A parsonage allowance, also known as rental or housing allowance, is a financial allotment designated by the church to its minister to offset their housing costs. Parsonage allowance is also tax-exempt from a minister’s gross income.
It is important to note that the term “minister” in this case encompasses all faiths as defined by the U.S. Internal Revenue Service (IRS), not exclusively Christian. Tax law recognizes ministers as being Christian, Jewish, Muslim, and any other religion.
Not all ministers may be eligible, however. The IRS may not regard certain clergy as a “minister” for tax purposes, even though the church may consider and refer to the individual as a minister. The IRS defines ministers as “individuals who are duly ordained, commissioned or licensed by a religious body constituting a church or church denomination.”
In other words, the IRS recognizes ministers as those providing ministerial services to the church, such as conducting religious worship, serving communion, holds a role as a religious leader by the church or denomination, and demonstrates managerial responsibilities in the church or denomination. The IRS is more likely to recognize ordained ministers as being eligible for the allowance exemption than commissioned or licensed ministers.
Additionally, the IRS makes no differentiation between active and retired ministers. Retired clergy can request distributions from their retirement accounts be designated, partially or entirely, as parsonage allowance.
What is Covered by the Parsonage Allowance?
Parsonage allowance applies to the minister’s primary residence to cover certain housing expenses, such as:
- Costs of purchasing home items, such as appliances, furniture, cookware, dishes, rugs, bedding, towels, etc.
- Homeowner’s association dues, and security system costs.
- Insurance on the home and contents, if not already included in mortgage payments.
- Maintenance, repair and remodeling costs, snow removal and lawn mowing services, cleaning supplies, and other expenses related to the home’s upkeep.
- Mortgage principal and interest payments, rent, down payments, or purchasing costs of the home.
- Property taxes, if not already included in mortgage payments.
- Utilities and services such as electric, gas, water, trash removal, basic phone expenses if not residing in church-owned housing. For those living in church-owned dwellings, cost of utilities exceeding what is provided by the church must be estimated based on anticipated expenses.
Ministers should maintain careful records of all housing expenses, such as receipts, invoices, and bank statements, to determine whether costs exceeded the annual allowance. Having a good record of expenses is also beneficial to the church board when determining allotment of the next year’s allowance.
Commercial real estate and vacation homes owned by the minister cannot be included in parsonage allowances. Additionally, non-housing expenses, such as food, clothing, cleaning services, tuition, and domestic help are not permitted as part of housing allowances.
Ministers with parsonage allowances who itemize deductions may be eligible to deduct mortgage interest and property taxes. Parsonage allowances are a tax exemption; mortgage interest and property taxes are considered income tax deductions.
It should be noted that while parsonage allowances are deducted on the minister’s federal income tax, the allotment must be included as earnings for self-employed ministers, per the requirements of self-employment tax.
Ministers are not required to pay federal income tax for the portion of their income designated as parsonage allowance. Allowances for ministers who own or are renting their home are also not taxable, so long as the allowance is used for housing expenses and does not exceed the home’s fair rental value.
This exclusion is greatly beneficial for ministers, provided the housing allowance meets certain IRS requirements:
- Correct reporting: Though housing allowance is not included in gross income, they must still be reported on the minister’s annual tax returns. The individual minister is responsible for correctly reporting this information, but church boards can assist with a detailed accounting of how compensation was paid.
- Fair value: The calculation of fair value for the parsonage allowance, plus furniture, utilities, repairs, and other expenses is fair and adequate. This is especially important for ministers as excess amounts are considered taxable by the IRS. The fair value rule is designed to prevent churches from designating large tax-free payments disguised as parsonage allowance.
- Parsonage designation: The church board must take official action approving the minister’s housing as part of the salary package if the minister resides in a church-owned property. Designating this protects the minister from paying taxes on the residence.
Can Allowances be Amended?
Churches may need to amend parsonage allowances over time due to inflation and higher housing expenses than the current allowance adequately covers. Churches may need to determine the adequacy of the housing allowance for circumstances, such as:
- Extensive remodeling
- Increases in the mortgage interest rate in adjustable-rate mortgage loans
- Increase of rent if the minister resides in a rental property
- Mortgage loan balloon payments
- Property insurance increases
- Property tax increases
- Purchasing or new furnishings or appliances
- Tax assessments to the property for public improvements
- The purchase of new housing
- Unexpected repairs
Amendments to a minister’s parsonage allowance is not required by law; religious organizations can choose to amend or not amend the allotment. However, doing so does not impose additional costs for the church. Amendments are a reclassification of an increased amount of housing allowance of the minister’s salary. When amending an allowance, there are rules for doing so:
- Authorization: The housing allowance must be authorized by the same governing body that designated the original allotment, typically the church board or congregation
- Written: Amendments should be recorded in the minutes of the official meeting when they are discussed, approved, and dated.
- Prospective: Amended housing allowances operate prospectively, meaning it begins on the date of approval through the remainder of the year. Amendments cannot be applied retroactively as prior expenses have already been paid.
In some instances, churches may neglect to designate a parsonage allowance, which is frequently the case when ministers change during the course of the year. It is also not uncommon for a church board to forget to designate the allowance before the start of a new year for current ministers.
To avoid such cases, church organizations should adopt a continuing resolution stating a predetermined percentage of the minister’s salary is designated as housing allowance for the current and future years, regardless of when the minister is hired.
What Percentage of Income Should be Designated for Parsonage Allowance?
Tax code does not designate a specific percentage or dollar amount for housing allowances, but the amount cannot be disproportionate to the minister’s job duties and be deemed by the IRS as “reasonable compensation” to qualify for the tax benefits.
In certain instances, an individual’s circumstances may be taken into account when determining what percentage of the minister’s income be designated for parsonage allowance. This typically applies to “bi-vocational” ministers of small churches or those in depressed economic areas that are unable to provide living wages. In such circumstances, ministers often seek additional employment to supplement their income and are thereby considered bi-vocational.
The same pertains to “supply pastors,” those not formally installed with a particular church and supplies temporary services to other churches as an acting minister, priest, rabbi, or other leader.
Both bi-vocational and supply pastors may be eligible for up to 100 percent of compensation they receive as long as it does not exceed reasonable compensation as defined by the IRS.
In both cases, a housing allowance designation may be for up to 100 percent of their cash compensation but cannot exceed IRS-defined reasonable compensation.
Virginia Beach Church Law Attorneys at Anchor Law Group, PLLC Assist Ministers and Church Leaders Regarding Parsonage Allowances
While tax laws provide housing-related exemptions and deductions for ministers and clergy, navigating the laws to determine appropriate allowances and expenses can be complex. Our Virginia Beach church law attorneys at Anchor Legal Group, PLLC have years of experience working with church organizations on parsonage allowances and tax law. Call us at 757-LAW-0000 or contact us online to schedule a free consultation. Located in Virginia Beach, we serve clients throughout Chesapeake, Norfolk, Suffolk, Portsmouth, Newport News, Hampton, and Eastern Shore, Virginia.