T.C. Summary Opinion 2005-76
UNITED STATES TAX COURT
JOHNNY J. AND BRENDA D. YOUNG, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 18021-02S. Filed June 7, 2005.
Johnny J. and Brenda D. Young, pro sese.
David R. Jojola, for respondent.
DEAN, Special Trial Judge: This case was heard pursuant to
the provisions of section 7463. Unless otherwise indicated, all
section references are to the Internal Revenue Code in effect for
the year in issue, and all Rule references are to the Tax Court
Rules of Practice and Procedure. The decision to be entered is
not reviewable by any other court, and this opinion should not be
cited as authority.
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Respondent determined a deficiency of $13,363 in
petitioners’ Federal income tax for 2000 and an accuracy-related
penalty under section 6662 of $2,672.60. Petitioners concede
that Johnny J. Young (petitioner) received wages of $36,000, and
self-employment income of $21,438. Respondent concedes that
petitioners have substantiated that the following $24,982 of
expenses were paid in the exercise of petitioner’s ministry: (a)
Automobile expenses of $7,000, (b) books of $3,000,
(c) advertising of $377, (d) office expenses of $5,000, and (e)
trips of $9,605. Respondent concedes that petitioners are
entitled to deductions for mortgage interest of $50,825 and
charitable contributions of $22,587. Respondent also concedes
that petitioners are not liable for the accuracy-related penalty
under section 6662. The issues remaining for decision are
whether petitioners: (a) Must allocate expenses incurred in the
exercise of petitioner’s ministry between exempt and nonexempt
income, and (b) have additional income subject to self-employment
tax.
Background
Some of the facts have been stipulated and are so found.
The stipulation of facts and the exhibits received in evidence
are incorporated herein by reference. At the time the petition
was filed, petitioners resided in Los Angeles, California.
Petitioner was ordained as a minister by the Church of God
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Pentecostal, Inc. (Church) on August 14, 1981. Petitioner filed
returns reporting net earnings from self-employment from his
ministry in the years 1992 through 1999 averaging more than
$2,400 a year.
As senior pastor of the Church in Inglewood, California,
petitioner was paid a salary of $78,000 of which the Church
designated $42,000 as a parsonage allowance and $36,000 as wages.
In addition to the salary received from the Church, petitioner
received self-employment income of $21,438 in the exercise of his
ministry. During the audit of petitioners’ return for 2000,
petitioner applied for and was denied an exemption from self-
employment tax.
Discussion
Because there are no factual matters in dispute in this
case, section 7491 is inapplicable.
Allocation of Expenses
Section 107 provides that for a minister of the Gospel, the
rental value or rental allowance used to provide a home is
excluded from gross income when it is part of compensation.
Petitioner received such a parsonage allowance for the taxable
year at issue, and respondent agrees that the parsonage allowance
is properly excludable under section 107.
Respondent argues, however, that some of the expenses
claimed as ministry expenses are allocable to petitioner’s tax-
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exempt parsonage allowance and are therefore nondeductible.
Petitioners’ position is that the Court should not deny deduction
of petitioner’s business-related ministry expenses simply because
he received a tax-exempt parsonage allowance.
Section 265 provides:
SEC. 265(a). General Rule.--No deduction shall be
allowed for--
(1) Expenses.--Any amount otherwise allowable as a
deduction which is allocable to one or more classes of
income other than interest (whether or not any amount
of income of that class or classes is received or
accrued) wholly exempt from the taxes imposed by this
subtitle, or any amount otherwise allowable under
section 212 (relating to expenses for production of
income) which is allocable to interest (whether or not
any amount of such interest is received or accrued)
wholly exempt from the taxes imposed by this subtitle.
Tax-exempt income is defined as “any class of income * * * wholly
exempt from the taxes imposed by subtitle A of the Code.” Sec.
1.265-1(b), Income Tax Regs. The result is that expenses
allocable to tax-exempt income are nondeductible. McFarland v.
Commissioner, T.C. Memo. 1992-440. Section 265 applies to
petitioner’s parsonage allowance. Deason v. Commissioner, 41
T.C. 465, 468 (1964); Dalan v. Commissioner, T.C. Memo. 1988-106.
Petitioner received both nonexempt income and a tax-exempt
parsonage allowance for his ministry work. The ministry expenses
petitioner attempts to deduct were incurred while petitioner was
earning both nonexempt income and a tax-exempt parsonage
allowance. This is precisely the situation section 265 targets.
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Section 1.265-1(c), Income Tax Regs., provides:
(c) Allocation of expenses to a class or classes
of exempt income. Expenses and amounts otherwise
allowable which are directly allocable to any class or
classes of exempt income shall be allocated thereto;
and expenses and amounts directly allocable to any
class or classes of nonexempt income shall be allocated
thereto. If an expense or amount otherwise allowable
is indirectly allocable to both a class of nonexempt
income and a class of exempt income, a reasonable
proportion thereof determined in the light of all the
facts and circumstances in each case shall be allocated
to each.
