Ministers are allowed to receive lodging or accommodations from the church free of income tax liabilities. However, churches need to “cover all their bases” in order to satisfy the requirements of the Internal Revenue Service (IRS) and to maximize housing allowance benefits for ministers.
What is a housing allowance?
Ministers should have a portion of their salaries designated as housing allowance. For ministers living in church-owned housing, an annual housing allowance covering expenses for furniture, personal property insurance on the house contents, utilities and telephone, and taxes should be considered.
For ministers who own their own homes, the annual housing allowance should include the amount of the annual mortgage payments, home insurance, maintenance and repairs, utilities and telephone, taxes, and all other expenses associated with keeping a home consistent with the standard of living typical for those in the same salary range.
In order for both the church and its minister to be protected and to be within the legal requirements, housing allowance provisions must be recorded in the official minutes of the first church board meeting of each year.
The housing allowance is excluded from ministers' gross salaries. The designated allowance is subtracted from compensation before the church computes its salary data for IRS Form W-2.
The excluded amount is not entered on IRS Form 1040 or any other form or schedule except Schedule SE. Housing allowances must be included as compensation for Social Security tax purposes and included as compensation in Schedule SE.
Reporting the allowance to the minister
Ministers who are employees of the church usually receive a Form W-2 from the church that indicates their total annual compensation. Churches should designate housing allowance in Box 14 of Form W-2 with a notation, “Housing Allowance.” Although this notation is not required, it is suggested in IRS Publication 517, “Social Security and Other Information for Members of the Clergy and Religious Workers.”
Churches also can report the designated housing allowance by providing a statement to the ministers (on church letterhead) that indicates the amount or percentage of compensation they are allowing for housing allowance.
It is very easy to mistakenly indicate housing allowance in Box 5 of Form W-2. If this happens, the church must issue a corrected form to the minister involved. If a corrected form has not been provided, ministers should deduct their actual housing expenses (must have receipts to confirm the expense) on line 21 of Form 1040 (for 2001 taxes).
Amount reported as housing allowance
Some churches set the housing allowance for ministers by applying a percentage to the total gross salary. Although there is no set standard of what percent of salary should be designated as housing allowance, the IRS generally has little problem if churches establish the percent in a range of 40 percent to 60 percent. Anything over 60 percent usually raises suspicion with the IRS.
Even though many churches use the percentage of income method, financial advisors usually feel that basing housing designations on an estimate of annual housing expenses is preferred over the percentage method.
One of the most beneficial tax advantages that the IRS allows for ministers is the housing allowance. However, in order for ministers to fully utilize the benefits allowed by the IRS, they need to ensure that their churches designate and report the housing allowance as dictated by the IRS.