Q. Are churches subject to FICA taxes on their employees' wages? Do the church's employees have to pay those taxes?

A. Churches can elect -- if they have religious reasons -- to be exempt from paying FICA taxes on the wages of their employees.

Social Security tax and Medicare's Hospital Insurance tax are FICA taxes. FICA stands for Federal Insurance Contributions Act, the law that requires employees and employers to pay Social Security and Medicare taxes. Generally, employees and employers each pay 7.65 percent of wages: 6.2 percent to Social Security and 1.45 percent to Medicare. That's a total FICA tax of 15.3 percent of wages.

To get an exemption from the employer's share of FICA taxes, a church must file the required paperwork when it hires its first employee and starts paying wages. The exemption application is due before the first mandatory quarterly employment tax return.

IRS Form 8274, Certification by Churches and Qualified Church-Controlled Organizations Electing Exemption From Employer Social Security and Medicare Taxes, is pretty simple by government standards. The form and its instructions fit on one page. On the form, the church identifies itself, and certifies that it has religious objections to paying Social Security and Medicare taxes.

Since ministers are considered self-employed for Social Security purposes, the 8274 does not cover them. Instead, a whole different set of rules applies to ministers.

The exemption applies only to the church's payment of Social Security and Medicare taxes. The church must still continue to withhold federal income taxes from employees' wages. The church must still submit quarterly employment tax returns (IRS Form 941) to the IRS and issue W-2s to employees. That's important: the IRS permanently revokes the exemptions of churches that fail to follow the rules.

The exemption does not apply to employees who are engaged in "unrelated business activity". In other words, if a church operates a business, it must pay FICA taxes for employees working in that business. That also means that a machine shop, for example, can't declare itself a church to qualify for the exemption.

Here's a big drawback to the exemption: If a church exempts itself from Social Security and Medicare taxes, that church's employees must pay both the employee and employer shares of the taxes. That's a total of 15.3 percent of their wages. Yikes!

In effect, the law treats those church employees much like self-employed people who are subject to a 15.3 percent self-employment tax. There are two main differences: An affected church employee pays Social Security and Medicare taxes if his or her gross wages are $100 or more in a year. But a self-employed person pays Social Security and Medicare taxes if his or her net profit is $400 or more in a year. Also, church employees--unlike the self-employed--are not permitted to deduct business expenses before calculating Social Security and Medicare taxes.

The IRS has jurisdiction over the collection of FICA taxes. Call them for additional information about these laws.