A church provides its minister a housing allowance but believes it must report the full amount of compensation (including the non-taxable housing allowance portion) on Form 1099-MISC in order to demonstrate the full earnings of the minister. (Starting in 2020, Form 1099-MISC is replaced with Form 1099-NEC for non-employee compensation.)
If the church reports his compensation, including the housing allowance, on the Form 1099-NEC as taxable income, will he be able to deduct his housing expenses somewhere else on the Form 1040?
This question brings up a couple of issues. First, most ministers are properly classified as employees who receive Form W-2, not as independent contractors who receive Form 1099-NEC. Box 1 on Form W-2 reports taxable compensation. It is reduced to reflect the church's designation of a portion of his pay as non-taxable housing. Then, in Box 14 (Other), Form W-2 typically reports as a memorandum item his additional non-taxable, housing allowance compensation.
Alternatively, the non-employee minister who receives Form 1099-NEC instead of Form W-2 must report the non-employee compensation on Form 1040, Schedule C where it will be fully taxable. In addition, any additional compensation received as a housing allowance must be documented. An excess allowance must also be reported on Schedule C. In the case when a church includes housing allowance as taxable on Form 1099-NEC, the minister must then claim a deduction on Form 1040 as "Other Income" a negative amount for his allowable housing allowance.
We recommend he attach an explanation of the negative amount and be ready to answer correspondence from the IRS regarding the deduction. It will be important for him to be able to demonstrate formal designation of his housing allowance by the church.
Of course, the full amount of compensation, including the non-taxable housing allowance, is subject to self-employment tax on Form 1040, Schedule SE unless the minister has successfully applied for exempt status using Form 4361.
Readers have sometimes been helped by the following discussions:
Reader Question/Comment 1: Isn't there a better way than having the minister record a large negative amount on his Form 1040?
Yes. We recommend that a church issuing Form 1099-NEC report only the taxable portion of the non-employee compensation. Then within a separate communication remind the minister of an additional compensation that was provided in the form of a housing allowance that he must prepare to report, as appropriate, within his annual tax return filing.
Reader Question/Comment 2: If the church issues a Form 1099-NEC, it includes the full amount, and the minister will then report the housing allowance as negative income on his tax return. Who decides whether to issue a Form W-2 or Form 1099-NEC, the church or the minister?
Since the church issues information returns, it falls upon its church officers to select the correct form. It is important to understand that a church filing a Form 1099-NEC with its pastor's compensation is rarely correct. He is an employee and should be issued a Form W-2. Being classified as an employee is very helpful to both the church and the pastor since independent contractors are ineligible for the employee fringe benefits that churches typically provide pastors (e.g., health insurance, retirement plans).
If a church erroneously issues a Form 1099-NEC, especially if it reports housing allowances as taxable, the church leaves the pastor with fewer options.
Reader Question/Comment 3: What if the church is "too small" to allow for it to provide benefits and treats all its pastors (and employees) as independent contractors, thus sending out Form 1099-NEC? Is the pastor then not entitled to the housing allowance?
Unfortunately, the size of the church is irrelevant when it comes to compliance with the law. Form 1099-NEC is only intended for truly independent contractors. Nevertheless, in these situations a church can still designate a portion of the pastor's compensation as housing allowance.
It is strongly recommended that the church provide the pastor with a report listing the amount of income designated as the housing allowance. This amount will not be reported on the Form 1099-NEC (i.e. only the amount the independent contractor pastor received as non-housing allowance income is reported on Form 1099-NEC). The pastor will report the amount listed on Form 1099-NEC on Form 1040, Schedule C (referenced above) and is responsible to report as additional income any amount of the housing allowance he did not use for housing expenses.
Reader Question/Comment 4: If a pastor receives only a housing allowance and no additional cash compensation, then should the church still issue him a Form W-2 with $0 in Box 1 and Box 14 reporting the actual amount of the housing allowance?
No, a minister who receives only a parsonage or housing allowance may exclude the entire amount from his income (Publication 1828). Instead of reporting the housing allowance in Box 14 on a Form W-2, the church should provide the pastor with a report listing the amount of income and that it was 100% designated as housing allowance.
The pastor also remains responsible to apply the Clergy Housing Allowance Clarification Act of 2002 which states that a housing allowance is nontaxable "to the extent such allowance does not exceed the fair rental value of the home, including furnishings and appurtenances such as a garage, plus the cost of utilities." In addition, his actual expenses, if less than the designation of the fair rental value, will limit the income tax-free character of the church compensation.