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Lane
Lane, JD, CFP, MBA, CRPS
Category: Tax
Satisfied Customers: 10108
Experience:  Law Degree, specialization in Tax Law and Corporate Law, CFP and MBA, Providing Financial & Tax advice since 1986
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A minister friend of mine was told by s tax preparer that he

Customer Question

A minister friend of mine was told by his tax preparer that he could take a housing allowance and save money. His church only paid him w2 income-- no housing or parsonage allowance. Is this legit? Can you just reclassify w2 minister income as housing allowance. Or is this just a form of cheating?
Submitted: 9 months ago.
Category: Tax
Expert:  Lane replied 9 months ago.

Hi,

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No this is complete legitimate, (THe tax policy here has it's origins in the separation of church and state).

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Although it's excluded from income for income tax purposes, it is still subject to self - employment tax.

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Here the guidance from IRS: https://www.irs.gov/Help-&-Resources/Tools-&-FAQs/FAQs-for-Individuals/Frequently-Asked-Tax-Questions-&-Answers/Interest,-Dividends,-Other-Types-of-Income/Ministers'-Compensation-&-Housing-Allowance/Ministers'-Compensation-&-Housing-Allowance

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From there:

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"A minister's housing allowance (sometimes called a parsonage allowance or a rental allowance) is excludable from gross income for income tax purposes but not for self-employment tax purposes."

Expert:  Lane replied 9 months ago.

Sorry ... meant to provide that as a link:

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https://www.irs.gov/Help-&-Resources/Tools-&-FAQs/FAQs-for-Individuals/Frequently-Asked-Tax-Questions-&-Answers/Interest,-Dividends,-Other-Types-of-Income/Ministers'-Compensation-&-Housing-Allowance/Ministers'-Compensation-&-Housing-Allowance

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Expert:  Lane replied 9 months ago.

(sorry looks like the link pasted option isn't working tonight) you'll need to copy and paste that into your browser)

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But yes the housing allowance for ministers is an age old tax incentive.

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I hope this has helped.

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Please let me know if you have any questions at all.

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If this HAS helped, and you DON’T have other questions … I'd really appreciate a positive rating (using the rating request, faces, or stars on your screen)

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That's the only way I'll be credited for the work here.

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Thank you!

Lane

Customer: replied 9 months ago.
Thank you for your response. For a while i was somehow unable to respond. And i had a follow up question.I understand that Ministers can be given a housing allowance. What not understand is they can claim a housing allowance even if they are not given one. If they ke w-2 income and create a housing allowance out of that, I would need to know how to do that.can that.
Expert:  Lane replied 9 months ago.

Yes, the housing allowance comes as an adjustment to income (adjustments to income section of the 1040) you might want to take a look at the 1040: https://www.irs.gov/pub/irs-pdf/f1040.pdf (Line 21) if it wasn't excluded on the W-2

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Here are the turbotax instructions, as an example:

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Enter your W-2 clergy earnings in TurboTax on the W-2 Summary screen under the Wages & Salaries – Form W-2 area. If you report clergy income and your employer does not pay Social Security and Medicare tax, you must pay these taxes yourself in the form of self-employment tax or have an exception.

On the W-2 entry screen, if you have an amount in your W-2 box 14 for your Clergy Housing Allowance, enter the amount with a description (clergy housing), then click Continue.

  1. On the Let's Review Your Box 14 screen, select Other-not on the above list and click Continue.
  2. On the Do Any of These Apply to This W-2? screen, check the I earned this income for religious employmentbutton, then click Continue.
    NOTE: Do not check this box if your W-2 has Social Security tax withheld in box 4 and Medicare taxes withheld in box 6.
  3. On the About Your Religious Employment screen, if you are clergy check the option You earned this income for clergy employment and click Continue.
  4. On the Tell us about your Clergy Housing screen be sure to enter amounts in both boxes, then click Continue.
    The amount of your housing allowance that exceeds your Qualifying Expenses will be treated as income.
  5. On the next screen, Clergy Self-Employment Tax, select the option that applies to you, then click Continue to return to the W-2 Summary screen.

If your W-2 box 1 income was not adjusted for your housing allowance, continue with the Enter Exception Informationsection below to enter a Form 1040 Line 21 Adjustment to Income.

