limited cases you must use the mid-quarter convention, if it applies. Irs efile For property in the 15-year class, use the 150% declining balance method and a half-year convention. Irs efile   You can also choose to use the 150% declining balance method for property in the 5- or 7-year class. Irs efile The choice to use the 150% method for one item in a class of property applies to all property in that class that is placed in service during the tax year of the election. Irs efile You make this election on Form 4562. Irs efile In Part III, column (f), enter “150 DB. Irs efile ” Once you make this election, you cannot change to another method. Irs efile   If you use either the 200% or 150% declining balance method, you figure your deduction using the straight line method in the first tax year that the straight line method gives you an equal or larger deduction. Irs efile   You can also choose to use the straight line method with a half-year or mid-quarter convention for 5-, 7-, or 15-year property. Irs efile The choice to use the straight line method for one item in a class of property applies to all property in that class that is placed in service during the tax year of the election. Irs efile You elect the straight line method on Form 4562. Irs efile In Part III, column (f), enter “S/L. Irs efile ” Once you make this election, you cannot change to another method. Irs efile MACRS Percentage Tables You can use the percentages in Table 2-2, earlier, to compute annual depreciation under MACRS. Irs efile The tables show the percentages for the first few years or until the change to the straight line method is made. Irs efile See Appendix A of Publication 946 for complete tables. Irs efile The percentages in Tables 2-2a, 2-2b, and 2-2c make the change from declining balance to straight line in the year that straight line will give a larger deduction. Irs efile If you elect to use the straight line method for 5-, 7-, or 15-year property, or the 150% declining balance method for 5- or 7-year property, use the tables in Appendix A of Publication 946. Irs efile How to use the percentage tables. Irs efile   You must apply the table rates to your property's unadjusted basis (defined below) each year of the recovery period. Irs efile   Once you begin using a percentage table to figure depreciation, you must continue to use it for the entire recovery period unless there is an adjustment to the basis of your property for a reason other than: Depreciation allowed or allowable, or An addition or improvement that is depreciated as a separate item of property. Irs efile   If there is an adjustment for any reason other than (1) or (2), for example, because of a deductible casualty loss, you can no longer use the table. Irs efile For the year of the adjustment and for the remaining recovery period, figure depreciation using the property's adjusted basis at the end of the year and the appropriate depreciation method, as explained earlier under Figuring Your Depreciation Deduction . Irs efile See Figuring the Deduction Without Using the Tables in Publication 946, chapter 4. Irs efile Unadjusted basis. Irs efile   This is the same basis you would use to figure gain on a sale (see Basis of Depreciable Property , earlier), but without reducing your original basis by any MACRS depreciation taken in earlier years. Irs efile   However, you do reduce your original basis by other amounts claimed on the property, including: Any amortization, Any section 179 deduction, and Any special depreciation allowance. Irs efile For more information, see chapter 4 of Publication 946. Irs efile Please click here for the text description of the image. Irs efile Table 2-2 Tables 2-2a, 2-2b, and 2-2c. Irs efile   The percentages in these tables take into account the half-year and mid-quarter conventions. Irs efile Use Table 2-2a for 5-year property, Table 2-2b for 7-year property, and Table 2-2c for 15-year property. Irs efile Use the percentage in the second column (half-year convention) unless you are required to use the mid-quarter convention (explained earlier). Irs efile If you must use the mid-quarter convention, use the column that corresponds to the calendar year quarter in which you placed the property in service. Irs efile Example 1. Irs efile You purchased a stove and refrigerator and placed them in service in June. Irs efile Your basis in the stove is $600 and your basis in the refrigerator is $1,000. Irs efile Both are 5-year property. Irs efile Using the half-year convention column in Table 2-2a, the depreciation percentage for Year 1 is 20%. Irs efile For that year your depreciation deduction is $120 ($600 × . Irs efile 20) for the stove and $200 ($1,000 × . Irs efile 20) for the refrigerator. Irs efile For Year 2, the depreciation percentage is 32%. Irs efile That year's depreciation deduction will be $192 ($600 × . Irs efile 32) for the stove and $320 ($1,000 × . Irs efile 32) for the refrigerator. Irs efile Example 2. Irs efile Assume the same facts as in Example 1, except you buy the refrigerator in October instead of June. Irs efile Since the refrigerator was placed in service in the last 3 months of the tax year, and its basis ($1,000) is more than 40% of the total basis of all property placed in service during the year ($1,600 × . Irs efile 40 = $640), you are required to use the mid-quarter convention to figure depreciation on both the stove and refrigerator. Irs efile Because you placed the refrigerator in service in October, you use the fourth quarter column of Table 2-2a and find the depreciation percentage for Year 1 is 5%. Irs efile Your depreciation deduction for the refrigerator is $50 ($1,000 x . Irs efile 05). Irs efile Because you placed the stove in service in June, you use the second quarter column of Table 2-2a and find the depreciation percentage for Year 1 is 25%. Irs efile For that year, your depreciation deduction for the stove is $150 ($600 x . Irs efile 25). Irs efile Table 2-2d. Irs efile    Use this table when you are using the GDS 27. Irs efile 5 year option for residential rental property. Irs efile Find the row for the month that you placed the property in service. Irs efile Use the percentages listed for that month to figure your depreciation deduction. Irs efile The mid-month convention is taken into account in the percentages shown in the table. Irs efile Continue to use the same row (month) under the column for the appropriate year. Irs efile Example. Irs efile You purchased a single family rental house for $185,000 and placed it in service on February 8. Irs efile The sales contract showed that the building cost $160,000 and the land cost $25,000. Irs efile Your basis for depreciation is its original cost, $160,000. Irs efile This is the first year of service for your residential rental property and you decide to use GDS which has a recovery period of 27. Irs efile 5 years. Irs efile Using Table 2-2d, you find that the percentage for property placed in service in February of Year 1 is 3. Irs efile 182%. Irs efile That year's depreciation deduction is $5,091 ($160,000 x . Irs efile 03182). Irs efile Figuring MACRS Depreciation Under ADS Table 2–1, earlier, shows the ADS recovery periods for property used in rental activities. Irs efile See Appendix B in Publication 946 for other property. Irs efile If your property is not listed in Appendix B, it is considered to have no class life. Irs efile Under ADS, personal property with no class life is depreciated using a recovery period of 12 years. Irs efile Use the mid-month convention for residential rental property and nonresidential real property. Irs efile For all other property, use the half-year or mid-quarter convention, as appropriate. Irs efile See Publication 946 for ADS depreciation tables. Irs efile Claiming the Correct Amount of Depreciation You should claim the correct amount of depreciation each tax year. Irs efile If you did not claim all the depreciation you were entitled to deduct, you must still reduce your basis in the property by the full amount of depreciation that you could have deducted. Irs efile For more information, see Depreciation under Decreases to Basis in Publication 551. Irs efile If you deducted an incorrect amount of depreciation for property in any year, you may be able to make a correction by filing Form 1040X, Amended U. Irs efile S. Irs efile Individual Income Tax Return. Irs efile If you are not allowed to make the correction on an amended return, you can change your accounting method to claim the correct amount of depreciation. Irs efile Filing an amended return. Irs efile   You can file an amended return to correct the amount of depreciation claimed for any property in any of the following situations. Irs efile You claimed the incorrect amount because of a mathematical error made in any year. Irs efile You claimed the incorrect amount because of a posting error made in any year. Irs efile You have not adopted a method of accounting for property placed in service by you in tax years ending after December 29, 2003. Irs efile You claimed the incorrect amount on property placed in service by you in tax years ending before December 30, 2003. Irs efile   Generally, you adopt a method of accounting for depreciation by using a permissible method of determining depreciation when you file your first tax return for the property used in your rental activity. Irs efile This also occurs when you use the same impermissible method of determining depreciation (for example, using the wrong MACRS recovery period) in two or more consecutively filed tax returns. Irs efile   If an amended return is allowed, you must file it by the later of the following dates. Irs efile 3 years from the date you filed your original return for the year in which you did not deduct the correct amount. Irs efile A return filed before an unextended due date is considered filed on that due date. Irs efile 2 years from the time you paid your tax for that year. Irs efile Changing your accounting method. Irs efile   To change your accounting method, you generally must file Form 3115, Application for Change in Accounting Method, to get the consent of the IRS. Irs efile In some instances, that consent is automatic. Irs efile For more information, see Changing Your Accounting Method in Publication 946,  chapter 1. Irs efile Prev  Up  Next   Home   More Online Publications
