Church & Clergy Tax Guide

Chapter Highlights

Introduction

Certain kinds of income are not included in gross income for federal income tax reporting purposes. These items are known as exclusions. The most important exclusions for ministers are the annual rental value of a church-provided parsonage and housing allowances. Because of the importance of these exclusions, they are discussed separately and fully in Chapter 6. This chapter will summarize other common exclusions.

Exclusions are reductions from gross income. Since Form 1040 begins with an itemization of various categories of gross income, there is no place on the return to list, or “deduct,” exclusions. They are “claimed” by not reporting them as taxable income.

Are items of income that are excludable in computing income taxes also excludable in computing Social Security taxes? Recall that ministers are treated as self-employed for Social Security with respect to their ministerial services, so they pay the self-employment tax. The income tax regulations specify that “income which is excludable from gross income under any provision of subtitle A of the Internal Revenue Code is not taken into account in determining net earnings from self-employment,” with certain exceptions. Treas. Reg. 1.1402(a)-2. The exceptions, which are included in income when computing the self-employment tax, include

Apart from these exceptions, the general rule is that the exclusions discussed in this chapter are excludable in computing both income taxes and self-employment taxes.

Money or property received as a gift or by inheritance is excluded from gross income (any income generated from money or property received as a gift or inheritance is taxable). Often it is difficult to determine whether a particular transfer of money or property is a nontaxable gift or taxable compensation for services rendered. The United States Supreme Court has provided some clarification by noting the following characteristics of a gift: “A gift in the statutory sense . . . ​proceeds from a detached and disinterested generosity . . . ​out of affection, respect, admiration, charity, or like impulses. . . . ​The most critical consideration is the transferor’s intention.” Commissioner v. Duberstein, 363 U.S. 285 (1960).

EXAMPLE Pastor C receives from a church member a Christmas card containing a check in the amount of $50 (payable directly to Pastor C). Occasional checks of token value may be gifts under some circumstances and, if so, are excludable from income. Goodwin v. United States, 67 F.3d 149 (8th Cir. 1995).

EXAMPLE Pastor G receives an inheritance of $100,000 in 2024 from the estate of a deceased relative. The inheritance is not included in Pastor G’s taxable income in 2024. However, any interest earned (or gains realized) on the inheritance will be taxable.

EXAMPLE Pastor K performs ministerial services for a neighboring church that temporarily is without a minister. In recognition of her services, the congregation presents her with an “honorarium” of $500. The honorarium represents compensation for services rendered and is not a gift. See “Love offerings” on page .

For a discussion of retirement and other special-occasion gifts to ministers and lay employees, see “Christmas and other special-occasion gifts” on page , “Retirement gifts” on page , and “Retirement Distributions Not Pursuant to a Formal Plan” on page .

Life insurance proceeds paid to you because of the death of an insured person ordinarily are not taxable income for you. However, if the proceeds are payable to you in installments, you must report as income the portion of each installment that represents earnings on the face amount of the policy. Generally, the taxable amount is that portion of each installment that exceeds the face amount of the policy divided by the number of annual installments you are to receive. For example, if the face amount of the policy is $100,000 and you are to receive 20 annual installments of $6,000, you would report as income $1,000 each year ($6,000 − ($100,000 / 20)).

If you receive a scholarship, fellowship grant, or other grant, all or part of the amount you receive may be tax-free. Scholarships, fellowship grants, and other grants are tax-free if you meet the following conditions:

You must include the following in gross income:

The term candidate for a degree means a full- or part-time student who

Note the following:

An eligible educational institution is one whose primary function is the presentation of formal instruction and that normally maintains a regular faculty and curriculum and normally has a regularly enrolled body of students in attendance at the place where it carries on its educational activities.

A scholarship or fellowship grant is tax-free only to the extent (1) it doesn’t exceed your qualified education expenses; (2) it isn’t designated or earmarked for other purposes (such as room and board) and doesn’t require (by its terms) that it cannot be used for qualified education expenses; and (3) it doesn’t represent payment for teaching, research, or other services required as a condition for receiving the scholarship.

Table 5-1: Tax Treatment of Scholarship Payments

Churches that would like to make a nontaxable scholarship payment to a student should consider taking the following precautions: (1) Prepare a written scholarship instrument that sets forth the terms and conditions of the scholarship, including a provision limiting the use of the proceeds to tuition, enrollment fees, books, and supplies. (2) Require an academic transcript to ensure that the student is enrolled at an educational institution. (3) Require receipt of an invoice or other record showing the amount of tuition (or other allowable expense) that is owed. (4) Consider paying the scholarship amount directly to the educational institution rather than to the student.

Any portion of a “scholarship” received by a graduate student that represents compensation for required teaching or research responsibilities cannot be a qualified scholarship.

Section 1.117-4(c) of the income tax regulations specifies that the following payments shall not be considered to be amounts received as a scholarship:

(1) Any amount paid or allowed to, or on behalf of, an individual to enable him to pursue studies or research, if such amount represents either compensation for past, present, or future employment services or represents payment for services which are subject to the direction or supervision of the grantor.

(2) Any amount paid or allowed to, or on behalf of, an individual to enable him to pursue studies or research primarily for the benefit of the grantor.

However, amounts paid or allowed to, or on behalf of, an individual to enable him to pursue studies or research are considered to be amounts received as a scholarship or fellowship grant for the purpose of section 117 if the primary purpose of the studies or research is to further the education and training of the recipient in his individual capacity and the amount provided by the grantor for such purpose does not represent compensation or payment for the services described in subparagraph (1) of this paragraph. Neither the fact that the recipient is required to furnish reports of his progress to the grantor, nor the fact that the results of his studies or research may be of some incidental benefit to the grantor shall, of itself, be considered to destroy the essential character of such amount as a scholarship or fellowship grant.

According to this language, amounts paid by a church for the education of a pastor or other church employee cannot be treated as a nontaxable scholarship if paid “as compensation for services.” This conclusion also applies to scholarships provided to the children of church employees.

The Supreme Court has upheld the validity of this regulation, stating that it comports with the “ordinary understanding of scholarships as relatively disinterested, no-strings educational grants, with no requirement of any substantial quid pro quo from the recipients.” Bingler v. Johnson, 394 U.S. 741 (1969).

The United States Tax Court has observed that this regulation is “designed to distinguish relatively disinterested payments made primarily for the purpose of furthering the education of the recipient from payments made primarily to reward or induce the recipient’s performance of services for the benefit of the payor.” Turem v. Commissioner, 54 T.C. 1494 (1970).

EXAMPLE The IRS addressed the question of whether amounts received by a taxpayer from his employer for tuition assistance for the education of his children were tax-free scholarships. The IRS concluded that they were not. It observed:

Section 1.117-4 of the regulation denies scholarship exclusion to amounts that are paid to an individual to enable him to pursue studies or research if such amounts represent compensation for past, present or future employment services. . . . ​When funds are made available as a part of the pattern of employment to the children of employees of a corporation for educational expenses, those amounts are includable as additional compensation in the employee’s gross income. Funds will be considered to be received as a part of the pattern of employment when they are made available to the children of employees merely because of the parent’s employment relationship, and without any substantial limitations on the right to receive the funds.

