What Is the IRS “Safe Harbor” Rule and How Does It Apply to the Clergy?

By Alex Kim, CFP^®, MBA, CPA

Are you a clergy taxpayer who is concerned about being hit with a tax penalty come tax day in April? The IRS “safe harbor” rule may be the solution. Let’s explore this regulation and see how it can potentially help you.

What is the IRS “safe harbor” rule?

Simply put, the IRS’s “safe harbor” rule allows taxpayers to avoid underpayment penalties by paying a minimum baseline tax amount throughout the year. The IRS will waive the underpayment penalty if the taxpayer can meet any one of the following requirements:

You owe less than $1,000.
You paid at least 90% of the taxes owed for the current year.
You paid at least 100% of the taxes owed for the previous tax year.

How the IRS 'Safe Harbor' rule is relevant to the clergy

The “safe harbor” rule is relevant to U.S. taxpayers, including clergy, because our tax system is what is known as a “pay-as-you-go” system. This means that taxpayers need to pay their tax obligation (both income tax and payroll tax) throughout the year as they earn their income and tax liability is incurred, rather than waiting until the year ends.

This is why employers withhold taxes from their employees’ paychecks and remit them to the tax authorities – to ensure their employees pay taxes throughout the year as the liability is incurred. It’s also the reason why self-employed taxpayers need to pay quarterly estimated taxes. And remember, income can arise not only from employment earnings, but also from interest, dividends, and capital gains (including from the sale of real property), as well as certain cancellation of debt.

As for clergy taxpayers, outside of certain exceptions (such as “voluntary withholding agreements”), they are not subject to mandatory tax withholding by their employers. As a result, like self-employed workers, clergy need to make quarterly estimated tax payments.

Let’s explore the details of the IRS 'Safe Harbor' rule

Taxpayers can qualify for the “safe harbor” exception and avoid the penalty by meeting any of these conditions:

You owed less than $1,000 in taxes after withholdings and credits. So, if the total tax you owe for the year, after subtracting your withholdings and credits, is less than $1,000, you will not be subject to any penalty.
You paid at least 90% of the taxes owed for the current year. However, this rule may be difficult to meet if there’s uncertainty about your income, because this option requires you to project your income and deductions for the full year. So, if you experience fluctuating income, this may not be the easiest requirement to meet.
You paid at least 100% of the taxes owed for the previous tax year. Note, this threshold is raised higher for high-income taxpayers. Specifically, if your previous year’s Adjusted Gross Income (AGI) was over $150,000, the threshold rises to 110% of the previous year’s tax liability. But given the full certainty about past income and taxes, this requirement may be the easier one to meet.

Note, these conditions can be met through any combination of estimated quarterly tax payments and withholdings. And “withholdings” include not just those from wages, but also from retirement plan distributions, pension, or annuities. Also, if you are married filing jointly, your income, withholdings, estimated tax payments, and tax obligations would be the combined amount for both you and your spouse. For example, taxes incurred from your income can be covered by your spouse’s withholding. Furthermore, the IRS treats withholding as if it occurred evenly throughout the year – regardless of actual timing – making it a very flexible way to cover your tax liability.

Keep in mind, however, that the “safe harbor” exception only waives the underpayment penalty – not the tax obligation itself.

What’s the key takeaway of the IRS 'Safe Harbor' rule?

The “safe harbor” rule can provide relief to those at risk of underpaying taxes and facing penalties. Remember, you only need to meet any one of the requirements to avoid the penalty. Keep in mind, however, that this rule applies only at the federal tax level – not state and local, which may have their own distinct rules. For further guidance, consult a tax advisor.