#1 Tax Benefit for Qualified Ministers: Housing Allowance pt. 1
This is one of the most misunderstood aspects of minister compensation. I am going to cover three areas that I hope will help make it a little less complicated for you.
Let’s begin with the Who & Why of Housing Allowance.
The who are qualified ministers according to the IRS. The definition of such is as follows:
“Ministers are individuals who are duly ordained, commissioned, or licensed by a religious body constituting a church or church denomination. Ministers have the authority to conduct religious worship, perform sacerdotal functions, and administer ordinances or sacraments according to the prescribed tenets and practices of that church or denomination. If a church or denomination ordains some ministers and licenses or commissions others, anyone licensed or commissioned must be able to perform substantially all the religious functions of an ordained minister to be treated as a minister for social security purposes.”
The first thing you need to know is that the IRS decides who qualifies, not the church or the minister.
Now that we know who qualifies, why does it matter? Because of the ability to claim a Housing Allowance. This benefit, if properly designated, can be worth thousands in tax savings to the minister if he owns or rents a home. Why? The allowable housing deduction is NOT subject to Federal Income tax! Talk about a huge benefit! Nearly all ministers should have a portion of their pay designated as housing. The key however, is to make sure that the housing allowance is properly designated AND reported to the minister.
How to Properly Designate and Report the Housing Allowance
The most important thing that you need to ensure is that the housing allowance is officially approved and documented by the church in writing IN ADVANCE of the minister receiving the first housing allowance payment. You can do this as an official action of the governing board or by a church vote at a business meeting and recorded in the meeting minutes. The IRS has also recognized the Housing Allowance in a ministers’ employee contract or a budgeted line item AS LONG AS these items are adopted by the church board or approved at a business meeting. (There’s that written documentation thing again 😊)
This needs to be done annually if the housing will change in the coming year, OR you can put the following verbiage in to ensure the legality of the housing allowance from year to year until it needs to be changed. Make sure to carefully word the resolution so that it will “remain in effect until a subsequent resolution is adopted” or something similar to that. Again, the key is that it MUST be written and approved BEFORE the payment can be made.
Now that you have it properly designated, let’s make sure that you are reporting it correctly on the year-end tax reporting form. Because of the dual-tax status of qualifying ministers, nearly every minister is considered an employee for wages and therefore, their wages should be reported on Form W-2 at the end of the year. The Housing should be deducted from their wages received and reported in Box 14 of the W-2. Box 1 of the W-2 should contain the taxable portion of the salary. You may also issue a separate statement on church letterhead stating the amount of the ministers designated Housing for the year. Do NOT issue a minister a 1099-NEC as that is incorrect and will cause Federal Income taxes to be calculated on the income listed in Box 1. 1099-NEC’s are for non-employee compensation and ministers are considered employees for income purposes according to the IRS.
Now that we’ve gotten the correct designation reported properly and to the minister at year-end, how does he properly claim the Housing Allowance deduction on his tax return?
Claiming the Housing Allowance on the Minister’s Tax Return
Hopefully, the minister is using a tax preparer well educated in the unique nuances of minister taxation. Let’s assume they do.
To calculate the allowable housing deduction on the tax return, you need to follow these criteria. The IRS goes by the “Least of 3” rule. These three rules are:
1. Properly designated housing allowance
2. Actual allowable housing expenses
3. Fair Rental Value + furnishings + utilities
The least dollar amount of the three items listed above is what is allowed to be excluded from Federal Income tax calculations. The full amount of Housing received is subject to self-employment taxes. Any excess Housing received from the church above the allowable amount WILL be subject to Federal Income taxes. The extra will flow through to Line 7 on Form 1040 and “excess housing” will print on the return to show that some of it was taxable.
Before we go, let’s touch on the Fair Rental Value (FRV). This is the most overlooked in the “least of 3” list. But this item is listed in 26 US Code Section 107 so the IRS takes it seriously and so should you. The determination of the FRV is the ministers responsibility. The best and easiest way get this done is to hire a local realtor and get them to give you an estimate on your home in writing. Keep a copy of the written estimate for your records, and give a copy to your tax preparer for their permanent file. I recommend that you do this every 3-5 years and/or as the housing market changes.
There are currently no provisions in the tax code to allow you to carry over any “unused” housing expenses to the next year.
And that’s a wrap for today’s post. I pray that it has been helpful to you and that you can apply something I shared here to make your life a little easier.
Until next time…. Be blessed!