Background. Ministers do not pay federal income tax on the amount of their compensation that is designated in advance by their employing church as a “housing allowance.” But there are limits. For ministers who own their home a housing allowance is nontaxable only to the extent that it is used to pay housing expenses and does not exceed the fair rental value of the home (furnished, plus utilities).
Sometimes ministers incur more housing expenses than they anticipated during the year, which may mean that their housing allowance is not enough to cover all of their housing expenses. Often this is due to unforeseen housing expenses, or to the purchase of a new home. For whatever reason, if a minister’s housing expenses exceed the church-designated housing allowance, then the minister may not be receiving the full value of this important tax benefit.
Key Point. Many ministers rent a home or live in a church-owned parsonage. The portion of their ministerial income that is designated in advance by their employing church as a housing allowance is nontaxable in computing federal income taxes to the extent it is used to pay housing expenses. For ministers who rent a home, such expenses include rent, utilities, insurance, and furnishings. For ministers who live in a parsonage, such expenses may include utilities and furnishings (if not paid for by the church). Ministers who rent a home or who live in a parsonage may incur housing expenses in excess of their housing allowance. If so, their employing church should consider amending their housing allowance for the remainder of the year.
How church treasurers can help
If your church designated a housing allowance for your minister (or ministers) for 2009, now is a good time to check the adequacy of the allowance. The key point is this—if a minister’s housing expenses are more than expected, and will likely exceed the housing allowance, then the church can amend the allowance to make it larger.
Unfortunately, many church treasurers and church boards do not know that a minister’s housing allowance can be amended during the year. Failing to amend a housing allowance to account for larger-than-expected housing expenses often will mean needless additional taxes for the minister.
Key Point. Amending a minister’s housing allowance costs the church nothing. The church simply redesignates a larger portion of the minister’s salary as a housing allowance. But as noted later in this article, an amended housing allowance is only effective prospectively.
When an amendment may be appropriate
There are a number of reasons why a housing allowance may need to be increased to cover larger than expected housing expenses. Here is a quick checklist of some of the circumstances that may call for a review of the adequacy of a minister’s housing allowance:
- purchase of a new home
- unexpected home repairs
- major remodeling
- purchase of new furnishings
- purchase of new appliances
- the mortgage interest rate under an adjustable rate mortgage is increased
- prepayment of a mortgage loan
- a “balloon” payment on a mortgage loan
- increase in property taxes
- a tax assessment is imposed on the minister’s property to pay for public improvements
- increase in property insurance
- increase in rent (for ministers who rent their home)
To amend your minister’s housing allowance you will need to pay attention to the following rules:
- Proper authorization. Be sure the amended housing allowance is authorized by the same group (usually the church board or congregation) that designated the original housing allowance.
- In writing. Be sure the amendment is duly recorded in the minutes of the group that approves it. The minutes should be dated, and recorded at or shortly after the meeting in which the amendment is approved.
- Prospective application. An amended housing allowance only operates “prospectively.” That is, it takes effect on the date it is approved, through the rest of the year. It cannot apply retroactively. To illustrate, a pastor’s housing expenses turn out to be $15,000 for 2009, but the housing allowance designated by the church was only $10,000. In December of 2009 the pastor asks the church board to retroactively increase the housing allowance for 2009 to $15,000. This cannot be done.
Example. Pastor Dave owns his own home. In December of 2008 his church board approved a compensation package for 2009 in the amount of $45,000. Of this amount, $30,000 was allocated to salary and $15,000 was designated as a housing allowance. The housing allowance was based on Pastor Dave’s estimated housing expenses for 2009. In June of 2009 Pastor Dave purchased a new and more expensive home. This caused his monthly housing expenses to increase by $400. The church board can amend the housing allowance for the remainder of the year by adopting a resolution that designates a larger amount of Pastor Dave’s compensation as a housing allowance for the balance of the year. This will cost the church nothing. It is simply reclassifying some of Pastor Dave’s remaining salary as a housing allowance (rather than salary).
Tip. Here is a sample resolution that the church in the previous example could adopt (prior to July 1, 2009) to amend Pastor Dave’s housing allowance:
“Whereas, the church designated a housing allowance for Pastor Dave for 2009 in the amount of $15,000; and, Whereas, Pastor Dave purchased a new home in June of 2009, resulting in increased housing expenses; and, Whereas, the housing allowance is insufficient to cover Pastor Dave’s increased housing expenses; now, therefore, be it resolved that the portion of Pastor Dave’s total 2009 compensation of $45,000 that was designated as a housing allowance is increased, effective July 1, 2009, from $15,000 to $20,000.”
This resolution will increase the housing allowance available to Pastor Dave for the last half of the year. Note that the increase in Pastor Dave’s housing allowance costs the church nothing. It is simply a reclassification of some of his remaining compensation as a housing allowance. For ministers who own their home, the housing allowance is nontaxable only if it is used for housing expenses and does not exceed the home’s fair rental value (furnished, plus utilities).