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Page Last Reviewed or Updated: 04-Feb-2014

The Irs Efile

Irs efile Publication 517 - Main Content Table of Contents Social Security CoverageCoverage of Members of the Clergy Coverage of Religious Workers (Church Employees) U. Irs efile S. Irs efile Citizens and Resident and Nonresident Aliens Ministerial ServicesMinisters Members of Religious Orders Christian Science Practitioners and Readers Exemption From Self-Employment (SE) TaxMembers of the Clergy Members of Recognized Religious Sects Self-Employment Tax: Figuring Net EarningsRegular Method Nonfarm Optional Method Income Tax: Income and ExpensesIncome Items Expense Items Income Tax Withholding and Estimated Tax Filing Your Return Retirement Savings ArrangementsDeducting contributions to tax-sheltered annuity plans. Irs efile Full-time student. Irs efile Adjusted gross income. Irs efile More information. Irs efile Earned Income Credit Comprehensive ExampleForm W-2 From Church Form W-2 From College Schedule C-EZ (Form 1040) Form 2106-EZ Schedule A (Form 1040) Schedule SE (Form 1040) Form 1040 Attachment 1 Attachment 2 How To Get Tax HelpLow Income Taxpayer Clinics Social Security Coverage This section gives information about which system (SECA or FICA) is used to collect social security and Medicare taxes from members of the clergy (ministers, members of a religious order, and Christian Science practitioners and readers) and religious workers (church employees). Irs efile Coverage of Members of the Clergy The services you perform in the exercise of your ministry, of the duties required by your religious order, or of your profession as a Christian Science practitioner or reader are covered by social security and Medicare under SECA. Irs efile Your earnings for these ministerial services (defined later) are subject to self-employment (SE) tax unless one of the following applies. Irs efile You are a member of a religious order who has taken a vow of poverty. Irs efile You ask the Internal Revenue Service (IRS) for an exemption from SE tax for your services and the IRS approves your request. Irs efile See Exemption From Self-Employment (SE) Tax , later. Irs efile You are subject only to the social security laws of a foreign country under the provisions of a social security agreement between the United States and that country. Irs efile For more information, see Bilateral Social Security (Totalization) Agreements in Publication 54. Irs efile Your earnings that are not from ministerial services may be subject to social security tax under FICA or SECA according to the rules that apply to taxpayers in general. Irs efile See Ministerial Services , later. Irs efile Ministers If you are a minister of a church, your earnings for the services you perform in your capacity as a minister are subject to SE tax, even if you perform these services as an employee of that church. Irs efile However, you can request that the IRS grant you an exemption, as discussed under Exemption From Self-Employment (SE) Tax , later. Irs efile For the specific services covered, see Ministerial Services , later. Irs efile Ministers defined. Irs efile   Ministers are individuals who are duly ordained, commissioned, or licensed by a religious body constituting a church or church denomination. Irs efile Ministers have the authority to conduct religious worship, perform sacerdotal functions, and administer ordinances or sacraments according to the prescribed tenets and practices of that church or denomination. Irs efile   If a church or denomination ordains some ministers and licenses or commissions others, anyone licensed or commissioned must be able to perform substantially all the religious functions of an ordained minister to be treated as a minister for social security purposes. Irs efile Employment status for other tax purposes. Irs efile   Even though all of your income from performing ministerial services is subject to self-employment tax for social security tax purposes, you may be an employee for income tax or retirement plan purposes in performing those same services. Irs efile For income tax or retirement plan purposes, your income earned as an employee will be considered wages. Irs efile Common-law employee. Irs efile   Under common-law rules, you are considered either an employee or a self-employed person. Irs efile Generally, you are an employee if you perform services for someone who has the legal right to control both what you do and how you do it, even if you have considerable discretion and freedom of action. Irs efile For more information about the common-law rules, see Publication 15-A, Employer's Supplemental Tax Guide. Irs efile   If a congregation employs you and pays you a salary, you are generally a common-law employee and income from the exercise of your ministry is wages for income tax purposes. Irs efile However, amounts received directly from members of the congregation, such as fees for performing marriages, baptisms, or other personal services, are not wages; such amounts are self-employment income for both income tax purposes and social security tax purposes. Irs efile Example. Irs efile A church hires and pays you a salary to perform ministerial services subject to its control. Irs efile Under the common-law rules, you are an employee of the church while performing those services. Irs efile Form SS-8. Irs efile   If you are not certain whether you are an employee or a self-employed person, you can get a determination from the IRS by filing Form SS-8. Irs efile Members of Religious Orders If you are a member of a religious order who has not taken a vow of poverty, your earnings for ministerial services you perform as a member of the order are subject to SE tax. Irs efile See Ministerial Services , later. Irs efile However, you can request that the IRS grant you an exemption as discussed under Exemption From Self-Employment (SE) Tax , later. Irs efile Vow of poverty. Irs efile   If you are a member of a religious order and have taken a vow of poverty, you are already exempt from paying SE tax on your earnings for ministerial services you perform as an agent of your church or its agencies. Irs efile You do not need to request a separate exemption. Irs efile For income tax purposes, the earnings are tax free to you. Irs efile Your earnings are considered the income of the religious order. Irs efile Services covered under FICA at the election of the order. Irs efile   However, even if you have taken a vow of poverty, the services you perform for your church or its agencies may be covered under social security. Irs efile Your services are covered if your order, or an autonomous subdivision of the order, elects social security coverage for its current and future vow-of-poverty members. Irs efile   The order or subdivision elects coverage by filing Form SS-16. Irs efile The election may cover certain vow-of-poverty members for a retroactive period of up to 20 calendar quarters before the quarter in which it files the certificate. Irs efile If the election is made, the order or subdivision pays both the employer's and employee's share of the tax. Irs efile You do not pay any of the FICA tax. Irs efile Services performed outside the order. Irs efile   Even if you are a member of a religious order who has taken a vow of poverty and the order requires you to turn over amounts you earn, your earnings are subject to federal income tax and either SE tax or FICA tax (including estimated tax payments and/or withholding) if you: Are self-employed or an employee of an organization outside your religious community, and Perform work not required by, or done on behalf of, the order. Irs efile   In these cases, your income from self-employment or as an employee of that outside organization is taxable to you directly. Irs efile You may, however, be able to take a charitable deduction for the amount you turn over to the order. Irs efile See Publication 526, Charitable Contributions. Irs efile Rulings. Irs efile   Organizations and individuals may request rulings from the IRS on whether they are religious orders, or members of a religious order, respectively, for FICA tax, SE tax, and federal income tax withholding purposes. Irs efile To request a ruling, follow the procedures in Revenue Procedure 2014-1, 2014-1 I. Irs efile R. Irs efile B. Irs efile 1, available at www. Irs efile irs. Irs efile gov/irb/2014-1_IRB/ar05. Irs efile html. Irs efile Christian Science Practitioners and Readers Generally, your earnings from services you perform in your profession as a Christian Science practitioner or reader are subject to SE tax. Irs efile However, you can request an exemption as discussed under Exemption From Self-Employment (SE) Tax , later. Irs efile Practitioners. Irs efile   Christian Science practitioners are members in good standing of the Mother Church, The First Church of Christ, Scientist, in Boston, Massachusetts, who practice healing according to the teachings of Christian Science. Irs efile State law specifically exempts Christian Science practitioners from licensing requirements. Irs efile   Some Christian Science practitioners also are Christian Science teachers or lecturers. Irs efile Income from teaching or lecturing is considered the same as income from their work as practitioners. Irs efile Readers. Irs efile   For tax purposes, Christian Science readers are considered the same as ordained, commissioned, or licensed ministers. Irs efile Coverage of Religious Workers (Church Employees) If you are a religious worker (a church employee) and are not in one of the classes already discussed, your wages are generally subject to social security and Medicare tax under FICA, not SECA. Irs efile Some exceptions are discussed next. Irs efile Election by Church To Exclude Its Employees From FICA Coverage Churches and qualified church-controlled organizations (church organizations) that