Ministers who own their home do not pay federal income taxes on the amount of their compensation that their employing church designates in advance as a housing allowance, to the extent that the allowance represents compensation for ministerial services, is used to pay housing expenses, and does not exceed the fair rental value of the home (furnished, plus utilities). Housing-related expenses include mortgage payments, utilities, repairs, furnishings, insurance, property taxes, additions, and maintenance.
Ministers who rent a home or apartment do not pay federal income taxes on the amount of their compensation that their employing church designates in advance as a housing allowance to the extent that the allowance represents compensation for ministerial services, is used to pay rental expenses, and does not exceed the fair rental value of the home (furniture, plus utilities).
Unfortunately, many churches fail to designate a housing allowance for their ministers. This practice denies ministers an important tax benefit. This article will help churches and ministers understand how—and when—to designate a housing allowance.
How to Designate a Housing Allowance
The income tax regulations specify that the designation of a housing allowance may be contained in “an employment contract, in minutes of or in a resolution by a church or other qualified organization or in its budget, or in any other appropriate instrument evidencing such official action.”
The regulations further provide that “the designation … is a sufficient designation if it permits a payment or a part thereof to be identified as a payment of rental allowance as distinguished from salary or other remuneration.” Treas. Reg. 1.107-1(b). In other words, the designation must simply distinguish a part of the minister’s compensation as a housing allowance. This can be done by giving a minister two separate checks—one designated as salary and the other as the housing or rental allowance. But this approach is not necessary, since a church that has designated a portion of a minister’s compensation as a housing or rental allowance has thereby made the required identification, and it is free to issue a minister one check per pay period that combines both salary and the housing allowance.
The church’s designation should be in writing, although if a board orally agrees to a specific allowance and neglects to make a written record of its action, it could draft an appropriate record of its action at a later time, dated as of the earlier meeting. The Tax Court has ruled that this is permissible. Kizer v. Commissioner, T.C. Memo. 1992-584.
Similarly, the Tax Court has ruled that an oral designation is sufficient, since “there is no requirement that the designation be in writing.” Libman v. Commissioner, 44 T.C.M. 370 (1982). This practice should be avoided, however, since it will always create problems of proof.
Example. A traveling evangelist was denied any housing allowance exclusion despite his insistence that various churches in which he had conducted services had orally designated a portion of his compensation as a housing allowance. The Tax Court noted that there was no evidence of such designations and that the minister’s testimony was “marred by numerous inconsistencies.” Holland v. Commissioner, 47 T.C.M. 494 (1983).
In summary, if your church board orally designated (in advance) a portion of your compensation as a housing or rental allowance, but failed to record its action in the minutes, there is legal precedent supporting the availability of a housing allowance exclusion. The church board could “memorialize” its earlier action in a written resolution if your return is audited and your allowance questioned. Such a practice is not recommended.
If You Fail to Designate a Housing Allowance
Many churches fail to designate a housing allowance by the end of a calendar year for a variety of reasons and discover the omission a few weeks or months into the new year. Is it too late to do so for that year? According to IRS regulations, the church can still designate a housing allowance for the minister for the remainder of the new year. The regulations state that a housing allowance “means an amount paid to a minister to rent or otherwise provide a home if such amount is designated as rental allowance pursuant to official action taken … in advance of such payment by the employing church or other qualified organization” (emphasis added). Treas. Reg. 1.107-1(b). Similarly, IRS Publication 1828 states that “the minister’s church or other qualified organization must designate the housing allowance pursuant to official action taken in advance of the payment.”
As a result, a housing allowance only operates prospectively, never retroactively. This principle is a corollary of the requirement that a housing allowance is nontaxable only to the extent that it is used to pay for housing expenses. This requirement would be compromised if housing allowances could be designated retroactively, after housing expenses are incurred and paid. In such a case, some or all of the allowance would not be used to pay for housing expenses.
Unfortunately, the IRS audit guidelines for ministers incorrectly state that the housing allowance exclusion “only applies if the employing church designates the amount of the parsonage allowance in advance of the tax year” (emphasis added). It is unfortunate that the IRS audit guidelines for ministers contradict the IRS regulations and IRS Publication 1828. The regulations are more authoritative than the audit guidelines, but many IRS agents will follow the guidelines when auditing ministers, and this will result in the unnecessary denial of a housing allowance exclusion to ministers whose church failed to designate an allowance until after the start of the year.
Under no circumstances can a minister exclude any portion of a housing allowance retroactively designated by a church.
