Church & Clergy Tax Guide

Tax advantages Several kinds of tax-favored retirement plans are available to ministers and lay church employees. Contributions to such plans ordinarily are partially or fully deductible (or excludable) for income tax purposes, and taxation of interest earnings generally is deferred until a later date.

The value of early participation Church employees can accumulate substantial retirement funds by using tax-deferred retirement plans. How much is accumulated depends on three variables—the amount of the annual contributions to the plan, the interest earned, and the number of years of participation. Younger employees should discipline themselves to participate in such plans at as early an age as possible since the value of their contributions will be magnified over time.

Types of retirement plans Common retirement plans for church employees include

Legal requirements Tax-sheltered retirement plans require compliance with complex rules (summarized in this chapter).

Denominational retirement plans Most denominations offer retirement plans to their ministers and lay church employees. These plans often offer unique advantages that make them attractive.

Housing allowances Church retirement plans can designate housing allowances for retired ministers if certain conditions are met. This is a significant tax benefit for retired ministers.

Retirement gifts Church congregations often distribute a lump-sum retirement gift to a retiring minister. Sometimes the gift is paid out in monthly installments. Ordinarily, these “gifts” constitute taxable compensation rather than a tax-free gift.

Key Point: Many tax-favored retirement plan options are available to churches. Contributions to such plans may be partly or fully tax-deductible (or excludable), and taxation of interest or earnings may be deferred until distribution.

Key Point: Ministers and lay staff members can accumulate substantial retirement funds by using tax-deferred retirement plans. How much is accumulated depends on three variables: the amount of the annual contributions to the plan, the rate of return, and the number of years of participation.

Most ministers and lay church employees are eligible to participate in a tax-favored retirement plan through either their employing church or a denominational plan. A tax-favored plan has the following two characteristics:

This chapter will address the following church- or denomination-sponsored retirement plans:

Also covered in this chapter are housing allowances for retired ministers and the eligibility of a minister’s spouse to have retirement distributions designated as a housing allowance.

Church employees also may establish IRAs. These are fully explained in IRS Publication 590, which can be downloaded from the IRS website (IRS.gov).

Key Point: The deferral of tax on income generated by a retirement plan can result in significant accumulations of wealth, especially if contributions begin early and are made systematically. See Table 10-1.

The tax code uses the term church plan in several contexts, including the following:

Section 415(c)(7) provides that church employees who participate in a church plan can elect an alternative amount for the limit on annual additions. Under this election, employees can contribute at least $10,000 a year to a tax-qualified retirement plan, even if nothing can be contributed under the regular 415(c) limit. Total contributions over one’s lifetime under this election cannot be more than $40,000.

The nondiscrimination rules that apply to 403(b) plans do not apply to church plans.

Under section 4(b)(2) of ERISA, a non-electing church plan is excluded from coverage under Title I of ERISA. This means that it is not subject to ERISA’s rules governing reporting, disclosure, and fiduciary conduct. In the case of a defined benefit pension plan, the plan is also not covered by the insurance provisions of Title IV of ERISA, which provides for certain benefit guarantees by the Pension Benefit Guaranty Corporation (PBGC) in the event of termination of an underfunded pension plan. These results are not limited to a church plan whose only participants are employees of a church but may also in some cases include employees of certain affiliated entities who are participants in a church plan as defined in section 414(e).

Key Point: In 2017 the U.S. Supreme Court ruled unanimously that ERISA’s exemption for church plans covers a plan maintained by a principal-purpose organization (an organization whose principal purpose is the administration or funding of a plan or program for the provision of retirement benefits or welfare benefits, or both, for the employees of a church or a convention or association of churches) if such organization is controlled by or associated with a church or a convention or association of churches, regardless of who established it. Advocate Health Care Network v. Kaplan, 137 S.Ct. 1652 (2017).

Key Point: The major advantage derived by a plan that qualifies as a church plan is that it allows the plan sponsor a choice to comply with the participation, vesting, and funding requirements imposed by the tax code. Besides being exempt from certain provisions of the tax code, church plans are exempt from Titles I and IV of ERISA.

Example: A federal court in Minnesota dismissed a lawsuit brought by several participants in a denominational pension plan citing ERISA violations and state law claims for breach of trust, breach of contract, breach of fiduciary duty, and consumer fraud. The court concluded that the retirement plan was a church plan that was exempt from ERISA and dismissed the plaintiffs’ ERISA claims. The court concluded: “The court has thoroughly reviewed the applicable law and the arguments of counsel, and finds no support for plaintiffs’ position that a single employer benefit plan, established and maintained by an organization controlled by or associated with a church, is not a church plan as defined by ERISA. Rather, the court finds that the statutory language defining ‘church plan,’ as well as the applicable agency determinations and court decisions support a finding that the plan is a church plan.” Thorkelson v. Publishing House, 764 F. Supp. 2d 1119 (D. Minn. 2011).

Example: The IRS ruled that a national denomination’s pension plan was a church plan that covered employees of an affiliated school. The IRS concluded:

The Church Plan Clarification Act, enacted by Congress in 2015, corrects several regulatory issues confronting church retirement plans, including the following:

In general

A nonqualified deferred compensation (NQDC) plan is an elective or nonelective plan, agreement, or arrangement between an employer and an employee to pay the employee compensation in the future. Despite their many names, NQDC plans typically fall into four categories:

Key Point: NQDC plans are rarely used by churches because so few ministers are able to contribute the maximum amount each year to a 403(b) or other qualified plan. To illustrate, for 2025, ministers who were 50 years of age or older can contribute up to $30,500 to a 403(b) plan. This amount, and any gains realized, are tax deferred. Only for those ministers who are able to contribute more than this amount does an NQDC plan make sense.

It often is difficult to determine whether an NQDC plan is feasible because of the “constructive receipt” and “economic benefit” doctrines.

