Section 107 of the Internal Revenue Code for Clergy Housing

Section 107 of the Internal Revenue Code provides a tax benefit for qualifying ministers, also known as the clergy housing or parsonage allowance. This provision allows ministers to exclude a portion of their compensation from what is reported as gross income for federal income tax purposes. The allowance is intended to cover expenses related to providing a home. This tax benefit is an exclusion from income, not a deduction, meaning the amount is removed from income before taxes are calculated.

Qualifying as a Minister for Tax Purposes

To be eligible for the housing allowance, an individual must meet the IRS definition of a “minister of the gospel” for tax purposes. The IRS evaluates several factors to determine if an individual qualifies for this status. While no single factor is determinative, the IRS looks for evidence of performing ministerial services. The five indicators the IRS reviews are:

• Is ordained, licensed, or commissioned
• Has the authority to administer ordinances or sacraments
• Conducts religious worship
• Holds a management position within the church or a related denominational body
• Is recognized as a religious leader by their church or denomination

An individual does not need to satisfy all five criteria, as the IRS considers the complete picture of a person’s duties. For example, a commissioned minister of music who leads worship but does not administer sacraments may still qualify if other factors are met. Simply having the title of “minister” from a church does not automatically grant eligibility for the housing allowance. The duties performed must align with those the IRS associates with ministerial functions, and individuals such as church secretaries or custodians are not eligible for this tax benefit.

Understanding the Two Forms of Housing Benefits

The clergy housing benefit under Section 107 can be provided in one of two primary forms. The first is a cash housing allowance, where the employing church designates a portion of the minister’s compensation for housing. With this allowance, the minister is responsible for securing and paying for their own residence, whether through renting or owning a home.

The second form is an in-kind benefit known as a parsonage, where the church provides the minister with a furnished home to live in rent-free. The term “home” includes the primary dwelling, associated structures like a garage, and other appurtenances. Ministers in a church-provided parsonage may also receive a cash allowance to cover expenses not paid by the church, such as utilities or furnishings.

Calculating the Maximum Exclusion

The excludable portion of a cash housing allowance is limited to the lowest of three specific amounts:

• The amount officially designated in advance by the employing church as the housing allowance.
• The minister’s actual housing expenses paid during the year, which can include rent or mortgage payments (both principal and interest), real estate taxes, property insurance, utilities, furnishings, and costs for repairs and maintenance.
• The fair rental value of the home, including furnishings, plus the cost of utilities.

A minister must calculate all three figures and can only exclude the smallest from their federal income tax. For instance, if a church designates $20,000, actual costs are $18,000, and the fair rental value is $19,000, the maximum exclusion is $18,000. Any portion of the designated allowance that exceeds the excludable amount must be reported as taxable income.

If a minister lives in a church-owned parsonage, the amount excluded from income is the fair rental value of the property, but this cannot be more than the reasonable pay for the minister’s services. The responsibility for determining the correct excludable amount rests with the individual minister, not the church.

Official Designation and Tax Reporting

For the housing allowance to be valid, it must be officially designated by the employing church before the compensation is paid. This designation must be made in advance, before the start of the calendar year, and documented in writing. Examples of proper documentation include an employment contract, church board meeting minutes, or the official church budget.

When it comes to tax reporting, the minister’s taxable salary is reported in Box 1 of their Form W-2. The designated housing allowance is often shown for informational purposes in Box 14. An aspect of the housing allowance is its treatment for self-employment taxes. While the properly calculated allowance is excludable from federal income tax, it is not excludable from the Self-Employment Contributions Act (SECA) tax.

Ministers are considered self-employed for Social Security and Medicare purposes. Therefore, they must add the excludable portion of their housing allowance back to their income when calculating self-employment tax. This calculation is performed on Schedule SE (Form 1040).