Q: I am a minister who qualifies to receive an annual housing allowance from my church. Based on IRS guidance and your online tax guide, I also can take a “double deduction” with respect to certain housing-related expenses on my federal income tax returns. But my CPA says I can’t do this and cites a couple of Tax Court cases that she thinks supports her conclusion. Who is mistaken?
A: You are eligible to take a “double deduction” related to certain expenses.
First, you are a minister who qualifies for an annual housing allowance if designated by your church. This means a portion of your ministerial income is not taxable for federal income tax purposes (within limits). These funds can be spent on qualifying housing expenses, including monthly mortgage payments and real estate taxes.
Second, while nontaxable income (such as the housing allowance) may be used to pay the mortgage payments and real estate taxes, you are also still allowed to claim on Schedule A (Form 1040) itemized deductions for home mortgage interest and real estate taxes.
Your ability to claim a deduction for expenses paid with tax-free income is what’s known as a “double deduction.” This “double deduction” is specifically made possible under Internal Revenue Code (IRC) Section 265(a)(6), which Congress adopted in 1986.
IRC Section 265 generally prohibits expense deductions paid with tax-free income. But Section 265(a)(6) allows clergy to include in itemized deductions their mortgage interest and real estate taxes on their federal income tax returns, even when they used part of their tax-free housing allowances to pay those expenses.
The cases your CPA cites— Dalan v. Commissioner, decided in 1988, and McFarland v. Commissioner, decided in 1992—both involved ordained ministers with tax-free housing allowances designated by their employing churches.
However, the Tax Court in both instances concluded the ministers could not itemize deductions for expenses covered by their allowances other than the mortgage interest and real estate taxes.
Audit guidance from the Internal Revenue Service (IRS), as well as IRS publications, affirms this double deduction exception for ministers for mortgage interest and taxes. However, this guidance also affirms this special treatment does not extend to other types of deductions, such as unreimbursed employee business expenses. To learn more, Chapter 6 of Church Law & Tax’s online tax guide provides further details.
