We recently asked church leaders about the following situation:
Ministers of the gospel can have their church board or council designate a portion of their compensation as housing allowance, making it exempt from federal income taxes.
We think that ministers of the gospel are special people. Apparently the United States government does as well because the Internal Revenue Service, or IRS, has special tax rules for ministers of the gospel that can reduce the amount of federal taxes that they are required to pay. But those special tax rules come with conditions:
In 1968 the Tax Court ruled that a minister of education in a Baptist church was not a
duly ordained, commissioned, or licensed minister. The
minister of education at the center of the ruling held a Masters Degree in Religious Education from a Baptist Theological Seminary, but he was not ordained. In addition it was revealed that as a minister of education he did not officiate at Baptisms or the Lords Supper, nor did he preside over or preach at worship services. While his church had commissioned him after he assumed the position, the court concluded that his duties as a minister of education were not equivalent to the duties of a Baptist minister. Because there had been no change in his duties after his commissioning, the court interpreted that the commissioning was done for tax purposes.
the portion of a ministers income needed for housing is considered exempt from federal income tax.
In 1989 the Tax Court fine tuned how it viewed the conditions that we listed above. It said that the only condition that was required was that someone be ordained, commissioned or licensed by a church. It went on to say that a balancing test should be applied to the remaining four conditions.
While the Tax Courts ruling in 1989 appears to be not as black and white as the one 21 years earlier, its still important for ministers to understand what conditions that they need to meet before they can take advantage of the special tax rules that have been set up for them. A minister who assumes that they meet the conditions and ends up having a tax return audited by the IRS could learn an expensive lesson if its determined that they dont meet the necessary qualifications after all.
Fortunately someone who genuinely qualifies to be considered a minister of the gospel for tax purposes can legally take advantage of several special tax rules that only apply to them. One such rule allows them to have a portion of their income that they receive from the church designated as a housing allowance. The result is that the portion of a ministers income needed for housing is considered exempt from federal income tax.
While there is also a similar tax benefit for ministers who live in a church provided parsonage, were going to limit our discussion to ministers who rent or own their own home.
Before we share what can be included in calculating someones housing allowance, lets take a moment and discuss ceilings. Not ceilings like you would find in your home, but the ceiling the IRS puts on how much of a ministers income eventually qualifies as housing allowance.
The IRS allows the least of the following three choices:
We realize that the first two are easier said than done. For example, should a minister get a formal rental value on his home from a local real estate appraiser? What about an informal realtors opinion? What about the one percent rule where one calculates one percent of a homes fair market value to arrive at a months rent? Then there is the question of what it would cost to rent the furnishings in a home.
Since we are not tax advisors, we cant really recommend what approach you should take in calculating the fair market rent of your home and furnishings. Hopefully weve made it clearer how complicated taxes can get and why a minister should have a trusted tax advisor. Because tax law changes and can get complicated, a minister should be sure that a preparer holds a valid preparer tax identification number issued by the IRS.
Even once the fair market rent issue is resolved some amount of record keeping and calculation are involved. In both cases, utility costs need to be totaled. This means keeping tabs on all the electric, natural gas, fuel oil or other bills from energy providers. As part of utility costs, land line telephone bills, cable or satellite television bills and bills for broadband Internet service can be included. Sorry, but cell phone fees do not count. Costs for water and sewer service, and trash pickup, however, do count.
In calculating actual housing expenses, a minister can also include the following costs:
Pretty much anything and everything it takes to make a house a home can be included in calculations of housing costs. Plus, if a minister files a Schedule A (itemized deductions) with his form 1040, interest paid on a mortgage can be included as a deduction even while also being used in determining a ministers federal income tax exemption through the housing allowance.
If you would like help in writing a resolution that approves Housing Allowance for a minister .
As we mentioned earlier, how much (or how little) a church designates for a ministers housing allowance can be a factor in how much of a tax benefit a minister will receive. There are three things a church should recognize:
At the end of the year its the minister and his or her trusted tax advisor, who determines just how much of a ministers actual income can be exempted from federal income tax. Once all the calculations are done, which will it be that stands out as the lowest amount? The fair market rent for the furnished home plus utilities, the actual housing expenses or the amount the church designated as housing allowance? If the answer is not the church designated housing allowance, the church has given its minister more take-home payand it didnt cost the church a penny!
One last note. There are some in our society who are at work to have the ministers housing allowance ruled unconstitutional. As a result, when it comes to housing allowance we encourage ministers and their tax advisors to play by the rules. Using creative and/or aggressive positions only serve to provide ammunition for these opponents to this long standing tax benefit for ministers of the gospel.
Postcard Update and Correction: While we don't specifically say here that exercise equipment can be included in calculating a minister's housing allowance, we did say it on the postcards that we distributed on this topic. Information that we have received since then indicates that exercise equipment is not considered part of ones furnishings and thus cannot be included in calculating housing allowance. We apologize for any inconvenience this error may have caused.
On November 22, 2013, the Western District Court of Wisconsin, in a lawsuit brought by the Freedom From Religion Foundation, ruled that ministerial housing allowance is unconstitutional. In its ruling the court added that its ruling
shall take effect at the conclusion of any appeals
or the expiration of the deadline for filing an appeal, whichever is later.
A federal appeals court reversed the decision by the Western District Court of Wisconsin on November 2014. The court concluded that the Freedom from Religion Foundation and two of its officers lacked standing to challenge the housing allowance. However the appeals court ruling left the door open for the plaintiffs to take a different approach and restart their legal challenge to the housing allowance.
So our recommendation is for churches and those who currently benefit from a housing allowance to stay tuned and be aware that the housing allowance is under attack. If the housing allowance is invalidated by the courts, people who benefit from it should prepare in a sudden increase in their income taxes.
Please Note: This information is provided with the understanding that Church Administrative Professionals is not rendering professional advice or service.