are opposed for religious reasons to the payment of social security and Medicare taxes can elect to exclude their employees from FICA coverage. Irs efile If your employer makes this election, it does not pay the employer's portion of the FICA taxes or withhold from your pay your portion of the FICA taxes. Irs efile Instead, your wages are subject to SECA and you must pay SE tax on your wages if they exceed $108. Irs efile 28 during the tax year. Irs efile However, you can request an exemption from SE tax if you are a member of a recognized religious sect, as discussed below. Irs efile Churches and church organizations make this election by filing two copies of Form 8274. Irs efile For more information about making this election, see Form 8274. Irs efile Election by Certain Church Employees Who Are Opposed to Social Security and Medicare You may be able to choose to be exempt from social security and Medicare taxes, including the SE tax, if you are a member of a recognized religious sect or division and work for a church (or church-controlled nonprofit division) that does not pay the employer's part of the social security tax on wages. Irs efile This exemption does not apply to your service, if any, as a minister of a church or as a member of a religious order. Irs efile Make this choice by filing Form 4029. Irs efile See Requesting Exemption—Form 4029 , later, under Members of Recognized Religious Sects. Irs efile U. Irs efile S. Irs efile Citizens and Resident and Nonresident Aliens To be covered under the SE tax provisions (SECA), individuals generally must be citizens or resident aliens of the United States. Irs efile Nonresident aliens are not covered under SECA unless a social security agreement in effect between the United States and the foreign country determines that you are covered under the U. Irs efile S. Irs efile social security system. Irs efile To determine your alien status, see Publication 519, U. Irs efile S. Irs efile Tax Guide for Aliens. Irs efile Residents of Puerto Rico, the U. Irs efile S. Irs efile Virgin Islands, Guam, the CNMI, and American Samoa. Irs efile   If you are a resident of one of these U. Irs efile S. Irs efile possessions but not a U. Irs efile S. Irs efile citizen, for SE tax purposes you are treated the same as a citizen or resident alien of the United States. Irs efile For information on figuring the tax, see Self-Employment Tax: Figuring Net Earnings , later. Irs efile Ministerial Services Ministerial services, in general, are the services you perform in the exercise of your ministry, in the exercise of your duties as required by your religious order, or in the exercise of your profession as a Christian Science practitioner or reader. Irs efile Income you receive for performing ministerial services is subject to SE tax unless you have an exemption as explained later. Irs efile Even if you have an exemption, only the income you receive for performing ministerial services is exempt. Irs efile The exemption does not apply to any other income. Irs efile The following discussions provide more detailed information on ministerial services of ministers, members of a religious order, and Christian Science practitioners and readers. Irs efile Ministers Most services you perform as a minister, priest, rabbi, etc. Irs efile , are ministerial services. Irs efile These services include: Performing sacerdotal functions, Conducting religious worship, and Controlling, conducting, and maintaining religious organizations (including the religious boards, societies, and other integral agencies of such organizations) that are under the authority of a religious body that is a church or denomination. Irs efile You are considered to control, conduct, and maintain a religious organization if you direct, manage, or promote the organization's activities. Irs efile A religious organization is under the authority of a religious body that is a church or denomination if it is organized for and dedicated to carrying out the principles of a faith according to the requirements governing the creation of institutions of the faith. Irs efile Services for nonreligious organizations. Irs efile   Your services for a nonreligious organization are ministerial services if the services are assigned or designated by your church. Irs efile Assigned or designated services qualify even if they do not involve performing sacerdotal functions or conducting religious worship. Irs efile   If your services are not assigned or designated by your church, they are ministerial services only if they involve performing sacerdotal functions or conducting religious worship. Irs efile Services that are not part of your ministry. Irs efile   Income from services you perform as an employee that are not ministerial services is subject to social security and Medicare tax withholding under FICA (not SECA) under the rules that apply to employees in general. Irs efile The following are not ministerial services. Irs efile Services you perform for nonreligious organizations other than the services stated above. Irs efile Services you perform as a duly ordained, commissioned, or licensed minister of a church as an employee of the United States, the District of Columbia, a foreign government, or any of their political subdivisions. Irs efile These services are not ministerial services even if you are performing sacerdotal functions or conducting religious worship. Irs efile (For example, if you perform services as a chaplain in the Armed Forces of the United States, those services are not ministerial services. Irs efile ) Services you perform in a government-owned and operated hospital. Irs efile (These services are considered performed by a government employee, not by a minister as part of the ministry. Irs efile ) However, services that you perform at a church-related hospital or health and welfare institution, or a private nonprofit hospital, are considered to be part of the ministry and are considered ministerial services. Irs efile Books or articles. Irs efile   Writing religious books or articles is considered to be in the exercise of your ministry and is considered a ministerial service. Irs efile   This rule also applies to members of religious orders and to Christian Science practitioners and readers. Irs efile Members of Religious Orders Services you perform as a member of a religious order in the exercise of duties required by the order are ministerial services. Irs efile The services are considered ministerial because you perform them as an agent of the order. Irs efile For example, if the order directs you to perform services for another agency of the supervising church or an associated institution, you are considered to perform the services as an agent of the order. Irs efile However, if the order directs you to work outside the order, this employment will not be considered a duty required by the order unless: Your services are the kind that are ordinarily performed by members of the order, and Your services are part of the duties that must be exercised for, or on behalf of, the religious order as its agent. Irs efile Effect of employee status. Irs efile   Ordinarily, if your services are not considered directed or required of you by the order, you and the outside party for whom you work are considered employee and employer. Irs efile In this case, your earnings from the services are taxed under the rules that apply to employees in general, not under the rules for services provided as agent for the order. Irs efile This result is true even if you have taken a vow of poverty. Irs efile Example. Irs efile Pat Brown and Chris Green are members of a religious order and have taken vows of poverty. Irs efile They renounce all claims to their earnings. Irs efile The earnings belong to the order. Irs efile Pat is a licensed attorney. Irs efile The superiors of the order instructed her to get a job with a law firm. Irs efile Pat joined a law firm as an employee and, as she requested, the firm made the salary payments directly to the order. Irs efile Chris is a secretary. Irs efile The superiors of the order instructed him to accept a job with the business office of the church that supervises the order. Irs efile Chris took the job and gave all his earnings to the order. Irs efile Pat's services are not duties required by the order. Irs efile Her earnings are subject to social security and Medicare tax under FICA and to federal income tax. Irs efile Chris' services are duties required by the order. Irs efile He is acting as an agent of the order and not as an employee of a third party. Irs efile He does not include the earnings in gross income, and they are not subject to income tax withholding or to social security and Medicare tax under FICA or SECA. Irs efile Christian Science Practitioners and Readers Services you perform as a Christian Science practitioner or reader in the exercise of your profession are ministerial services. Irs efile Amounts you receive for performing these services are generally subject to SE tax. Irs efile You may request an exemption from SE tax, discussed next, which applies only to those services. Irs efile Exemption From Self-Employment (SE) Tax You can request an exemption from SE tax if you are a member of the clergy (minister, member of a religious order, or Christian Science practitioner or reader) or a member of a recognized religious sect. Irs efile Generally, members of religious orders who have taken a vow of poverty are already exempt from paying SE tax, as discussed earlier under Members of Religious Orders under Social Security Coverage. Irs efile They do not have to request the exemption. Irs efile Who cannot be exempt. Irs efile   You cannot be exempt from SE tax if you made one of the following elections to be covered under social security. Irs efile These elections are irrevocable. Irs efile You elected to be covered under social security by filing Form 2031, Revocation of Exemption From Self-Employment Tax for Use by Ministers, Members of Religious Orders, and Christian Science Practitioners, for your 1986, 1987, 2000, or 2001 tax year. Irs efile You