Signed into law by the President on May 20, 2002
Article summary. A new law amends the tax code to limit the nontaxable amount of a housing allowance for ministers who own their home to the annual “fair rental value” of the home. This legislation was designed to bring an end to the “Warren case,” in which the Tax Court had ruled two years ago that a 1971 IRS ruling imposing the “fair rental value” limit to ministers’ housing allowances was an unwarranted interpretation of the tax code. The IRS appealed this ruling to a federal appeals court. In a preliminary order, the court indicated that it was going to rule that the housing allowance violates the first amendment’s nonestablishment of religion clause. In response, Congress enacted the Clergy Housing Allowance Clarification Act to resolve the appeal of the Warren case. This article reviews the background of this legislation, and explains its application to ministers.
In 1971 the IRS issued a revenue ruling limiting the nontaxable portion of a church-designated housing allowance for ministers who own their homes to the annual “fair rental value” of the home (furnished, including utilities). However, in a 2000 case (Warren v. Commissioner) the Tax Court struck down the fair rental value test as an unwarranted interpretation of the tax law by the IRS.
The IRS appealed the Tax Court’s decision to the ninth circuit federal court of appeals in California, and the appeals court issued a preliminary ruling on March 5, 2002 ordering the parties (and a law professor) to submit briefs addressing the question of whether the housing allowance is an unconstitutional “establishment” of religion. The court’s order left little doubt that it considered the housing allowance to be unconstitutional. The court’s action was extraordinary, since neither party had ever raised the constitutionality of the housing allowance as an issue in the case.
In response to this threat to the housing allowance, the “Clergy Housing Allowance Clarification Act of 2002” (H.R. 4156) was introduced in the House of Representatives. It was enacted on April 16 by a vote of 408 to 0. The Senate unanimously enacted the same bill on May 2. President Bush signed it into law on May 20.
The Act was passed in order to force a dismissal of the Warren case and deprive the federal appeals court of the opportunity to address the constitutionality of the housing allowance on its own initiative. For the record, no other court has ever even suggested that the housing allowance is unconstitutional since its enactment in 1954, perhaps because there are compelling arguments that can be made to defend its constitutionality.
The full text of the Clergy Housing Allowance Clarification Act is as follows:
SECTION 1. SHORT TITLE.
This Act may be cited as the “Clergy Housing Allowance Clarification Act of 2002”.
SEC. 2. CLARIFICATION OF PARSONAGE ALLOWANCE EXCLUSION.
(a) In General.—Section 107 of the Internal Revenue Code of 1986 is amended by inserting before the period at the end of paragraph (2) “and to the extent such allowance does not exceed the fair rental value of the home, including furnishings and appurtenances such as a garage, plus the cost of utilities”.
(b) Effective Date.—
(1) In general.—The amendment made by this section shall apply to taxable years beginning after December 31, 2001.
(2) Returns positions.—The amendment made by this section also shall apply to any taxable year beginning before January 1, 2002, for which the taxpayer—
(A) on a return filed before April 17, 2002, limited the exclusion under section 107 of the Internal Revenue Code of 1986 as provided in such amendment, or
(B) filed a return after April 16, 2002.
(3) Other years before 2002.—Except as provided in paragraph (2), notwithstanding any prior regulation, revenue ruling, or other guidance issued by the Internal Revenue Service, no person shall be subject to the limitations added to section 107 of such Code by this Act for any taxable year beginning before January 1, 2002.
Will the Act accomplish its purpose of depriving the federal appeals court of jurisdiction over the Warren case? It is too soon to tell. While the government has agreed to dismiss the appeal (as a result of the legislation), the court has not dismissed the case. It is conceivable, given the court’s obvious desire to invalidate the housing allowance, that it will attempt to retain jurisdiction of the case even though there is no existing controversy. This would be an extraordinary act, but so was the court’s decision to address the constitutionality of the housing allowance on its own initiative. As this newsletter was going to the printer, the law professor who was selected by the court to submit a brief addressing the constitutionality of the housing allowance filed a motion to intervene in the case as a taxpayer. We will report any developments in future editions of this newsletter.
Assuming that the the appeals court eventually dismisses the Warren case (or is ordered to do so by the Supreme Court), how does the enactment of this legislation affect ministers who, in reliance on the Warren case, claimed a housing allowance exclusion in 2000 or 2001 in excess of the fair rental value of their home? As noted above, the Act responds to this question with the following two rules:
(1) the fair rental value test is reinstated for tax years after 2001
(2) the fair rental value test is applied retroactively for tax years prior to 2002 only if a minister applied the fair rental value limit in computing his or her taxes for a previous year
Let’s illustrate these rules with a few examples.
Example. In 2000 a retired pastor had $50,000 distributed from his retirement account, and had the entire amount designated as a housing allowance (in reliance on the Warren case). The pastor used the distribution for a down payment on a new home and other housing related expenses for 2000. The fair rental value of the home (furnished, plus utilities) was $20,000. The Clergy Housing Allowance Clarification Act of 2002, which reinstates the “fair rental value” limit on housing allowances, only applies to tax years beginning after December 31, 2001. Since the housing allowance in this example was designated for 2000, the Act does not apply, and the fair rental value limit does not apply in computing the nontaxable amount of the pastor’s housing allowance. The pastor does not need to file an amended tax return since his taxes were correctly reported.
Example. Same facts as the previous example, except that the $50,000 was distributed in 2001. The same analysis would apply. The fair rental value limit would not apply.
Example. Same facts as the first example, except that the $50,000 was distributed in 2002. The nontaxable portion of the retired pastor’s $50,000 housing allowance is limited to $20,000 (the annual fair rental value of his home). As a result, $30,000 of the housing allowance is taxable.
Example. In 2001, a pastor was paid a salary of $50,000, of which $25,000 was designated as a housing allowance. The pastor incurred $20,000 of actual housing expenses in 2001. In preparing his tax return for 2001, the pastor decided to be “conservative,” and applied the “fair rental value” limit in computing the nontaxable portion of his housing allowance. Since he estimated that the fair rental value of his home was $15,000, he only treated this amount as nontaxable, and reported the “excess housing allowance” ($10,000) as taxable. In 2002 the pastor learns about the Clergy Housing Allowance Clarification Act, and would like to file an amended tax return for 2001 computing his housing allowance without regard to the fair rental value limit. May he do so? The answer is no. The Act specifies, “the amendment made by this section also shall apply to any taxable year beginning before January 1, 2002, for which the taxpayer … on a return filed before April 17, 2002, limited the exclusion under section 107 of the Internal Revenue Code of 1986 as provided in such amendment …. ” Since the pastor filed a return before April 17, 2002 that computed the nontaxable portion of his housing allowance on the basis of the fair rental value limit reinstated by the Act, he is not permitted to file an amended return to recompute the nontaxable portion of his housing allowance without regard to the fair rental value limit.
© Copyright 2002 by Church Law & Tax Report. All rights reserved. This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is provided with the understanding that the publisher is not engaged in rendering legal, accounting, or other professional service. If legal advice or other expert assistance is required, the services of a competent professional person should be sought. Church Law & Tax Report, PO Box 1098, Matthews, NC 28106. Reference Code: m96 c0402