The constructive receipt doctrine is set forth in income tax regulation 1.451-2(a):

The economic benefit doctrine (codified in section 83 of the tax code) provides that property transferred to a person as compensation for services (including deferred compensation) generally will be taxed at the first time the property can be reasonably valued. For example, this rule applies when assets are unconditionally and irrevocably paid into a fund or trust to be used for an employee’s sole benefit. However, the IRS generally rules that no income is includible in an employee’s income under the economic benefit doctrine if the source of the deferred compensation remains subject to the general creditors of the employer or was otherwise subject to a substantial risk of forfeiture.

To illustrate, in Revenue Ruling 72-25 the IRS ruled that an employee did not receive taxable income as a result of his employer’s purchase of an insurance contract to provide a source of funds for deferred compensation because the insurance contract was the employer’s asset and was subject to the claims of the employer’s general creditors.

NQDC plans are either funded or unfunded, though most are intended to be unfunded because of the tax advantages unfunded plans afford participants.

Unfunded arrangement: The employee has only the employer’s “mere promise to pay” future benefits, unsecured. Assets remain subject to the employer’s creditors. This provides tax deferral.

Funded arrangement: Assets are set aside beyond creditors’ reach (e.g., in trust/escrow). For NQDC purposes, if participants gain a beneficial interest shielded from creditors, the benefits become taxable under sections 83 and 402(b).

NQDC plans may be formal or informal, but they must be in writing. Churches with NQDC arrangements should have tax professionals review documents for compliance with section 409A.

Section 409A imposes comprehensive rules for NQDC arrangements. Amounts deferred are includible in income unless the plan satisfies strict requirements. Failures trigger penalties, including back taxes and an additional 20% tax, assessed against the employee. Employers must withhold income tax on includible amounts, except possibly for ministers (whose church compensation is exempt from withholding).

“Failed deferrals” must be reported separately on Form W-2 (box 12, code Z).

Church leaders should consider these four points:

Key Point: Any church or other organization with a rabbi trust or other deferred compensation arrangement should have it reviewed by legal counsel for section 409A compliance. This protects against IRS penalties and clarifies the plan’s viability.

CAUTION: Congress has imposed several restrictions on rabbi trusts. These restrictions are explained below. All rabbi trusts should be reviewed by legal counsel to ensure compliance.

A synagogue asked the IRS whether its rabbi would realize taxable income if it funded a trust for his benefit. The trust was irrevocable, subject to the synagogue’s creditors, and could not be assigned or used as collateral. The IRS ruled that the trust was not taxable under the constructive receipt or economic benefit doctrines. IRS Letter Ruling 8113107.

A taxable fund arises if assets are irrevocably placed with a third party and vested. Because the rabbi trust remained subject to the employer’s creditors, no taxable economic benefit occurred at creation.

Income is constructively received when set aside or made available. The IRS concluded that since trust assets were subject to the employer’s creditors, no constructive receipt occurred. Payments would be taxable only when actually received.

This ruling launched extensive use of rabbi trusts, mostly by business executives. In 1992 the IRS issued a model rabbi trust agreement (Revenue Procedure 92-64). The IRS stressed that only verbatim adoption of the model language ensures desired tax treatment.

Rabbi trusts are rarely used by churches but can be effective for highly compensated ministers. Key requirements include:

CAUTION: Any church considering a rabbi trust should have it reviewed by a tax attorney for compliance with section 409A and IRS regulations.

Example: A federal appeals court ruled that a pastor whose rabbi trust funds were lost due to securities violations could not sue the investment company, since he had no present interest in the assets. Smith v. Pennington, 352 F.3d 884 (4th Cir. 2003).

Example: The IRS ruled that a rabbi trust established by a church, conforming to the 1992 model trust, was owned by the church and not taxable to beneficiaries until distributions occurred. IRS Letter Ruling 200434008 (2004).

One of the most popular retirement plans for church employees is the 403(b) plan. These allow nontaxable contributions, with earnings tax-deferred until distribution.

403(b) plans may be structured as:

Churches often prefer 403(b)(9) accounts for flexibility and suitability for ministers.

Eligible employers include public schools, 501(c)(3) tax-exempt organizations (including churches), and non-exempt employers employing a minister for ministerial services.

Key Point: While the tax code permits self-employed ministers to participate in 403(b) plans, the same is not true for nonminister self-employed persons who perform services for churches.

Example: Pastor H is employed as the senior pastor of a church, has always reported his income taxes as a self-employed person, and participates in the church’s 403(b) program. Pastor H’s participation in such a program is permitted by law.

Example: J is an ordained minister who is a full-time self-employed itinerant evangelist. He is eligible to establish and contribute to a 403(b) plan. He will be treated as his own employer that is presumed to be an exempt organization eligible to participate in a 403(b) tax-sheltered annuity. In addition, he will use his earned income as his compensation for purposes of computing the limits on contributions.

Example: A minister employed as a chaplain by a state-run prison and a chaplain in the U.S. Armed Forces are eligible employees because their employers aren’t section 501(c)(3) organizations and they are employed as ministers.

Example: M is an ordained minister who is temporarily working in a secular job as a salesman. In the past, he has participated in a denominationally sponsored 403(b) plan. M cannot continue contributing to his 403(b) plan, since his present job does not constitute the exercise of ministry.

A 403(b) plan can be funded by the following contributions.

Key Point: IRS Publication 571 (Tax-Sheltered Annuity Plans) states: “If you are a self-employed minister, you are treated as an employee of a tax-exempt organization that is an eligible employer.”

Generally, for 2024 the MAC is the lesser of (1) the limit on annual additions (total employer contributions + employee elective deferrals) or (2) the separate limit on elective deferrals.

For 2024, the annual additions limit is the lesser of $69,000 or 100% of includible compensation for your most recent year of service (IRC 415(c)). The $69,000 limit is indexed in $1,000 increments.

Includible compensation. Compensation “received from the employer … and includible in gross income” for the most recent period (ending not later than the close of the taxable year). It includes elective deferrals, section 125 amounts, wages for personal services with the 403(b) employer, and certain foreign earned income; it does not include employer 403(b) contributions.