If, however, the funds are only available to a limited number of the employees’ children and are awarded on the basis of need or merit, they may be treated as tax-free scholarships. The IRS cautioned that “convincing evidence is required to establish that an educational grant from an employer to an employee or his dependents does not constitute compensation.” IRS Letter Ruling 8541002.

EXAMPLE A federal appeals court found that college education payments for a taxpayer’s children made by an educational trust set up by his employer were taxable compensation. In determining that the payments were includible in the parent employee’s taxable income, the court stated, “When such a benefit is created in an employment situation and in connection with the performance of services, we are unable to conclude that such a benefit [does not represent taxable compensation].” The court concluded:

The IRS argues that the amounts paid by the educational trust were generated by the employees in connection with their performance of services for their employer and were, therefore, compensatory in nature. We find this view to be amply supported by the record. The plan was adopted by the employer to relieve its most important employees from concern about the high costs of providing a college education for their children. It was hoped that the plan would thereby enable the key employees to render better service. Moreover, the eventual payment of benefits by the trust was directly related to the taxpayers’ employment. This is illustrated quite graphically by the fact that only those expenses incurred by their children while the parent was employed by the employer were covered by the plan. . . . ​In substance, by commencing or continuing to be employed by their employer, the employees have allowed a portion of their earnings to be paid to their children. Armantrout v. Commissioner, 570 F.2d 210 (7th Cir. 1978).

EXAMPLE A pastor takes a course at a local college in business administration. He is not a candidate for a degree. The church pays the tuition expense. The amount paid by the church is not a qualified scholarship, since the pastor is not a candidate for a degree, and the church’s payment likely would be viewed by the IRS as compensation based on past or present services. However, the amount may be nontaxable as employer-provided educational assistance (see “Employer-provided educational assistance” on page ).

EXAMPLE A church operates an unaccredited training program for persons wanting to engage in full-time ministry. Students attend the program for one year on a full-time basis. The program includes both classroom instruction and practical experience. Students who complete the program are given a certificate. Students are charged $8,000 to enroll in the program, representing both tuition ($4,000) and room and board ($4,000). Another church sends one of its members to the program and pays his entire enrollment fee. None of this amount can be treated as a nontaxable qualified scholarship, since the student is not a candidate for a degree at an accredited educational institution.

EXAMPLE A church establishes a scholarship fund for seminary students. L is a church member who is pursuing a master’s degree at an accredited seminary. The church board votes to award her a scholarship of $1,500 for 2024. So long as L uses the scholarship award for tuition or other course-related expenses, she need not report it as income on her federal tax return, and the church need not issue her a Form 1099-NEC. The better practice would be for the church to stipulate that the scholarship is to be used for tuition or other course-related expenses (e.g., fees, books, supplies). This will ensure that the scholarship does not inadvertently become taxable income because its specific use was not designated and the recipient used it for nonqualified expenses. See “Scholarship gifts” on page  for a discussion of the deductibility of church members’ payments to the scholarship fund.

EXAMPLE A seminary maintains a four-year curriculum leading to a degree that must be completed by all students who wish to graduate and be ordained into the ministry. The first, second, and fourth years are spent on campus, and the third year is spent in a church as an intern. The seminary selects the churches in which the students will serve during their third year. Interns are paid a monthly support allowance by their host church, as prescribed by the seminary. The IRS ruled that the amounts received from local churches by interns were not tax-free scholarships but rather constituted taxable compensation for services rendered. Revenue Ruling 57-522.

EXAMPLE A professor was given a year off to pursue studies overseas. He was paid $27,000 during his sabbatical, and he treated this entire amount as a tax-free scholarship. The IRS ruled that the sabbatical income represented taxable income, and the Tax Court agreed. The court noted that scholarships are nontaxable only if certain conditions are met. The recipient must be “a candidate for a degree at an educational organization,” and the scholarship must be used for qualified tuition. The court noted that the professor’s sabbatical income was not a nontaxable scholarship, since he was not a candidate for a degree and failed to prove that he used any portion of the income for qualified tuition expenses. This ruling will be useful to church treasurers in evaluating the tax status of sabbatical income provided to pastors or other staff members. Kant v. Commissioner, T.C. Memo. 1997-217.

EXAMPLE An employer paid an employee an $8,000 “commission” in addition to his regular salary. Throughout his employment, the employee was enrolled at a local university, earning an undergraduate degree. He had a verbal agreement with his employer that he would be reimbursed for certain educational expenses he incurred. He did not report the $8,000 as taxable income because he considered it to be a nontaxable scholarship. The Tax Court disagreed. It noted that the tax code excludes from taxable income “any amount received as a qualified scholarship by an individual who is a candidate for a degree” at certain educational institutions. However, a “qualified scholarship” does not include any amount received by a student that represents compensation for past, present, or future employment services. The court concluded that the $8,000 was “a form of compensation and not the result of disinterested generosity,” and therefore it was not a nontaxable qualified scholarship. Lewis v. Commissioner, T.C. Sum. Op. 2003-78 (2003).

A cafeteria plan, including a flexible spending arrangement (FSA), is a written plan that allows employees to choose between receiving cash or taxable benefits instead of certain qualified benefits for which the law provides an exclusion from wages. If an employee chooses to receive a qualified benefit under the plan, the fact that the employee could have received cash or a taxable benefit instead will not make the qualified benefit taxable.

Generally, a cafeteria plan does not include any plan that offers a benefit that defers pay.

A cafeteria plan can include any “qualified benefit.” A qualified benefit is defined by section 125 of the tax code to include

Distributions from an HSA may be used to pay eligible long-term care insurance premiums or to pay for qualified long-term care services.

However, “the term ‘qualified benefit’ does not include any product which is advertised, marketed, or offered as long-term care insurance [or] any qualified health plan . . . ​offered through an exchange.”

A cafeteria plan cannot include the following benefits:

Simple cafeteria plans

Eligible employers meeting contribution requirements and eligibility and participation requirements can establish a simple cafeteria plan. A simple cafeteria plan is treated as meeting the nondiscrimination requirements of a cafeteria plan and certain benefits under a cafeteria plan.

You are an eligible employer if you employ an average of 100 or fewer employees during either of the two preceding years. If you establish a simple cafeteria plan in a year that you employ an average of 100 or fewer employees, you are considered an eligible employer for any subsequent year if you do not employ an average of 200 or more employees in a subsequent year.

These requirements are met if all employees who had at least 1,000 hours of service for the preceding plan year are eligible to participate and each employee eligible to participate in the plan may elect any benefit available under the plan. You may elect to exclude from the plan employees who (1) are under age 21 before the close of the plan year, (2) have less than one year of service with you as of any day during the plan year, (3) are covered under a collective bargaining agreement, or (4) are nonresident aliens working outside the United States whose income did not come from a U.S. source.

