By taking some simple actions, a well-informed church can help its minister save money. The parsonage exclusion and housing allowance (also called rental allowance) is the largest tax benefit available to ministers. This exemption allows a minister to exclude from Federal taxable income either the value of a home provided by the church or payments specifically allocated as a housing allowance.
The housing allowance is a unique opportunity available only to those people who are considered “ministers of the gospel” for tax purposes. The church is allowed to designate a portion of the minister’s salary as a housing allowance. The amount should be set considering the limits explained below. This designation should be in writing and approved by the governing board of the church. Once this is in place, future amounts paid as a housing allowance can be excluded from Federal income tax with some limitations.
The housing allowance must be spent on renting, purchasing or providing a home. This has been interpreted to include a down payment for a home, mortgage payments (interest and principal), real estate taxes, homeowner’s association dues, condominium fees, property insurance, utilities, local telephone service, furnishings, appliances (including repairs), structural repairs, remodeling, yard maintenance and improvements, pest control, snow removal, maintenance items and trash pickup. Any amount not spent on these qualified expenses must be included in wages.
There is a limit on the excludable portion of the housing allowance. It is limited to the smallest of the amount actually spent to provide a home, the amount officially designated as an allowance, or an amount that is considered reasonable compensation for the minister’s services and the fair rental value of the home including furnishings, garage and utilities. Any portion of the housing allowance that is above the smallest of these amounts must be included in wages.
The IRS has not issued any rules requiring the church to report the amount of the housing allowance paid to the minister. The housing allowance is not included as wages, Box 1, on the W-2. However, the church can choose to notify the minister of the amount by including it in Box 14 on the W-2, labeled as housing allowance, or including it in a letter to the minister.
It is important to note that this exclusion only applies to Federal income taxes. It does not apply to self-employment taxes. Therefore, the housing allowance will be subject to self-employment taxes unless the minister meets the requirements and has opted out of the Social Security system.
The future of the housing allowance exclusion and parsonage exclusion is in question. The exclusions have been in place since 1954, but they have now been challenged as unconstitutional. A Federal lawsuit was filed by the Freedom from Religion Foundation in California in 2009. They argue that any special deductions for ministers violate the separation of church and state. This case may be appealed all the way to the U.S. Supreme Court and it may not be decided for several years. However, it is an issue that churches and ministers need to continue monitoring, considering the significant impact it could have on a minister’s take-home pay if he / she is currently taking advantage of this tax exclusion.
The housing allowance exclusion is currently available for ministers, so the tax planning opportunity should be considered as a way to further your minister’s income. See your tax advisor for more information.
For the purposes of this E-focus, the term “minister” is used for all clergy persons including ministers, pastors, priests, rabbis, clerics, etc. In addition, the term “church” is used for all religious denominations, sects, and organizations. These terms were chosen because they are the terms most frequently used by the IRS.
Under U.S. Treasury Department guidelines, we hereby inform you that any tax advice contained in this communication is not intended or written to be used, and cannot be used by you for the purpose of avoiding penalties that may be imposed on you by the Internal Revenue Service, or for the purpose of promoting, marketing or recommending to another party any transaction or matter addressed within this tax advice. Further, RubinBrown LLP imposes no limitation on any recipient of this tax advice on the disclosure of the tax treatment or tax strategies or tax structuring described herein.
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