Key Point: Includible compensation isn’t the same as income on your tax return; it combines income and benefits received for services to your employer.

Because section 107 excludes a minister’s housing allowance (or parsonage FRV) from gross income, the excluded portion generally is not treated as includible compensation for 415(c) purposes. Historically, the IRS has stated that tax-free housing allowance may not be treated as compensation under 1.415-2(d) for 415(c) limits.

Key Point: Check with a tax professional to determine whether your housing allowance counts as includible compensation for your specific plan and facts.

Example: Applying pre-2002 law, the IRS ruled that ministers’ housing allowances are not “compensation” for computing 403(b) 415(c) limits, since they are not includible in gross income. IRS Letter Ruling 200135045 (see also 8416003). Although definitions were updated post-2001, the “includible in gross income” phrase persists and supports the same conclusion.

The elective deferral limit for 2024 was $23,000 across all 401(k), SIMPLE, SEP, and 403(b) plans combined. Excess deferrals must be included in gross income for that year.

Key Point: Computing your MAC and any excess contributions can be complex. See the worksheets in Chapter 9 of IRS Publication 571 (IRS.gov).

A “church employee” includes employees of a church or a convention/association of churches, and employees of tax-exempt organizations controlled by or associated with such bodies. Special rules include:

If you have at least 15 years of service with a qualifying organization (e.g., church, church association, certain schools/hospitals/charities), your elective deferral limit may increase by the least of:

Self-employed ministers count full and partial years treated as employed by a qualified employer. Church employees aggregate all years of service with churches/associations as one employer.

Church employees may elect a special annual additions limit of $10,000 per year, with a $40,000 lifetime cap, even if the general 415(c) limit would permit less. (IRC 415(c)(7)(A))

The limit on elective deferrals under a 403(b) plan is increased for individuals who have attained age 50 by the end of the year. Additional contributions may be made by an individual who has attained age 50 before the end of the plan year and with respect to whom no other elective deferrals may otherwise be made to the plan for the year because of the application of any limitation of the tax code (e.g., the annual limit on elective deferrals) or of the plan.

The additional amount of elective contributions that may be made by an eligible individual participating in such a plan is the lesser of (1) the applicable dollar amount or (2) the excess of your compensation for the year over the elective deferrals that are not catch-up contributions.

The applicable dollar amount for a 403(b) plan was $7,500 for 2024. Catch-up contributions are not subject to any other contribution limits and are not considered in applying other contribution limits.

When figuring allowable catch-up contributions, combine all catch-up contributions made by your employer on your behalf to the following plans:

The total amount of the catch-up contributions on your behalf to all plans maintained by your employer cannot be more than the annual limit. For 2024, it was $7,500. In 2025, it remains $7,500. Under SECURE 2.0, a higher catch-up contribution limit of $11,250 takes effect in 2025 for employees aged 60 to 63 who participate in these plans.

Key Point: If you are eligible for both the 15-year rule increase in elective deferrals and the age-50 catch-up, allocate amounts first under the 15-year rule and next as an age-50 catch-up.

Key Point: Catch-up contributions are not counted against your MAC. Therefore, the maximum amount that you are allowed to have contributed to your 403(b) account is your MAC plus your allowable catch-up contribution.

If your actual contributions are greater than your MAC, you have an excess contribution. Excess contributions can result in additional taxes and penalties.

You cannot deduct voluntary after-tax employee contributions you make to your 403(b) plan.

Note the following rules.

Contributions to a 403(b) plan under a salary reduction agreement are considered wages for Social Security and Medicare taxes. The employer must take into account the entire amount of these contributions for Social Security and Medicare tax purposes, whether they are wholly or partially excludable for income tax purposes. These wages are credited to the employee’s Social Security account for benefit purposes. However, if the employer makes a contribution to a 403(b) plan that is not under a salary reduction agreement, that amount is not considered wages for Social Security tax purposes.

A church or church-related organization may have chosen, for religious reasons, to exempt itself from the employer’s share of Social Security and Medicare taxes by filing a timely Form 8274 with the IRS. If such an election is in effect, the wages of lay church employees are generally subject to self-employment tax.

IRS Publication 517 instructs ministers, when computing self-employment taxes: “Don’t include … contributions by your church to a tax-sheltered annuity plan set up for you, including any salary reduction contributions (elective deferrals), that are not included in your gross income.” See also Revenue Ruling 68-395 and Revenue Ruling 78-6.

Further, section 1402(a)(8) of the tax code specifies that “an individual who is a duly ordained, commissioned, or licensed minister of a church … shall not include in net earnings from self-employment the rental value of any parsonage or any parsonage allowance (whether or not excludable under section 107) provided after the individual retires, or any other retirement benefit received by such individual from a church plan after the individual retires” (emphasis added).

Generally, you do not report contributions to your 403(b) account (except Roth contributions) on your tax return. Your employer will report contributions on your Form W-2. Elective deferrals will be shown in box 12 (code E), and the “retirement plan” box will be checked in box 13. Exceptions to this rule apply to self-employed ministers and chaplains:

If you participate in a 403(b) plan, your employer must report this participation by checking the “retirement plan” box, which is box 13 on the Form W-2 given to you and the IRS after the end of the year. Also, your employer must report in box 12 (using code E) of your Form W-2 your total elective deferrals, including any excess contributions to a 403(b) plan. Employers and plan administrators must report contributions in excess of the limits that apply. Form 1099-R includes boxes for reporting gross and taxable amounts of total distributions.

Generally, a distribution cannot be made from a 403(b) plan until the employee:

Key Point: Distributions prior to age 59½ that do not satisfy one of the above exceptions are subject to an additional “tax on early distributions” of 10 percent multiplied by the amount of the distribution.

The term hardship is not defined in section 403(b) of the tax code. The same term is used in connection with premature distributions under a 401(k) plan and is defined there as a distribution that “is made on account of an immediate and heavy financial need of the employee and is necessary to satisfy the financial need. The determination of the existence of an immediate and heavy financial need and of the amount necessary to meet the need must be made in accordance with nondiscriminatory and objective standards set forth in the plan.” Treas. Reg. 1.401(k)-1(d)(2)(i). This definition probably will be relevant in construing the same term under section 403(b).

