The housing exclusion has been characterized as the most important tax benefit available to ministers. There are two commonly encountered situations in regard to housing for a minister. In the first case, the minister lives in church-provided housing. While this was quite common in the past the number of churches providing a parsonage for the pastor has declined significantly in recent years.
Under these arrangements, a minister lives in the parsonage without charge. In some cases, the church will also provide a housing or utility allowance to cover expenses incurred by the minister in maintaining the home. The value of the provided housing and allowance are not subject to income tax, but the fair rental value plus any allowance amount are subject to self-employment taxes.
In the second case, the minister owns or rents his or her home. This approach allows a minister to designate a portion of salary as housing allowance. Qualified housing expenditures up to the designated amount will not be subject to income tax, but are subject to self-employment taxes, as with a parsonage. The amount of the housing allowance that may be excluded from income tax is limited to the lesser of:
1. The amount used to provide a home from current ministerial income,
2. The amount designated as housing allowance by an appropriate church body,
3. Reasonable compensation or,
4. The fair rental value of the furnished home plus utilities.
The amount to be designated as housing allowance should be set in advance at the beginning of each year. This amount can be increased or decreased during the year, but only prospectively. A retroactive housing allowance change is not permitted. Any amount designated as housing allowance not spent on housing reverts to regular income, subject to income and self-employment taxes. This excess would be included on line 7 of the 1040. Since the only consequence of having too much housing allowance is that it is subject to income tax, it would be better for the minister to overstate the housing allowance amount. This helps avoid having housing expenditures that exceed the designated amount.
There is no limit on the percentage of the minister’s salary that may be designated as housing allowance. This is particularly relevant for a bi-vocational minister who receives a relatively small salary from the church while having full-time secular employment.
The housing allowance may include the following:
1. Rent or principal payments, cost of buying a home, and down payments.
2. Real estate taxes and mortgage interest. These are also deductible on Schedule A, resulting in a deduction for non-taxable income.
3. Homeowner’s insurance.
4. Repairs, improvements, and upkeep of the home and its contents.
5. Furnishings and appliances.
8. Cleaning supplies, lawn care, landscaping and tools, etc.
The minister should keep account of housing expenditures in order to demonstrate to the church, tax preparer, and the IRS that the amount of the housing allowance was actually spent on allowable housing expenditures. It is not required to submit this to the church, but can be used to demonstrate the amount of housing expenditures incurred by the minister.
A minister may not claim a housing allowance for more than one home. A 2010 court decision ruled that this was permissible, but it was reversed on appeal in 2012. The Supreme Court declined to hear the case, leaving the appeals court ruling intact.
Retired ministers who receive a pension from a denominationally-sponsored retirement program may designate a portion of the pension as housing allowance. Likewise, an amount paid to a retired minister by a church may be designated as housing allowance.
There are some legal issues relating to the housing allowance, as it has been challenged in more than one court case. The resolution of these cases has not been finalized at this time.