The issue of whether petitioner’s ministry expenses are
deductible against his tax-exempt parsonage income has been
examined by this Court before. In McFarland v. Commissioner,
supra, we held that ministry expenses incurred by the taxpayer
were indirectly allocable to a class of nonexempt income and a
class of exempt income when the taxpayer’s only business activity
was his ministry and he received both taxable compensation and
tax-exempt parsonage allowance. Likewise, in Dalan v.
Commissioner, supra, the Court held that section 265(a)(1) barred
the deduction of the taxpayer’s ministry expenses to the extent
the expenses were allocable to his tax-exempt ministry income
even though the taxpayer had nonexempt income from his job as a
guidance counselor. See Deason v. Commissioner, supra (minister
taxpayer denied deduction for automobile business expenses when
virtually all income earned during year was tax-exempt parsonage
allowance under section 107.)
Petitioner’s circumstances are not factually distinguishable
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from the cases cited above. Petitioner earned both nonexempt
income as a minister and tax-exempt parsonage income from the
Church. The parsonage allowance is a class of income wholly
exempt from tax under section 107, and section 265(a)(1)
expressly disallows a deduction to the extent that the expenses
are directly or indirectly allocable to his nontaxable ministry
income. Sec. 1.265-1(b), Income Tax Regs.
Respondent argues that a “double allocation” must be made in
this case. According to respondent, the ministry expenses must
be allocated between Schedule A, Itemized Deductions, for his
ministry employment income, and Schedule C, Profit and Loss From
Business, for his other ministry income as well as between tax
exempt and nonexempt income. The Court agrees with respondent.
Because petitioners have failed to provide evidence that
would allow the Court to determine which of his ministry
activities generated which expenses, the Court will allocate the
expenses on a pro rata basis. See McFarland v. Commissioner,
supra. The Court concludes that petitioner’s Schedule C ministry
activities generated 22 percent ($21,438/$99,438) of his total
ministry income, and therefore allocates 22 percent of his
$24,982 of ministry expenses ($5,496) to Schedule C, and the
balance of $19,486 to Schedule A. Because 54 percent of
petitioner’s ministry salary was his parsonage allowance
($42,000/$78,000), 54 percent of his Schedule A deductions
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($10,522) are rendered nondeductible because of section 265.
Petitioner may deduct, subject to the 2-percent floor of section
67(a), the balance of $8,964 as itemized miscellaneous deductions
on Schedule A.
Self-employment Tax
Petitioners disagree with the inclusion of Church salary
payments as income subject to self-employment tax.
Section 1401(a) imposes on the self-employment income of
every individual a tax for old-age, survivors, and disability
insurance. Beginning with taxable years ending after 1967,
ordained ministers are automatically subject to the self-
employment tax with respect to services performed by them. Sec.
1402(c); see also Peverill v. Commissioner, T.C. Memo. 1986-354.
Provided certain requirements are met, section 1402(e)
exempts from the self-employment tax, the self-employment income
of certain ministers and others. Under section 1402(e)(1), a
minister must file an application for exemption “in such form and
manner, and with such official, as may be prescribed by
regulations”. The application must be filed no later than the
due date of the return (including any extension) for the second
taxable year for which the applicant had net earnings from self-
employment of at least $400, any part of which was from services
as a minister. Sec. 1402(e)(3).
Section 1.1402(e)-2A(b), Income Tax Regs., specifies that
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the application must be made on Form 4361, in triplicate, with
the specified office of the Internal Revenue Service, within the
prescribed time limit.
The time limitations of section 1402(e) are mandatory and
must be complied with strictly. Treadway v. Commissioner, T.C.
Memo. 1984-153; Allinson v. Commissioner, T.C. Memo. 1979-405.
Petitioner filed returns reporting net earnings from self-
employment from his ministry in the years 1992 through 1999
averaging more than $2,400 a year. Petitioners, however, failed
to present to respondent the appropriate Form 4361 until the
examination of the return for 2000. Petitioner failed to obtain
an exemption, and his net earnings from his ministry are
therefore subject to self-employment tax.
The term “net earnings from self-employment” means the gross
income of a taxpayer’s trade or business less the allowable
deductions attributable to the trade or business. Sec. 1402(a).
In computing the gross income and deductions, a minister must
compute his net earnings from self-employment, as a licensed
minister in the exercise of his ministry, without regard to
section 107, which exempts amounts for parsonage. Sec.
1402(a)(8), (c)(4). In other words, the parsonage allowance is
part of a minister’s gross income from his trade or business for
purposes of self-employment tax. Bass v. Commissioner, T.C.
Memo. 1983-536; sec. 1.1402(a)-11, Income Tax Regs.
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In computing his net earnings from self-employment,
petitioner must include all his earnings from his ministry,
including his parsonage allowance, and may claim the deductions
“allowed by chapter 1 of the Code which are attributable to such
trade or business”. Sec. 1.1402(a)-1(a)(1), Income Tax Regs.
Because a portion of petitioner’s deductions, $10,522, is
allocable to his parsonage allowance, and is disallowed as a
deduction by section 265, it may not be deducted in computing
petitioner’s net earnings from self-employment. Id.
Reviewed and adopted as the report of the Small Tax Case
Division.
To reflect the foregoing,
Decision will be entered
under Rule 155.