Ministers do not pay federal income tax on the amount of their compensation that is designated in advance by their employing church as a “housing allowance.” But there are limits. For ministers who own or rent their home a housing allowance is nontaxable only to the extent that it is used to pay housing expenses and does not exceed the fair rental value of the home (furnished, plus utilities).
Sometimes ministers incur more housing expenses than they anticipated during the year, which may mean that their housing allowance is not enough to cover all of their housing expenses. Often this is due to unforeseen housing expenses, or to the purchase of a new home. For whatever reason, if a minister’s housing expenses exceed the church-designated housing allowance, then the minister may not be receiving the full value of this important tax benefit.
Key Point. Some ministers live in a church-owned parsonage. The portion of their ministerial income that is designated in advance by their employing church as a parsonage allowance is nontaxable in computing federal income taxes to the extent it is used to pay housing expenses. Such expenses may include utilities and furnishings (if not paid by the church). Ministers who live in a parsonage may incur housing expenses in excess of their parsonage allowance. If so, their employing church should consider amending their allowance for the remainder of the year.
How church treasurers can help. If your church designated a housing allowance for your minister (or ministers) for 2013, now is a good time to check the adequacy of the allowance. The key point is this—if a minister’s housing expenses are more than expected, and will likely exceed the housing allowance, then the church can amend the allowance to make it larger.
Unfortunately, many church boards do not know that a minister’s housing allowance can be amended during the year. Failing to amend a housing allowance to account for larger than expected housing expenses often will mean needless additional taxes for the minister.
Key Point. Amending a minister’s housing allowance costs the church nothing. The church simply redesignates a larger portion of the minister’s salary as a housing allowance. But as noted later in this article, an amended housing allowance is only effective prospectively.
When an amendment may be appropriate. There are a number of reasons why a housing allowance may need to be increased to cover larger than expected housing expenses. Here is a quick checklist of some of the circumstances that may call for a review of the adequacy of a minister’s housing allowance:
- purchase of a new home
- unexpected home repairs
- major remodeling
- purchase of new furnishings
- purchase of new appliances
- the mortgage interest rate under an adjustable rate mortgage is increased
- prepayment of a mortgage loan
- a “balloon” payment on a mortgage loan
- increase in property taxes
- a tax assessment is imposed on the minister’s property to pay for public improvements
- increase in property insurance
- increase in rent (for ministers who rent their home)
Key Point. Amending a minister’s housing allowance is not a legal requirement. Church boards and congregations are free to amend, or not amend, their minister’s housing allowance. But note that amending an allowance to make it larger costs the church nothing. It is simply a reclassification of a larger amount of a minister’s salary as a housing allowance.
Pointers. To amend your minister’s housing allowance you will need to pay attention to the following rules:
- Proper authorization. Be sure the amended housing allowance is authorized by the same group (usually the church board or congregation) that designated the original housing allowance.
- In writing. Be sure the amendment is duly recorded in the minutes of the group that approves it. The minutes should be dated, and recorded at or shortly after the meeting in which the amendment is approved.
- Prospective application. An amended housing allowance only operates “prospectively.” That is, it takes effect on the date it is approved, through the rest of the year. It cannot apply retroactively. To illustrate, a pastor’s housing expenses turn out to be $15,000 for 2013, but the housing allowance designated by the church was only $10,000. In December of 2013 the pastor asks the church board to retroactively increase the housing allowance for 2013 to $15,000. This cannot be done.
Example.
Pastor Dave owns his own home. In December of 2012 his church board approved a compensation package for 2013 in the amount of $45,000. Of this amount, $30,000 was allocated to salary and $15,000 was designated as a housing allowance. The housing allowance was based on Pastor Dave’s estimated housing expenses for 2013. In June of 2013 Pastor Dave purchased a new and more expensive home. This caused his monthly housing expenses to increase by $500. The church board can amend the housing allowance for the remainder of the year by adopting a resolution that designates a larger amount of Pastor Dave’s compensation as a housing allowance for the balance of the year. This will cost the church nothing. It is simply reclassifying some of Pastor Dave’s remaining salary as a housing allowance (rather than salary).
Some churches forget to designate a housing allowance for their minister in advance of the year. After all, few churches have a tax attorney or CPA on their board who is familiar with clergy taxes and so it is understandable that a church board may overlook this task. Is it too late after January 1 of 2013 to designate a housing allowance for a minister for 2013? The answer is no, but the allowance operates prospectively, meaning that it may only be used to pay for housing expenses incurred for the remainder of the year. This is simply another way of saying that a housing allowance is nontaxable only to the extent it is used to pay for housing expenses. This requirement cannot be met if a housing allowance is designated or applied retroactively since the expenses already have been paid.
Example.
In December of 2012 a church board agreed to pay its pastor a salary of $40,000 for 2013. The board failed to designate a housing allowance. In December of 2013 the board discovers that no housing allowance was designated for 2013. It can designate a housing allowance in December of 2013 that can be used to pay for housing expenses incurred during the remainder of the year, but not for any expenses incurred prior to the date the allowance is declared.
“Safety net” housing allowances
Churches often neglect to designate a housing allowance for their minister. This frequently happens when a new minister is called or hired during the year, but it can also happen when a church inadvertently fails to designate a housing allowance for a minister before the start of a new year. To avoid these omissions, church boards should consider adopting a continuing resolution similar to the following: “40 percent of the salary of any minister on staff, regardless of when hired, is hereby designated as a housing allowance for the current year and each future year, unless otherwise specifically provided.”
The “40 percent” designation is used for illustrative purposes. Churches are free to use a different amount. However, the higher the amount, the more likely it will exceed the fair rental value of a minister’s home.
Tip. 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 to designate a timely housing allowance. Their efficacy has never been addressed by either the IRS or the courts.
Resource. See Richard Hammar’s Church & Clergy Tax Guide for additional information on the housing allowance.