In most cases, the payments you receive or that are made available to you under your 403(b) plan are taxable in full as ordinary income. In general, the same tax rules apply to distributions from 403(b) plans that apply to distributions from other retirement plans.

You cannot keep retirement funds in your account indefinitely. You generally must start taking withdrawals from your 403(b) plan as prescribed by law. In December 2022, Congress enacted the Setting Every Community Up for Retirement Enhancement Act (SECURE 2.0 Act) as part of the Consolidated Appropriations Act of 2022. The SECURE 2.0 Act increases the required minimum distribution age to 73 starting January 1, 2023, and to 75 starting January 1, 2033.

The required minimum distribution (RMD) for any year is the account balance as of the end of the immediately preceding calendar year divided by a distribution period from the IRS’s “Uniform Lifetime Table.” A different table is used if the sole beneficiary is the owner’s spouse who is 10+ years younger.

Previously, failing to withdraw an RMD resulted in a 50% penalty tax on the amount not withdrawn. The SECURE 2.0 Act reduced this penalty to 25% (and to 10% in some cases if promptly corrected).

Calculating your RMD can be difficult. The IRS website (IRS.gov) provides updated worksheets and tables for RMD calculations.

You can generally roll over, tax-free, all or any part of a distribution from a 403(b) plan to a traditional IRA or an eligible retirement plan (defined below) except for any nonqualifying distributions. The most you can roll over is the amount that, except for the rollover, would be taxable. The rollover must be completed by the 60th day following the day on which you receive the distribution. The IRS may waive the 60-day rollover period if the failure to waive such requirement would be against equity or good conscience, including cases of casualty, disaster, or other events beyond the reasonable control of the individual. To obtain a hardship exception, you must apply to the IRS for a waiver of the 60-day rollover requirement.

Contributions from a designated Roth account can only be rolled over to another Roth account or a Roth IRA.

You can roll over, tax-free, all or any part of a distribution from an eligible retirement plan to a 403(b) plan. Additionally, you can roll over, tax-free, all or any part of a distribution from a 403(b) plan to an eligible retirement plan, except for any nonqualifying distributions, described below. If a distribution includes both pre-tax contributions and after-tax contributions, the portion of the distribution that is rolled over is treated as consisting first of pre-tax amounts (contributions and earnings that would be includible in income if no rollover occurred). This means that if you roll over an amount that is at least as much as the pre-tax portion of the distribution, you do not have to include any of the distribution in income.

The following are considered eligible retirement plans: IRAs, Roth IRAs, qualified retirement plans, 403(b) plans, and eligible 457 plans. You cannot roll over, tax-free, any of the following nonqualifying distributions: minimum distributions (generally required to begin at age 73), substantially equal payments over your life or life expectancy, substantially equal payments over the joint lives or life expectancies of your beneficiary and you, substantially equal payments for a period of 10 years or more, or hardship distributions.

The instructions for the current IRS Form 5500 state that church plans not electing ERISA coverage under section 410(b) of the tax code are not required to file Form 5500. See the introduction to this chapter for a definition of church plans.

Section 403(b) plans that include employee elective salary deferrals must satisfy a “universal availability” rule demonstrating that salary deferrals, including after-tax Roth deferrals, do not discriminate in favor of highly compensated employees (defined under “Certain Fringe Benefits” on page ). This rule provides that if any employee is permitted to make elective salary deferrals to a 403(b) plan, then all employees, with limited optional exclusions, must be provided the same opportunity. IRC 403(b)(1)(D) and 403(b)(12).

The universal availability requirement does not apply to 403(b) plans of (1) a church; (2) a convention or association of churches; (3) an elementary or secondary school that is controlled, operated, or principally supported by a church or convention or association of churches; or (4) a qualified church-controlled organization (QCCO). IRC 403(b)(1)(D) and 403(b)(12)(A). A qualified church-controlled organization is defined in section 3121(w)(3)(B) of the tax code as

The committee report on the Tax Reform Act of 1986, in construing the term qualified church-controlled organization in another context, noted that it included “the typical seminary, religious retreat center, or burial society, regardless of its funding sources, because it does not offer goods, services, or facilities for sale to the general public.” The committee report also noted that the term qualified church-controlled organization includes

Key Point: See the introduction to this chapter for a definition of church plan.

Church retirement plans are exempt from various requirements imposed by the Employee Retirement Income Security Act of 1974 (ERISA) on pension plans. For example, church plans are not subject to ERISA’s vesting, coverage, and funding requirements. However, according to a comment in the conference committee’s official report to the Small Business Job Protection Act of 1996, in some cases, church plans will be “subject to provisions in effect before the enactment of ERISA,” and under these rules, a church plan “cannot discriminate in favor of officers … or persons whose principal duties consist in supervising the work of other employees, or highly compensated employees.”

What church plans are subject to the pre-ERISA nondiscrimination rules? The general rule is that qualified church pension plans under section 401(a) of the tax code must satisfy the pre-ERISA nondiscrimination rules. See “Qualified Pension Plans” on page for more information.

The Act clarifies that church plans subject to these pre-ERISA nondiscrimination rules may not discriminate in favor of “highly compensated employees” as defined under the Act, and this single nondiscrimination rule replaces the pre-ERISA rule banning discrimination in favor of officers or persons whose principal duties consist in supervising the work of other employees (unless they also satisfy the definition of a highly compensated employee). The Act’s definition of a highly compensated employee (for 2024) includes an employee who had compensation for the previous year in excess of $135,000 and, if an employer elects, was in the top 20 percent of employees by compensation.

Churches that are affiliated with a denomination that offers a 403(b) plan should check with their denominational plan for compliance-related questions. Churches that offer 403(b) plans through one or more commercial mutual fund or investment firms should check with those vendors for assistance. In addition, the IRS website contains a section devoted to compliance with the regulations.

