Clearing the Clouds: Clergy Housing Allowance
Wespath Benefits and Investments (Wespath) recognizes the unique and often complex nature of clergy taxes. The following information is designed to help clear some of the gray when thinking about a housing allowance. It pertains to active clergy living in an owned or rented home, active clergy living in a parsonage and retired clergy.
What does the housing allowance permit?
The housing allowance permits duly ordained, commissioned, or licensed clergy in the exercise of their ministry1 to exclude a portion of their compensation when reporting gross income for federal income tax purposes. The amount excluded must be used to provide housing. Additionally, there are limits on what can be claimed as housing expense. For more details including the current tax law and the Clarification Act of 2002, go to The Warren Case: Clergy Housing and You on our website.
Is the Housing Allowance a deduction or exclusion?
The housing allowance is an exclusion from income, not a deduction. This means that the amount claimed is never reported to the Internal Revenue Service (IRS) as part of your annual income. A housing allowance can be taken only if the amount to be excluded is officially designated as a housing allowance by your congregation or church organization through a resolution, meeting minutes or a budget before compensation is paid for the tax year to which it applies. If you are a retired clergyperson, your annual conference is the church entity that designates the housing allowance for your pension payments. However, you are not necessarily entitled to exclude from your income the entire amount designated as a housing allowance. You may exclude from your income only the smallest of the following amounts:
the amount designated in advance of your expenditures as your housing allowance for the current tax year;
the amount spent for your primary residence (mortgage principal and interest, utilities, taxes, insurance, furnishings, maintenance, etc.); or
the current fair rental value of your home, including furnishings, plus the current year cost of your utilities (no matter whether your home is owned or rented).
If you are a pastor living in a parsonage provided by the church, you may exclude the annual fair rental value of the parsonage from your gross compensation for federal income tax purposes. (In the absence of Internal Revenue Code section 107(1), you would owe income tax on the fair rental value of the parsonage, even though you do not pay rent to live there.) In addition to the free use of the parsonage, your church may grant you a parsonage or housing allowance to pay for things such as furniture or utilities. Make sure you meet with your church prior to the current tax year to designate your parsonage or housing allowance. You may not exclude from income any expenses incurred before the allowance is designated for a given tax year, so get it documented before January 1 each year to maximize your eligible expenses.
If you are a retired pastor receiving annuity payments (or taking one or more lump sum distributions) from a Wespath retirement program, you may qualify for a clergy housing allowance exclusion. The exclusion applies to distributions of contributions made while you were serving under call, including their accumulated earnings. The same rules for determining the excludable amount for active clergy also apply to you, with one twist. While the local church generally designates a housing allowance for active clergy, your annual conference designates this amount for retirees. You may exclude from taxable income the smallest of the following three amounts:
the amount designated during the prior tax year by your annual conference as the housing allowance for the current tax year (generally conferences designate up to 100% of your pension payments from Wespath);
the amount spent for your home (mortgage principal and interest, utilities, taxes, insurance, furnishings, maintenance, etc.); or
the current fair rental value of your home, including furnishings, plus the cost of utilities (whether you own or rent your home).
Note: Distributions rolled out of a Wespath retirement plan to an Individual Retirement Account or non-church related program may not be eligible for a housing allowance exclusion. If you used your distribution from a Wespath plan to purchase a commercial annuity, however, payments from that annuity generally qualify for a housing allowance exclusion (consult your annual conference’s housing allowance designation for retirees). Your clergy housing allowance exclusion ends at your death. IRS rules do not allow your surviving spouse or beneficiaries to claim it.
Navigating through the complexity of clergy taxes and housing allowance rules can indeed feel like you are traveling through a fog with no direction. Certainly there are many other aspects of taxes to consider when determining the housing allowance exclusion such as its impact on housing equity, social security tax and taxes on retirement distributions. To further shine the light on your situation, consult a qualified tax adviser knowledgeable about the unique tax situations for clergy.
1 A clergyperson must be recognized as a minister of the gospel under Internal Revenue Code section 107, which may exclude certain deacons, especially those in extension ministries.