Ministers' Common Tax Questions

The Minister's Housing Allowance 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 though. 

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 like it is for typical employees. 

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. 

Your tax liability will depend heavily on your personal situation, but the key thing for ministers to remember is their Social Security and Medicare tax obligations. 

Regular employees who are not ministers have these taxes taken out of their paychecks and never have to think about them again. For ministers, these taxes have to be paid separately and will be calculated when you file your tax return each spring. I regularly see ministers who have little to no income tax obligation wind up with a five figure Social Security and Medicare tax bill. 

There are no credits or deductions to reduce Social Security and Medicare taxes like there are with income taxes. No matter your income tax situation, you will owe approximately 15% of your salary plus housing allowance in Social Security and Medicare tax. 15% of $50,000 is $7650, so it adds up pretty quickly. 

At an absolute minimum, you should plan to owe 15% of your salary and housing allowance in Social Security and Medicare taxes. This can be set aside to make quarterly estimate payments, but I find most minsters prefer to voluntarily have the taxes withheld from their employer and automate the process. 

Yes, you can. There are absolutely no limits on the designated housing allowance in relation to your total compensation anywhere in the tax rules. 

Be careful though, because that does not mean the amount you declare will be fully exempt from income tax. It's easy to confuse the designation with the taxation. 

The income-tax exempt portion of the housing allowance is limited to the least of three numbers: 

•  the designated housing allowance,
•  your actual housing expenses (list in the next topic), or
•  the fair rental value of the home (furnished, with utilities)

If the designated allowance is above one of the other limits, then the difference is simply recaptured as regular income. No penalties or fees to do that. I keep worksheets with all of these details for all of my minister tax clients. 

It's not a bad idea to designate a housing allowance higher than what you expect for the other two limits, because the designation must be set in advance of payment. The designation cannot be changed after the fact, and this requirement is crystal clear and heavily emphasized in the tax rules.  If the designation is lower than your actual expenses or home's fair rental value, you can't go back and increase your designation. 

You can adjust the designation going forward, and I regularly work with minister tax clients to make these adjustments as needed. 

Really these are any costs associated with owning and maintaining your home. There is no official list from the tax authorities, but reliable sources include the following items:

• mortgage or rent payments
• down payment
• real estate taxes
• property or renter's insurance
• utilities (cell phone costs are excluded because they're not attached to the home)
• purchase or repair of appliances and furnishings
• remodeling or repair costs
• yard maintenance or improvements
• other maintenance items (pest control, cleaning supplies, etc)
• Home security systems
• HOA dues

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. 

What's important is to document a reasonable estimate. This isn't a math test with a single correct answer; you just need a reasonable estimate with documentation of how you got there. When ministers get into trouble here, it's generally from having no documentation, not from being 5%  off on rental value. 

Some online sources offer monthly rental estimates, and some clergy resources 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 an additional 10 to 20% to the unfurnished rental price. 

Again, the takeaway here is to have a documented number with support of how you arrived at it. I keep detailed records of these items for all my minister tax clients. 

In addition to the records all taxpayers need to keep, ministers need documentation supporting the three limits on the housing allowance. Those are: 

• The designated housing allowance itself (from your employer)
• The fair rental value of the home (furnished and including utilities)
• The actual expenses you incurred in owning the home (outlined above)

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 tax rules state that the housing allowance has to be declared before it's 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 need more than one annual adjustment you may just need help with tightening up your forecasts. 

The designated housing allowance is simply a portion of your total compensation. There shouldn't be any financial impact to your employer from having a higher portion of your existing compensation declared as housing allowance. 

It's true that paying off your mortgage will reduce your actual housing expenses which will reduce that limit in the calculations. But don't let the tax tail wag the dog here. 

If you are in a position to pay off your mortgage, doing that can dramatically change your household budget and can bring peace of mind that's difficult to quantify in a spreadsheet. 

The Bible has nothing good to say about debt, and moving in a direction towards less of it is generally not a bad idea. I don't know a single person who paid off their mortgage and later regretted it. If you pay off your home and can't stand the freedom, you can always go back and take out another mortgage. 

As a minister, you have to remember that your tax picture is unique from other taxpayers. What makes sense for another taxpayer may be terrible financial advice for you. 

Generally, a tax-deductible retirement plan through your employer's payroll (like a traditional 403b) is the most advantageous for ministers from a tax perspective. The contributions are deducted from both income tax and payroll taxes. Then, in retirement, withdrawals can be designated as housing allowance where they can be exempt from income tax, and payroll taxes are not collected on retirement withdrawals. This is a tough deal to beat. 

Other retirement plans such as non-deductible Roths or other tax-deductible plans outside of payroll will tend to have a heavier tax burden for ministers. 

That being said, do not make any changes to your retirement plans without talking to an advisor who fully understands the details of ministers income taxes. If you have questions, I'm happy to help any time. 

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 to deliver as they are to receive.  I always felt it was better to know where things are heading in September than to find out where they landed in April.