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.
If the church reports his compensation, including the housing allowance, on the Form 1099-MISC 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-MISC. Box 1 on Form W-2 reports taxable compensation. It is reduced reflecting 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 minister who receives Form 1099-MISC instead of Form W-2 must report the full income on Schedule C (Page 2, Part V) where it will be fully taxable. The minister could then claim as a deduction on Form 1040 as "Other Income" (Schedule 1, Line 21) 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.
Of course, the full amount of compensation, including the non-taxable housing allowance, is subject to self-employment tax on Schedule SE unless the minister has successfully applied for exempt status using Form 4361.
Reader Question/Comment 1: If the church issues a Form 1099-MISC, 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-MISC, 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-MISC 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 all of the employee fringe benefits that churches typically provide pastors (e.g., health insurance).
If a church erroneously issues a Form 1099-MISC, especially if it reports housing allowances as taxable, the church leaves the pastor with few options.
Reader Question/Comment 2: 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-MISC? 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-MISC 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-MISC (i.e. only the amount the independent contractor pastor received as non-housing allowance income is reported on Form 1099-MISC). The pastor will report the amount listed on Form 1099-MISC on 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 3: 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, Page 22). 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 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 or the fair rental value, will limit the income tax-free character of the church compensation.