You must make a contribution to provide qualified benefits on behalf of each qualified employee in an amount equal to (1) a uniform percentage (not less than 2 percent) of the employee’s compensation for the plan year or (2) an amount which is at least 6 percent of the employee’s compensation for the plan year or twice the amount of the salary reduction contributions of each qualified employee, whichever is less. If the contribution requirements are met using option 2, the rate of contribution to any salary reduction contribution of a highly compensated or key employee cannot be greater than the rate of contribution to any other employee.

Written plan

A cafeteria plan must be set forth in a written agreement. The income tax regulations describe the required agreement as follows:

The written document embodying a cafeteria plan must contain at least the following information: (i) a specific description of each of the benefits available under the plan, including the periods during which the benefits are provided (i.e., the periods of coverage); (ii) the plan’s eligibility rules governing participation; (iii) the procedures governing participants’ elections under the plan, including the period during which elections may be made, the extent to which elections are irrevocable, and the periods with respect to which elections are effective; (iv) the manner in which employer contributions may be made under the plan, such as by salary reduction agreement between the participant and the employer or by nonelective employer contributions to the plan; (v) the maximum amount of employer contributions available to any participant under the plan; and (vi) the plan year on which the cafeteria plan operates. Proposed Treas. Reg. 1.125-1 (question and answers, answer A-3).

Discrimination in favor of highly compensated or key employees

If a cafeteria plan discriminates in favor of highly compensated employees, then such employees lose the benefit of the exclusion and are taxed on the value of the benefits received. In this context, a highly compensated employee of a church is any of the following employees:

If a cafeteria plan favors key employees, you must include in their wages the value of taxable benefits they could have selected. A plan favors key employees if more than 25 percent of the total of the nontaxable benefits you provide for all employees under the plan goes to key employees. For 2024, a key employee of a church is generally an employee who was an officer having annual pay of more than $220,000 in the lookback year of 2023.

Further, the exclusion is denied to key employees if the qualified benefits provided to such employees exceed 25 percent of total nontaxable benefits provided to all employees under the plan. Special nondiscrimination rules apply to cafeteria plans that provide health benefits. IRC 125(b)(2). See “Certain Fringe Benefits” on page  for definitions of highly compensated employee and key employee.

Election requirements

For participants to avoid constructive receipt of taxable benefits, the plan must offer an election, and participants must elect the amounts and types of benefits to be received prior to the beginning of the plan year. If a salary reduction is permitted to pay for the benefits chosen, the salary reduction amount must be elected prior to the beginning of the plan year.

Generally, the plan may not permit participants to elect their benefit coverage, benefit reimbursement, or salary reduction for less than 12 months. However, this does not prohibit new employees from electing benefits for a part of the cafeteria-plan year.

After a participant has elected and begun to receive benefits under the plan, the plan may not allow the participant to revoke the benefit election during the period of coverage unless the revocation is due to a change in status (discussed below).

Changes in status

Under the change-in-status rules, a plan may permit participants to revoke an election and make a new election if a change in status occurs and the election change is “consistent” with the change in status. Change-in-status events may include one or more of the following events, depending on the qualified benefits provided by the plan:

An election change is “consistent” if it is “on account of” and “corresponds with” a change-in-status event that affects eligibility for coverage. In the case of accident or health coverage (such as a health FSA), if a change in status results in an increase or decrease in the number of an employee’s family members or dependents who may benefit from coverage under the plan, the eligibility requirement is satisfied. Election changes must be on a prospective basis only.

A flexible spending account, also known as a flexible spending arrangement (FSA), is a special kind of cafeteria plan consisting of a special account you put money into that you use to pay for certain out-of-pocket health care costs. You don’t have to pay taxes on this money. This means you’ll save an amount equal to the taxes you would have paid on the money you set aside.

You can use funds in your FSA to pay for certain medical and dental expenses, including copayments and deductibles.

FSAs are available only with job-based health plans. Employers may make contributions to your FSA.

You cannot spend FSA funds on health insurance premiums.

You can put up to $3,200 into an FSA for 2024. You generally must use that money within the plan year. But your employer can provide a grace period of up to 2½ months after the end of the plan year. If there is a grace period, any qualified medical expenses incurred in that period can be paid from any amounts left in the account at the end of the previous year. An employer isn’t permitted to refund any part of the balance to the employee. Plans may allow up to $640 of unused amounts remaining at the end of 2024 to be paid or reimbursed for qualified medical expenses an employee incurs in the following plan year.

You can spend FSA funds on prescription medications as well as over-the-counter medicines with a doctor’s prescription. Reimbursements for insulin are allowed without a prescription.

FSAs may also be used to cover costs of medical equipment such as crutches; supplies, such as bandages; and diagnostic devices, such as blood sugar test kits.

A cafeteria plan may not allow an employee to request salary reduction contributions for a health FSA in excess of $3,200 (for 2024). A cafeteria plan that doesn’t limit health FSA contributions to the dollar limit isn’t a cafeteria plan, and all benefits offered under the plan are includible in the employee’s gross income.

IRS Notice 2013-54 states:

The market reforms do not apply to a group health plan in relation to its provision of benefits that are excepted benefits. Health FSAs are group health plans but will be considered to provide only excepted benefits if the employer also makes available group health plan coverage that is not limited to excepted benefits and the health FSA is structured so that the maximum benefit payable to any participant cannot exceed two times the participant’s salary reduction election for the health FSA for the year (or, if greater, cannot exceed $500 plus the amount of the participant’s salary reduction election). Therefore, a health FSA that is considered to provide only excepted benefits is not subject to the market reforms.

If an employer provides a health FSA that does not qualify as excepted benefits, the health FSA generally is subject to the market reforms, including the preventive services requirements. Because a health FSA that is not excepted benefits is not integrated with a group health plan, it will fail to meet the preventive services requirements.

This exclusion applies to life insurance coverage that meets all the following conditions:

Group term life insurance does not include the following insurance:

Employee

For this exclusion, treat the following individuals as employees:

The 10-employee rule

Generally, life insurance is not group term life insurance unless you provide it to at least 10 full-time employees at some time during the year. For this rule, count employees who choose not to receive the insurance unless, to receive it, they must contribute to the cost of benefits other than the group term life insurance. For example, count an employee who could receive insurance by paying part of the cost, even if that employee chooses not to receive it. However, do not count an employee who must pay part or all of the cost of permanent benefits to get insurance unless that employee chooses to receive it. A permanent benefit is an economic value extending beyond one policy year (for example, a paid-up or cash-surrender value) that is provided under a life insurance policy.

Even if you do not meet the 10-employee rule, two exceptions allow you to treat insurance as group term life insurance. Under the first exception, you do not have to meet the 10-employee rule if all the following conditions are met:

The second exception generally will not apply to churches.

