25 Nov Designating a Housing Allowance for 2021
The housing allowance is the most important tax benefit available to ministers. But many ministers do not take full advantage of it because they (or their tax adviser or church board) are not familiar with the rules.
What can church leaders do to help? Consider the following guidance.
If your minister lives in a church-owned parsonage
Ministers who live in a church-provided parsonage or manse can exclude from their income for federal income tax reporting purposes (1) the fair rental value of the parsonage, and (2) the portion of their compensation designated in advance by the church as a “parsonage allowance”—to the extent that it is used to pay for parsonage-related expenses such as utilities, repairs, and furnishings and does not exceed the fair rental value of the home (furnished, plus utilities).
Recommendation. If your pastor lives in a church-provided parsonage or manse, and incurs any out-of-pocket expenses living there (for example, for utilities or furnishings), then have the church designate a portion of the pastor’s 2021 compensation as a “parsonage allowance.” This should be done in December of 2020 so that it will be effective for all of 2021. Parsonage allowances cannot be designated retroactively.
Example. Your youth pastor lives in a church-provided parsonage. He is expected to pay his utilities and provide his furniture. His compensation for 2021 will be $35,000. In its December 2020 meeting, the church board designates $3,000 of this amount as a “parsonage allowance.” The youth pastor has parsonage expenses of at least $3,000 in 2021 (for utilities and furnishings). At the end of the year, the church treasurer issues the youth pastor a W-2 reporting only $32,000 as church compensation. The parsonage allowance is not taxable (assuming that it was used for parsonage expenses) for income tax reporting purposes.
If your minister owns a home
Many ministers own their homes. The portion of their compensation that is designated in advance by the church as a “housing allowance” is not subject to income tax to the extent it is used for housing expenses and does not exceed the home’s annual fair rental value (furnished, plus utilities).
Recommendation. If your pastor owns a home, have the church designate a portion of the pastor’s 2021 compensation as a housing allowance. This action should be taken in December of 2020 so that it will be effective for all of 2021. Housing allowances cannot be designated retroactively.
Tip. Use the form in “Sample Housing Allowance for Pastors.”
Tip. Who should designate the housing allowance? In most churches, it will be the governing board. But this is not always the case. Some church boards delegate this authority (and other compensation decisions) to a personnel or compensation committee. In other churches, the membership approves all compensation decisions at the annual business meeting. Whichever method your church uses, be sure that the allowance is designated in advance, and that the action is in writing.
If your minister rents a home
Many ministers rent their homes. The Apostle Paul did for a brief time during his ministry. Acts 28:30 states that “for two whole years, Paul stayed there in his own rented house.” Perhaps your minister is renting a home or apartment. If so, you should understand that the portion of your minister’s compensation that is designated in advance by the church as a housing or rental allowance is not subject to income tax to the extent that it is used for rental expenses and does not exceed the fair rental value of the home (furnished, plus utilities). See the above recommendations and tips for ministers who own their homes.
Determining the amount of the allowance
How does your church determine the appropriate amount for a parsonage, housing, or rental allowance? A common practice is for churches to provide their pastor with an “estimated expense form” prior to the end of the year. The pastor estimates likely expenses for the following year on this form, and returns it to the board or other body that designates housing allowances. The allowance is based on the pastor’s estimated expenses.
Tip. Sample expense forms are reproduced at the end of chapter 6 in my annual Church & Clergy Tax Guide. There are separate forms for computing parsonage allowances, housing allowances, and rental allowances. This is a simple and convenient way for your church to designate an appropriate allowance.
Tip. Your church should not be too conservative in designating a housing allowance. The pastor cannot exclude from taxable income an amount more than the church-designated allowance. So, your church may want to designate an allowance in excess of a pastor’s estimated housing expenses for the new year.
Most churches reduce the pastor’s W-2 by the amount the church designated as a housing allowance. But remember that the allowance is not necessarily nontaxable for income tax reporting purposes. For ministers who own or rent their home, the allowance is nontaxable only to the extent that it does not exceed actual housing expenses or the annual rental value of the home (furnished, plus utilities). It is the minister’s responsibility to report any excess housing allowance as taxable income on his or her tax return . IRS Publication 517 states:
You must include in gross income the amount of any [housing, rental, or parsonage] allowance that is more than the smallest of
- Your reasonable salary,
- The fair rental value of the home plus utilities, or
- The amount actually used to provide a home.
Include this amount in the total on Form 1040, line 1. On the dotted line next to line 1, enter “Excess allowance” and the amount.
Example. At the end of 2020, a church board determined that Pastor T’s compensation for 2021 would be $50,000. It designated $20,000 of this amount as a housing allowance. At the end of the year the church treasurer issues Pastor T a W-2 that reports taxable income of $30,000 (salary less housing allowance). However, Pastor T only has $17,000 of housing expenses in 2021. As a result, taxable income is understated on his W-2 by $3,000. It is Pastor T’s responsibility to report this $3,000 as additional income on line 7a of Form 1040.
Church treasurers should be sure that their pastor is aware of this reporting responsibility. Many pastors erroneously assume that they can reduce their taxable income by the full amount of the church-designated housing allowance. This will be true only if the allowance is less than the pastor’s actual housing expenses and the annual rental value of the home (including utilities).
Amending the housing allowance
What if the housing allowance designated for your pastor turns out to be too low? For example, the pastor has to pay for unanticipated home repairs, or begins to prepay part of the home mortgage loan. Can the church amend the pastor’s housing allowance? Yes it can, but note that the amendment only operates prospectively—from the date of the amendment forward.
For detailed information on the parsonages and housing allowances, see chapter 6 in the annual Church & Clergy Tax Guide.
Original content by the Church Law & Tax – October 13, 2020. This information is provided with the understanding that Payroll Partners is not rendering legal, human resources, or other professional advice or service. Professional advice on specific issues should be sought from a lawyer, HR consultant or other professional.