- Ministers who own or rent their homes can exclude from their federal income taxes the portion of their ministerial income designated by their employer as a "housing" allowance to the extent that the allowance is in fact used to pay for housing-related expenses such as:
- mortgage payments,
- utilities,
- property taxes
- insurance,
- furnishings,
- and repairs)
- and does not exceed the annual "fair rental value" of their home.
Lesson
- While a small percentage of ministers live in a manse or a church-owned parsonage, most live in a home that they own or rent.
Ministers who own or rent their home do not pay income taxes on the portion of their compensation that is designated in advance by their employing church as a housing allowance—to the extent that the allowance is used to pay for housing-related expenses and, in the case of minsiters who own their home, does not exceed the annual fair rental value of the home (furnished, plus utilities).
There are a number of points that ministers should know about housing allowances.
(1) minister
- A housing allowance is a tax-free fringe benefit (in computing income taxes) only if it is provided to a "minister of the gospel" as compensation for services performed in the exercise of ministry.
Some churches designate housing allowances for nonminister church employees.
This accomplishes nothing since the full amount of the allowance must be reported as taxable income to the employee.
(2) an exclusion
- A housing allowance is an exclusion from gross income, rather than a deduction.
As a result, it is not reported anywhere on Form 1040. In effect, the exclusion is "claimed" by not reporting the allowance as income.
(3) designating a housing allowance
- Whether a minister owns or rents a home, it is essential that his or her employing church designate a housing allowance.
Housing allowances should be:
- (1) adopted by the church board or congregation,
- (2) recorded in written form (such as minutes),
- and (3) designated in advance of the calendar year.
However, churches that fail to designate an allowance in advance of a calendar year should do so as soon as possible in the new year.
The allowance will operate prospectively.
- The income tax regulations specify that the designation of the allowance may be contained in "an employment contract, in minutes of or in a resolution by a church or other qualified organization or in its budget, or in any other appropriate instrument evidencing such official action."
- Under no circumstances can a minister exclude any portion of an allowance retroactively designated by a church.
(4) amending a housing allowance
- While neither the IRS nor the courts have addressed this question, it seems perfectly reasonable to conclude that a church can amend a housing allowance designation during the course of the year if changed circumstances render the allowance inadequate.
Of course, any change would only operate prospectively.
(5) how much should a church designate as a housing allowance?
- There is no "limit" on the amount of a minister’s compensation that can be designated by a church as a housing allowance (assuming that the minister’s compensation is reasonable in amount).
However, a church ordinarily should not designate a housing allowance for a minister who has a home significantly above the minister’s housing expenses, or the annual fair rental value of the home, since the minister can exclude the housing allowance only to the extent that it does not exceed either of these limits.
(6) "safety net" allowances
- It is wise not to limit a housing allowance to a particular calendar year.
For example, if a church intends to designate $10,000 of a pastor's salary as a housing allowance for the next year, its designation should recite that it is effective for the next year and all future years unless otherwise provided.
This clause will protect the pastor in the event that the church neglects to designate an allowance prior to the beginning of a future year.
It is also wise for a church to have a safety net designation to cover mid?year changes in personnel, delayed designations, and other unexpected contingencies. Such a designation could simply recite that "40 percent [or some other amount] of the salary of every minister on staff, regardless of when hired, is hereby designated as a housing allowance for the current year and all future years, unless otherwise specifically provided."
Such "safety net" designations should not be used as a substitute for annual housing allowance designations for each minister.
They are simply a means of protecting ministers against inadvertent failures by the church board to designate a timely housing allowance.
(7) "double deduction"
- Ministers who own their homes and who itemize their deductions are eligible to deduct mortgage interest and property taxes on Schedule A (Form 1040) even though these items were excluded as part of the housing allowance. This is the so?called "double deduction."
(8) Social Security
- The housing allowance is an exclusion for federal income tax purposes only.
It cannot under any circumstances be excluded in computing a minister’s Social Security self-employment) tax liability.
Therefore, in computing the self-employment taxes on Schedule SE (Form 1040) a minister must include the actual housing allowance exclusion as income.
This information is designed to provide accurate and authoritative information in regard to the subject matter covered. It is offered with the understanding that the information is not given to engage in rendering legal, accounting, or other professional service. If legal advice or other expert assistance is required, the services of a competent professional person should be sought.
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