The housing allowance is one of the most valuable tax benefits available to ministers. Yet, many ministers either fail to claim it or do not claim enough. In some cases, this results from tax advisors who are unfamiliar with ministers’ taxes. In this article, I will summarize the requirements for obtaining the full benefit available to ministers who live in a church-owned parsonage. In the next issue, I will discuss the rules that apply to ministers who rent or own their homes. Section 107 of the Internal Revenue Code says simply that “in the case of a minister of the gospel, gross income does not include—(1) the rental value of a home furnished to him as part of his compensation, to the extent used by him to rent or provide a home.” There are four important considerations to note in this section, First, the housing allowance is available only to a minister of the gospel. The income tax regulations (drafted by the Treasury Department and interpreting the Code) define a minister of the gospel to include any minister who has been ordained, commissioned, or licensed by a church or church organization that qualifies as a tax-exempt religious organization. Ministers who have been licensed by a religious organization that both licenses and ordains clergy must perform substantially all the religious functions of an ordained minister in order to qualify for the exemption.
Second, the housing allowance is an exclusion from gross income, rather than a deduction in computing or reducing adjusted gross income. As a result, it is not reported anywhere on Form 1040. In effect, the housing allowance is “claimed by not reporting it as income.
Third, section 107 excludes the fair rental value of a parsonage provided rent-free to a minister as well as an allowance paid to a minister to the extent used by him or her to pay expenses incurred in maintaining the parsonage (e.g., utilities, repairs, furnishings). Ministers who live in a church-owned parsonage do not report the fair rental value of the parsonage as income (as they ordinarily would do if they were allowed to live rent-free in a home provided by any other employer). The church is not required to declare an allowance in the amount of the fair rental value of the parsonage. The exclusion is automatic. However, if the minister incurs any expenses in living in the parsonage, then he or she may exclude them only to the extent that they do not exceed a “parsonage allowance” declared in writing and in advance by the church board.
Example. Rev. White lives rent-free at a church owned parsonage having a fair rental value of $6000 in 1986k The church expects Rev. White to incur some expenses in living in the parson age, and accordingly provides him with an allowance of $100 each month. His salary (not including the monthly allowance,) is $20,000 in 1986. On his 1986 federal income tax return Rev. White would not report the fair rental value of the parsonage ($6000) as income, even though the church never designated that amount as a housing allowance. However, he would have to report the total monthly allowances ($1200) as income unless the church board declared a parsonage allowance” in writing and in advance of at least $1200.
Suggestion. Ministers living in parsonages should be sure to have the church board declare a “parsonage allowance” in advice of each calendar year to cover any miscellaneous expenses the minister may incur in living in the parsonage. The allowance should be declared in writing and be incorporated into the board’s minutes.. The allowance can be a portion of the minister’s salary. For example, in the previous example, the church could have declared $1200 of Rev. White’s annual salary of $20,000 to be a parsonage allowance. The effect of this would have been to exclude the $1200 from gross income (to the extent Rev. White incurred expenses of at least that amount).
Churches failing to declare a parsonage allowance before January 1 should not wait until the following year to act. The declaration is effective from the date of its enactment on. Therefore, a church failing to declare a parsonage allowance until Match can still provide its minister with an important tax benefit for the remainder of the year.
Finally, section 107 requires that the parsonage be furnished to the minister as part of his or her compensation for services performed in the exercise of ministry. The regulations define “services performed in the exercise of ministry” to include (1) the performance of sacerdotal functions, (2) the conduct of religious worship, (3) direction, managing or promoting the activities of a religious organization under the authority of a church or church denomination, or (4) teaching or administrative duties at a theological seminary under the authority of a church or church denomination. A parsonage must be provided to a minister as compensation for one or more of these categories of employment in order for the minister to exclude the parsonage’s rental value from gross income.
The housing allowance is an exclusion for federal income tax purposes only. It cannot under any circumstances be excluded in computing a minister’s social security (self-employment) tax liability. Therefore, in computing the social security tax on Schedule SE of Form 1040, a minister must include the fair rental value of his or her parsonage as income on line 2 of Part 1. A minister must also include any parsonage allowance paid by his or her church to cover miscellaneous expenses in maintaining the parsonage. The rental value of a parsonage is a question of fact to be determined in each case on the basis of its particular circumstances.