A church has an unoccupied parsonage which it would like to rent at below market value to a non-ministerial employee of the church. How should the church treat this arrangement for tax purposes?
As long as this arrangement is not a condition of employment, the difference between market value and the amount of the rental payments must be reported as compensation on Form W-2, subject to income and FICA taxes. This does not qualify as a housing allowance because the employee is not a minister.
If the employee were required by the church to live on the premises, the church could rent the parsonage to him at below market value (or provide it free of cost) with no tax consequences. For example, if the church custodian is required to live on the premises and be on call around the clock, housing provided by the church would not be considered additional income.
According to IRS Publication 525, lodging is nontaxable to an employee if it is "a. Furnished on the business premises of your employer, b. Furnished for the convenience of your employer, and c. A condition of your employment. (You must accept it in order to be able to properly perform your duties.)"