Example. A pastor performed ministerial services for a congregation that provided him with a monthly rental allowance. The pastor excluded the amount of the housing allowance from his gross income each year in question. The pastor and his employing church later asked the IRS if they could amend the amount of the housing allowance to reflect the true cost of providing the home. The church claimed that the amount of the rental allowance was selected without understanding its legal consequences. The IRS rejected the church’s request. It observed, “The church is attempting to increase the amount of the pastor’s rental allowance through official action taken after payments were made. The tax code and regulation are clear in the treatment of rental allowances for ministers of the gospel. The church must designate the amount of its minister’s rental allowance before the minister receives payment for his services. The church may not retroactively increase the amount of the taxpayer’s rental allowance. The minister properly excluded from his gross income the amount of his compensation that was designated as rental allowance by his church in advance of payment.” IRS Technical Advice Memorandum 8120007 (1981).
Example. In preparing his income tax return for 2009, Pastor H discovers that his church failed to designate a housing allowance for 2009. He asks his church board to pass a resolution retroactively granting the allowance for 2008. Such a resolution is ineffective, and Pastor H will not be eligible for any housing allowance in 2009. Hoelz v. Commissioner, 42 T.C.M. 1037 (1981); Ling v. Commissioner, 200 F. Supp. 282 (D.D.C. 1962).
Example. Pastor K was paid a salary by his church, but no portion of the salary was designated by the church as a housing allowance. The Tax Court ruled that Pastor K was not able to exclude any part of the expenses incurred in owning and maintaining his home as a housing allowance, since the church had not designated any portion of Pastor K’s compensation as a housing allowance. Eden v. Commissioner, 41 T.C. 605 (1964).
Example. A church board orally discussed a new minister’s compensation package with him and agreed to pay him a salary of $30,000, out of which $6,250 was designated as a housing allowance. The board’s housing allowance designation was not recorded in the church minutes or in any other writing. The IRS audited the minister and denied any housing allowance exclusion on the ground that no allowance had been properly designated.
The Tax Court disagreed and ruled that the minister was eligible for a housing allowance in the amount of $6,250. It observed: “It is clear that there was discussion about a parsonage allowance for [the minister], and that all of the members of the board of directors [of the church] who testified recollected that he was taking a cut in total compensation to come to their church. The recording secretary, the person whose obligation it was to keep the minutes of the various meetings, had a clear recollection of the discussion and thought that [the minister] was to receive the same amount as a parsonage allowance that he received at [his former church].” The court referred to a 1982 decision (Libman v. Commissioner) in which it ruled that “there is no requirement that the parsonage allowance designation be in writing. Rather, we held, the designation requirement is satisfied upon satisfactory proof of official action.” In the present case, the court concluded that there was sufficient evidence of a proper designation, in advance of the year in question, though never committed to writing. Accordingly, the minister was entitled to the housing allowance exclusion. Kizer v. Commissioner, T.C. Memo. 1992-584.
Example. The IRS ruled that a pastor was not entitled to a housing allowance because there was no evidence that his employing church had designated an allowance for the year in question. In 1982 the church board adopted a motion stating simply that “the pastor’s housing allowance for 1982 will be $10,000.” The pastor claimed a housing allowance of $10,000 in the following year, although the church had not designated such an allowance. The pastor and church maintained that it was their understanding that the 1982 allowance was effective for future years until there was a salary change. As a result, the pastor claimed a $10,000 allowance in 1983. The church board, in 1984, adopted a resolution stating that “the pastor’s salary and housing allowance for 1984 will be the same as 1983.”
The IRS concluded, “You have not furnished any information or documents that show that the church designated a portion of your compensation as rental allowance for the year 1983 pursuant to official action taken in advance of your payments for 1983. In 1984, the church made a retroactive designation that $10,000 of your 1983 compensation was a rental allowance. However, this does not satisfy the requirement of [the tax regulations] that the designation must be made before the payments are made. Accordingly, we conclude that because the rental allowance for 1983 was not designated by official action before it was paid to you, you may not exclude $10,000 from your gross income.” IRS Private Letter Ruling 8511075.
Who Designates the Allowance?
Section 1.107-1(b) of the income tax regulations provides that the term “housing allowance” means an amount paid to a minister to rent or otherwise provide a home if such amount is designated as a housing allowance pursuant to official action taken in advance of the payment of such amounts by “the employing church or other qualified organization.”
Example. An ordained minister was employed as a chaplain by a municipal police department. The police department’s chaplaincy 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 excludible 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 was not eligible for a housing allowance. 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 was also involved in the operation of the police chaplaincy program. If a problem arose concerning a police chaplain, a police department official usually would 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 his salary as a housing allowance was valid. The Tax 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 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. Boyd v. Commissioner, 42 T.C.M. 1136 (1981).
This article was adapted from chapter 6 of Richard Hammar’s Church & Clergy Tax Guide.