elected before 1968 to be covered under social security for your ministerial services. Irs efile Requesting exemption. Irs efile    Table 2, earlier, briefly summarizes the procedure for requesting exemption from the SE tax. Irs efile More detailed explanations follow. Irs efile If you are a minister, member of a religious order, or Christian Science practitioner, an approved exemption only applies to earnings you receive for ministerial services, discussed earlier. Irs efile It does not apply to any other self-employment income. Irs efile Table 2. Irs efile The Self-Employment Tax Exemption Application and Approval Process   Who Can Apply Members of the Clergy Members of Recognized  Religious Sects How File Form 4361 File Form 4029 When File by the due date (including extensions) of your income tax return for the second tax year in which you had at least $400 of net earnings from self-employment (at least part from ministerial services) File anytime Approval If approved, you will receive an approved copy of Form 4361 If approved, you will receive an approved copy of Form 4029 Effective Date For all tax years after 1967 in which you have at least $400 of net earnings from self-employment For all tax years beginning with the first year you meet the eligibility requirements discussed later Members of the Clergy To claim the exemption from SE tax, you must meet all of the following conditions. Irs efile You file Form 4361, described below under Requesting Exemption—Form 4361 . Irs efile You are conscientiously opposed to public insurance because of your individual religious considerations (not because of your general conscience), or you are opposed because of the principles of your religious denomination. Irs efile You file for other than economic reasons. Irs efile You inform the ordaining, commissioning, or licensing body of your church or order that you are opposed to public insurance if you are a minister or a member of a religious order (other than a vow-of-poverty member). Irs efile This requirement does not apply to Christian Science practitioners or readers. Irs efile You establish that the organization that ordained, commissioned, or licensed you, or your religious order, is a tax-exempt religious organization. Irs efile You establish that the organization is a church or a convention or association of churches. Irs efile You did not make an election discussed earlier under Who cannot be exempt . Irs efile You sign and return the statement the IRS mails to you to certify that you are requesting an exemption based on the grounds listed on the statement. Irs efile Requesting Exemption—Form 4361 To request exemption from SE tax, file Form 4361 in triplicate (original and two copies) with the IRS. Irs efile The IRS will return to you a copy of the Form 4361 that you filed indicating whether it has approved your exemption. Irs efile If it is approved, keep the approved copy of Form 4361 in your permanent records. Irs efile When to file. Irs efile   File Form 4361 by the date your income tax return is due, including extensions, for the second tax year in which both of the following are true. Irs efile You have net earnings from self-employment of at least $400. Irs efile Any part of those net earnings was from ministerial services you performed as a: Minister, Member of a religious order, or Christian Science practitioner or reader. Irs efile The 2 years do not have to be consecutive tax years. Irs efile    The approval process can take some time, so you should file Form 4361 as soon as possible. Irs efile Example 1. Irs efile Rev. Irs efile Lawrence Jaeger, a clergyman ordained in 2013, has net self-employment earnings as a minister of $450 in 2013 and $500 in 2014. Irs efile He must file his application for exemption by the due date, including extensions, for his 2014 income tax return. Irs efile However, if Rev. Irs efile Jaeger does not receive IRS approval for an exemption by April 15, 2015, his SE tax for 2014 is due by that date. Irs efile Example 2. Irs efile Rev. Irs efile Louise Wolfe has only $300 in net self-employment earnings as a minister in 2013, but earned more than $400 in 2012 and expects to earn more than $400 in 2014. Irs efile She must file her application for exemption by the due date, including extensions, for her 2014 income tax return. Irs efile However, if she does not receive IRS approval for an exemption by April 15, 2015, her SE tax for 2014 is due by that date. Irs efile Example 3. Irs efile In 2011, Rev. Irs efile David Moss was ordained a minister and had $700 in net self-employment earnings as a minister. Irs efile In 2012, he received $1,000 as a minister, but his related expenses were over $1,000. Irs efile Therefore, he had no net self-employment earnings as a minister in 2012. Irs efile Also in 2012, he opened a book store and had $8,000 in net self-employment earnings from the store. Irs efile In 2013, he had net self-employment earnings of $1,500 as a minister and $10,000 net self-employment earnings from the store. Irs efile Rev. Irs efile Moss had net earnings from self-employment in 2011 and 2013 that were $400 or more each year, and part of the self-employment earnings in each of those years was for his services as a minister. Irs efile Thus, he must file his application for exemption by the due date, including extensions, for his 2013 income tax return. Irs efile Death of individual. Irs efile   The right to file an application for exemption ends with an individual's death. Irs efile A surviving spouse, executor, or administrator cannot file an exemption application for a deceased clergy member. Irs efile Effective date of exemption. Irs efile   An approved exemption is effective for all tax years after 1967 in which you have $400 or more of net earnings from self-employment and any part of those earnings is for services as a member of the clergy. Irs efile Once the exemption is approved, it is irrevocable. Irs efile Example. Irs efile Rev. Irs efile Trudy Austin, ordained in 2010, had $400 or more in net self-employment earnings as a minister in both 2010 and 2013. Irs efile She files an application for exemption on February 20, 2014. Irs efile If an exemption is granted, it is effective for 2010 and the following years. Irs efile Refunds of SE tax. Irs efile   If, after receiving an approved Form 4361, you find that you overpaid SE tax, you can file a claim for refund on Form 1040X. Irs efile Generally, for a refund, you must file Form 1040X within 3 years from the date you filed the return or within 2 years from the date you paid the tax, whichever is later. Irs efile A return you filed, or tax you paid, before the due date is considered to have been filed or paid on the due date. Irs efile   If you file a claim after the 3-year period but within 2 years from the time you paid the tax, the credit or refund will not be more than the tax you paid within the 2 years immediately before you file the claim. Irs efile Members of Recognized Religious Sects If you are a member of a recognized religious sect, or a division of a recognized religious sect, you can apply for an exemption from payment of social security and Medicare taxes on both your self-employment income and the wages you earn from an employer who also has an exemption. Irs efile Exception. Irs efile   If you received social security benefits or payments, or anyone else received these benefits or payments based on your wages or self-employment income, you cannot apply. Irs efile However, if you pay your benefits back, you may be considered for exemption. Irs efile Contact your local Social Security Administration office to find out the amount you must pay back. Irs efile Eligibility requirements. Irs efile   To claim this exemption from SE tax, all the following requirements must be met. Irs efile You must file Form 4029, discussed later under Requesting Exemption—Form 4029 . Irs efile As a follower of the established teachings of the sect or division, you must be conscientiously opposed to accepting benefits of any private or public insurance that makes payments for death, disability, old age, retirement, or medical care, or provides services for medical care. Irs efile You must waive all rights to receive any social security payment or benefit and agree that no benefits or payments will be made to anyone else based on your wages and self-employment income. Irs efile The Commissioner of Social Security must determine that: Your sect or division has the established teachings as described in (2) above, It is the practice, and has been for a substantial period of time, for members of the sect or division to provide for their dependent members in a manner that is reasonable in view of the members' general level of living, and The sect or division has existed at all times since December 31, 1950. Irs efile Requesting Exemption—Form 4029 To request the exemption, file Form 4029 in triplicate (original and two copies) with the Social Security Administration at the address shown on the form. Irs efile The sect or division must complete part of the form. Irs efile The IRS will return to you a copy of the Form 4029 that you filed indicating whether it has approved your exemption. Irs efile If it is approved, keep the approved copy of Form 4029 in your permanent records. Irs efile When to file. Irs efile   You can file Form 4029 at any time. Irs efile   If you have an approved exemption from SE tax and for some reason that approved exemption ended, you must file a new Form 4029 if you subsequently meet the eligibility requirements, discussed earlier. Irs efile See Effective date of exemption next for information on when the newly approved exemption would become effective. Irs efile    If you have a previously approved exemption from SE tax and you change membership to another recognized religious sect, without any change to your eligibility requirements, then you do not need to file a new Form 4029. Irs efile Effective date of exemption. Irs efile   An approved exemption from SE tax generally is effective for all tax years beginning with the first year you meet the eligibility requirements