Understanding the Minister's Housing Allowance

What is the Minster’s Housing Allowance?

The Minister’s Housing Allowance, also known as a parsonage or rental allowance, is a substantial tax benefit provided to qualifying ministers based on Section 107 of the Internal Revenue Code (IRC). Section 107 provides:

"In the case of a minister of the gospel, gross income does not include: 1) the rental value of a home furnished to him as part of his compensation; or 2) the rental allowance paid to him as a part of his compensation, to the extent used by him to rent or provide a home and 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.” [i]

Essentially, the Minister’s Housing Allowance allows ministers to exclude from their gross income for federal income tax purposes any compensation received for rental or housing expenses. The term “rental allowance” includes church provided parsonages, rental allowances with which the minister may rent a home, and housing allowances with which the minister may purchase a home. This article will discuss who is eligible for the Minister’s Housing Allowance, what housing expenses qualify under the housing allowance, the tax reporting process, and the effect of retirement on the allowance.

[i] I.R.C. § 107.

Rules for the Minster’s Housing Allowance:

1. Minister’s Housing Allowance Eligibility

To be eligible for the Minister’s Housing Allowance, an individual must be an ordained, licensed, or commissioned minister. Additionally, the minister must perform “ministerial services,” such as administering the sacraments, conducting religious worship, or demonstrating management responsibility in a local church or denomination, and be considered as a religious leader by the church and/or denomination. Bi-vocational ministers are eligible for a housing allowance, but only from their ministerial income.[i] Lay church staff are not eligible for a housing allowance.

Further, to be eligible for a housing allowance exclusion, tax regulations require that the housing allowance be both designated and reasonable. Regarding designation, ministers may only exclude the housing allowance from their gross income if the employing church or organization specifically designates the amount of the housing allowance in advance of the tax year. The designation must be in writing and may appear in the minister's employment contract, the church minutes, the church budget, or any other document indicating official action.[ii] The preferred method is for the employing church council or board to adopt a housing allowance resolution prior to each calendar year (or prior to the arrival of a new pastor) and record the resolution in the minutes of the meeting. Regarding reasonableness, tax regulations specify that the housing allowance may not be more than reasonable pay for the ministerial services performed.[iii]

2. Qualifying Expenses under the Minister’s Housing Allowance

Tax regulations specify that a minister may exclude from his gross income all expenses used for rent of a home, purchase of a home, or “expenses directly related to providing a home.”[iv] While the IRS does not provide a specific list of allowance expenses, it is widely understood that most reasonable household expenses can be included in the housing allowance. Some of these items include: down payment on a home, mortgage payments (including both interest and principal), rental payments, home equity loan payments (assuming the loan proceeds are used for housing-related expenses), real estate taxes, homeowners’ association dues, property insurance, utilities, furnishings and appliances (including repairs), structural repairs, remodeling, yard maintenance and improvements, pest control, snow removal, maintenance items, and trash pickup. The costs of food, clothing, cleaning services, and domestic help are not qualifying housing expenses.[v]

3. The Tax Reporting Process

The Minister’s Housing Allowance is an exclusion from federal income taxes, not a deduction. This means that when filing federal income taxes, the employing church or ministry does not include the value of the designated housing allowance in the minister’s income subject to income tax and does not include the designated housing allowance in W-2 wages.[vi] If a church-owned parsonage is provided to the minister, rather than a designated rental or housing allowance, the minister excludes from his gross income the fair rental value of the house, including furnishings and utilities.[vii] If an employing church or ministry desires to account for the housing allowance, the church may report the rental allowance or fair rental value of the parsonage in box 14 of the minister’s W-2.[viii]  

For illustrative purposes, if a minister has an annual salary of $50,000 with a designated housing allowance of $28,000, the minister reports only $22,000 as his gross income for federal income tax purposes. The IRS then only taxes the minister on the reported $22,000, rather than the entire $50,000 salary.

It is important to note in the reporting process that the minister must claim as income any excess allowance the minister did not utilize to rent or otherwise provide a home during the taxable year.[ix] For example, if the minister above only utilized $25,000 of his $28,000 housing allowance, he must report the remaining $3,000 as income. Additionally, while the housing allowance is excluded from the minister’s gross annual income for federal income tax purposes, the housing allowance along with other earnings are still subject to self-employment tax.[x]

4. Retirement and the Minister’s Housing Allowance

Upon retirement, the IRS allows credentialed ministers to declare a housing allowance on distributions from their 403(b) retirement accounts. The IRS states, “If you are a retired minister, you can exclude from your gross income the rental value of a home (plus utilities) furnished to you by your church as a part of your pay for past services, or the part of your pension that was designated as a rental allowance.” [xi]

For housing allowance purposes, the IRS does not differentiate between an active and retired minister. Accordingly, the Minister’s Housing Allowance operates similarly in retirement as it does in active ministry. For a housing allowance to qualify as an income exclusion in retirement, the allowance must first be provided for services that are ordinarily the duties of a minister of the gospel. According to the IRS, housing allowances designated under a pension distribution qualify, as the distribution is made as compensation for past ministerial services.[xii] Additionally, the trustee of the retirement account must designate the allowance as a housing allowance in advance of the tax year.[xiii] Ministers may allocate up to 100% of their retirement distributions as a housing allowance, as long as the amount is previously designated.

Prior to filing federal taxes, a retired minister receiving distributions from a 403(b) Retirement Plan will receive a Form 1099-R, which discloses the total annual withdrawals from the retirement account. It is the individual minister’s responsibility to determine the amount qualifying as an exclusion from taxes. To the extent that the minister has verifiable housing expenses, he can lower the taxable withdrawals from his 403(b)-retirement plan by the smallest of: (1) the housing allowance designated by the trustee of the minister’s housing allowance, (2) the actual qualified housing expenses, (3) or the fair rental value of the home.[xiv] The house expenses eligible to be excluded from income remain the same in retirement. 

If a minister moves funds outside of a church sponsored 403(b) account, such as to an IRA or 401(k) account, it will result in forfeiture of the housing allowance benefit. The Housing Allowance exclusion is a feature specific to church-sponsored 403(b) plans only. Therefore, the only retirement distributions that are eligible to be designated as a Housing Allowance are those paid through a church-sponsored 403(b) plan. As a result, if a minister transfers his 403(b)-retirement account to a separate retirement account (IRA, Roth IRA, 401(k), etc), he will forfeit his eligibility for the Minister’s Housing Allowance and future distributions from the respective retirement account will be fully taxable.[xv]