How Does the IRS Clergy Housing Allowance Work?

The clergy housing allowance is a tax benefit available to qualifying ministers, allowing them to exclude a portion of their income used for housing from federal income taxes. This provision, found in Section 107 of the Internal Revenue Code, recognizes that a minister’s home is often an extension of their ministry. The allowance is not an additional payment but rather a designated part of a minister’s regular compensation.

Determining Eligibility as a Minister

To qualify for the housing allowance, an individual must first be considered a “minister of the gospel” for federal tax purposes. The IRS evaluates this status based on a series of functional tests of the duties performed, rather than a single title. The criteria include whether the person is ordained, licensed, or commissioned, which serves as a primary indicator of ministerial standing.

The IRS also examines if the person performs certain duties. These include:

• Administering ordinances, such as baptisms or communion
• Conducting religious worship services
• Holding a position of management or authority within the organization
• Being regarded as a religious leader by their church or denomination

An individual does not need to satisfy every test, but a combination of these duties must be present to establish eligibility.

Calculating the Housing Allowance Exclusion

The amount a minister can exclude from taxable income for housing is strictly limited. The excludable amount is the lesser of three specific figures: the amount officially designated in advance by the church, the minister’s actual housing expenses for the year, or the fair rental value of the home, including furnishings and utilities. The minister is responsible for calculating these three amounts annually to determine the correct figure.

Qualifying housing expenses are comprehensive and cover the costs of providing and maintaining a home. These expenditures can include:

• Mortgage payments (both principal and interest) or rent payments
• Property taxes and homeowners’ or renters’ insurance
• The cost of all utilities, such as electricity, gas, water, and trash removal
• Costs for repairs, maintenance, furnishings, and appliances

For example, consider a minister whose church designates $25,000 as a housing allowance. If the minister’s actual housing expenses total $22,000, and the fair rental value of their furnished home plus utilities is $24,000, the exclusion is limited to $22,000. Any designated allowance not used for housing expenses must be reported as taxable income.

Official Designation and Recordkeeping

A requirement for the housing allowance is that the employing church or religious organization must formally designate the amount in advance of it being paid. This designation cannot be made retroactively. The official action is documented in the minutes of a board meeting, an employment contract, or the organization’s budget. Failure to designate the allowance in advance can result in the complete disallowance of the exclusion for that year.

While the church is responsible for the designation, the minister bears the burden of proof for the amount they exclude. This requires meticulous and contemporaneous recordkeeping of all housing-related expenditures. Ministers must retain receipts, bank statements, and other documentation to substantiate the costs. These records are necessary to justify the exclusion if the minister’s tax return is audited, as the IRS can deny the claim without proper documentation, leading to back taxes and penalties.

Tax Reporting and Self-Employment Tax

While the properly calculated allowance is excludable from gross income for federal income tax purposes, it is not excluded from earnings for self-employment tax purposes. Ministers are considered self-employed for Social Security and Medicare taxes, which are paid through the Self-Employment Contributions Act (SECA). The housing allowance must be added back to income when calculating these SECA taxes on Schedule SE of Form 1040.

The employing church reports the designated allowance in Box 14 of the minister’s Form W-2 for informational purposes, but it is not included in the taxable wages in Box 1. If the minister’s actual housing expenses are less than the designated allowance, the minister is required to report the excess amount as taxable income on their Form 1040. This is often done on the “Wages, salaries, tips” line with the notation “Excess allowance.”

Retired ministers may also benefit from this provision. Pension distributions from a denominational retirement plan, such as a 403(b), can be designated as a housing allowance for retired clergy. This allows retired ministers to continue excluding a portion of their retirement income from federal income tax to cover their housing costs, subject to the same “lesser of” calculation rules as active ministers. However, unlike with active ministers, the housing allowance portion of retirement income is not subject to SECA tax.