It’s unclear what direction Congress will take on controversial tax issues in 2017; one area is the clergy housing allowance—also known as the parsonage exemption. Congress could propose to keep, amend to better describe the nature and scope or repeal the current housing allowance exemption. The housing allowance’s constitutionality also could be reviewed by the U.S. Supreme Court.
Internal Revenue Code (IRC) Section 107 defines clergy housing allowances, stating, “In the case of a minister of the gospel, gross income does not include the rental value of a home furnished to him as part of his compensation; or the rental allowance paid to him as a part of his compensation, to the extent used by him to rent or provide a home 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.”
Excluding the housing allowance from a minister’s income should be designated in advance of the payment and noted in the minutes of the church’s board or finance committee as a housing allowance. While all of a minister’s compensation could be designated as housing allowance, it may not be excluded from income. IRS Publication 517, Social Security and Other Information for Members of the Clergy and Religious Workers, provides guidance on calculating the housing allowance amount excluded from income tax. The minister is responsible for calculating the amount incurred for providing a home. The allowance includes expenses such as rent, cost of purchasing a home, taxes, utilities, insurance and repairs.
Qualified housing allowance payments are excluded from federal income tax, but still included in the Social Security and Medicare tax computation. Generally, housing allowance payments also are exempt from state income tax.
This allowance also can apply to retired ministers. The church board or designated church retirement plan can continue to designate all or part of their pension distributions as housing allowance.
The Freedom From Religion Foundation (FFRF) and others have challenged the housing allowance exclusion. In Freedom From Religion Foundation, Inc. v. Lew 114 AFTR 2d 2014-6570, FFRF challenged IRC §107’s constitutionality. The court concluded FFRF lacked the standing to challenge the clergy housing allowance. In this case, FFRF had paid its co-presidents a portion of their salaries as a housing allowance, but the co-presidents didn’t deduct this as a minister’s housing allowance on their personal returns. The court found they weren’t harmed from a tax standpoint and, therefore, dismissed the case. FFRF renewed its case against the minister’s housing allowance in 2016. Part of the case was dismissed again for lack of standing, but their constitutional challenge to the housing allowance was able to proceed.
The emergence of nontraditional churches also raises questions about the allowance’s nature and scope. The definition of minister must be considered. In general, there are five factors to determine a minister of the gospel. These factors require an individual to:
- Administer sacraments
- Conduct religious worship
- Be responsible for management duties
- Be ordained, commissioned or licensed
- Be considered a religious leader by the church or denomination
Since there’s no dollar cap on the housing allowance, some ministers can exclude significant amounts. The congressional Joint Committee on Taxation has reported the housing allowance amounts to about $700 million a year in lost revenue.
A possible outcome is a legislative amendment that caps the housing allowance and defines a more stringent set of tests for religious organizations and their ministers. Change also could come from judicial action challenging the allowance’s constitutionality. Ultimately, however, Congress could decide to not take any action on this particular issue.
Contact your BKD advisor if you have questions.