Parsonage Allowance is not subject to income taxes.
Religious organization can provide to clergy ministers non-taxable benefits referred to as parsonage allowance. It’s done as part of total compensation paid to the minister.
How does this work? Religious organization can provide to a minister with rent-free furnished apartment or housing that is owned by the religious organization. Religious organization also can pay the fair market value of furnished apartment or house directly to the landlord or reimburse the minister. Religious organization pays directly or reimburses the minister for the mortgage and escrow payments of purchased apartment or a house. Based on the above, cash for housing allowance can be provided to the minister to rent or purchase a home. An allowance continues to be income tax free even during minister’s retirement, but it will be stopped once minister will depart this life.
How to qualify for a Parsonage Allowance. Under Sec. 1.107-1(a), the parsonage allowance is tax free if provided as remuneration for services that are ordinarily the duties of an ordained minister. What qualifies someone to be an ordained minister? Under Sec. 1.1402(c)-5(a)(2), an ordained minister is one who is “duly ordained, commissioned, or licensed” as a minister and it’s available for ministers in all-religious faiths. The parsonage allowance is excluded for income tax purposes, but is subject to SE tax. The minister may elect to be excluded from Social Security coverage (SE tax). Sec. 1402(e) provides that a minister may elect to be exempt from SE tax by filing Form 4361. This form is due no later than the due date of the return for the second year in which the minister has at least $400 of SE income, any part of which is derived from services as a minister.
How to adapt Parsonage Allowance. It is strongly recommended to outline the parsonage allowance and other non-taxable benefits on a written document. It can be adapted annually in official minutes, resolution, budget, bylaws or any other appropriate documentation evidencing official action. The religious organization also needs to have a written document signed by the receiver (minister) of the parsonage allowance and other non-taxable benefits.
The religious organization should:
- Prepare job descriptions for minister who will receive compensation.
- Determine the amount that qualifies as a tax-free allowance.
- Obtain parsonage allowance approval from the board of directors or other committee.
- Record the action adapting allowances in the official minutes.
- Provide each minister with written statement identifying the compensation amount designated as an allowance.
- Remind each minister to maintain detailed records of expenditures related to the allowance.
A good example of the above provision is an employment contract where religious organization can specify these requirements. If actual out-of-pocket expenses exceed designated allowance, the minister must report the excess as income. In light of that, the religious organization may consider overestimating the allowance amount to cover unexpected expenses and increased costs.
Expenses Covered by the Allowance. The housing allowance must relate to a dwelling place including furnishings. Under Sec. 1.107-1(c), the exclusion is allowed when: renting a home, purchasing a home and/or costs related to providing a home. A minister who is a common-law employee may participate in an employer-sponsored retirement or annuity plan. The minister may also contribute to an IRA, subject to the income limitation applicable to IRAs. Based on Rev. Rul. 73-258, tax-free parsonage allowance is considered compensation for retirement limitation purposes.
What expenses qualify as parsonage allowance?
- Mortgage payment (principal & interest)
- Property taxes
- Home insurance
- Structural repairs and remodeling
- Cost of utilities
- Furnishings and appliances (purchase and repair)
- Yard maintenance and improvements
- Maintenance items (household cleansers, light bulbs, pest control, etc.)
- Other housing costs
- Rental value of the house (furnished) plus utilities
Effect on SE Tax Religious organization are exempt from income tax under Sec. 501(c)(3), but are covered by the Social Security Act. An employee’s wages of a religious organization are subject to FICA. Under Sec. 1402(a)(8), a minister is considered to be self-employed and thus is responsible for SE tax payments. Parsonage allowance is included in SE taxable income. The religious organization may provide an allowance or reimbursement for the minister’s SE tax, although the minister must report this payment as additional income subject to SE tax.
How to report parsonage allowance? Compensation to the minister, other than the housing allowance, is reported as wages on W-2. Sec. 31.3402(p)-1 provides that a minister may request the religious organization to withhold Federal income taxes from his/her paycheck. By doing this, it eliminates the need for the minister to submit estimated SE tax payments to the IRS. The housing allowance is indicated in Box 14 on Form W-2. The minister wages from a religious organization are reported on Form 1040, line 7, along with wages from other sources. Amounts received for weddings and similar non-wage type of services are reported on Schedule C. The SE income includes housing allowance, salary and net income from Schedule C. If the religious organization withholds FICA taxes from minister’s paycheck (as noted above), then only housing allowance and Schedule C income will be subject to SE tax.
Taking Deductions. Under Sec. 265(a)(6), a minister who purchases a home can deduct interest and property taxes related to the home, even though those costs are paid or reimbursed by the religious organization. Yes this is one of the legal double tax deduction allowed by the IRS. In most cases, the minister is an employee, so if a minister incurred employee-business expenses and he/she was not reimbursed for those expenses by the religious organization, those unreimbursed expenses are deductible as miscellaneous itemized deductions on Schedule A of form 1040 and are subject to the 2% floor.
As explained above its imperative that the religious organization, and minister keep good records and documentation related to parsonage allowance and other non-taxable benefits provided to employees.Business Tax ArticlesThis article was written by TaxBizPro, LLC 2020, all rights reserved ©.
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