Do not consider employees who were denied insurance for any of the following reasons:

The exclusion of the cost of up to $50,000 of group term life insurance paid for by an employer is not available to “key employees” if the plan discriminates in their favor. For 2024, a key employee is an employee who is an officer of the employer having annual compensation greater than $215,000 in the lookback year of 2023. IRC 416(i).

Section 79(d) of the tax code specifies that the nondiscrimination rules pertaining to key employees “shall not apply to a church plan maintained for church employees.” In this context a “church employee” does not include an employee of (1) “an educational organization which normally maintains a regular faculty and curriculum and normally has a regularly enrolled body of pupils or students in attendance at the place where its educational activities are regularly carried on,” or (2) “an organization the principal purpose or functions of which are the providing of medical or hospital care or medical education or medical research, if the organization is a hospital.”

Exclusion from wages

You can generally exclude the cost of up to $50,000 of group term life insurance from the wages of an insured employee. You can exclude the same amount from the employee’s wages when figuring Social Security and Medicare taxes. In addition, you do not have to withhold federal income tax on any group term life insurance you provide to an employee.

Coverage over the limit

You must include in your employee’s wages the cost of group term life insurance beyond $50,000 worth of coverage, reduced by the amount the employee paid toward the insurance. Report it as wages in box 1 of a minister’s Form W-2 and in boxes 1, 3, and 5 for nonminister employees. Also, show it in box 12 with code C. The amount is subject to Social Security and Medicare taxes, and you may, at your option, withhold federal income tax. Figure the monthly cost of the insurance to include in the employee’s wages by multiplying the number of thousands of dollars of all insurance coverage over $50,000 (figured to the nearest $100) by the cost shown in Table 5-2. For all coverage provided within the calendar year, use the employee’s age on the last day of the employee’s tax year. You must prorate the cost from the table if less than a full month of coverage is involved.

Compute the taxable income associated with excess coverage by referring to Table 5-2. Employers also must include the imputed cost of employer-provided group term life insurance on the life of a spouse or dependent if the coverage provided exceeds $2,000. Treas. Reg. 1.79(d)(2). If part of the coverage for a spouse or dependents is taxable, use Table 5-2 to determine the imputed cost. The entire amount is taxable, not just the amount that exceeds $2,000.

Table 5-2: Cost per $1,000 of protection for a one-month period

EXAMPLE A church pays the premiums on a $70,000 group term insurance policy on the life of Pastor B, with B’s wife as beneficiary. Pastor B is 50 years old. The imputed cost of the excess coverage on Pastor B is $2.76 (23 cents × 12 months) per $1,000 of coverage. Since Pastor B had $20,000 of insurance in excess of the $50,000 exclusion amount, the church must include $55.20 in Pastor B’s income ($2.76 × 20). The church should include this amount with wages in box 1 of Form W-2. This amount should also be reported in box 12 and labeled “C.” Any includible amount is subject to income tax as well as Social Security and Medicare withholding for nonminister church employees.

EXAMPLE Pastor Tim’s church provides him with group term life insurance coverage of $200,000. Pastor Tim is 45 years old, is not a key employee, and pays $100 per year toward the cost of the insurance. The church must include $170 in his wages. The total cost of the insurance, $360 ($.15 × 200 × 12), is reduced by the cost of $50,000 of coverage, $90 ($.15 × 50 × 12), and by the $100 the pastor pays for the insurance. The church includes $170 in box 1 of the pastor’s Form W-2. The church also enters $170 in box 12 with code C.

As noted in Chapter 4, a fringe benefit is any material benefit provided by an employer to an employee (or self-employed person) apart from his or her stated compensation. Certain fringe benefits are generally includible in an employee’s gross income for both income tax and Social Security tax purposes. Such taxable fringe benefits are discussed in Chapter 4. Some fringe benefits are specifically excluded from income if certain requirements are satisfied. Several of these nontaxable fringe benefits are described in section 132 of the tax code.

Before summarizing these fringe benefits, it is necessary to define two important terms: highly compensated employee and key employee. Many of the fringe benefits summarized below are excludable from taxable income only to the extent that the employee is not highly compensated or a key employee. These terms, for 2024 and in the context of religious organizations, are summarized below:

In applying the $150,000 test to ministers, do not include a housing allowance or the annual rental value of a parsonage. Section 414(q) of the tax code, which contains the definition of a highly compensated employee, defines the term compensation by referring to section 415(c)(3). The income tax regulations specify that for purposes of 415(c)(3), the term compensation means “the employee’s wages . . . ​to the extent that the amounts are includible in gross income.” Treas. Reg. 1.415-2(d)(2). Since a housing allowance is not “includible in gross income” (to the extent that it is used to pay for housing expenses and, for ministers who own their home, does not exceed the fair rental value of the home), it is not included in the definition of compensation and would not be considered in applying the $150,000 limit. The same would be true for the annual rental value of a parsonage provided to a minister.

If an employer offers an employee a service free of charge (or at a reduced price) that is the same service it offers to the public in the ordinary course of its business, and if the employer does not discriminate in favor of highly compensated employees in dispensing the service, the service is considered a no-additional-cost service and is excludable from the employee’s income. In addition, the employer cannot incur substantial additional cost in providing the service to the employee. This exclusion ordinarily will not benefit ministers.

A qualified employee discount is a reduction in price that an employer offers employees on certain property or services it offers to the public in the ordinary course of its business. Such discounts cannot be excluded by highly compensated employees unless the same benefit is made available on substantially similar terms to lower-paid employees. Conditions apply.

Prior to the Tax Cuts and Jobs Act of 2017 (TCJA), employees did not include in income the value of a working condition fringe benefit. A working condition fringe benefit was any property or service provided to you by your employer to the extent that you could have deducted the cost of the property or service as an employee business expense had you paid for it yourself. Common examples were an employee’s use of an employer’s car for business, an employer-provided cell phone provided primarily for noncompensatory business purposes, and job-related education.

While the TCJA did not repeal the working condition fringe benefit exclusion, it may have indirectly had that effect by denying a business expense itemized deduction by employees since the loss of such a deduction meant that employees could not have deducted the cost of the property or service as an employee business expense had they paid for it themselves. Some tax professionals believe this was an unintended consequence of the TCJA. If so, corrective legislation or guidance may be forthcoming. Until official guidance occurs, ministers should not rely on the working condition fringe benefit exclusion without the advice of a tax professional.

If your employer provides you with a fringe benefit so minimal in value that it would be unreasonable or administratively impractical to account for it, you will not have to include the value of such benefits in your income.

Excludable benefits

Examples of de minimis fringe benefits that are excludable from taxable income include

In determining whether a benefit is de minimis, you should always consider its frequency and its value. An essential element of a de minimis benefit is that it is occasional or unusual in frequency. It also must not be a form of disguised compensation.

Whether an item or service is de minimis depends on all of the facts and circumstances. In addition, if a benefit is too large to be considered de minimis, the entire value of the benefit is taxable to the employee, not just the excess over a designated de minimis amount. The IRS has ruled in a previous case that items with a value exceeding $100 could not be considered de minimis, even under unusual circumstances.

