There‘a a long history with the housing allowance, and it’s been a part of the tax code for north of 100 years. I have an illustrated history available here
Basically the tax rules say that a minister’s housing allowance (either a cash payment or a physical home) are exempt from income tax. The housing allowance is still taxable for Social Security & Medicare taxes.
The short answer is because it's not required. Ministers are dual status employees according to the IRS (employees for income tax, self-employed for Social Security & Medicare taxes). Because of that IRS distinction, tax withholding for ministers is not automatic.
Ministers can make quarterly tax estimate payments or can voluntarily have their employer withhold taxes from their paychecks. A lot of my minister clients find the payroll withholding easier than dealing with quarterly payments. Whichever route clients prefer, I'll work with them to get their payments in line with their liability to reduce large refunds or balances due.
Yes, you can. There are no percentage limits on the designated housing allowance relative to your total compensation according to the IRS. Be careful though, because that doesn't mean the amount you declare will necessarily be exempt from income tax. It's easy to confuse the declaration with the taxation.
Clergy can only exclude from income tax the least of the following three dollar amounts:
It's not a bad idea to declare a housing allowance slightly above the other two limits. If the declaration is higher than one of the other limits, you just recapture the difference as income. No penalties or fees. If you're too low on the declaration, you can't go back and increase the housing allowance after the fact. So declaring a higher amount and recapturing the difference is a good way to optimize the situation.
Really these are any costs associated with owning and maintaining your home. These include:
Remember, you've still got the fair rental value limit that applies. Some large expenses like a down payment or major remodel may exceed the fair rental value limit in a given year. Advance planning with these larger expenses is a good idea.
Housing expenses are those items outlined above that that are associated with owning and maintaining a home. A home equity line of credit (HELOC) is simply a way of financing a purchase, similar to a mortgage.
There aren't any tax rules about how eligible expenses are paid for, the rules are about the eligible expenses themselves. The tax court has stated this in previous cases.
Where HELOCs can become problematic is when other ineligible items creep their way into the balance. As with any of these tax items, you'll just want to have clear documentation outlining the eligible expenses.
What's important here is to document a reasonable estimate. There's not a single price bullseye we're looking for, but you do need to hit the dartboard and have documentation supporting the number. Zillow offers monthly rental estimates. Some sources suggest 1% of a home's market value as a reasonable monthly rent. Local print or online rental listings may also be useful.
Don't forget that the fair rental value includes utilities and furnishings. If you can't find a comparable furnished rental, several sources suggest adding an additional 10 to 20% to the unfurnished rental price.
In addition to the records all taxpayers need to keep, ministers need documentation supporting the three limits on the housing allowance. Those are:
The most common tax problem ministers run into with documentation is a lack of it. It's not difficult to do the work and keep it in your tax records. You just need to be deliberate about it. Each year I work with my clients to make sure that we have all their tax documentation up to speed.
Your payroll department may have that rule, but there aren't any tax rules against it. The rules state that the housing allowance has to be declared before it is paid, and that there must be record of the declaration as an official church action (like meeting minutes or a budget line item). If you're needing to adjust it more than once per year you may just need help with tightening up your forecasts.
Remember that the designated housing allowance is simply a portion of your total compensation. There isn't a financial impact to your employer of having a higher portion of your existing compensation declared as housing allowance.
As a minister, you have to remember that your tax picture is unique from other taxpayers. What makes sense for someone else may be terrible financial advice for you.
Generally, a tax-deductible retirement plan through your employer's payroll (like a traditional 403b) is most advantageous from a tax perspective. The contributions are deducted from both income and Social Security & Medicare taxes. In retirement, withdrawals can be designated as housing allowance where they can be exempt from income tax, and Social Security & Medicare taxes are not collected on retirement withdrawals.
Other retirement plans such as non-deductible Roths and other tax-deductible plans outside of payroll will tend to have a heavier tax burden for ministers.
That being said, don't make any changes to your retirement plans without talking to an advisor who understands the details of ministers income taxes. If you have questions, contact me anytime.
Don't feel bad, you're not alone. I am different from a lot of tax offices in that I proactively work with clients to plan ahead and avoid surprises. Tax surprises are as bad of a message to deliver as they are to hear. I always felt it was better to know where things are heading in September than to find out where they landed in April.
ASHLAND ADVISORS, PLLC
Luke Speltz CPA, CMA | Van Meter, Iowa
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