What Is the Clergy Housing Allowance Clarification Act?

The clergy housing allowance is a tax benefit for qualifying ministers, allowing them to exclude a portion of their income designated for housing from federal income taxes. This provision, found in Section 107 of the Internal Revenue Code, has faced legal questions regarding its limits. To address this, Congress passed specific legislation to provide a clear boundary on the amount that can be excluded.

The Core Clarification of the Act

The Clergy Housing Allowance Clarification Act of 2002 was enacted to resolve uncertainty surrounding the maximum value of the housing allowance. Prior to this act, there was no explicit statutory limit, which led to questions about its proper application. The legislation amended the Internal Revenue Code to establish a clear ceiling on the amount a minister can exclude from their gross income.

The Act stipulates that the housing allowance exclusion cannot exceed the “fair rental value” of the home. This valuation includes the primary residence, furnishings, and related property features, such as a garage. Additionally, the fair rental value calculation incorporates the cost of utilities, which provided a definitive cap on the tax benefit.

Determining the Housing Allowance Amount

A minister’s ability to exclude income for housing is governed by a three-part calculation. The amount that can be excluded from federal income tax is the lesser of three figures. The first is the amount formally designated in advance as a housing allowance by the employing church or religious organization before the compensation is paid.

The second figure is the minister’s actual housing expenses for the year. These expenses can encompass a wide range of costs, including:

• Mortgage payments (principal and interest) or rent payments
• Real estate taxes and property insurance
• Utilities such as electricity, gas, and water
• Costs for repairs, maintenance, and furnishings

The third and final figure is the fair rental value of the home, including furnishings and utilities, as established by the Clarification Act. For instance, if a church designates $30,000 as a housing allowance, the minister’s actual housing expenses total $28,000, and the fair rental value of their furnished home plus utilities is $26,000, the minister can only exclude $26,000. The lowest of these three amounts is the maximum exclusion permitted under the law.

Designation and Reporting Requirements

For the housing allowance to be valid, it must be officially designated by the employer before it is paid, and this designation cannot be made retroactively. The employing church or organization should formally document the allowance amount in its official records, such as board meeting minutes, an employment agreement, or a compensation resolution.

When it comes to tax reporting, the designated housing allowance is not included in the taxable wages reported in Box 1 of Form W-2. The employer may, for informational purposes, report the designated amount in Box 14 with a description like “Housing Allowance.”

The minister is responsible for determining the actual excludable amount. If the designated allowance exceeds the amount that can be legally excluded, the minister must report the difference as “Other income” on their Form 1040. This ensures that any portion of the allowance that does not qualify is properly subjected to income tax.

Interaction with Self-Employment Taxes

The clergy housing allowance is treated differently for self-employment tax purposes. While the allowance can be excluded from gross income for federal income tax, this exclusion does not apply to self-employment taxes under the Self-Employment Contributions Act (SECA).

Ministers are generally considered self-employed for Social Security and Medicare purposes. Consequently, the full amount of the designated housing allowance, in addition to their regular salary, must be included as earnings from self-employment. This total figure is used to calculate their self-employment tax liability on Schedule SE (Self-Employment Tax), which is then filed with their Form 1040. Failure to include the housing allowance in this calculation can result in an underpayment of SECA taxes.