Rasmussen v. Commissioner, T.C. Memo. 1994-311.
Background. Ministers are able to exclude from their income (for federal income tax reporting purposes) that portion of their compensation that is designated by the church as a housing allowance—to the extent they in fact use the allowance “to provide a home.” The biggest expense for most ministers who own their homes is their monthly mortgage payment. When ministers who own their homes pay off their mortgage loan they lose a big housing expense and reduce the value of the housing allowance. Many of these ministers have obtained home equity loans, or a conventional loan secured by mortgage on their otherwise debt-free home, in order to include their loan repayments as a housing expense. The argument is this—since these loans are secured by a mortgage on the minister’s home they are a legitimate housing expense since the minister will lose the home if the loan is not paid. The IRS issued a ruling in 1991 that disallowed this practice. The Tax Court recently addressed the same issue and agreed with the IRS position.
The IRS ruling. In 1991 the IRS ruled that ministers cannot take into account home equity loan payments or payments on a personal loan secured by a mortgage on a home that is otherwise owned debt-free as legitimate housing-related expenses in computing the housing allowance.
Example. Rev. C is paid salary of $30,000 for 1994 plus a housing allowance of $10,000. Rev. C has housing expenses of $10,000, consisting of mortgage payments on a conventional home loan of $6,000, utilities of $2,500, and property taxes and insurance of $1,500. Rev. C can claim the full church-designated housing allowance as an exclusion from taxable income for income tax reporting purposes since he has housing-related expenses of at least this amount.
Example. Same facts as the previous example, except that Rev. C pays off his home mortgage loan. Rev. C is still eligible for a housing allowance, but it is excludable only to the extent of his actual housing-related expenses of $4,000. As a result, $6,000 of the housing allowance represents taxable income.
Example. Same facts as the previous example, except that Rev. C obtains a loan, secured by mortgage on his home, to pay for various personal expenses (a car, a vacation, a child’s college education, and various medical bills). The loan payments amount to $6,000 in 1994. Rev. C cannot include any portion of the $6,000 in computing his housing allowance exclusion for the year, since these are not an expense of providing a home. Rev. C’s housing allowance exclusion (the amount by which he can reduce his taxable income) is $4,000 (utilities, property taxes and insurance). The “excess housing allowance” of $6,000 must be reported as taxable income.
Example. Same facts as the previous example, except that Rev. C obtains a loan, secured by a mortgage on his home, to pay for remodeling expenses and furnishings. The full amount of these loan payments can be considered in computing Rev. C’s housing allowance for the year.
The IRS ruling was predictable, but its reasoning was questionable. After all, if a minister defaults on a home equity loan, or on a personal loan secured by a mortgage on his or her home (that is otherwise debt-free), the lender has the legal authority to sell the home in a foreclosure sale. For this reason it has been difficult to understand the IRS position that the threat of foreclosure does not make such loan payments an expense of “providing a home” as required by federal tax law. More clarification was needed, and the Tax Court responded in a recent ruling.
The Tax Court’s decision. The facts in the recent Tax Court ruling are simple. A Baptist minister bought a home in 1970 for $50,000. He financed the purchase through a mortgage loan, and had annual loan payments of $3,000. Between 1982 and 1986 the minister received $108,000 in personal loans from his church to assist him in paying various personal expenses (including medical bills, education expenses, and taxes). The church loans provided for interest rates “equal to current Treasury Bill rates.” Each year the church loan committee prepared a written acknowledgement stating that the loans were “deemed by the parties to be secured by a non-recorded deed of trust on the [pastor’s home].” Other than these acknowledgments, there were no documents purporting to be a mortgage held by the church on the pastor’s property. The church did not receive an appraisal of the property nor did it make any inquiry regarding title to the property. The church board designated large housing allowances for the pastor each year. The allowances were large enough to cover not only the pastor’s annual home mortgage loan payments of $3,000, but also miscellaneous housing expenses and repayments of the personal loans from the church. The IRS audited the minister and refused to let him count the loan repayments to the church in computing his housing allowance exclusion. The minister appealed to the Tax Court.
The minister claimed that he was entitled to include the loan repayments to the church in computing his housing allowance. He pointed out that the church loans were secured by a mortgage on his home and accordingly the repayments were payments to provide a home. The IRS countered by insisting that there was insufficient proof that the church loans in fact were secured by a mortgage on the pastor’s home. And, even if there were, the payments on the church loans were not used to “provide a home” as required by federal law.
Key point. The IRS relied on a 1984 Tax Court ruling in which the Court observed: “Congress intended to exclude from the minister’s income only that portion of his compensation paid by the church which was actually used by the minister for the purposes of renting or otherwise providing a home for himself.”
The Tax Court, in rejecting the pastor’s position, concluded:
Exemptions from gross income are to be construed narrowly … and [federal law does not] provide for the exclusion of payments on loans secured by a home if they are not used to “provide a home.” The proceeds of the church loans were used to pay personal expenses of [the pastor and his wife] unrelated to their home. Thus, even assuming that the loans were secured by the [pastor’s home, he has] not shown that the portion of the parsonage allowance used to repay the church loans was used for the maintenance or purchase of the home. On the record before us, we hold that [the pastor and his wife] have not proven that the portion of the parsonage allowance used to repay the church loans was used to provide a home as required by [federal law].
Significance to church treasurers. What is the significance of this ruling to church treasurers? Consider the following:
• Housing allowance designations. Church treasurers should alert ministers that they should not include loan payments in computing their housing allowance exclusion for 1994, even if the loan is secured by a mortgage on the minister’s home, unless the loan is “to provide a home.” According to the Tax Court, this refers to housing-related expenses. Ministers also should be advised not to take into account these kinds of loan repayments when estimating their housing allowance for 1995. If your church has developed a form for ministers to use in estimating their housing expenses each year, be sure to modify the form to clarify that these kinds of payments are not to be considered.
Key point. Ministers who have paid off their home mortgage loan and who later obtain a loan secured by a mortgage on their otherwise debt-free home may include their loan repayments in computing their housing allowance so long as the loan is used for housing expenses. The Tax Court conceded as much. Any form used by ministers to estimate their housing allowance should make this important distinction.
• Amending a housing allowance. If your minister has been treating repayments of personal loans as “housing expenses” for purposes of computing the housing allowance exclusion, you may want to consider amending the church’s housing allowance designation for 1994. While this is not necessary, it may result in a much more realistic amount. This in turn may reduce the “excess housing allowance” (the amount by which the church designated housing allowance exceeds actual housing expenses) that the minister must report as additional income on Form 1040.
• Gardening expenses. There is one additional aspect of the court’s decision that is worth mentioning. The court noted that the IRS had conceded on appeal that the minister was able to include, in computing his housing allowance exclusion, “other payments for providing a home such as maintenance, utilities, and gardening services.” In the past it has been unclear whether or not ministers can consider gardening services as housing expenses for purposes of computing their housing allowance exclusion. While this reference by the court to the IRS position on appeal does not constitute an authoritative pronouncement on this issue, it provides some support for this position. Once again, churches that use forms for computing a minister’s estimated housing expenses may want to add this item to the list of expenses.
This article originally appeared in Church Treasurer Alert, October 1994.