Everything You Need To Know About Housing Allowance

Understanding and calculating a housing allowance for ministers is complex and, therefore, can be very confusing. Besides determining an amount that can be excluded from federal income tax, there are several rules to follow to ensure compliance with IRS guidelines. 

For example, while the housing allowance is the lower of four different limits, many ministers, bookkeepers and tax professionals are only aware of two, maybe three.  And while housing allowance is a benefit to reduce federal income tax, many people are unsure of how it impacts self-employment taxes. If you would like to learn more about this topic, this article will help you find answers to 20 of the most frequently asked questions regarding housing allowance for ministers. 

Your Questions Answered

1. What is a housing allowance?

• It is a portion of a minister’s income designated by their church to cover housing expenses, which is excluded from federal income tax but subject to self-employment tax. It is not an additional expense from the church budget. 

2. Who qualifies for a housing allowance?

• Only ministers who meet the IRS definition of a minister for tax purposes. This can include ordained, licensed, or commissioned ministers who are performing ministerial duties. 

3. Who’s responsible for the housing allowance?

• The minister is responsible for calculating, documenting, and reporting the housing allowance correctly. The church is responsible to approve and pay the allowance.

4. Is a housing allowance considered taxable income?

• It is exempt from federal income tax but subject to self-employment tax unless the minister has opted out of Social Security. 

5. When should a minister request a housing allowance?

• It should be approved before the beginning of the year to maximize benefits. Expenses incurred before approval cannot be included. 

6. What expenses can be covered?

• Expenses to furnish your home can include items like down payments, mortgage payments, rent, utilities, property taxes, homeowner’s insurance, furnishings, appliances, dishes, cookware, cleaning supplies, repairs, maintenance, landscaping and lawn care. 

7. How does a church designate a housing allowance?

• The church must designate the allowance before the allowance is effective. Putting it in writing is a best practice. The designation can be a written resolution approved by the governing board or congregation. It can also be shown as a budget line item, included in an employment contract, listed in minutes of the church board, or included in any official action approved by the church in advance of the payment. 

8. When should the housing allowance be designated?

• The church should approve and document the allowance before the start of each year. For a minister hired during the year, the allowance should be designated before the minister’s first payroll. 

9. Can a minister change their housing allowance mid-year?

• Yes, but this change is not retroactive—expenses incurred before the change cannot be included. 

10. How much of the housing allowance is tax-exempt?

• The IRS allows ministers to exclude the lesser of the following:
  --The amount officially designated by the church as housing allowance.
  --The amount actually spent on housing.
  --The fair market rental value of the home (including furnishings, utilities, garage, etc).
  

• Important note: there is technically a fourth limit: the pastor’s total compensation cannot be “unreasonable” per the IRS. So, the minister’s total pay must be reasonable for the services provided. 

11. What happens if a minister overestimates their housing allowance?

• While it is better to overestimate rather than underestimate the allowance, the excess amount must be reported as taxable income when filing taxes. 

12. Is the housing allowance exempt from self-employment tax?

• No, unless the minister has opted out of Social Security. 

13. Can a minister receive a housing allowance while living in a parsonage?

• Yes, but only for out-of-pocket housing expenses like utilities and furnishings. Remember, if your congregation provides a parsonage as pay for your services as a minister, you may also exclude the fair market rental value of the parsonage from income, but you must include the fair market rental value of the parsonage as earnings for self-employment tax purposes. 

14. What documentation should a minister keep?

• Receipts, invoices, and records of all housing-related expenses to substantiate the allowance. 

15. Can a minister receive a housing allowance for a second home?

• No, the allowance applies only to the minister’s primary residence. 

16. Does the housing allowance apply to retired ministers?

• Yes, if they receive qualifying retirement income designated as a housing allowance. 

17. What happens if a church forgets to designate a housing allowance?

• Unfortunately, the minister cannot claim expenses for past expenses, but the church can designate a housing allowance at any time during the year, which allows the minister to take advantage of the allowance moving forward. 

18. Can the church designate an allowance for future years?

• Yes, the church can designate an allowance for future years by adopting a resolution that remains in effect until it is changed in the future. Such a resolution might include wording similar to this: “This housing allowance designation will remain in effect for all future years unless changed by official action of the board.” 

19. What is the difference between a housing allowance, a parsonage allowance, and a rental allowance?

• These three terms are generally interchangeable and only reflect whether you rent or own your home or live in a church-provided parsonage. In all three cases, the allowance is excludable from gross income for income tax purposes but not for self-employment tax purposes. 

20. How does the church report the housing allowance?

• The church will exclude the total housing allowance from taxable income reported in Box 1 of the Form W-2. Similarly, for ministers who are independent contractors, the housing allowance is not included on the Form 1099-NEC. However, the church can voluntarily report the total housing allowance on the W-2, in box 14, as “Housing Allowance.” If the church does not report the housing allowance in box 14, it should provide a letter to the minister that documents the approved housing allowance to help complete their personal income tax return.

 

Step-by-Step Calculation

Calculating a housing allowance for ministers involves determining the amount that can be excluded from federal income tax while ensuring compliance with IRS guidelines. Here’s how it’s done:

 

1. Estimate Housing Expenses.

• Ministers should estimate their annual housing costs, including:
  • Mortgage or rent payments
  • Utilities (electricity, water, gas, internet)
  • Property taxes
  • Homeowners/renters insurance
  • Furnishings and appliances
  • Repairs and maintenance
  • Landscaping and lawn care

2. Determine the Fair Market Rental Value.

• The IRS requires that the housing allowance not exceed the fair market rental value of the home, including utilities and furnishings. You can ask a real estate professional to help with this estimate. 

3. Church Designation.

• The church must formally designate the housing allowance before the start of the tax year. This is typically done through a written resolution by the church board. 

4. Track Your Expenses.

• Keep receipts, invoices and key documents to support your housing expenses throughout the year. 

5. Compare the Four Limits

• The excludable amount is the lowest of the following:
  • The amount officially designated by the church as housing allowance.
  • The amount actually spent on housing.
  • The fair market rental value of the home (including furnishings, utilities, garage, etc).
  • An amount that represents reasonable pay for your ministerial service. 

6. Report Excess Amounts

• If the designated allowance exceeds actual expenses, the excess must be reported as taxable income.

• Key point: The housing allowance is exempt from federal income tax but subject to self-employment tax unless the minister has opted out of Social Security.

 

Helpful Resources

• The IRS guidelines on housing allowances can be found in IRS Publication 517.

• Visit the Church Administration Essentials website for the following housing allowance templates:

1. Sample housing allowance declaration for a minister
2. Sample housing allowance notification letter
3. Listing of eligible ministerial housing allowance expenses