What if no housing allowance has been declared? Some churches forget to designate a housing allowance for their minister in advance of the year. After all, few churches have a tax attorney or CPA on their board who is familiar with clergy taxes and so it is understandable that a church board may overlook this task. Is it too late in June of 2009 to designate a housing allowance for a minister? The answer is no, but the allowance may only be used to pay for housing expenses incurred for the remainder of the year. This is simply another way of saying that a housing allowance is nontaxable only to the extent it is used to pay for housing expenses. This requirement cannot be met if a housing allowance is designated or applied retroactively since the expenses already have been paid.
Example. In December of 2008 a church board agreed to pay its pastor a salary of $40,000 for 2009. The board failed to designate a housing allowance. In December of 2009 the board discovers that no housing allowance was designated for 2009. It can designate a housing allowance in December of 2009 that can be used to pay for housing expenses incurred during the remainder of the year, but not for any expenses incurred prior to the date the allowance is declared.
“Safety net” housing allowances
Churches often neglect to designate a housing allowance for their minister. This frequently happens when a new minister is called or hired during the year, but it can also happen when a church inadvertently fails to designate a housing allowance for a minister before the start of a new year. To avoid these omissions, church boards should consider adopting a continuing resolution similar to the following:
Forty percent of the salary of any minister on staff, regardless of when hired, is hereby designated as a housing allowance for the current year and each future year, unless otherwise specifically provided.
The “40 percent” designation is used for illustrative purposes. Churches are free to use a different amount. However, the higher the amount, the more likely it will exceed the fair rental value of a minister’s home.
Tip. Such “safety net” designations should not be used as a substitute for annual housing allowance designations for each minister. They are simply a means of protecting ministers against inadvertent failures by the church to designate a timely housing allowance.
Matching of allowances and expenses
If your church increases a minister’s housing allowance in June of 2009, can the larger amount be applied to higher than expected housing expenses incurred and paid for earlier in the year? To illustrate, assume that in December of 2008 a church agreed to pay its pastor a salary of $30,000 and a housing allowance of $10,000 for 2009. Because of unexpected repairs and remodeling, the pastor incurred $10,000 of housing expenses during the first six months of 2009.
If the church board reclassifies an additional $10,000 of salary as “housing allowance” for the remainder of the year, can the original allowance of $10,000 be applied to all of the expenses incurred during the first half of the year?
Unfortunately, neither the IRS nor any court has addressed this question directly. However, there is a reasonable basis for the conclusion that a housing allowance (including amendments) can apply to all housing expenses incurred after the designation of the allowance, and that no further “matching” of allowances and expenses is required.
In the example just cited, this would mean that (1) the original housing allowance of $10,000 would be nontaxable, and (2) the amended allowance (an additional $10,000) would be nontaxable if used to pay for housing expenses incurred after the date of the amendment. For ministers who own their home, the housing allowance is nontaxable only if it is used for housing expenses and does not exceed the home’s fair rental value (furnished, plus utilities).
RESOURCE. See pages 235-236 in Richard Hammar’s 2009 Church & Clergy Tax guide for additional information on “matching” of housing allowances to housing expenses.
Fair rental value
The tax code limits the nontaxable portion of a housing allowance for ministers who own their home to the lesser of actual housing expenses or the home’s fair rental value (furnished, plus utilities). This directly affects the amount of a housing allowance that is nontaxable, and the same limitation applies to any amendments to a minister’s housing allowance. So, if your minister owns a home, and your church decides this month to increase the minister’s housing allowance for the remainder of the year, keep in mind that the nontaxable portion of the allowance cannot exceed the lesser of actual housing expenses or the fair rental value of the minister’s home (furnished, plus utilities).
Example. In December of 2008 a church board agreed to pay its pastor a salary of $40,000 for 2009, plus a housing allowance of $10,000. The pastor owns his home. In June of 2009 it is clear that the pastor will be incurring more housing expenses than expected for the remainder of the year. The church board reclassifies an additional $10,000 of the pastor’s salary as housing allowance on July 1, 2009 for the remainder of the year. This increases the pastor’s 2009 housing allowance to $20,000. If the fair rental value of the pastor’s home (furnished, plus utilities) is $15,000 in 2009, this is the maximum amount of the housing allowance that he can treat as nontaxable (this assumes that the pastor has actual housing expenses of this much or more).
Example. In December of 2008 a church board agreed to pay its pastor a salary of $40,000 plus a housing allowance of an additional $15,000 for 2009. The pastor owns his home. In June of 2009 the pastor incurs substantial expenses in remodeling his home, and asks the church to increase his housing allowance to $30,000 for the remainder of the year (by reclassifying $15,000 of salary as a housing allowance) to cover the increased expenses. Assume that the pastor incurs housing expenses of at least $30,000 in 2009, and that the annual fair rental value of his home is $20,000. The nontaxable amount of the housing allowance is $20,000.
This article first appeared in Church Finance Today, June 2009.