This article originally ran on June 5, 2015.
By Kimberly Flett
Ministers (defined under federal tax Code Section 107 as “minister of the gospel”) are subject to certain exclusions from federal taxation and an “in-kind” housing allowance under the federal tax Code. Treas. Reg. §1.1402(c)-5 specifically provides a broad definition to include “duly ordained, commissioned, or licensed minister of a church.”
This regulation encompasses a number of faiths and religious sects, as well as ministers performing specific duties related to their role — including religious worship and conduct or maintenance of religious organizations. It does not include other personnel including ministerial staff who are employed by the organization. There are numerous tax court cases involving this subject.
The housing allowance, also known as a “parsonage allowance” specifically designates a tax-free benefit for ministers. This includes church-provided housing and the rental value of a home or apartment. Generally this amount excluded from tax includes the fair market value of the use of the property including rental value or specific related costs. Note the church or religious organization must specifically designate the housing allowance and prorate it for the specific tax year prospectively — either within the annual budget or other specified contract. The amount of the housing allowance is excluded from federal income taxation but subject to Social Security tax.
Under Section 107, the actual amount of the allowance that is not taxable is the lesser of:
1. the actual amount paid for home provisions;
2. the amount of the housing allowance; or
3. the fair rental value of the home including furnishings, utilities and improvements excluding maintenance.
Following is an example:
Wright, an ordained minister, is pastor at local non-denominational church in Oregon. His compensation includes a salary of $75,000 per year and a $35,000 housing allowance. His $35,000 housing allowance is included in Social Security taxable income. The fair value of rental for the home is $27,000 per year. The actual cost of his housing is $20,000 in rental payments, $5,000 in utilities and $3,000 for maintenance. Wright may exclude $27,000 which is the lesser of the three amounts from gross income. Note the difference between the $35,000 of the housing allowance to the $27,000 actually excluded is $8,000 that should be included in Ffderal taxable income.
For qualified plan purposes, the definition of compensation as noted in the plan document is vital for allocations, plan testing and plan matters related to the employee’s use of compensation. This includes 403(b) and 401(k) plans that may each be offered by a church or other religious institution.
In general, the housing allowance is excluded from compensation for qualified plan purposes for the qualified plan and is not a part of includible compensation for 403(b) plans. There are varying schools of thought; however, the plan’s definition of compensation would need to include Social Security taxes in the definition in order to include the value of the housing allowance in compensation. Practically speaking, these amounts should be quantified accurately, including a fair value measurement, and therefore often is better excluded.
The self-employment income is calculated by adding income related to the church activity, such as W-2 wages, Schedule C income, the housing and any auto allowance. This is reported on Form 1040 for Schedule SE income. Note Form W-2 issued to a minister should be prepared properly to reflect the Federal taxable income and adjustments for Social Security.
Retired ministers are afforded similar treatment in terms of the housing allowance exclusion. The fair value of the housing allowance or similar cost is excluded from the retired minister’s self-employment earnings, even if incurred after retirement. Additionally, a retired minister may receive a housing allowance as part of pension benefits in a qualified plan. Note this does not apply to the surviving spouse. The exclusion for retired ministers applies also to the self-employment tax as well as federal tax. If the distributions post retirement are designated in the plan document, or through board resolution, to the extent used for housing costs, they are tax-free.
Qualified plan practitioners can refer further to IRS Publication 517 for detailed examples and explanations regarding the housing allowance for ministers. Proper planning can assist in qualified plan designs that will provide retirement benefits for these taxpayers with special tax issues.
Kimberly Flett is Senior Director at STS Compensation and Benefits.
Opinions expressed are those of the author, and do not necessarily reflect the views of NTSA, or its members.