Do Pastors Pay Taxes on Housing Allowance?

A minister’s housing allowance is a specific tax provision that often leads to questions regarding its taxability. Understanding the applicable rules and conditions is important.

Defining a Minister’s Housing Allowance

A housing allowance, also known as a parsonage or rental allowance, is an amount paid to a minister as part of their compensation specifically designated to cover housing expenses. Internal Revenue Code Section 107 allows for the exclusion of these costs from a minister’s gross income for federal income tax purposes. The historical purpose behind this tax provision was to create a more equitable tax situation for ministers who arrange their own housing compared to those who reside in church-provided parsonages.

To qualify for this allowance, an individual must meet the Internal Revenue Service’s (IRS) definition of a “minister of the gospel.” This includes individuals who are ordained, commissioned, or licensed by a religious body and perform ministerial services. Such services typically involve performing sacerdotal functions, conducting religious worship, or administering sacraments. The minister’s services must be directly related to the religious organization’s purposes.

Conditions for Tax Exclusion

While a housing allowance is excluded from federal income tax, it is subject to self-employment (SE) tax. Ministers are considered self-employed for Social Security and Medicare tax purposes, so the housing allowance, along with their salary, is subject to SE tax.

To exclude the housing allowance from federal income tax, specific conditions must be met. The employing church or organization must officially designate the amount as a housing allowance before payment. Retroactive designations are not permitted. The minister must then use these funds for actual housing expenses.

Eligible housing expenses are broad and include costs such as rent or mortgage payments, real estate taxes, property insurance, and utilities. The purchase or rental of appliances and furnishings, along with remodeling expenses and home repairs, can also qualify.

The amount excluded is limited to the least of three figures: the designated housing allowance, the amount actually used for housing expenses, or the fair rental value (FRV) of the home, including furnishings and utilities. The FRV represents what the home would rent for on the open market. If the designated allowance or FRV exceeds actual housing expenses, the excess must be included as taxable income on the minister’s individual tax return.

Designation and Record Keeping

Designation of a minister’s housing allowance is required for both the employing organization and the minister. The church or religious organization must make the designation through an official action, such as a resolution or employment contract. This must occur before payments are distributed, as retroactive designation is not allowed. Written documentation is highly recommended.

Ministers must meticulously track and substantiate all housing expenses. This requires maintaining thorough records, including receipts, invoices, and bank statements for eligible costs. These records are essential for determining the excludable amount and supporting claims during an IRS inquiry or audit.

The housing allowance is not included in Box 1 of Form W-2 for federal income tax purposes. It may be reported in Box 14 of Form W-2 or on a separate statement. For self-employed ministers, the housing allowance is included when calculating self-employment tax on Schedule SE. Any portion of the designated allowance that cannot be excluded due to exceeding actual expenses or fair rental value must be reported as additional income on Form 1040.