MinistryCPA - Corey A. Pfaffe, CPA, LLC

New ministers frequently have several questions as they enter a new field that has significantly different rules than the standard employee of a business has. We have assembled a list of some of the most important questions that a new minister should investigate when starting their new job.  1. How can I live within my means? You need a budget. Enjoying a long-term ministry in Christian service requires an ability to live within your means. Lots of tools are available: Christian authors with “how to” instructions and online apps, to name a couple. Try You Need a Budget (www.ynab.com), if you need an idea. 2. What does it mean to be a dual status employee? A minister, per IRS regulations, is both an employee and self-employed—dual status. As an employee, a minister is eligible for all fringe benefits offered to non-minister employees — health coverage, retirement plans and so on. The exception lies in social security and Medicare tax. Non-minister employees must have 7.65% of thei...

This is another posting in the MinistryCPA Top 10 series: Understanding what to offer a pastor as part of his compensation package can be a difficult task. There are a number of different factors to consider. Variables such as compensation, insurance, housing allowance, taxes, and retirement all play into compensation. We have compiled a list of factors that a church should consider when designing a compensation package for the pastor. Every church situation is unique, and each church should analyze what it can actually afford. 1. How does the church determine an appropriate compensation rate? Determining an appropriate compensation level can be a difficult task in a small ministry. There are a few factors that can be used to help determine a fair compensation for the pastor. The first factor that should be taken into consideration is the needs of the pastor. If the church wants a pastor to work full time, then it must consider what he needs to be paid to support himself and his fami...

Question: How can the church and I work together to sell the parsonage and get my family into a home of our own? Answer: The answer varies greatly based on the church’s and minister’s specific situation. However, the following are several issues that likely need to be addressed.       1.  Any property transferred by the church to the minister will be considered taxable compensation at its fair market value (reduced by any payment by the minister to the church).       2.   Because the minister will no longer be living in real estate that is exempt from property taxes, his costs of living will increase accordingly.       3. An excludable housing allowance is governed by a three-part test . Some ministers may believe that designating as housing allowance a one-time, large bonus from the church, which the pastor intends to use as a significant down payment, will fully qualify as exempt income under the three-part test...

Question: As a pastor, what can I deduct for a housing (parsonage) allowance? Answer: A minister who receives a housing allowance may exclude the allowance from gross income to the extent it is used to pay expenses in providing a home. A minister living in a parsonage qualifies for a housing allowance to the extent of his own out-of-pocket cost s.  The IRS lists only food and servants as prohibitions to allowable housing expenses. The minister’s church or other qualified organization (e.g. religious school or college with board members accountable to local churches) must designate the housing allowance by official action taken in advance of the payment. If none of the minister's salary has been officially designated as housing allowance, the full salary must be included in gross income.  If a minister owns a home, the amount excluded from the minister’s gross income as a housing allowance is limited to the least of the following three amounts: (a) the amount actuall...

Question : Every December, a church designates its pastor's next year's housing allowance. Its pastor resigned during the year to pursue other employment. How should his annual designated housing allowance be assigned to part-year compensation? Answer : To our knowledge, there is no specific guidance available in IRS regulations or rulings or in court case records to authoritatively clarify this reporting. It seems appropriate, however, that the annual housing allowance should simply be prorated over the time he was employed by the church. This situation does demonstrate the potential wisdom of documenting housing allowance as a monthly amount since mid-year turnover in the office of a pastor is not an uncommon event. A pastor contemplating an earlier departure may wish to declare (or request) in advance that his housing allowance be increased immediately for the remainder of his service. The minister's church or other qualified organization must desig...

For a quick review, readers should be reminded that ministers may be eligible to make contributions to an Internal Revenue Code section 403(b) plan established by their not-for-profit employers. The traditional 401(k) plan is available to for-profit employers. Also, ministers' distributions at retirement taken from 403(b) plans may be designated as non-taxable housing allowance. See other postings on this blog for a refresher of these rules: 403(b) Retirement Distributed as Housing Allowance Question 1: An ordained minister, formerly working for a for-profit company, is now working for a nonprofit ministry. His former retirement plan was a 401(k). The current employer offers a 403(b) plan. Can a 401(k) distribution be rolled over into a 403(b) plan? Answer 1: According to IRS Publication 571, “ You can generally roll over tax free all or any part of a distribution from an eligible retirement plan to a 403(b) plan.” Question 2: But should a minister consider d...

Question: Do batteries qualify as a housing allowance expense? Answer: The expenditure for batteries, if meeting the following general guidelines for use in connection with the pastor's personal residence, may meet the requirements. Although there are not likely court cases or Revenue Rulings citing the exact examples offered here. In a June 2016 post, we shared the following: "A minister’s housing allowance benefit is non-taxable income to the extent that the allowance is used for housing expenses. The three-part test includes consideration of the fair rental value of the home, plus actual costs of utilities (see this blog post regarding the three-part test). In addition, the expenses must be incurredrelative to the minister’s principal residence. According to Federal Tax Regulations, Regulation, §1.107-1, Internal Revenue Service, Rental Value of Parsonages, only food and servants are specifically excluded." If, for example, the batteries are for a smoke ala...