Nonexcludable benefits

Examples of fringe benefits that are not excludable from taxable income as de minimis fringe benefits include the following (these items must be valued and reported as income to the employee):

In determining whether a benefit is minimal, the frequency with which the benefit is provided must be considered. Therefore, if your employer provides you with a free lunch each day, such a benefit will not be de minimis; though the value of any one lunch would be.

Discounted meals

Some employers provide meals to employees at less than fair market value (i.e., the employer subsidizes the cost of meals). Under a special de minimis fringe rule, if your employer operates a cafeteria or other eating facility on or near the business premises for employees, you will not have to include in income the excess of the value of the meals over the fees charged to you. To qualify for this rule, (1) the revenue received by the employer must generally equal or exceed its operating cost; (2) the employer must own or lease the facility; (3) substantially all of the use of the facility must be by employees; (4) meals must be provided during or immediately before or after the workday; and (5) access to the facility must not be primarily for the benefit of officers, directors, or highly compensated employees.

Athletic facilities

Some churches operate athletic facilities (such as a gym or pool) on church property and make these facilities available to employees. You do not have to include in income the value of such a fringe benefit if substantially all the use of the facility is by employees and their spouses and dependent children.

Transportation fringe benefits

Qualified transportation fringe benefits provided by an employer are excluded from an employee’s gross income for income tax purposes and from an employee’s wages for employment tax purposes. Qualified transportation fringe benefits include parking, transit passes, vanpool benefits, and qualified bicycle commuting reimbursements. No amount is includible in the income of an employee merely because the employer offers the employee a choice between cash and qualified transportation fringe benefits (other than a qualified bicycle commuting reimbursement).

Qualified transportation fringe benefits also include a cash reimbursement (under a bona fide reimbursement arrangement) by an employer to an employee for parking, transit passes, or vanpooling. In the case of transit passes, however, a cash reimbursement is considered a qualified transportation fringe benefit only if a voucher or similar item that may be exchanged only for a transit pass is not readily available for direct distribution by the employer to the employee.

For 2024, the amount that can be excluded as qualified transportation fringe benefits is limited to $315 per month in combined transit pass and vanpool benefits and qualified parking benefits.

Holiday gifts to employees

Many churches provide employees and volunteers with gifts at Christmas. Common examples include hams, turkeys, fruit baskets, small amounts of cash, or gift certificates. Church treasurers may assume that these gifts are so small that they need not be reported as taxable income. An IRS ruling suggests that this assumption is incorrect. IRS Letter Ruling 200437030 (2004). A charity annually provided employees with a ham, turkey, or gift basket as a holiday gift. Over the years, several employees complained about the gifts because of religious or dietary restrictions and requested a gift coupon of comparable value. In response, the charity began providing employees with a gift coupon having a face value of $35 instead of a ham, turkey, or gift basket. The coupons list food stores where the coupon is redeemable. The charity did not withhold or pay any employment taxes for any portion of the $35 gift coupons provided to employees.

The IRS ruled that these coupons represented taxable income that should have been added to the employees’ Forms W-2. It rejected the charity’s argument that the coupons were a de minimis fringe benefit (i.e., so low in value that they could be ignored for tax purposes).

The IRS conceded that taxable income does not include any fringe benefit that qualifies as a de minimis fringe benefit. Section 132(e)(1) of the tax code defines a de minimis fringe benefit as “any property or service the value of which is (after taking into account the frequency with which similar fringes are provided by the employer to the employer’s employees) so small as to make accounting for it unreasonable or administratively impracticable.”

The IRS concluded that cash can never be a de minimis fringe benefit, since it is not “unreasonable or administratively impracticable” to account for its value. The same conclusion applies to cash equivalents, such as gift coupons, even though the property acquired with the coupon would be a nontaxable de minimis fringe benefit had it been provided by the employer.

The IRS noted:

When an employee attends a staff meeting where two pots of coffee and a box of donuts are provided by the employer, the value of the benefit the employee receives is not certain or easily ascertained. Further, the administrative costs associated with determining the value of the benefit and accounting for it may be more expensive than providing the benefit. In this case, there is no difficulty in determining the value or accounting for it; each employee that received a gift coupon received a cash equivalent fringe benefit worth $35.

In support of its conclusion, the IRS cited the following considerations:

The IRS concluded:

It is our view that the employer-provided gift coupon operates in essentially the same way as a cash equivalent fringe benefit such as a gift certificate. As with a gift certificate, it is simply not administratively impracticable to account for the employer-provided gift coupons; they have a face value of $35. Accordingly, we conclude that an employer-provided holiday gift coupon with a face value of $35 that is redeemable at several local grocery stores is not excludable from gross income as a de minimis fringe benefit.

The IRS acknowledged that some courts have ruled that gift certificates of small amounts may be nontaxable fringe benefits, but it noted that all of these cases were decided many years ago, prior to the enactment of section 132, so they are no longer relevant.

The following examples will illustrate the application of the IRS ruling to common church practices.

EXAMPLE A church provides its nonpastoral employees with a turkey at Christmas. This is a nontaxable de minimis fringe benefit, so the value of the turkey need not be reported on the employees’ Forms W-2. The income tax regulations provide several examples of de minimis fringe benefits, including “traditional birthday or holiday gifts of property (not cash) with a low fair market value.”

EXAMPLE A church provides its senior pastor with a $250 check as a Christmas gift. This is not a de minimis fringe benefit, and the entire value must be reported on the pastor’s Form W-2.

EXAMPLE A church provides employees with a $50 gift certificate redeemable at a local restaurant as a holiday gift. The certificate is a cash equivalent the value of which is readily ascertainable. It is not a nontaxable de minimis fringe benefit, despite the token amount, so it must be reported as taxable compensation.

EXAMPLE A church provides employees with a $25 gift certificate redeemable at a local doughnut store. The certificate is a cash equivalent the value of which is readily ascertainable. It must be reported as additional income on employees’ Forms W-2. It is not a nontaxable de minimis fringe benefit, despite the token amount, so it must be reported as taxable compensation.

EXAMPLE A church provides employees with a Christmas card containing a $25 check. The value of the check must be reported as additional income on employees’ Forms W-2. It is not a nontaxable de minimis fringe benefit, despite the token amount, so it must be reported as taxable compensation. The fact that the amount of a check is $25 is irrelevant. No cash gift provided to an employee, regardless of how small the amount, can be treated as a nontaxable de minimis fringe benefit.

EXAMPLE A church treats its staff to a holiday dinner at a local restaurant. The value of each dinner averages $20. The value of the meals is a nontaxable de minimis fringe benefit. The income tax regulations provide several examples of de minimis fringe benefits, including “group meals or picnics for employees and their guests” and “traditional birthday or holiday gifts of property (not cash) with a low fair market value.”

