Many churches are lax in their housing allowance designations. Internal Revenue Regulation 1.107(b) requires that in order to be housing allowance, the amount must be designated as such pursuant to an official action taken in advance of the payment of the allowance by the employing church or other qualifying organization.
I recommend that housing allowance designations be approved every year and be approved by either the appropriate committee, the board of directors, or by a high ranking employee that has specifically been granted the authority to make the designations on behalf of the church.
Remember, the designation has to be done prior to the payment of the allowance, so beware of late designations or of designations that attempt to reclassify prior payments. In this area, it's wise to do it well and do it early in order to provide the maximum benefit to the minister.
This post is adapted from an article that first appeared on Elaine Sommerville's blogElaine's Tax Tips for Nonprofits.
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