Tax-sheltered annuities involve complex rules. However, they provide attractive tax benefits, making them worthy of serious consideration. Persons wishing to pursue this subject further should consult with a CPA or tax attorney with experience in handling such arrangements or with the staff of a denominational retirement plan (most of which utilize 403(b) plans).

Some churches and religious denominations have established qualified pension plans to finance retirement benefits for their employees. Such plans enjoy several tax benefits, including the following: (1) the employer gets an immediate tax deduction for contributions to the plan (this benefit is not relevant to tax-exempt churches and religious organizations); (2) fund earnings are tax-exempt; (3) employees are not taxed on their share of the fund until they receive distributions; (4) qualifying distributions can be rolled over tax-free to another plan or IRA; and (5) an employee can elect to have benefits payable to a designated beneficiary after his or her death without incurring gift tax liability.

These various tax benefits are available only if the plan is qualified. Qualification means that the plan satisfies the several conditions enumerated in section 401 of the tax code. Some of the more important requirements for qualification include the following: (1) the plan must be a written program that is communicated to all employees; (2) the plan must be for the exclusive benefit of employees and their beneficiaries; (3) the plan must be properly funded; (4) the plan must begin making payments no later than a specified date; (5) contributions and benefits may not exceed specified limitations; (6) certain employees must be permitted to participate in the plan; and (7) an employee’s interest in the plan must vest within a specified time. Additional requirements apply to plans benefiting owner-employees and certain “top-heavy” plans (i.e., plans that disproportionately benefit highly compensated employees).

Key Point: ERISA (Employee Retirement Income Security Act) is a comprehensive pension law enacted by Congress in 1974 containing numerous provisions regulating pension plans (such as vesting, participation, and nondiscrimination).

Key Point: See the introduction to this chapter for a definition of church plan.

Church plans are exempted from the minimum participation, vesting, funding, and nondiscrimination requirements of ERISA unless they elect to be covered. IRC 410. Such an election is irrevocable. Tax code section 414(e) defines the term church plan as a plan “maintained for its employees by a church.” The income tax regulations clarify that, for the purpose of this definition, the term church includes “a religious organization if such organization (1) is an integral part of a church, and (2) is engaged in carrying out the functions of a church, whether as a civil law corporation or otherwise.” Treas. Reg. § 1.414(e)-1(e).

Qualified pension plans can be either defined benefit or defined contribution plans. In a defined benefit plan, each employee is promised specified benefits upon retirement, either for a term of years or for life, based upon such factors as years of service and amount of compensation earned. Employer contributions are actuarially calculated to provide the promised benefits and are not allocated to individual accounts for each employee. In a defined contribution plan, the employer does not promise specified benefits to the employees. Rather, the employer promises specified contributions on behalf of each employee. Such contributions must be allocated to individual accounts for each employee. Retirement benefits are whatever can be provided by the accumulated employer contributions plus any earnings.

The establishment of a qualified pension plan obviously is a complex task that should be handled by an attorney having experience with employee benefits. While IRS approval is not necessary, it ordinarily is advisable. Often employee pension plans are drafted using a master or prototype plan previously approved by the IRS.

The instructions for the current IRS Form 5500 state that church plans not electing ERISA coverage under tax code section 410(b) are not required to file Form 5500.

A plan cannot be a qualified plan if it provides for contributions or benefits in excess of specified amounts. A defined benefit plan cannot provide annual benefits that exceed the lesser of $345,000 (for 2025) or 100 percent of an employee’s average compensation for his or her highest three years. Contributions (and any other additions) to a defined contribution plan must not exceed the lesser of $69,000 or 100 percent of an employee’s compensation for 2025.

Key Point: Congress enacted legislation in 1996 replacing any pre-ERISA nondiscrimination rules that still apply to churches with a simplified nondiscrimination rule. This legislation is addressed under “Tax-Sheltered Annuities” on page .

Occasionally, a church that has made no provision for a minister’s retirement will begin making payments to the minister after his or her retirement. For example, assume that Pastor T was employed by a church for 30 years preceding his retirement in 2024 and that the church never established a retirement program for him. The church board, embarrassed that no provision had ever been made for Pastor T’s retirement, enacts a resolution in 2024 agreeing to pay Pastor T a monthly sum of $500 until the time of his death. What is the tax effect of such distributions? Are they tax-free gifts to Pastor T or taxable compensation for services rendered?

Prior to 1987, a number of courts ruled that payments to a retired minister constituted a tax-free gift to the minister rather than taxable compensation if all of the following conditions were satisfied: (1) the payments were made by a local church congregation with which the minister was associated; (2) the payments were not made in accordance with any enforceable agreement or established plan; (3) the payments were authorized at or about the time of the minister’s retirement; (4) the minister did not perform any further services for the church and was not expected to do so; and (5) the minister was adequately compensated during his or her previous working relationship with the church. See, e.g., Abernathy v. Commissioner, 211 F.2d 651 (D.C. Cir. 1954); Hershman v. Kavanagh, 210 F.2d 654 (6th Cir. 1954); Mutch v. Commissioner, 209 F.2d 390 (3rd Cir. 1954).

The IRS concurred with these decisions in a 1955 ruling. Revenue Ruling 55-422.

Similarly, a federal appeals court ruled that an annual sum paid to a minister by a former church from which he had to resign because of illness was a gift and not taxable compensation. The minister had served the church for several years when he was stricken with a severe heart attack. After a prolonged recovery, including eight months in a hospital, the minister was advised by his physician to move from Pennsylvania to Florida. The church congregation, aware of the physician’s advice and of the minister’s lack of funds to make the move, adopted the following resolution:

The minister made no request to the congregation for such payments, had no knowledge that the resolution would be adopted, did not agree to render any services in exchange for the payments, and performed no pastoral services for the church following his resignation. Under these facts, the court concluded that the payments to the minister were nontaxable gifts rather than taxable compensation. Noting that “a gift is none the less a gift because inspired by gratitude for past faithful service,” the court observed that the payments were gifts because they were “bestowed only because of personal affection or regard or pity and not with the intent to pay the minister what was due him.” Schall v. Commissioner, 174 F.2d 893 (5th Cir. 1949).

