3.14 Minister’s Rental or Housing Allowance

A duly ordained minister pays no tax on the rental value of a home provided as part of his or her pay. If a minister is provided with an allowance rather than a home itself, the allowance is generally tax free if used to pay rent, to make a down payment to buy a house, to pay mortgage installments, or for utilities, interest, tax, and repair expenses of the house. However, the exclusion for an allowance is limited to the fair rental value of the home, including furnishings and appurtenances such as a garage, plus the cost of utilities. A rabbi or cantor is treated the same as a minister for purposes of the allowance or in-kind housing exclusion.

The Tax Court has held that the parsonage allowance exclusion is allowed for expenses of a second home as well as for a principal residence. However, the Eleventh Circuit appeals court reversed the Tax Court, concluding that the parsonage allowance can apply only to one home.

The church or local congregation must officially designate the part of the minister’s compensation that is a rental or housing allowance. To qualify for tax-free treatment, the designation must be made in advance of the payments. Official action may be shown by an employment contract, minutes, a resolution, or a budget allowance.

Filing Tip

Mortgage Interest and Taxes

If you itemize deductions on Schedule A (Form 1040), deduct payments for qualifying home mortgage interest (15.1) and real estate taxes (16.6) on your home even if you use a tax-free housing allowance to finance the payments.

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Who qualifies for tax-free allowance?

Tax-free treatment is allowed to ordained ministers, rabbis, and cantors who receive housing allowances as part of their compensation for ministerial duties. Retired ministers qualify if their allowance is furnished in recognition of past services.

The IRS has allowed the tax-free exclusion to ministers working as teachers or administrators for a parochial school, college, or theological seminary which is an integral part of a church organization. A traveling evangelist was allowed to exclude rental allowances from out-of-town churches to maintain his permanent home. Church officers who are not ordained, such as a “minister” of music (music director) or “minister” of education (Sunday School director), do not qualify.

The IRS has generally barred an exclusion to ordained ministers working as executives of nonreligious organizations even where services or religious functions are performed as part of the job. The Tax Court has focused on the duties performed. A minister employed as a chaplain by a municipal police department under church supervision was allowed a housing exclusion, but the exclusion was denied to a minister-administrator of an old-age home that was not under the authority of a church and a rabbi who worked for a religious organization as director of inter-religious affairs.

Allowance subject to self-employment tax.

Although parsonage allowances are not taxable income, they are reported by self-employed ministers, rabbis, and cantors as self-employment income for Social Security purposes; see Chapter 45. If you do not receive a cash allowance, report the rental value of the parsonage as self-employment income. Rental value is usually equal to what you would pay for similar quarters in your locality. Also include as self-employment income the value of house furnishings, utilities, appurtenances supplied—such as a garage—and the value of meals furnished that meet the rules in 3.13.

Business expenses allocable to tax-free allowance are not deductible.

A minister may deduct business expenses allocable to taxable compensation, but not expenses allocable to a tax-free housing allowance. If part of a minister’s salary is designated as a housing allowance, and the minister also has self-employment earnings from the exercise of his ministry, a double allocation is required, first between salary income and self-employment income, and then between the taxable and tax free parts of salary.

For example, in one case a minister had self-employment income comprising 21.56% of his annual income. Of the rest, 53.85% was a tax-free housing allowance and 46.15% was taxable salary. The Tax Court agreed with the double allocation required by the IRS. Since the minister did not provide evidence as to which expenses were generated by which type of income, the Court allocated expenses on a pro rata basis, applying the ratio of salary and self-employment income to total income. Since the self-employment income was 21.56% of total income (including the allowance), 21.56% of the expenses were deductible on Schedule C. The remaining expenses were treated as job-related costs deductible, if at all, as miscellaneous itemized expenses on Schedule A. However, because 53.85% of the minister’s salary was a tax-free housing allowance, 53.85% of the expenses were nondeductible. The balance (46.15% of the expenses) could be claimed on Schedule A as a miscellaneous itemized deduction subject to the 2% of adjusted gross income floor (19.3).