Customer: replied 9 months ago.
Thank you. Unforunately per IRS Pub 517 "The church or organization that employs you must officially designate the the payment as a housing alloowance before it makes the payment. It cannot determine the amount of housing allowance at a later date. If the church or organization does not officially designate a definite amount as housing allowance, you must include your total salary in your income." So it does not do my client much good for this year. Do you agree? Or m I missing something?.That being said, it might be wise if he set it up for next year. His church has a weekly pay system,I re not set salary. It depends on how much he ministered and how much the church made. The drawback for him on this is he take housing allowance, he pays the Employer 7.65 % FICA. He has a second income and likely his housing allowance is less than his housing expense. Could his church designate his pay as housing allowance? What would be the logistics of this? If this is not your area of expertise, fine. I will give you 5 stars for your good work so far. I recognize I may be a big afield.
Expert:  Lane replied 9 months ago.

CPA, Bill O’Connell, a well know practitioner in this arena says the following:

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“Most bi-vocational (or poorly paid) clergy should not be receiving salary – only housing allowance. Thus some churches may be able to stop running payroll all together – at least until they pay more than the pastors housing allowance.

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... a very good fit, it seems, with your situation. ... Further I agree; What the IRS says in it's positions are simply that positions. IRS did not write the tax code, Congress did. ... and the number of US tax court cases, federal district court, and US supreme court cases that overrule the commissioner (IRS) shows that they many times (1)get the legislative intent wrong and (2) don't clearly specify (relying on their standard "facts and circumstances" mantra) what's actually needed to evidence something.

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For example there was a time when receipts were a must. Now IRS' position on many things, such as mileage, is that it simply need be in writing (which of course can be created between the time of an audit notice and and audit)

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In THIS case I would submit that you have both:

(1) Congressional intent with the housing allowance was to be able to provide something non-taxable to the minister when that's the best the church could do, and

(2) What does officially designate mean?

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Section 107 of the Internal Revenue Code states the following:

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“In the case of a minister of the gospel, gross income does not include (1)the rental value of a home furnished to him as part of his compensation; or

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(2)the rental allowance paid to him as a part of his compensation, to the extent used by him to rent or provide a home and to the extent such allowance does not exceed the fair rental value of the home, including furnishings and appurtenances such as a garage, plus the cost of utilities."

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The rest of this is IRS taking a position .. this is WHY the intuit folks provide the method for going back and adjusting the well meaning but many times misguided handling of a church's reporting

Expert:  Lane replied 9 months ago.

One more thought:

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Look up and study past Tax Court cases regarding housing allowances such as Holmes v. Commissioner, T.C. Summary Opinion 1010-42.

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In that particular case, the Tax Court ruled that the pastor’s housing allowance was not subject to income taxation even though the amount was over 95% of his total church compensation.

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The pastor was able to prove that the $13,000 he received annually as his housing allowance did not even cover all of his eligible housing expenses, so the court upheld his housing allowance exclusion.

Expert:  Lane replied 9 months ago.

Given the ambiguity (nothing new) in the code (the primary source of the law) .. and the hard line IRS' collection division takes (a secondary source) on skewing everything toward collecting more tax revenue - here are a couple of other secondary sources:

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Richard Hammar J.D., LL.M., CPA...states in his book Church & Clergy Tax Guide, "No limit has been placed on the amount of a minister's compensation that can be designated by a church as a housing allowance (assuming that the amount is reasonable).

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Wisdom over Wealth, a firm that focuses ministry and churches says this:

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"in certain circumstances designating all salary as housing allowance is not only acceptable but encouraged.

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If your church is not able to compensate your minister more than $500 or $1000 a month and the lesser of these three amounts:

  1. Actual expenses
  2. Housing allowance payments
  3. Fair rental value of the home plus utilities

...exceeds that amount, why shouldn’t you designate all salary as housing allowance? It is more tax beneficial to the qualifying minister and more cost effective for the church as they would not have to hire a payroll service to handle the minister’s compensation."

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Hope this helps to provide a foundation for an informed decision

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Lane

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Expert:  Lane replied 9 months ago.

Again, I'd really appreciate a positive rating (using the rating request, faces, or stars on your screen)

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That's the only way I'll be credited for the work here.

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Thank you!

Lane

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