EXAMPLE At the end of each year, a church provides volunteers who work in the church nursery or in children’s ministries with a $25 gift certificate to a local restaurant in recognition of their selfless services. The IRS ruling addressed in this section suggests that the value of these certificates represents taxable income to the volunteers. However, since they are not employees, the church is not required to report the amount of the certificates on a Form W-2. No Form 1099-NEC is required either, assuming that the volunteers do not receive compensation of $600 or more during the year. It will be up to the volunteers to decide how to handle the certificates for tax purposes.

Many churches operate schools and offer tuition discounts to employees of both the school and church whose children attend the school. For example, a church operates a private school (kindergarten through grade 12). The annual tuition is $5,000. The school allows the children of its employees to attend at half tuition. The same rate applies to the children of church employees. For 2023, tuition reductions were provided to the children of five school employees and four church employees. Are there tax consequences to these tuition discounts? Do the tuition reductions represent taxable income to the parents, or are they nontaxable? If they are nontaxable, what conditions apply?

Qualification requirements

Section 117(d) of the tax code specifies that qualified tuition reductions are not taxable. To be qualified, however, certain conditions must be met. These include the following:

EXAMPLE The IRS issued a “field service advisory” in which it concluded that tuition reductions provided by a school to graduate students who were employed by the school could not be excluded from tax as either a qualified tuition reduction or a working condition fringe benefit. The qualified tuition reduction exclusion did not apply, since this exclusion only applies to “education below the graduate level.” The IRS also rejected the school’s claim that the tuition reductions could avoid tax as a working condition fringe benefit. A working condition fringe benefit is any “property or service provided to an employee of the employer to the extent that, if the employee paid for such property or services, such payment would be allowable as a [business] deduction.” IRC 132. However, section 132 states that the working fringe benefit exclusion is not available “to any fringe benefits of a type the tax treatment of which is expressly provided for in any other section” of the tax code. Since section 117(d) of the code addresses tuition reductions, graduate students who do not qualify for this exclusion cannot look to section 132 for relief. Field Service Advice 200231016 (2002).

Church employees

Many churches that operate private schools offer tuition discounts to employees of both the church and school and assume that the tax treatment is the same. But is it? Does the exclusion of qualified tuition reductions from a school employee’s taxable income apply to church employees? As noted above, section 117(d) defines a qualified tuition reduction as “any reduction in tuition provided to an employee of an organization described in section 170(b)(1)(A)(ii) for the education at such organization.” Section 170(b)(1)(A)(ii) refers to educational institutions that “normally maintain a regular faculty and curriculum and normally have a regularly enrolled body of pupils or students in attendance at the place where its educational activities are regularly carried on.” In other words, tuition reductions granted to the employees of an educational institution are tax-exempt.

But what about employees of a church that operates a private school? In the past, it was not clear whether the IRS or the courts would consider an employee who works directly for a church to be an employee of an educational institution, even if the church operates a private school. The eligibility of a church employee for a qualified tuition reduction was doubtful because of two considerations: (1) A church is a religious rather than an educational institution. (2) A qualified tuition reduction must be provided by an educational institution as described in section 170(b)(1)(A)(ii) of the tax code. This section is preceded by section 170(b)(1)(A)(i), which refers to churches as a separate category. This makes it difficult to argue that employees of a church described in section 170(b)(1)(A)(i) are eligible for an exclusion that is limited to employees of schools described in section 170(b)(1)(A)(ii).

IRS clarification

An IRS ruling directly addressed the eligibility of church employees for qualified tuition reductions and concluded that they are not eligible for the exclusion. IRS Private Letter Ruling 200149030. The IRS noted that nontaxable qualified tuition reductions must be provided by an educational organization described in section 170(b)(1)(A)(ii), which refers to schools.

The IRS conceded, however, that a school that is “operated as an activity or function of” a church may qualify as an educational organization for purposes of section 117(d), even though not separately organized or incorporated. It concluded:

An unincorporated school operated by a church or parish . . . ​or the school system of a synod or diocese, all may constitute “educational organizations” described in 170(b)(1)(A)(ii) for purposes of section 117(d). The employees generally of such an “educational organization” would be eligible to receive excludable “qualified tuition reductions” from their employer; the exclusion is not limited solely to individuals providing teaching services, but would extend to the employees generally within such function, including secretarial, managerial, administrative, and support function employees.

However, in these circumstances, an excludable [qualified tuition reduction] could not be extended to church employees who were not employed within the context of the school function, or “educational organization,” so defined. Thus, for example, a diocese operating a school system may not properly exclude from reportable wages as “qualified tuition reductions” . . . ​the value of tuition reduction benefits it might provide to employees of a hospital it also operates.

Conclusions

Does your church operate a private school? If so, do you offer tuition discounts to both church and school employees? If you do, here are the main points to consider:

To illustrate, the IRS ruled that a worker hired to teach English as a second language by a public school and who worked only three evenings per week was a school employee. IRS Private Letter Ruling 9821053. This ruling and others like it may support the availability of the qualified tuition reduction exclusion for pastors and other church employees who teach one or more classes each semester at a church-operated school. After all, this ruling leaves little doubt that the IRS considers part-time teachers who work only a few hours each week to be employees. The same logic may apply to the definition of a school employee for purposes of determining eligibility for the qualified tuition reduction exclusion. Churches that treat a minister or staff member who teaches a course at a church-operated school as a school employee should be consistent. Any teaching compensation should be reported as employee wages. If the school issues its own paychecks, it should do so for the minister or staff member. This is an aggressive tax position that should not be adopted without legal counsel.

What about pastors who serve as a church school’s president? Should they be considered part-time school employees because their job description includes serving as the school’s president? Does it matter whether they are paid for their services? Obviously, employees ordinarily must be paid something, although it does not necessarily have to be in the form of cash. But while pastors may not be compensated directly for their services as a school president, the argument could be made that if their job description includes these duties, a portion of their church salary should be considered school compensation. This, too, is an aggressive position that should not be adopted without legal counsel.

EXAMPLE A pastor served as senior pastor of a Baptist church, and his wife served as principal of a private school operated by the same church. The couple received tuition discounts for their children who attended the school. The Tax Court noted that “by reason of their employment with the church and the school, petitioners, as well as all other full-time employees of the school, received tuition reductions for their children’s education at the school.” In fact, the court noted that the IRS had conceded that the couple’s tuition discounts were not taxable. It is interesting that the court observed that the couple received tuition discounts “by reason of their employment with the church and the school.” However, this language should not be pushed too far. After all, the wife was a school employee, and the tuition discounts were nontaxable by reason of her employment. Nevertheless, this case will be of some value in supporting the nontaxability of tuition discounts received by the children of pastors and other church employees who are not employees of a school operated by their church. Rasmussen v. Commissioner, 68 T.C.M. 30 (1994).