discussed earlier. Irs efile (For example, if you meet the eligibility requirements in 2011, you file Form 4029 in 2012, and the IRS approves your exemption in 2013, your exemption is effective for tax year 2011 and all later years. Irs efile )   The exemption will end if you fail to meet the eligibility requirements or if the Commissioner of Social Security determines that the sect or division fails to meet them. Irs efile You must notify the IRS within 60 days if you are no longer a member of the religious group, or if you no longer follow the established teachings of this group. Irs efile The exemption will end for the tax year where you or your sect/division first fails to meet the eligibility requirements. Irs efile Refunds of SE tax paid. Irs efile    To get a refund of any SE tax you paid while the exemption was in effect, file Form 1040X. Irs efile For information on filing this form, see Refunds of SE tax under Requesting Exemption—Form 4361, earlier. Irs efile Exemption From FICA Taxes Generally, under FICA, the employer and the employee each pay half of the social security and Medicare tax. Irs efile Both the employee and the employer, if they meet the eligibility requirements discussed earlier, can apply to be exempt from their share of FICA taxes on wages paid by the employer to the employee. Irs efile A partnership in which each partner holds a religious exemption from social security and Medicare is an employer for this purpose. Irs efile If the employer's application is approved, the exemption will apply only to FICA taxes on wages paid to employees who also received an approval of identical applications. Irs efile Information for employers. Irs efile   If you have an approved Form 4029 and you have an employee who has an approved Form 4029, do not report wages you paid to the employee as social security and Medicare wages. Irs efile   If you have an employee who does not have an approved Form 4029, you must withhold the employee's share of social security and Medicare taxes and pay the employer's share. Irs efile Form W-2. Irs efile   When preparing a Form W-2 for an employee with an approved Form 4029, enter “Form 4029” in box 14, “Other. Irs efile ” Do not make any entries in boxes 3, 4, 5, or 6. Irs efile Forms 941, 943, and 944. Irs efile   If both you and your employee have received approved Forms 4029, do not include these exempt wages on the following forms. Irs efile Instead, follow the instructions given below. Irs efile Form 941, Employer's QUARTERLY Federal Tax Return: check the box on line 4 and enter “Form 4029” in the empty space below the check box. Irs efile Form 943, Employer's Annual Federal Tax Return for Agricultural Employees: enter “Form 4029” on the dotted line next to the lines 2 and 4 entry spaces. Irs efile Form 944, Employer's ANNUAL Federal Tax Return: check the box on line 3 and enter “Form 4029” in the empty space below the check box. Irs efile Effective date. Irs efile   An approved exemption from FICA becomes effective on the first day of the first calendar quarter after the quarter in which you file Form 4029. Irs efile The exemption will end on the last day of the calendar quarter before the quarter in which the employer, employee, sect, or division fails to meet the requirements. Irs efile Self-Employment Tax: Figuring Net Earnings There are two methods for figuring your net earnings from self-employment as a member of the clergy or a religious worker. Irs efile Regular method. Irs efile Nonfarm optional method. Irs efile You may find Worksheets 1 through 4 helpful in figuring your net earnings from self-employment. Irs efile Blank worksheets are in the back of this publication, after the Comprehensive Example. Irs efile Regular Method Most people use the regular method. Irs efile Under this method, figure your net earnings from self-employment by totaling your gross income for services you performed as a minister, a member of a religious order who has not taken a vow of poverty, or a Christian Science practitioner or reader. Irs efile Then, subtract your allowable business deductions and multiply the difference by 92. Irs efile 35% (. Irs efile 9235). Irs efile Use Schedule SE (Form 1040) to figure your net earnings and SE tax. Irs efile If you are an employee of a church that elected to exclude you from FICA coverage, figure net earnings by multiplying your church wages shown on Form W-2 by 92. Irs efile 35% (. Irs efile 9235). Irs efile Do not reduce your wages by any business deductions when making this computation. Irs efile Use Schedule SE (Form 1040), Section B, to figure your net earnings and SE tax. Irs efile If you have an approved exemption, or you are automatically exempt, do not include the income or deductions from ministerial services in figuring your net earnings from self-employment. Irs efile Amounts included in gross income. Irs efile   To figure your net earnings from self-employment (on Schedule SE (Form 1040)), include in gross income: Salaries and fees for your ministerial services (discussed earlier), Offerings you receive for marriages, baptisms, funerals, masses, etc. Irs efile , The value of meals and lodging provided to you, your spouse, and your dependents for your employer's convenience, The fair rental value of a parsonage provided to you (including the cost of utilities that are furnished) and the rental allowance (including an amount for payment of utilities) paid to you, and Any amount a church pays toward your income tax or SE tax, other than withholding the amount from your salary. Irs efile This amount is also subject to income tax. Irs efile   For the income tax treatment of items (2) and (4), see Income Tax: Income and Expenses , later. Irs efile Example. Irs efile Pastor Roger Adams receives an annual salary of $39,000 as a full-time minister. Irs efile The $39,000 includes $5,000 that is designated as a rental allowance to pay utilities. Irs efile His church owns a parsonage that has a fair rental value of $12,000 per year. Irs efile The church gives Pastor Adams the use of the parsonage. Irs efile He is not exempt from SE tax. Irs efile He must include $51,000 ($39,000 plus $12,000) when figuring his net earnings for SE tax purposes. Irs efile The results would be the same if, instead of the use of the parsonage and receipt of the rental allowance for utilities, Pastor Adams had received an annual salary of $51,000 of which $17,000 ($5,000 plus $12,000) per year was designated as a rental allowance. Irs efile Overseas duty. Irs efile   Your net earnings from self-employment are determined without any foreign earned income exclusion or the foreign housing exclusion or deduction if you are a U. Irs efile S. Irs efile citizen or resident alien serving abroad and living in a foreign country. Irs efile   For information on excluding foreign earned income or the foreign housing amount, see Publication 54. Irs efile Example. Irs efile Diane Jones was the minister of a U. Irs efile S. Irs efile church in Mexico. Irs efile She earned $35,000 in that position and was able to exclude it all for income tax purposes under the foreign earned income exclusion. Irs efile The United States does not have a social security agreement with Mexico, so Mrs. Irs efile Jones is subject to U. Irs efile S. Irs efile SE tax and must include $35,000 when figuring net earnings from self-employment. Irs efile Specified U. Irs efile S. Irs efile possessions. Irs efile    The exclusion from gross income for amounts derived from American Samoa or Puerto Rico does not apply in computing net earnings from self-employment. Irs efile Also see Residents of Puerto Rico, the U. Irs efile S. Irs efile Virgin Islands, Guam, the CNMI, and American Samoa , earlier, under U. Irs efile S. Irs efile Citizens and Resident and Nonresident Aliens. Irs efile Amounts not included in gross income. Irs efile   Do not include the following amounts in gross income when figuring your net earnings from self-employment. Irs efile Offerings that others made to the church. Irs efile Contributions by your church to a tax-sheltered annuity plan set up for you, including any salary reduction contributions (elective deferrals) that are not included in your gross income. Irs efile Pension payments or retirement allowances you receive for your past ministerial services. Irs efile The rental value of a parsonage or a parsonage allowance provided to you after you retire. Irs efile Allowable deductions. Irs efile   When figuring your net earnings from self-employment, deduct all your expenses related to your ministerial services performed as a self-employed person. Irs efile These are ministerial expenses you incurred while working other than as a common-law employee of the church. Irs efile They include expenses incurred in performing marriages and baptisms, and in delivering speeches. Irs efile Deduct these expenses on Schedule C or C-EZ (Form 1040), and carry the net amount to line 2 of Schedule SE (Form 1040), Section A or B. Irs efile   Wages earned as a common-law employee (explained earlier) of a church are generally subject to self-employment tax unless an exemption is requested, as discussed earlier under Exemption From Self-Employment (SE) Tax . Irs efile Subtract any allowable expenses (including unreimbursed employee business expenses) from those wages, include the net amount on line 2 of Schedule SE (Form 1040), Section A or B, and attach an explanation. Irs efile Do not complete Schedule C or C-EZ (Form 1040). Irs efile However, for income tax purposes, the expenses are allowed only as an itemized deduction on Schedule A (Form 1040) to the extent they exceed 2% of adjusted gross income. Irs efile Employee reimbursement arrangements. Irs efile   If you received an advance, allowance, or reimbursement for your employee expenses, how you report this amount and your employee expenses depends on whether your employer reimbursed you under an accountable plan or a nonaccountable plan. Irs efile Ask your employer if you are not sure if it reimburses you using an accountable or a nonaccountable plan. Irs efile Accountable plans. Irs efile   To be an