What is a Housing Allowance?

A housing allowance is a portion of clergy income that may be excluded from income for federal income tax purposes (W-2 “Box 1” wages) under Section 107 of the Internal Revenue Code. To be eligible, the minister must be a “minister of the gospel” and be ordained, licensed, or commissioned by a church, convention or association of churches.

What is the advantage of declaring a minister’s housing allowance?

The main advantage of declaring a housing allowance is that it helps the minister save the amount of income tax paid. (See the illustration below).

Illustration Example:

Assumptions: Salary of $60,000, tax rate for 2024 is 22% for married filing Jointly, and total housing expenses of $20,000 (rent/mortgage, insurance, taxes, utilities, furnishings, etc.)

Taxes without housing allowance:

• Salary of $60,000
• Taxed on $60,000 * 22%= $13,200
• Owed income tax of $13,200
  

Taxes with housing allowance:

• Salary of $60,000
• Housing allowance of $20,000
• Reduction of taxable income $60,000-$20,000= $40,000
• Taxed on $40,000 * 12%= $4,800
• Owed income tax of $4,800

In this illustration there is a $8,400 tax savings with the Housing Allowance, because the minister’s taxable income is $20,000 less and is taxed in the 12% tax bracket and not 22%.

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Can all church employees have a tax-free housing allowance?

No. Section 107 of the Internal Revenue Code allows only a “minister of the gospel” to have a housing allowance. Thus, only taxpayers who are serving as clergy under IRS rules for tax purposes are eligible for a housing allowance. These rules state that the person must be ordained, commissioned or licensed by the church or denominational authorities and should be performing “ministerial services” such as administering the sacraments, conducting religious worship, or demonstrating management responsibility in a local church or denomination, and be considered as a religious leader by the church and/or denomination. Therefore, a church custodian or administrative assistant cannot have a housing allowance. (Lay employees do get the benefit of having the church pay one half of their social security/ Medicare taxes).

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Can Clergy exclude from gross income the ENTIRE cost of owning, renting and/or furnishing a home?

It depends. The amount that can be excluded from federal income tax is the lesser of:

1. the amount designated as the housing allowance
2. the amount of actual housing expenses, or
3. the fair rental value of the property (furnished, plus utilities)

How is the housing allowance set up?

A minister’s housing allowance must be established or designated by the church or denominational authority. The preferred way to do this is for the appropriate church council, board, or committee to approve the housing allowance prior to each calendar year (or prior to the arrival of a new minister) and record the approval in the minutes of the meeting. In determining the amount of the housing allowance designation, past experience is the best indicator with an added “cushion” included for unanticipated expenses (i.e. repair or replacement of household appliances, etc.) Adding this cushion allows the minister to take full advantage of federal tax savings. Keep in mind that designated housing allowance not used for household expenses becomes taxable.

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What types of housing related expenses can be included in the housing allowance?

While there is no list of allowance expenses provided by the IRS, it is understood that most reasonable household expenses can be included in the housing allowance. Some of these items include - down payment on a home, mortgage payments (including both interest and principal), home equity loan payments (assuming the loan proceeds are used for housing-related expenses), real estate taxes, homeowners’ association dues, property insurance, improvements, pest control, snow removal, maintenance items, and trash pickup. The cost of food and/ or clothing may not be included in the housing allowance. Also, housing-related expenses can only be included in the housing allowance for the year in which they are incurred.

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What type of housing expense records should clergy be keeping?

Ideally, clergy should keep careful housing expense records to determine whether expenses are greater or less than the annual designation. Records are also important for estimating a reasonable housing allowance for the next year. Original receipts, invoices, canceled checks, charge card records, etc. are all essential. To simplify record keeping, some ministers find it helpful to have one charge card or bank account dedicated solely to household expenses, while others simply use financial software or keep all applicable receipts in one handy place.

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What happens if the minister doesn’t spend all of the designated housing allowance on housing expenses?

As noted above, the exclusion from gross income cannot exceed the lesser of the designated housing allowance, the actual housing expenses, or the fair rental value of the property. In particular, the exclusion from gross income can never exceed the actual housing expenses. This means any “unused” portion of the designated housing allowance must be included in the minister’s gross income when filing the annual tax return.

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Can the housing allowance be adopted or amended mid-year?

Yes. The housing allowance resolution can be adopted or amended at any time. However, it can only be applied prospectively. That is why it is important for the housing allowance be adopted by the appropriate church council or committee prior to each new calendar year (or prior to the arrival of a new minister) and for ministers to accurately estimate their housing expenses in advance.

Example: A local church waits until June 30 to establish its calendar year housing allowance of $10,000. In that case, at most $5,000 of the $10,000 housing allowance can be excluded from the minister’s gross income in that calendar year.

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Is the housing allowance excluded from earnings subject to self- employment taxes?

No. The housing allowance exclusion only applies to federal income tax purposes. By law, clergy are considered “dual status” employees. This, in essence, means that while ministers receive W-2s from their employers, they are considered self-employed for the purpose of paying self-employment taxes, unless they have opted out by using Form 4361. Therefore, housing allowance and/or the fair rental value of a parsonage provided to a minister (including the cost of utilities and furnishings provided) must be included as self-employment earnings subject to the self-employment tax. (See IRS Publication 517).

Example: A church pays its minister an annual salary of $35,000 and provides the use of a church-owned parsonage. The church pays all expenses of maintaining the home. The fair rental value of the parsonage (furnished, plus utilities) is $10,000 per year. The minister’s gross income for federal income tax purposes is $35,000, but for self-employment tax purposes the gross earnings are $45,000 ($35,000 salary + $10,000 fair rental value of the parsonage).

Some churches do establish a (taxable) “social security allowance” increasing the cash compensation of the minister to help defray the extra cost of the self- employment tax.

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How is the housing allowance reported for social security purposes?

It is reported by the minister on Schedule SE of Form 1040, line 2, together with salary.

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