EXAMPLE A federal appeals court rejected the claim of one church that its school employees were church employees and therefore exempt from the Fair Labor Standards Act (minimum wage and overtime pay). The church pointed out that the school was “inextricably intertwined” with the church, that the church and school shared a common building and a common payroll account, and that school employees were required to subscribe to the church’s statement of faith. The court rejected this reasoning without explanation. This case suggests that church employees should not assume that they can be treated as school employees in order to qualify for the exclusion of qualified tuition reductions. Dole v. Shenandoah Baptist Church, 899 F.2d 1389 (4th Cir. 1990).

Paying tuition through salary reductions

Many churches that operate schools have allowed school employees (with a child who attends the school) to pay for some or all of their child’s tuition expenses through salary reduction. To illustrate, assume that a church operates a private religious school and provides employees with a tuition discount of 50 percent off of the regular annual tuition of $3,000 (for any child who attends the school). An employee earns annual income of $20,000 and sends a child to the school. The employee pays tuition of $1,500 (the regular tuition of $3,000 reduced by 50 percent). The church would like to reduce the employee’s taxable compensation by $1,500 to pay for the remaining tuition. In other words, can the employee pay for the remaining tuition ($1,500) with pretax dollars through a salary reduction arrangement?

The answer is no. Salary reductions can reduce taxable income only if specifically authorized by law. For example, federal law specifically authorizes the payments of contributions to a 403(b) plan (tax-sheltered annuity) or to a cafeteria plan to be made through salary reductions. No authorization is given to pay for tuition expenses through salary reductions. Section 127 of the tax code permits employees, with certain limits, to exclude from taxable income the amounts paid by an employer for the employee’s educational expenses. This benefit is available only to employees (not their children.)

Obviously, this exclusion is not available to the children of church employees. Section 117(a) of the tax code provides for the exclusion of qualified scholarships from a recipient’s taxable income. This benefit is available to students who are pursuing a degree at a school that is accredited by a nationally recognized accreditation agency. This exclusion would not be relevant in this example, since the benefit is only available to the student and not to the student’s parents.

EXAMPLE A college provided certain of its employees the option of electing from a variety of fringe benefits, including payment of tuition expenses of employees’ children attending private secondary schools. Employees desiring to take advantage of the tuition benefits would inform the college, which would then contact the high school, determine the tuition, and begin paying the high-school tuition as it became due. It made a corresponding reduction of the employee’s salary, and the reduced amount was later reported on each employee’s Form W-2. The college did not withhold federal income taxes on amounts by which the salaries of participating employees were reduced. The IRS claimed that these salary reductions did not reduce the employees’ taxable compensation. It insisted that the employees’ Forms W-2 should have reported the full amount of the salary reductions. A federal court agreed with the IRS position. The court based this conclusion on the following language in the tax regulations: “Any amount deducted by an employer from the remuneration of an employee is considered to be a part of the employee’s remuneration and is considered to be paid to the employee as remuneration at the time that the deduction is made.” Further, the court concluded that the college should have withheld taxes on the salary reductions. Marquette University v. United States, 645 F. Supp. 1007 (E.D. Wis. 1985).

Meals and lodging for employees

Section 119(a) of the tax code specifies that the value of meals furnished to an employee by an employer is not subject to income taxes or Social Security and Medicare taxes if the meals are furnished on the business premises of the employer and they are furnished for the convenience of the employer.

All meals furnished to employees on an employer’s premises are for the convenience of the employer if the meals furnished to at least half of the employees are for the convenience of the employer. Generally, meals are for the convenience of the employer if the employer has a noncompensatory business reason for furnishing the meals (for example, there are few, if any, restaurants nearby, and the employer would have to provide employees with longer lunch breaks if they were not furnished meals at work).

In addition, you may exclude any occasional de minimis meal or meal money you provide to an employee if it has so little value (considering how frequently you provide meals to your employees) that accounting for it would be unreasonable or administratively impracticable. The exclusion applies, for example, to the following items:

The de minimis exception does not apply to highly compensated employees (defined above) who receive meals not available on the same terms to all other employees.

Section 119(a) of the tax code specifies that the value of lodging furnished to an employee by an employer is not subject to income taxes or Social Security and Medicare taxes if three tests are met:

The third requirement means that the employee is required to accept such lodging to enable him to properly perform the duties of his employment. Lodging will be regarded as furnished to an employee to enable him to perform his duties properly when, for example, the lodging is furnished because the employee is required to be available for duty at all times or because the employee could not perform the services required of him unless he is furnished such lodging.

To illustrate, if a church located in a high-crime area hires a security guard and requires that he reside in a home located on the church’s premises, the value of such lodging need not be included in the gross income of the employee if the tests described above are satisfied.

EXAMPLE A religious organization required that certain of its executive officers live in houses it owned and that they use the houses as the primary place for performing their duties. The executives were not charged for their use or occupancy of the homes. The lodging was furnished on the business premises of the employer, it was furnished for the convenience of the employer, and the employees were required to accept such lodging as a condition of their employment. Accordingly, the value of such lodging was not includible in the gross income of the employees for income tax purposes. Revenue Ruling 77-80.

EXAMPLE A religious college provided meals and lodging to its faculty and staff members. The value of such meals and lodging was not excludable from the employees’ gross income. They were not furnished for the convenience of the employer since they were “not functionally related to the educational or religious goals of the institution.” In addition, the employees were not required to accept such arrangements as a condition of their employment. Bob Jones University v. Commissioner, 670 F.2d 167 (Ct. Cl. 1982).

EXAMPLE A religious secondary school furnished lodging to its teachers. The value of such lodging was includible in the employees’ gross income since the lodging was not located on the business premises of the employer and was not the site of a significant portion of the employees’ duties. Goldsboro Christian School, Inc. v. Commissioner, 436 F. Supp. 1314 (D.D.C.1978), aff’d 103 S. Ct. 2017 (1983). See also IRS Letter Ruling 8213005.

EXAMPLE Ten “church centers” were engaged in religious activities including praying, preaching the gospel, ministering to the spiritual needs of members, and teaching the Bible. The centers employed full-time ordained ministers and lay workers who were required as a condition of their employment to live at the assigned church center. The primary service required of the ministers and lay workers was prayer. In addition, the ministers conducted Sunday services, held prayer meetings, counseled and helped church members, and carried out evangelistic work. The lay workers taught Bible school, administered the church’s business affairs, organized and ran annual conventions, and maintained the facilities. Although the ministers and lay workers were not paid a salary, they were provided with meals and lodging.

The church centers asked the IRS for a ruling addressing the federal Social Security tax consequences of the meals and lodging provided to the full-time ordained ministers and full-time lay workers. Regarding the lay workers, the IRS concluded that the lodging was for the convenience of the employer and accordingly was not includible in gross income for either federal income tax or Social Security (FICA) purposes. Similarly, the IRS concluded that the meals furnished on the church premises for the lay employees were for the convenience of the employer and accordingly were not includible in gross income for federal tax purposes. However, regarding the ordained ministers who were employed by the churches, the IRS noted that such persons are self-employed for Social Security with respect to service performed in the exercise of their ministries. Accordingly, they are not subject to FICA taxes but rather pay the self-employment tax with respect to such services.