accountable plan, your employer's reimbursement arrangement must include all three of the following rules. Irs efile Your expenses must have a business connection—that is, you must have paid or incurred deductible expenses while performing services as an employee of your employer. Irs efile You must adequately account to your employer for these expenses within a reasonable period of time. Irs efile You must return any excess reimbursement or allowance within a reasonable period of time. Irs efile   The reimbursement is not reported on your Form W-2. Irs efile Generally, if your expenses equal your reimbursement, you have no deduction. Irs efile If your expenses are more than your reimbursement, you can deduct your excess expenses for SE tax and income tax purposes. Irs efile Nonaccountable plan. Irs efile   A nonaccountable plan is a reimbursement arrangement that does not meet all three of the rules listed under Accountable plans above. Irs efile In addition, even if your employer has an accountable plan, the following payments will be treated as being paid under a nonaccountable plan. Irs efile Excess reimbursements you fail to return to your employer. Irs efile Reimbursement of nondeductible expenses related to your employer's business. Irs efile   Your employer will combine any reimbursement paid to you under a nonaccountable plan with your wages, salary, or other compensation and report the combined total in box 1 of your Form W-2. Irs efile Since reimbursements under a nonaccountable plan are included in your gross income, you can deduct your related expenses (for SE tax and income tax purposes) regardless of whether they are more than, less than, or equal to your reimbursement. Irs efile   For more information on accountable and nonaccountable plans, see Publication 463, Travel, Entertainment, Gift, and Car Expenses. Irs efile Married Couple Missionary Team If both spouses are duly ordained, commissioned, or licensed ministers of a church and have an agreement that each will perform specific services for which they are paid jointly or separately, they must divide the self-employment income according to the agreement. Irs efile If the agreement is with one spouse only and the other spouse is not paid for any specific duties, amounts received for their services are included only in the self-employment income of the spouse having the agreement. Irs efile Earnings Subject to SE Tax For 2013, the maximum net earnings from self-employment subject to social security (old age, survivors, and disability insurance) tax is $113,700 minus any wages and tips you earned that were subject to social security tax. Irs efile The tax rate for the social security part is 12. Irs efile 4%. Irs efile In addition, all of your net earnings are subject to the Medicare (hospital insurance) part of the SE tax. Irs efile This tax rate is 2. Irs efile 9%. Irs efile The combined self-employment tax rate is 15. Irs efile 3%. Irs efile Additional Medicare Tax. Irs efile   Beginning in 2013, a 0. Irs efile 9% Additional Medicare Tax applies to Medicare wages, railroad retirement (RRTA) compensation, and self-employment income that are more than: $125,000 if married filing separately, $250,000 if married filing jointly, or $200,000 for any other filing status. Irs efile Medicare wages and self-employment income are combined to determine if income exceeds the threshold. Irs efile A self-employment loss is not considered for purposes of this tax. Irs efile RRTA compensation is separately compared to the threshold. Irs efile For more information, see Form 8959, Additional Medicare Tax, and its separate instructions. Irs efile Nonfarm Optional Method You may be able to use the nonfarm optional method for figuring your net earnings from self-employment. Irs efile In general, the nonfarm optional method is intended to permit continued coverage for social security and Medicare purposes when your income for the tax year is low. Irs efile You may use the nonfarm optional method if you meet all the following tests. Irs efile You are self-employed on a regular basis. Irs efile You meet this test if your actual net earnings from self-employment were $400 or more in at least 2 of the 3 tax years before the one for which you use this method. Irs efile The net earnings can be from either farm or nonfarm earnings or both. Irs efile You have used this method less than 5 prior years. Irs efile (There is a 5-year lifetime limit. Irs efile ) The years do not have to be consecutive. Irs efile Your net nonfarm profits were: Less than $5,024, and Less than 72. Irs efile 189% of your gross nonfarm income. Irs efile If you meet all three tests, use Table 3 to figure your net earnings from self-employment under the nonfarm optional method. Irs efile Table 3. Irs efile Figuring Nonfarm Net Earnings IF your gross nonfarm income is . Irs efile . Irs efile . Irs efile THEN your net earnings are equal to . Irs efile . Irs efile . Irs efile $6,960 or less Two-thirds of your gross nonfarm income. Irs efile More than $6,960 $4,640. Irs efile Actual net earnings. Irs efile   Multiply your total earnings subject to SE tax by 92. Irs efile 35% (. Irs efile 9235) to get actual net earnings. Irs efile Actual net earnings are equivalent to net earnings under the “Regular Method. Irs efile ” More information. Irs efile   For more information on the nonfarm optional method, see Publication 334, Tax Guide for Small Business, and the Schedule SE (Form 1040) instructions. Irs efile Income Tax: Income and Expenses Some income and expense items are treated the same for both income tax and SE tax purposes and some are treated differently. Irs efile Note. Irs efile For purposes of this section, references to members of the clergy are only to ministers or members of a religious order. Irs efile Income Items The tax treatment of offerings and fees, outside earnings, rental allowances, rental value of a parsonage, earnings of members of religious orders, and foreign earned income is discussed here. Irs efile Offerings and Fees If you are a member of the clergy, you must include in your income offerings and fees you receive for marriages, baptisms, funerals, masses, etc. Irs efile , in addition to your salary. Irs efile If the offering is made to the religious institution, it is not taxable to you. Irs efile Outside Earnings If you are a member of a religious organization and you give your outside earnings to the organization, you still must include the earnings in your income. Irs efile However, you may be entitled to a charitable contribution deduction for the amount paid to the organization. Irs efile For more information, see Publication 526. Irs efile Exclusion of Rental Allowance and Fair Rental Value of a Parsonage Ordained, commissioned, or licensed ministers of the gospel may be able to exclude from income tax the rental allowance or fair rental value of a parsonage that is provided to them as pay for their services. Irs efile Services include: Ministerial services, discussed earlier, Administrative duties and teaching at theological seminaries, and The ordinary duties of a minister performed as an employee of the United States (other than as a chaplain in the Armed Forces), a state, possession, political subdivision, or the District of Columbia. Irs efile This exclusion applies only for income tax purposes. Irs efile It does not apply for SE tax purposes, as discussed earlier under Amounts included in gross income under Self-Employment Tax: Figuring Net Earnings. Irs efile Designation requirement. Irs efile   The church or organization that employs you must officially designate the payment as a housing allowance before it makes the payment. Irs efile It must designate a definite amount. Irs efile It cannot determine the amount of the housing allowance at a later date. Irs efile If the church or organization does not officially designate a definite amount as a housing allowance, you must include your total salary in your income. Irs efile   If you are employed and paid by a local congregation, a resolution by a national church agency of your denomination does not effectively designate a housing allowance for you. Irs efile The local congregation must officially designate the part of your salary that is a housing allowance. Irs efile However, a resolution of a national church agency can designate your housing allowance if you are directly employed by the national agency. Irs efile Rental allowances. Irs efile   If you receive in your salary an amount officially designated as a rental allowance (including an amount to pay utility costs), you can exclude the allowance from your gross income if: You use the amount to provide or rent a home, and The amount is not more than reasonable pay for your services. Irs efile   The amount you exclude cannot be more than the fair rental value of the home, including furnishings, plus the cost of utilities. Irs efile Fair rental value of parsonage. Irs efile   You can exclude from gross income the fair rental value of a house or parsonage, including utilities, furnished to you as part of your earnings. Irs efile However, the exclusion cannot be more than the reasonable pay for your services. Irs efile If you pay for the utilities, you can exclude any allowance designated for utility costs, up to your actual cost. Irs efile Example. Irs efile Rev. Irs efile Joanna Baker is a full-time minister. Irs efile The church allows her to use a parsonage that has an annual fair rental value of $24,000. Irs efile The church pays her an annual salary of $67,000, of which $7,500 is designated for utility costs. Irs efile Her actual utility costs during the year were $7,000. Irs efile For income tax purposes, Rev. Irs efile Baker excludes $31,000 from gross income ($24,000 fair rental value of the parsonage plus $7,000 from the allowance for utility costs). Irs efile She will report $60,000 ($59,500 salary plus $500 of unused utility allowance). Irs efile Her income for SE tax purposes, however, is $91,000 ($67,000 salary + $24,000 fair rental value of the parsonage). Irs efile Home ownership. Irs efile   If you own your home and you