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 selfemployment 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 selfemployment 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 selfemployment 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 selfemployment 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.