Question: Are missionaries who raise their own support without affiliation with an agency able to designate  a housing allowance  and, therefore, exclude it from taxable income? Answer: First, in order to qualify for a housing allowance, one has to be properly classified as a minister (see 2015 blog post relating to this topic). Second, the housing allowance designation needs to be prospectively designated by a 501(c)(3) organization.  According to the IRS Ministers Audit Technique Guide ,  “The exclusion under Internal Revenue Code §107 only applies if the employing church [including a mission agency] designates the amount of the parsonage allowance in advance of the tax year. The designation may appear in the minister's employment contract, the church minutes, the church budget, or any other document indicating official action. Treas. Reg. §1.107-1(b).” The IRS Publication 1828 also states, "The minister’s church or other qualified organization mu...

Question: If a minister rents his principal residence, but he performs services (mowing the lawn, repairing the roof, etc.) in lieu of rent, can he still qualify the rent amount for a housing allowance tax benefit? Answer: Of course, bartering income is taxable. The Internal Revenue Code interprets that above situation as follows: tenant/minister receives taxable income for the fair market value of the services he provides, and tenant/minster pays landlord for renal of residence. The minister in this case reports taxable income for services provided in lieu of rent. It is also likely subject to self-employment tax. He may then claim as qualifying housing allowance expense equal to the amount he "pays" for rent of his personal residence. Essentially, there is no difference than if the minister and his landlord simply traded checks . See a past MinistryCPA post regarding this topic: http://ministrycpa.blogspot.com/2016/09/services-to-church-in-l...

Question: A pastor is receiving a $20,000 renting (housing) allowance per year, and he is currently paying Self-Employment (SE) tax on it. Is there a way to exclude this compensation from SE income status? Answer: He will not be able to exclude this amount from SE income.  IRS Publication 517  states, "To figure your net earnings from self-employment (on Schedule SE (Form 1040)), include in gross income: 1. ... 4. The fair rental value of a parsonage provided to you (including the cost of utilities that are furnished) and the rental allowance (including an amount for payment of utilities) paid to you." Further, the IRS Minister's Audit Technique Guide offers IRS agents the following guidance: "Computing Self-Employment Tax Salaries and fees for services, including offerings and honoraria received for marriages, funerals, baptisms, etc.. Include gifts which are considered income as discussed under the section on income. Any housing allowance or utility all...

Question: Are expenditures related to the sale of a home considered to be qualifying housing allowance disbursements? Answer: The Internal Revenue Code lists only food and servants as specific exceptions to otherwise qualifying housing allowance expenditures. The amounts must be incurred relative to the minister’s principal residence and for costs directly related to providing a home. According to Internal Revenue Regulation §1.107-1, Rental Value of Parsonages, only food and servants are specifically excluded. With every housing allowance the three part test must be considered (see  Ministry CPA Blog   past post  regarding the three-part test). For example, if a minister's fair rental value is less than his actual expenses, he would receive no tax benefit from including expenditures from the sale of his home. This is often the case in the event of the sale of a minister's home.

Question: I am a commissioned missionary of a local church. Do I qualify for a housing allowance tax exclusion? Answer: In order for any missionary or minister to qualify for a housing allowance, the individual must fit the IRS’s definition of a minister. Let’s review the qualifications of ministerial treatment as noted in the IRS’s Minister Audit Technique Guide. Treas. Reg. § 1.1402(c)-5(b)(2) provides that service performed by a minister in the exercise of the ministry includes: 1. Ministration of sacerdotal functions; 2. Conduct of religious worship; 3. Control, conduct, and maintenance of religious organizations (including the religious boards, societies, and other integral agencies of such organizations), under the authority of a religious body constituting a church or denomination. Treas. Reg. § 1.1402(c)-5(b)(2) also provides that whether service performed by a minister constitutes conduct of religious worship or ministration of sacerdotal functio...

Question: A pastor has requested that the church increase his housing allowance for the rest of the year. Is it permissible for the church to change the pastor's housing allowance midyear? Answer: The minister's church or other qualified organization must designate the housing allowance pursuant to official action taken in advance of the payment. The new designation must be made prospectively, not retrospectively. In other words, the pastor can claim the new housing allowance designation only on the remaining pay periods of the year.  There is often a prorated calculation that must take place when midyear housing allowance changes occur. Here is an example: For 2015, Pastor Smith's salary is $48,000 ($4,000 per month). Of the $48,000, the church has designated a housing allowance of $12,000 ($1,000 per month).  In June of 2015, Pastor Smith realizes that his actual housing expenses and the fair rental value of his home will far exceed $12,000 during the calendar...