receive as part of your salary a housing or rental allowance, you may exclude from gross income the smallest of: The amount actually used to provide a home, The amount officially designated as a rental allowance, or The fair rental value of the home, including furnishings, utilities, garage, etc. Irs efile Excess rental allowance. Irs efile   You must include in gross income the amount of any rental allowance that is more than the smallest of: Your reasonable salary, The fair rental value of the home plus utilities, or The amount actually used to provide a home. Irs efile   Include in the total on Form 1040, line 7. Irs efile On the dotted line next to line 7, enter “Excess allowance” and the amount. Irs efile You may deduct the home mortgage interest and real estate taxes paid on your home even though you pay all or part of those expenses with funds you get through a tax-free rental or parsonage allowance. Irs efile However, you can only deduct these expenses as itemized deductions on Schedule A (Form 1040). Irs efile Retired ministers. Irs efile   If you are a retired minister, you can exclude from your gross income the rental value of a home (plus utilities) furnished to you by your church as a part of your pay for past services, or the part of your pension that was designated as a rental allowance. Irs efile However, a minister's surviving spouse cannot exclude the rental value unless the rental value is for ministerial services he or she performs or performed. Irs efile Teachers or administrators. Irs efile   If you are a minister employed as a teacher or administrator by a church school, college, or university, you are performing ministerial services for purposes of the housing exclusion. Irs efile However, if you perform services as a teacher or administrator on the faculty of a nonchurch college, you cannot exclude from your income a housing allowance or the value of a home that the college provides to you. Irs efile    If you live in faculty lodging as an employee of an educational institution or academic health center, all or part of the value of that lodging may be nontaxable under a different rule. Irs efile In Publication 525, see Faculty lodging in the discussion on meals and lodging under Fringe Benefits. Irs efile   If you serve as a minister of music or minister of education, or serve in an administrative or other function of your religious organization, but are not authorized to perform substantially all of the religious duties of an ordained minister in your church (even if you are commissioned as a minister of the gospel), the housing exclusion does not apply to you. Irs efile Theological students. Irs efile   If you are a theological student serving a required internship as a part-time or assistant pastor, you cannot exclude a parsonage or rental allowance from your income unless you are ordained, commissioned, or licensed as a minister. Irs efile Traveling evangelists. Irs efile   You can exclude a designated rental allowance from out-of-town churches if you meet all of the following requirements. Irs efile You are an ordained minister. Irs efile You perform ministerial services at churches located away from your community. Irs efile You actually use the rental allowance to maintain your permanent home. Irs efile Cantors. Irs efile   If you have a bona fide commission and your congregation employs you on a full-time basis to perform substantially all the religious functions of the Jewish faith, you can exclude a rental allowance from your gross income. Irs efile Earnings—Members of Religious Orders Your earnings may be exempt from both income tax and SE tax if you are a member of a religious order who: Has taken a vow of poverty, Receives earnings for services performed as an agent of the order and in the exercise of duties required by the order, and Renounces the earnings and gives them to the order. Irs efile See Members of Religious Orders , earlier, under Social Security Coverage. Irs efile Foreign Earned Income Certain income may be exempt from income tax if you work in a foreign country or in a specified U. Irs efile S. Irs efile possession. Irs efile Publication 54 discusses the foreign earned income exclusion. Irs efile Publication 570, Tax Guide for Individuals With Income From U. Irs efile S. Irs efile Possessions, covers the rules for taxpayers with income from U. Irs efile S. Irs efile possessions. Irs efile You can get these free publications from the Internal Revenue Service at IRS. Irs efile gov or from most U. Irs efile S. Irs efile Embassies or consulates. Irs efile Expense Items The tax treatment of ministerial trade or business expenses, expenses allocable to tax-free income, and health insurance costs is discussed here. Irs efile Ministerial Trade or Business Expenses as an Employee When you figure your income tax, you must itemize your deductions on Schedule A (Form 1040) to claim allowable deductions for ministerial trade or business expenses incurred while working as an employee. Irs efile You also may have to file Form 2106, Employee Business Expenses (or Form 2106-EZ, Unreimbursed Employee Business Expenses). Irs efile You claim these expenses as miscellaneous itemized deductions that are subject to the 2%-of-adjusted-gross-income (AGI) limit. Irs efile See Publication 529 for more information on this limit. Irs efile However, you cannot deduct any of your employee business expenses that are allocable to tax-free income (discussed next). Irs efile Expenses Allocable to Tax-Free Income If you receive a rental or parsonage allowance that is exempt from income tax (tax free), you must allocate a portion of the expenses of operating your ministry to that tax-free income. Irs efile You cannot deduct the portion of your expenses that you allocate to your tax-free rental or parsonage allowance. Irs efile Exception. Irs efile   This rule does not apply to your deductions for home mortgage interest or real estate taxes on your home. Irs efile Figuring the allocation. Irs efile   Figure the portion of your otherwise deductible expenses that you cannot deduct (because you must allocate that portion to tax-free income) by multiplying the expenses by the following fraction:      Tax-free rental or parsonage allowance     All income (taxable and tax free) earned from your ministry           When figuring the allocation, include the income and expenses related to the ministerial duties you perform both as an employee and as a self-employed person. Irs efile    Reduce your otherwise deductible expenses only in figuring your income tax, not your SE tax. Irs efile Example. Irs efile Rev. Irs efile Charles Ashford received $40,000 in earnings for ministerial services consisting of a $28,000 salary for ministerial services performed as an employee, $2,000 for weddings and baptisms performed as a self-employed person, and a $10,000 tax-free parsonage allowance. Irs efile He incurred $4,000 of unreimbursed expenses connected with his earnings for ministerial services. Irs efile $3,500 of the $4,000 is for employee expenses related to his ministerial salary, and $500 is related to the weddings and baptisms he performed as a self-employed person. Irs efile Rev. Irs efile Ashford figures the nondeductible (tax-free) portion of expenses related to his ministerial salary as follows: ($10,000 ÷ $40,000) x $3,500 = $875   Rev. Irs efile Ashford figures the nondeductible (tax-free) portion of expenses related to his wedding and baptism income as follows: ($10,000 ÷ $40,000) x $500 = $125 Required statement. Irs efile   If you receive a tax-free rental or parsonage allowance and have ministerial expenses, attach a statement to your tax return. Irs efile The statement must contain all of the following information. Irs efile A list of each item of taxable ministerial income by source (such as wages, salary, weddings, baptisms, etc. Irs efile ) plus the amount. Irs efile A list of each item of tax-free ministerial income by source (parsonage allowance) plus the amount. Irs efile A list of each item of otherwise deductible ministerial expenses plus the amount. Irs efile How you figured the nondeductible part of your otherwise deductible expenses. Irs efile A statement that the other deductions claimed on your tax return are not allocable to your tax-free income. Irs efile   See the attachments prepared for the Comprehensive Example , later. Irs efile Following the example, you will find blank worksheets for your own use. Irs efile Health Insurance Costs of Self-Employed Ministers If you are self-employed, you may be able to deduct the amount you paid in 2013 for medical and dental insurance and qualified long-term care insurance for you, your spouse, and your dependents. Irs efile If you qualify, you can take this deduction as an adjustment to income on Form 1040, line 29. Irs efile See the Instructions for Form 1040 to figure your deduction. Irs efile The following special rules apply to the self-employed health insurance deduction. Irs efile You cannot take a medical expense deduction on Schedule A (Form 1040) for any expenses you claim for purposes of the self-employed health insurance deduction. Irs efile You cannot take the deduction for any month you are eligible to participate in a subsidized plan of your (or your spouse's) employer. Irs efile The deduction cannot exceed your net earnings from the business under which the insurance plan is established. Irs efile Your net earnings under this rule do not include the income you earned as a common-law employee (discussed earlier) of a church. Irs efile More information. Irs efile   For more information about the self-employed health insurance deduction, see chapter 6 in Publication 535. Irs efile Deduction for SE Tax You can deduct one-half of your SE tax in figuring adjusted gross income. Irs efile This is an income tax deduction only, on Form 1040, line 27. Irs efile Do not claim this deduction in figuring net earnings from self-employment subject to SE tax. Irs efile Income Tax Withholding and Estimated Tax The federal income tax is a pay-as-you-go tax. Irs efile You must pay the tax as you earn or receive income