Another federal appeals court ruled that a $20,000 retirement payment by a church to its retiring minister was a tax-free gift rather than taxable compensation. Stanton v. Commissioner, 287 F.2d 876 (2d Cir. 1961).

For a full explanation of the continuing relevance of these cases, see “Retirement gifts” on page .

Key Point: Section 409A of the tax code imposes strict requirements on most nonqualified deferred compensation plans (NQDPs). In 2007 the IRS published final regulations interpreting section 409A. The final regulations define an NQDP broadly to include any plan that provides for the deferral of compensation, with some exceptions, as noted above. This definition is broad enough to include rabbi trusts and many other kinds of church compensation arrangements. Any church or other organization that is considering a rabbi trust (or any other arrangement that defers compensation to a future year) should contact an attorney to have the arrangement reviewed to ensure compliance with both section 409A and the final regulations. Such a review will protect against the substantial penalties the IRS can assess for noncompliance. It also will help clarify whether a deferred compensation arrangement is a viable option considering the limitations imposed by section 409A and the final regulations.

Key Point: Denominational pension plans can designate housing allowances for retired ministers if certain conditions are satisfied. This is a significant tax benefit and is one of the main advantages of denominational pension plans.

Are retired ministers eligible for a housing allowance? In 1989 the IRS announced that this is a question “under extensive study” and that it will “not issue rulings or determination letters on the question … until it resolves the issue through publication of a revenue ruling, revenue procedure, regulation, or otherwise.” Revenue Procedure 89-54.

Several years of “extensive study” have failed to produce the promised clarification. In the meantime, consider the following.

Section 1.107-1(b) of the income tax regulations specifies that ministers may exclude from their taxable income (for federal income tax reporting purposes) that portion of their compensation that is designated as a housing allowance “pursuant to official action taken by the employing church or other qualified organization before the payment is made” (emphasis added).

In 1962 the IRS ruled that a resolution of the executive committee of a national religious denomination could not effectively designate a portion of the salaries of ministers of local congregations as a housing allowance where each local congregation employed and compensated its own minister. The IRS concluded that the national church was not an “employing church or other qualified organization” eligible to designate a housing allowance for local ministers, since local congregations were independent of the national church as to policy and conduct of their local affairs, and ministers were hired and paid by the local congregations. Accordingly, “each congregation was the ‘employing church’ and only action taken by the individual church could effectively designate a portion of its minister’s salary as a [housing allowance].” The IRS conceded that the national church could designate housing allowances for ministers who were employees of the national church.

The IRS addressed the question of whether a retired minister of the gospel could exclude a housing allowance furnished to him “pursuant to official action taken by the employing qualified organization in recognition of his past services which were the duties of a minister of the gospel in churches of his denomination.” The IRS concluded that “the rental allowance paid to him as part of his compensation for past services is excludable … to the extent used by him for expenses directly related to providing a home.”

The IRS addressed the question of whether the widow of a retired minister could exclude as a rental allowance amounts she receives from her deceased husband’s church. Prior to his retirement and death, the husband was a minister of the gospel and pastor of a church. Shortly before he retired, in recognition of his years of past service, the church, through official action of its governing body, authorized the payment of a specific amount to be paid each month upon retirement, for so long as he lived, with survivor benefits for his wife. The authorization designated a portion of the payment as a rental allowance. The wife was not a minister of the gospel, and she did not perform any services for the church.

The IRS concluded that “until his death, and to the extent used to provide a home, the rental allowance paid to the retired minister was excludable from his gross income since it was paid as part of his compensation for past services and it was paid pursuant to official action of his church. However, the rental allowance exclusion does not apply to amounts paid to his widow since it does not represent compensation for services performed by her as a minister of the gospel.”

Key Point: This ruling suggests that local churches can designate housing allowances out of retirement distributions paid to a retired minister under a church-sponsored plan.

In 1975 the IRS addressed the question of whether the board of a denominational pension fund can designate a portion of a retired minister’s pension distributions as a housing allowance. Could the pension board be deemed to be an “employing church or other qualified organization” eligible to designate housing allowances for retired ministers? The IRS concluded that it was. In reaching its decision, the IRS noted the following factors:

Based on these factors, the IRS concluded that the pension board met the requirement of being an “employing church”:

The IRS noted that the facts in this case were distinguishable from those in Revenue Ruling 62-117 (summarized above) “in that the minister, effective with his retirement, has severed his relationship with the local church and is reliant upon the fund for his pension.”

The IRS addressed the question of whether the financial board of a denomination’s pension fund could designate 40 percent of pensions paid to retired ministers as a housing allowance. The IRS concluded:

Key Point: The IRS has issued audit guidelines for its agents to follow when auditing ministers. The guidelines state that the “trustees of a minister’s retirement plan may designate a portion of each pension distribution as a parsonage allowance excludable under Code section 107.”

The availability of a housing allowance exclusion for denominationally sponsored pension plans has been an attractive benefit for many retired ministers. In many instances, retired ministers can exclude some or all of their pension income by having the pension plan designate a portion of their income as a housing allowance.

Until further guidance is issued, retired ministers and denominational pension plans may continue to rely on the 1975 IRS ruling (its most recent official guidance) in evaluating whether the designation of housing allowances by denominational pension boards is appropriate.

Example Pastor B was the minister of First Church at the time of her retirement in 2024. She had been employed by First Church for 20 years and, prior to coming to First Church, had been employed as a minister in three other churches, all of which were affiliated with Pastor B’s denomination. The denomination operates a qualified pension plan for its ministers, and Pastor B was a participant in the plan for the last several years of her active ministry. The plan was designed to compensate retired ministers for their service to local churches, and it is characterized by the same factors as described in Revenue Ruling 75-22. The denomination may declare a portion of Pastor B’s retirement income as a housing allowance, and Pastor B can exclude her actual expenses in owning or providing a home to the extent that they do not exceed the designated allowance or, if Pastor B owns her home, the fair rental value of the home plus the cost of utilities. See Chapter 6 for further details.