The IRS further noted that section 1402(a)(8) of the tax code prevents the section 119 exclusion for meals and lodging from reducing a minister’s net earnings. Thus, the value of meals and lodging provided by the churches to their ordained ministers “must be included in the ministers’ net earnings from self-employment” for self-employment tax purposes. On the other hand, the ordained ministers were entitled to exclude from their taxable income for federal income tax purposes the value of the housing provided to them on a cost-free basis (the parsonage exclusion). IRS Letter Ruling 9129037.

EXAMPLE A church provided a minister with a $300 monthly allowance for food and clothing. The minister claimed that the portion of these funds allocable to food was nontaxable based on the exclusion of meals provided for the convenience of an employer. The Tax Court disagreed, noting that “there is no indication that the amounts involved pertain to any meals provided by the church on the church premises.” Kalms v. Commissioner, 64 T.C.M. 153 (1992).

Faculty lodging

If you are an employee of an educational institution and you are provided with lodging that does not meet the three conditions noted above, you still may not have to include the value of the lodging in income. However, the lodging must be qualified campus lodging, and you must pay an adequate rent.

“Qualified campus lodging” is lodging furnished to you, your spouse, or one of your dependents by or on behalf of the institution for use as a home. The lodging must be located on or near a campus of the educational institution.

The amount of rent you pay for the year for qualified campus lodging is considered adequate if it is at least equal to the lesser of (1) 5 percent of the appraised value of the lodging, or (2) the average of rentals paid by individuals (other than employees or students) for comparable lodging held for rent by the educational institution. If the amount you pay is less than the lesser of these amounts, you must include the difference in your income.

EXAMPLE Carla, a college professor, rents a home from the college that is qualified campus lodging. The house is appraised at $200,000. The average rent paid for comparable university lodging by persons other than employees or students is $14,000 a year. Carla pays an annual rent of $11,000. She does not include in her income any rental value because the rent she pays equals at least 5 percent of the appraised value of the house (5 percent × $200,000 = $10,000). If Carla paid annual rent of only $8,000, she would have to include $2,000 in her income ($10,000 − $8,000).

Employer-paid educational expenses are excludable from the gross income and wages of an employee if provided under an educational assistance program. Section 127 provides an exclusion of up to $5,250 annually for employer-provided educational assistance. In order for the exclusion to apply, certain requirements must be satisfied. The educational assistance must be provided pursuant to a separate written plan of the employer, and the educational assistance program must not discriminate in favor of highly compensated employees (i.e., for 2024, those earning annual compensation of $150,000 or more in 2023).

Under the terms of the exclusion, employees are limited to an exclusion of up to $5,250 of the benefits they receive during a calendar year. This exclusion applies to both income tax and Social Security tax.

An educational assistance program in the context of church employers (1) is a separate written plan of an employer for the exclusive benefit of its employees to give them educational assistance, (2) cannot have eligibility requirements that discriminate in favor of officers or highly compensated employees or their dependents (as defined under “Certain Fringe Benefits” on page ), (3) must not provide eligible employees with a choice between educational assistance and cash, and (4) must provide for reasonable notification of the availability and the terms of the program to eligible employees. IRC 127.

Employees

The term employee includes self-employed persons for purposes of this exclusion.

Educational assistance

Educational assistance provided by an employer includes payments for such expenses as tuition, fees, books, and equipment. It does not include payment for tools or supplies (other than books) that an employee may retain after the completion of a course, meals or lodging, or transportation. This exclusion applies to undergraduate and graduate education.

Examples

EXAMPLE Pastor E is taking graduate-level counseling courses at a local seminary. His church paid $5,000 in tuition expenses that he incurred in 2024. The church’s payment of Pastor E’s tuition in 2024 may be nontaxable employer-provided educational assistance, since this benefit is not limited to undergraduate education.

EXAMPLE An employer paid an employee an $8,000 “commission” in addition to his regular salary. Throughout his employment the employee was enrolled at a local university, earning an undergraduate degree. He had a verbal agreement with his employer that he would be reimbursed for certain educational expenses he incurred. The employee did not report the $8,000 as taxable income because he considered it to be nontaxable employer-paid educational assistance. The Tax Court disagreed. It noted that section 127 of the tax code excludes from taxable income “amounts paid by the employer for educational assistance to the employee,” but only if the assistance is furnished pursuant to an “educational assistance program.” An “educational assistance program” is a “separate written plan of an employer” which meets certain requirements. The court concluded that the $8,000 was not tax-free employer-paid educational assistance, since “the amounts at issue were not provided pursuant to a written plan maintained by the employer as required by the statute.” Lewis v. Commissioner, T.C. Sum. Op. 2003-78 (2003).

Working condition fringe benefit

Educational expenses that do not qualify for the section 127 exclusion or that exceed the annual $5,250 limit may be excludable from income as a working condition fringe benefit. In general, education qualifies as a working condition fringe benefit if the employee could have deducted the education expenses under section 162 if the employee paid for the education. In general, education expenses are deductible by an individual under section 162 if the education (1) maintains or improves a skill required in a trade or business currently engaged in by the taxpayer or (2) meets the express requirements of the taxpayer’s employer, applicable law, or regulations imposed as a condition of continued employment. However, education expenses are generally not deductible if they relate to certain minimum educational requirements or to education or training that enables a taxpayer to begin working in a new trade or business.

The Tax Cuts and Jobs Act of 2017 suspends both the moving expense deduction for unreimbursed moving expenses and the exclusion of employer reimbursements of moving expenses under an accountable arrangement—except in the case of a member of the Armed Forces of the United States on active duty who moves pursuant to a military order.

This provision is effective for taxable years beginning after December 31, 2017, and before January 1, 2026.

Employers no longer have to file an annual Form 5500 and Schedule F for so-called “pure fringe benefit plans.” Employers who in the past filed Form 5500 and Schedule F (Fringe Benefit Plan Annual Information Return) solely to meet the reporting requirements of section 6039D of the tax code (“fringe benefit plans”) should file neither Form 5500 nor Schedule F. In fact, Schedule F has been eliminated, and Form 5500 has been modified so fringe benefit plan information cannot be reported.

Fringe benefit plans are often associated with ERISA group health plans and other welfare benefit plans. The exemption of pure fringe benefit plans from the Form 5500 filing requirement does not cover these associated welfare plans. But, in many cases, a Form 5500 was not required for the welfare plan because it was exempt from filing a Form 5500 report under Department of Labor regulations. For example, fully insured or unfunded welfare plans covering fewer than 100 participants at the beginning of the plan year are eligible for a filing exemption, as are church plans. Unless exempt, however, ERISA welfare plans must still file in accordance with the Form 5500 instructions on welfare plan filing requirements.

Form 5500 must be filed annually by every pension benefit plan. However, church plans are exempt from this requirement so long as they have not elected to be covered by ERISA. See Chapter 10 for more information about church retirement plans.