during the year. Irs efile An employee usually has income tax withheld from his or her wages or salary. Irs efile However, your salary is not subject to federal income tax withholding if both of the following conditions apply. Irs efile You are a duly ordained, commissioned, or licensed minister, a member of a religious order (who has not taken a vow of poverty), or a Christian Science practitioner or reader. Irs efile Your salary is for ministerial services (see Ministerial Services , earlier). Irs efile If your salary is not subject to withholding, or if you do not pay enough tax through withholding, you may need to make estimated tax payments to avoid penalties for not paying enough tax as you earn your income. Irs efile You generally must make estimated tax payments if you expect to owe taxes, including SE tax, of $1,000 or more, when you file your return. Irs efile Determine your estimated tax by using the worksheets in Publication 505, Tax Withholding and Estimated Tax. Irs efile Pay the entire estimated tax for 2014 or the first installment by April 15, 2014. Irs efile See Form 1040-ES for the different payment methods. Irs efile The April 15 date applies whether or not your tax home and your abode are outside the United States and Puerto Rico. Irs efile For more information, see chapter 2 of Publication 505. Irs efile If you perform your services as a common-law employee of the church and your salary is not subject to income tax withholding, you can enter into a voluntary withholding agreement with the church to cover any income and SE tax that may be due. Irs efile Filing Your Return You must file an income tax return for 2013 if your gross income was at least the amount shown in the third column of Table 4 above. Irs efile Table 4. Irs efile 2013 Filing Requirements for Most Taxpayers IF your filing status is . Irs efile . Irs efile . Irs efile AND at the end of 2013 you were* . Irs efile . Irs efile . Irs efile THEN file a return if your gross income** was at least . Irs efile . Irs efile . Irs efile single under age 65 65 or older   $10,000 $11,500   married filing jointly*** under 65 (both spouses) 65 or older (one spouse) 65 or older (both spouses)   $20,000  $21,200  $22,400   married filing separately any age   $3,900   head of household under 65 65 or older   $12,850 $14,350   qualifying widow(er) with dependent child under 65 65 or older   $16,100  $17,300   * If you were born on January 1, 1949, you are considered to be age 65 at the end of 2013. Irs efile ** Gross income means all income you received in the form of money, goods, property, and services that is not exempt from tax, including any income from sources outside the United States or from the sale of your main home (even if you can exclude part or all of it). Irs efile Do not include any social security benefits unless (a) you are married filing a separate return and you lived with your spouse at any time in 2013, or (b) one-half of your social security benefits plus your other gross income and any tax-exempt interest is more than $25,000 ($32,000 if married filing jointly). Irs efile If (a) or (b) applies, see the instructions for Form 1040, lines 20a and 20b, to figure the taxable part of social security benefits you must include in gross income. Irs efile Gross income includes gains, but not losses, reported on Form 8949 or Schedule D (Form 1040). Irs efile Gross income from a business means, for example, the amount on Schedule C (Form 1040), line 7, or Schedule F (Form 1040), line 9. Irs efile But, in figuring gross income, do not reduce your income by any losses, including any loss on Schedule C (Form 1040), line 7, or Schedule F (Form 1040), line 9. Irs efile *** If you did not live with your spouse at the end of 2013 (or on the date your spouse died) and your gross income was at least $3,900, you must file a return regardless of your age. Irs efile Additional requirements. Irs efile   Even if your income was less than the amount shown in Table 4, you must file an income tax return on Form 1040, and attach a completed Schedule SE (Form 1040), if:    You are not exempt from SE tax, and you have net earnings from self-employment (discussed earlier under Self-Employment Tax: Figuring Net Earnings ) of $400 or more in the tax year, You are exempt from SE tax on earnings from ministerial services and you have $400 or more of other net earnings subject to SE tax, or You had wages of $108. Irs efile 28 or more from an electing church or church-controlled organization (see Coverage of Religious Workers (Church Employees) , earlier, under Social Security Coverage). Irs efile Self-employment tax. Irs efile   If you are liable for SE tax, you must file Schedule SE (Form 1040) with your return. Irs efile   If you filed Form 4361 and did not receive approval from the IRS, you must pay SE tax on your ministerial earnings, as explained earlier. Irs efile You should report ministerial earnings and expenses from nonemployee ministerial services on Schedule C or C-EZ (Form 1040). Irs efile You should then carry the net amount over to line 2 of Schedule SE (Form 1040), Section A or B. Irs efile However, if you were a duly ordained minister who was an employee of a church and you must pay SE tax on the wages you earned for those services, do not report those wages on Schedule C or C-EZ (Form 1040). Irs efile Instead, report those wages less any allowable expenses (including any unreimbursed employee business expenses), on line 2 of Schedule SE (Form 1040), Section A or B, and attach an explanation. Irs efile Note. Irs efile For income tax purposes, the unreimbursed employee business expenses that you incurred as an employee of the church and subtracted from your wages on line 2 of Schedule SE (Form 1040) are allowed only as an itemized deduction on Schedule A (Form 1040) if they exceed 2% of your adjusted gross income. Irs efile You cannot deduct these expenses on Schedule C or C-EZ (Form 1040) as a trade or business expense. Irs efile Exemption from SE tax. Irs efile   If you filed Form 4361 and received IRS approval not to be taxed on your ministerial earnings, and you do not have any other income subject to SE tax, do not file Schedule SE (Form 1040). Irs efile Instead, enter “Exempt—Form 4361” on the dotted line next to Form 1040, line 56. Irs efile However, if you had net earnings from another trade or business of $400 or more subject to SE tax, see line A at the top of Schedule SE (Form 1040), Section B. Irs efile    If you filed Form 4029 and received IRS approval not to be taxed on those earnings, and you do not have any other income subject to SE tax, do not file Schedule SE (Form 1040). Irs efile Instead, enter “Exempt—Form 4029” on the dotted line next to Form 1040, line 56. Irs efile More information. Irs efile   For more information on filing your return, including when and where to file it, see the Instructions for Form 1040. Irs efile Retirement Savings Arrangements Retirement savings arrangements are plans that offer you a tax-favored way to save for your retirement. Irs efile You generally can deduct your contributions to the plan. Irs efile Your contributions and the earnings on them are not taxed until they are distributed. Irs efile Retirement plans for the self-employed. Irs efile   To set up one of the following plans you must be self-employed. Irs efile SEP (simplified employee pension) plan. Irs efile SIMPLE (savings incentive match plan for employees) plan. Irs efile Qualified retirement plan (also called a Keogh or H. Irs efile R. Irs efile 10 plan). Irs efile   The common-law rules determine whether you are an employee or a self-employed person for purposes of setting up a retirement plan. Irs efile See Employment status for other tax purposes under Coverage of Members of the Clergy, earlier. Irs efile This result is true even if your compensation for ministerial services (defined earlier) is subject to SE tax. Irs efile   For example, if a congregation pays you a salary for performing ministerial services and you are subject to the congregation's control, you generally are a common-law employee. Irs efile You are not a self-employed person for purposes of setting up a retirement plan. Irs efile This result is true even if your salary is subject to SE tax. Irs efile   On the other hand, amounts received directly from members of the congregation, such as fees for performing marriages, baptisms, or other personal services that you report on Schedule C or C-EZ (Form 1040), are earnings from self-employment for all tax purposes. Irs efile   For more information on establishing a SEP, SIMPLE, or qualified retirement plan, see Publication 560, Retirement Plans for Small Business (SEP, SIMPLE, and Qualified Plans). Irs efile Individual retirement arrangements (IRAs). Irs efile   The traditional IRA and the Roth IRA are two individual retirement arrangements you can use to save money for your retirement. Irs efile Generally, your maximum contribution for 2013 to either of these plans (or to a combination of the two) is the smaller of your taxable compensation or $5,500 ($6,500 if you are age 50 or older). Irs efile   However, your maximum contribution to a Roth IRA will be further reduced or eliminated if your adjusted gross income is above a certain amount. Irs efile You cannot deduct Roth IRA contributions, but if you satisfy certain requirements, all earnings in the Roth IRA are tax free and neither your nondeductible contributions nor any earnings on them are taxable when distributed. Irs efile   If you contribute to a traditional IRA, your contribution may be deductible. Irs efile However, your deduction may be reduced or eliminated if you or your spouse is covered by an employer retirement plan (including, but not limited to, a SEP, SIMPLE, or qualified retirement plan). Irs efile   For more information on IRAs, see Publication 590. Irs efile Tax-sheltered annuity plans. Irs efile   Church employees, members of religious orders, and duly ordained, commissioned, or licensed ministers working as ministers or chaplains can participate in tax-sheltered annuity (403(b)) plans. Irs efile For more