Yesterday, the Chicago-based 7th Court of Appeals rejected a case brought by the Freedom From Religion Foundation (FFRF) that would have declared tax-exempt housing allowances unconstitutional. The court overturned a previous ruling in favor of FFRF by claiming that FFRF lacked "standing" because the law did not affect them.  Had the court of appeals upheld the previous ruling, thousands of clergy would have been affected by an increase in income taxes. This news comes as an encouragement to us at MinistryCPA and to the clients we serve. Although FFRF vows to appeal their case to the Supreme Court, the court of appeal's decision sets a strong precedence in favor of clergy.

Question:   A minister recently accepted a call to a new ministry where he and his family are staying in the church parsonage.  Meanwhile, the minister's home in the previous location is unsold. The minister is responsible for payments, taxes, and so forth, on the unsold home in the previous location.    Can the minister claim a housing allowance on the unsold home?  Answer: The Ministers Audit Techniques Guide states that "A minister can receive a parsonage allowance for only one home." Many ministers own two homes due to the fact that the minister has accepted a position in a different community and has yet to sell his previous home (similar to the question above).  Not only may a minister receive a housing allowance for only one home, but that home must be the minister's principal residence. A key term to understand here is the phrase "principal residence," which can be defined as the home where an individual is currently residing.   ...

 We have recently updated our Top Ten Questions that Ministers, Missionaries, and Church Treasurers Ask Tax Preparers .  Based on our experience, the Top Ten Questions are frequent questions asked by ministers, missionaries, church treasurers, and others serving in ministry positions as licensed or ordained ministers. Our answers are not intended to be exhaustive. Accordingly, you should consult your own tax professional for assistance in applying our information to your specific situation.  The "Top Ten Q&A" has been our most hit web page since 2010. Providing a helpful resource to many who are involved in ministry, it averages close to 1,000 page views every two weeks.  If you prefer to download a PDF of our Top Ten Questions , click here . 

Question: Am I supposed to include my minister’s housing allowance when determining household income for the Health Insurance Premium Tax Credit? Answer: Per final regulations issued by the IRS and Department of the Treasury on May 18, 2012, household income is calculated as follows. [i] Taxpayer’s adjusted gross income (AGI) +All Dependents’ AGI (if required to file a tax return) +Foreign earned income excluded from AGI +Tax-exempt interest +Social Security Benefits not included in gross income Modified Adjusted Gross Income The above calculation does not include an adjustment for housing allowance; therefore, the minister’s housing allowance that is excluded from federal tax is also excluded from household income for purposes of the Health Insurance Premium Tax Credit. [i] 77FR 30377-30400 (May 23, 2012)

Many of our readers have been paying close attention to the Wisconsin Housing Allowance Case. In November of 2013, Federal Judge Barbara Crabb declared the minister's housing allowance to be unconstitutional; the case is currently under appeal. To familiarize yourself with the ruling, read our December 4, 2013 and February 14, 2014 blog posts concerning the case. Below, you will find some statistics based on research that we have performed. What would your 2013 tax return have looked like if the housing allowance was denied? Between January 1 and April 30, 2014, MinistryCPA prepared 64 returns for ministers who claimed a housing allowance in 2013 and would have experienced negative consequences had it been denied. The average increase in federal and state income tax would have been $3,499, with a minimum increase in tax costs of $245 and a maximum of $10,531. Assuming our sample is representative of all U.S. ministers (and this is a stretch), the true average for all si...

Question: A church owns a parsonage on which it makes a monthly $500 mortgage payment. The fair rental value of the property is $800 per month. The church would like to allow its minister to live in the parsonage and pay to the church only the mortgage payment each month because it cannot afford to provide him with additional cash compensation. First, is this a legal arrangement? Second, what are the tax consequences? Answer: This arrangement appears to violate no legal requirements that we are aware of. The parsonage allowance will be income-tax free, but the pastor should report the full fair rental value as housing allowance on Form 1040, Schedule SE when filing his personal income taxes. Additionally, the church should designate at least $500 per month of the pastor's cash compensation as housing allowance since he has at least that much of justifiable housing expenses. He will be responsible to estimate a justifiable fair rental value in excess of his payment for purpose...

A question related to a previous post : As an ordained minister, I spent 20 years working for a parachurch organization which designated a housing allowance for me. in 2012, my full-time position was eliminated, but I have continued to consult as an independent contractor for the organization. I received Form 1099-MISC rather than a W-2 for my 2013 compensation. Am I still eligible to claim a housing allowance? If so, what documentation will I need? Answer: Housing allowance rules are identical for independent contractors and W-2 employees, so your eligibility for a housing allowance remains the same. However, the organization must designate a portion of your ministerial compensation as housing allowance in order for you to be able to claim any amount, based on the following three-part test from the IRS :  You can report as housing allowance the lesser of three amounts: Actual housing expenses, plus utilities Fair rental value of the property, plus utilities Amount of c...