Q: Does a church have a legal obligation to review the housing allowance requested by a pastor to determine both how it was computed and whether it fairly reflects the value of expected housing expenses for the new year?
The simple answer is that while a church is free to exercise this level of oversight over the pastor’s housing allowance, it is not legally required and is, in fact, rarely done. Section 107 of the tax code specifies that “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 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.”
The income tax regulations state: “In order to qualify for the exclusion, the home or rental allowance must be provided as remuneration for services which are ordinarily the duties of a minister of the gospel.”
What Does the Tax Code Require?
In summary, the tax code and regulations require that a “church” designate a housing allowance from the compensation paid to a “minister” for services performed in the exercise of ministry. However, there is no requirement for the church to verify the reasonableness of the housing allowance it declares.
Key Points to Consider:
- Neither the IRS nor any court has imposed a duty upon a religious congregation to determine the reasonableness of a housing allowance. While it is permissible for a congregation to do so, it is not mandatory.
- To determine the reasonableness of a housing allowance, a church would need to review its minister’s anticipated housing expenses for the year. This process can be burdensome and subject to change as actual expenses are incurred.
- Churches are unlikely to face penalties for failing to verify a pastor’s housing allowance. The main penalty would be aiding and abetting in the substantial understatement of tax, outlined in Section 6701 of the tax code. However, no reported case has applied this penalty to a religious congregation for this reason.
Best Practices for Housing Allowance Designation
Churches should ensure that the housing allowance represents compensation for services performed in the exercise of ministry. While there is no legal limit on the portion of a minister’s compensation designated as a housing allowance, the allowance is nontaxable only to the extent it does not exceed the fair rental value of the home or the amount spent on housing expenses.
Common Practices:
- Ministers typically report the nontaxable portion of their housing allowance and list any “excess allowance” as taxable income on their Form 1040, following IRS Publication 517.
- This approach reduces administrative burdens on the congregation and aligns with IRS guidelines for housing allowances.
- Most churches opt to designate housing allowances conservatively, avoiding amounts that significantly exceed the fair rental value of a minister’s home.
FAQ: Housing Allowance Verification
1. Does the IRS require churches to verify housing allowances?
No, the IRS does not require churches to verify the fairness or accuracy of housing allowances. It is sufficient for the church to designate an allowance as part of the minister’s compensation.
2. Can a church be penalized for not verifying housing allowances?
It is highly unlikely. Penalties for aiding in the understatement of taxes have not been applied to churches for failing to verify housing allowances in any reported cases.
3. Should churches designate housing allowances conservatively?
Yes, churches should avoid designating allowances that significantly exceed the fair rental value of the minister’s home, as the nontaxable portion is limited to actual housing expenses and fair rental value.
4. How should a minister handle excess housing allowance amounts?
The minister must report any excess allowance as taxable income on their Form 1040, ensuring compliance with IRS requirements.
For further details on housing allowance regulations, consult IRS.gov or legal counsel specializing in church tax matters.
