The latest constitutional challenge to the clergy housing allowance brought by the Freedom From Religion Foundation (FFRF) cleared its first significant legal hurdle in October, when a federal district court judge ruled the valuable longtime tax benefit for ministers to be an unconstitutional preference for religion. The parsonage allowance pertaining to church-owned housing remains unaffected.
The decision may now head to the Seventh Circuit Court of Appeals. Were the Seventh Circuit to affirm the lower court’s decision (a decision is expected to come during the second half of 2018), it would apply only to ministers in that circuit (Illinois, Indiana, and Wisconsin). It would become a national precedent binding on ministers in all states if (1) such a decision is ever affirmed by the United States Supreme Court, or (2) the Internal Revenue Service follows a Seventh Circuit affirmation to promote consistency in tax administration nationwide. Because the Supreme Court accepts less than 1 percent of all appeals, it is uncertain that the Court will agree to hear the case and, moreover, uncertain how the Court would rule. Absent a Court decision, it’s unclear how other federal circuits would address future litigation as well.
With the situation far from certain, churches nationwide should think through preparations now that would help ready their pastors were the clergy housing allowance ever to go away. Senior Editor Richard Hammar identifies three immediate implications of such an outcome that churches can address now:
1. Compensation. The sudden elimination of this tax benefit would immediately thrust many clergy into a dire financial position with a mortgage loan based on a tax benefit that no longer is available. Many church leaders would want to reduce the impact of such a predicament by increasing compensation, likely through some type of phased approach.
2. Tax payments. Many ministers would need to increase their quarterly estimated tax payments or voluntary withholdings to reflect the increase in income taxes in order to avoid an underpayment penalty.
3. Future home purchases. Ministers currently considering the purchase of a home should not base financing decisions on the availability of a housing allowance unless and until the courts conclusively rule in favor of the constitutionality of the allowance or their congregation is able to assure them that their compensation will be increased to compensate for the loss of the allowance.
We asked Ted Batson, tax attorney and CPA with the accounting firm CapinCrouse, to evaluate the financial and administrative aspects of these three implications, and provide additional recommendations as churches and pastors navigate this uncertain situation.
Let’s assume for a moment that the housing allowance is suddenly a lost benefit for all clergy. What would happen?
Many pastors who currently take advantage of the benefit will quickly figure out that they can’t make it on their current salaries. So churches will need to plan for the potential need to increase their pastor’s compensation. This includes asking the congregation to give more generously to support the increase. However, if the churches can’t increase their pay, these pastors will decide whether they have to (a) become bivocational, (b) find an opportunity at a church that will pay more, or (c) leave the ministry.
If a pastor chooses either of the last two options, it will put the current church in a bind because it most likely can’t afford to replace the pastor who has left or may have to accept a less qualified candidate. This could lead to other options for the church. For instance, a church could decide to consolidate with another church or share a pastor.
Let’s say a church wants to do what it can, in terms of compensation, to retain that pastor. How would it implement Hammar’s first recommendation?
What if the housing allowance doesn’t go away and you’ve set aside all this money?
If the pastor does need the additional compensation at some point, what about unreasonable or excessive compensation?
What if a church simply decides to start raising the pastor’s salary right now in anticipation of losing the housing allowance deduction?
Hammar also indicates the need to prepare for increased quarterly estimated tax payments or voluntary withholdings. What other affects may pastors feel?
What are some specific ways the loss of the housing allowance would affect a pastor’s housing situation?
It creates some challenging financial man-agement issues, doesn’t it?
This also means pastors currently looking to buy should make a decision that keeps the possibility of this lost benefit in mind, right?
Sorting Options amid Uncertainty
How should churches respond if the housing allowance is invalidated? Currently, my firm isn’t attempting to answer this question for the churches we serve. The case still has potential issues with legal standing, and the Seventh Circuit may remand the decision back to federal district court or overturn it. Additional issues exist with the effective date and who is affected by a ruling. When a circuit court rules on a tax issue, it is technically only binding on persons within that circuit. The IRS may or may not agree to enforce it as the law of the land. As to timing, the decision is effective when it is final, but could be stayed until the case is either taken up by the Supreme Court or denied certiorari by the Supreme Court. These factors delay any effective date of the ruling. We plan on providing guidance after the Seventh Circuit’s rules.
If the decision is upheld by the Seventh Circuit, and potentially the Supreme Court, churches will need to educate their ministers on the change and its ramifications. If the housing allowance is disallowed, Congress may adjust other laws to provide relief for some ministers or other existing laws may provide relief. Only the cash housing allowance is in dispute and not the provision of the parsonage. The parsonage may provide some avenues of planning in light of an adverse ruling.
A factor complicating this issue, and making recommendations difficult, is potential tax law reform under consideration. Proposed tax law changes might mitigate some of the housing allowance benefits through changes in itemized deductions. But, again, it is difficult to speculate.
Whatever the tax law landscape, churches can’t begin to determine potential budget additions without evaluating the effects on individual ministers. To evaluate the effect of the potential change on a minister’s taxes, and thus the potential effect on the church’s budget, a church should ask each minister to provide an estimate of the potential tax effects. A church may engage a professional to help with this analysis. Once the potential tax costs facing its ministers are determined, a church can begin to assess its actions to assist ministers in mitigating the tax effects.
When considering a new house purchase, ministers will need to evaluate the potential increase in taxes from losing the housing allowance. It is doubtful churches will be able to provide enough additional compensation to mitigate all the tax consequences of losing the housing allowance.