The Clergy Housing Allowance Clarification Act of 2002 directly impacts the designation of housing allowances for retired ministers. The Act amended section 107 of the tax code to limit the amount of a housing allowance that is nontaxable. As amended, section 107 specifies that a housing allowance provided to ministers who own their homes is nontaxable (in computing federal income taxes) only to the extent that it does not exceed the lesser of actual housing expenses or the fair rental value of the home (furnished, plus utilities).

Some ministers have accumulated significant amounts in their pension or retirement account and may consider electing a lump-sum distribution to pay for a large down payment or the entire purchase price of a new home or to pay off a mortgage loan on an existing home. Electing a lump-sum distribution in such cases often is based on the assumption that the entire distribution can be nontaxable if designated by the pension board as a housing allowance. As the following example illustrates, this often is not the case.

Example Pastor T is a recently retired pastor who has accumulated $200,000 in his pension account. He builds a new home costing $200,000, and in 2024 he asks the pension board to distribute the entire balance in his pension account as a lump-sum distribution. He further requests that the entire distribution be designated as a housing allowance. His objective is to pay for the entire cost of his new home with tax-free dollars. Assume that the annual fair rental value of the home (furnished, plus utilities) is $25,000. The $200,000 housing allowance is nontaxable only to the extent that it does not exceed either actual housing expenses or the fair rental value of the home (furnished, plus utilities). Since the lower of these two amounts is $25,000, Pastor T’s nontaxable housing allowance is limited to this amount. This means that the excess housing allowance of $175,000 must be reported as taxable income by Pastor T in 2024. This will push him into a higher tax bracket and will result in a significant tax liability.

One additional concern is associated with large lump-sum distributions from church pension plans. If a housing allowance (combined with any other church income that a pastor may receive from a church) is excessive or unreasonable in amount, the IRS may assess intermediate sanctions against the pastor. Intermediate sanctions are excise taxes that the IRS can assess against any “disqualified person” who is involved in an excess benefit transaction. Disqualified persons include officers and directors and their relatives. These excise taxes are substantial. They begin at 25 percent of the amount of compensation the IRS deems to be excessive. If the excess is not returned to the church before the 25-percent tax is assessed, the pastor faces an additional tax of 200 percent of the amount of the excess. Intermediate sanctions and the related issue of inurement and its impact on a church’s tax-exempt status are addressed fully under “Unreasonable compensation” on page and “Intermediate sanctions” on page . IRC 4958.

Key Point: Managers and directors of church pension boards who approve an excess benefit transaction also face potential liability (collectively, up to $20,000).

Some local churches establish their own retirement programs for retired ministers, apart from a denominational plan. In some cases, these churches are not affiliated with a denomination; in others, they simply choose not to participate in a denomination-sponsored plan. Can such churches designate a portion of the retirement distributions paid to retired ministers as a housing allowance? The answer would appear to be yes, based on the following precedent:

In Revenue Ruling 72-249 (summarized above), the IRS concluded that a local church could designate a portion of the retirement distributions it paid to a retired minister as a housing allowance.

In Revenue Ruling 75-22, the IRS concluded that a denominational pension fund could designate housing allowances out of the distributions paid to retired ministers since

The denominational pension plan could designate housing allowances because it was acting on behalf of local churches. The implication here is that local churches have the authority to designate housing allowances if they maintain a retirement plan.

In IRS Letter Ruling 7734028, the IRS reached the same result as in Revenue Ruling 75-22:

Again, the implication is that local churches can designate housing allowances with regard to distributions made from their own retirement programs.

Example A local church congregation decided that cash should be set aside annually, as the church council deemed appropriate, to provide funding for housing for its senior pastor upon his retirement. The amounts allocated to the fund were deposited in a separate account in the church’s name. The funds in that account were assets of the church, and the pastor had no access to them prior to distribution. The church council determined that the total amount in the fund at the date of the pastor’s retirement would be used to provide him with retirement housing. The council planned to designate amounts set aside in the fund for the pastor’s retirement housing as a housing allowance after his retirement. The IRS ruled that “amounts paid by the church to the pastor as a rental allowance after his retirement, which are designated as rental allowances pursuant to official action taken by the church council in advance of such payment, are excludable from the gross income of the pastor” to the extent they are used for housing expenses and do not exceed the fair rental value of the home. IRS Private Letter Ruling 8344062.

Key Point: Housing allowances paid to retired ministers by church or denominational pension plans are not subject to the self-employment tax.

One of the most popular retirement plans for church employees is the 403(b) plan (sometimes called a tax-sheltered annuity). Such plans permit employees of churches and other public charities to make nontaxable contributions to their 403(b) account up to the allowable limits. In addition, earnings and gains on 403(b) accounts are tax-deferred, meaning that they are not taxed until distributed.

When section 403(b) accounts were first introduced in 1958, the only investment option available to employees was an annuity (hence the name “tax-sheltered annuity”). In 1974 Congress added section 403(b)(7) to the tax code. This section allows employees of churches and other charities to invest their 403(b) account with a mutual-fund company. These types of 403(b) plans are called 403(b)(7) accounts or custodial accounts. Then, in 1982, Congress added section 403(b)(9) to the tax code, which recognizes retirement income accounts of churches as yet another kind of 403(b) plan. Such accounts may be invested in annuities or mutual funds, and they usually are. But they are not limited to these investments.

Church employees whose employing church did not maintain a 403(b) plan could establish such a plan directly with an insurance company (tax-sheltered annuity) or mutual fund company (403(b)(7) custodial account). In addition, up until 2009, church employees whose employing church had established a 403(b) retirement income account could transfer their 403(b) account to an outside vendor (such as a mutual-fund company) if they were not satisfied with whatever investment option was provided by their employing church, in what was called a “90-24 exchange.” IRS regulations that took effect on January 1, 2009, no longer permit such exchanges. Now church employees must choose an investment option authorized by their employing church. Further, the regulations impose burdensome reporting and compliance requirements on churches that allow multiple investment providers, so most churches and other charities that maintain 403(b) plans for their employees are consolidating the investment options. Many are only recognizing a single provider. In the case of churches that are affiliated with a denomination, the single provider typically is a denominational pension plan. This will make 403(b)(7) custodial accounts less common. However, they are still available to church employees whose employing church has not established a retirement plan. Such employees can go directly to a mutual fund company and establish their own 403(b)(7) custodial account.

Churches and denominational pension plans that have established retirement income accounts for their employees can designate some or all of a retired minister’s account distributions as a housing allowance so long as the requirements for a valid housing allowance are met (see Chapter 6). But what about church employees who have established a 403(b)(7) custodial account directly with a mutual fund company? Are they eligible for a housing allowance, and if so, who designates it? The mutual fund company? Their former employing church? Their denomination?

The income tax regulations specify that a housing allowance must be designated by a minister’s “employing church or other qualified organization before the payment is made.” Obviously, retired ministers no longer have an employing church, so who can designate a housing allowance for them? The IRS has ruled that a denominational pension plan can designate some or all of a retired minister’s retirement distributions under a plan as a housing allowance if several conditions are satisfied (see Revenue Ruling 75-22 and IRS Letter Ruling 7734028, addressed earlier in this chapter).

But what about ministers who have invested in a 403(b)(7) custodial account with a mutual-fund company without any participation by their church other than reducing their compensation by a specified amount and remitting it to the mutual-fund company? There is no question that these ministers are eligible for a housing allowance, assuming they are credentialed ministers and the 403(b)(7) account was funded with compensation they performed in the exercise of ministry. The question is whether a housing allowance can be designated by their “employing church or other qualified organization,” as required by the regulations. Neither the IRS nor any court has addressed this issue directly, so no definitive guidance exists as it does for retired ministers who have invested in a denominational retirement plan. Consider these three possibilities:

The best attempt to define the term other qualified organization was by the Tax Court in a 1981 decision. Boyd v. Commissioner, 42 T.C.M. 1136 (1981). An ordained minister was employed as a chaplain by a municipal police department. The police department’s chaplain program was established through its joint efforts with a local federation of churches. The minister claimed that amounts designated by the federation as a housing allowance were excludable from his gross income. The IRS maintained that because the minister was employed by the city, and not by the federation, the city was the only “other qualified organization” eligible to designate a housing allowance; since it failed to do so, the minister could not claim a housing allowance exclusion.

The Tax Court reversed the IRS determination and ruled that the minister was entitled to a housing allowance. It noted that as a police chaplain, the minister was under the direct supervision of the chief of police. However, the federation retained supervision over his ecclesiastical performance and maintained day-to-day contact with him and other chaplains. The federation also was involved in the operation of the police chaplaincy program. If a problem arose concerning a police chaplain, a police-department official would usually contact the federation to resolve the problem. When a vacancy occurred for a chaplain, the federation assumed primary responsibility for finding a qualified person to fill the vacancy.

The federation annually designated a specific amount of the minister’s salary, in advance, as a housing allowance even though his salary was paid by the city. The city neither provided him with a home nor designated any portion of his salary as a housing allowance.

The Tax Court concluded that the federation was an “other qualified organization” within the meaning of section 1.107-1(b) of the regulations and that its designation of a portion of the minister’s salary as a housing allowance was valid. The court based its decision on the “constant and detailed involvement of the federation” in the city’s police chaplaincy program. The IRS later acquiesced in the Tax Court’s ruling on the ground that the federation’s responsibilities toward the chaplaincy program were similar to those of an employer and that the federation was closely involved with the police department in its employer–employee relationship with the ministers.

Could a mutual-fund company that served merely as an investment provider for a minister pursuant to a 403(b)(7) custodial account be considered an “other qualified organization” capable of designating a housing allowance? It would appear doubtful, based on this Tax Court ruling.

Retired ministers who have participated in a 403(b)(7) custodial account with a mutual fund company should consult with a competent tax professional in assessing their eligibility for a housing allowance and identifying the entity that can designate the allowance. Unfortunately, the IRS has announced that it will not issue letter rulings on this question, so no definitive guidance is possible.

The IRS ruled that a church pension plan can designate housing allowances for retired ministers, but it cannot designate housing allowances for the surviving spouses of deceased ministers unless (1) they are active or retired ministers and (2) the housing allowance is designated out of income from a retirement account that was funded from compensation earned by the spouse for the performance of ministerial services. Revenue Ruling 72-249, IRS Private Letter Ruling 8404101.

For a more complete analysis of this issue, see “Ministers’ Spouses” on page .

The tax code specifies that self-employment tax does not apply to “the rental value of any parsonage or any parsonage allowance (whether or not excludable under section 107) provided after the individual retires, or any other retirement benefit received by such individual from a church plan … after the individual retires.” IRC 1402(a)(8). IRS Publication 517 similarly provides: “If you are a retired minister, you can exclude from your gross income the rental value of a home (plus utilities) furnished to you by your church as a part of your pay for past services, or the part of your pension that was designated as a rental allowance. However, a minister’s surviving spouse can’t exclude the rental value unless the rental value is for ministerial services he or she performs or performed.”

Five things should be noted about this section of the tax code:

Example In 2024 Pastor G retires from many years of ministry. He has participated in a church retirement plan that begins making monthly distributions to him in 2024, some of which are designated as a housing allowance by action of the church plan. Retirement distributions total $9,000 for 2024, of which $5,000 was designated as a housing allowance. Pastor G will not pay self-employment tax on the housing allowance ($5,000) or on the balance of his retirement distributions ($4,000).

Example Pastor T retires after many years of ministry. She is allowed to reside in a church parsonage without any rental charge. Pastor T does not pay self-employment taxes on the fair rental value of the parsonage.