Housing Allowance Presents New Challenges
Paul G. Schloemer and Ryan Wilson
2005 - For over 50 years, ministers have enjoyed the benefits
of tax-free housing. IRC section 107 permits qualified ministers
to exclude housing-related compensation from gross income
to the extent it relates to service performed in their ministry.
term “minister” as used herein refers to people
holding various titles in a variety of religious organizations.
A “minister of the gospel” as defined below,
meets specific criteria defined in Treasury Regulations
sections 1.107-1(a) and 1.1402(c)-5.] This benefit has recently
come under scrutiny due to heightened concern about the
separation of religious organizations and government, and
because of perceived abuses of this privilege.
in the operation of religious organizations have meant that
more ministers are serving in nontraditional roles, including
situations where they have both ministry and nonministry
responsibilities. This results in situations where an employee’s
right to a housing allowance is less clear. A careful application
of IRC section 107 is necessary to ensure that the minister
has a valid claim to a housing allowance and that the claim
will withstand IRS examination.
preparers can provide assistance by verifying that an individual
meets the definition of a minister under IRC section 107
and by maintaining adequate documentation to ensure that
valid housing-allowance claims are upheld. This information
can also aid those serving on church boards or as advisors
to churches. These preparers can enhance tax-law compliance
by educating church leaders and employees on the requirements
of IRC section 107 and by providing advice in cases where
an employee’s right to a housing allowance is less
of IRC Section 107
section 107 allows a tax-free housing benefit for a “minister
of the gospel” in two situations. First, the employer
can allow the minister to live rent-free in a home (parsonage)
owned by the church. The minister can exclude this benefit
from gross income up to the home’s fair rental value.
The value of the parsonage must be clearly distinguished
from other compensation, and includes items such as furniture,
insurance, utilities, and taxes.
a parsonage is not provided to the minister, a nontaxable
housing allowance can be provided so that the minister can
rent or buy a home. This is the option used most frequently.
It provides ministers with the freedom to choose their preferred
type of housing. The allowance covers items such as mortgage
payments (principal and interest), insurance, repairs, utilities,
and other expenses to keep the home in working order.
value of a home or a housing allowance provided to a minister
is nontaxable for federal income tax purposes and typically
nontaxable under state income tax laws. To exclude this
compensation, the amount should be designated prior to the
year in which it is paid, and documented in an employment
contract, church budget, or the minutes from church meetings
or church board meetings [Treasury Regulations section 1.107-1(b)].
the term “minister” is not defined in the IRC,
the IRS and courts have helped clarify the definition. Per
Treasury Regulations section 1.107-1(a), the housing allowance
must be provided in exchange “for services which are
ordinarily the duties of a minister of the gospel.”
The regulations under section 107 reference the regulations
under section 1402 for a definition of the duties of a minister.
Under Treasury Regulations section 1.1402(c)-5, these duties
include: 1) the ministration of sacerdotal functions, 2)
the conduct of religious worship, and 3) the direction of
organizations within the church. In addition to performing
these duties, the individual must be ordained, commissioned,
or licensed as a minister of the church.
the past 40 years, the Tax Court has decided several key
cases that help define a minister for the purposes of IRC
section 107. The IRS has enlisted these rulings to clarify
the government position on this issue. In defining a minister,
the focal point is on the duties carried out by the individual,
rather than her education or position in the organization.
Salkov v. Comm’r [(1966) 46 TC 190], at issue
was whether a Jewish cantor met the definition of a minister.
The court found that Salkov had a position of authority
similar to that of a rabbi and, with one exception (addressing
issues of Jewish law), performed the same duties. Therefore,
the cantor was “the equivalent of a minister of the
gospel within the intendment of section 107.” The
court found in Salkov’s favor because he essentially
performed all the duties of a religious leader in the Jewish
Lawrence v. Comm’r [(1968) 50 TC 494], a “minister
of education” at a Baptist church did not qualify
as a minister. Bob Lawrence was “commissioned”
by his church, but not ordained. He supervised several church
programs, trained workers and teachers, sought new church
members, visited the sick, provided counseling, and assisted
during worship services. Occasionally, he even preached
at worship services, a task typically reserved for the senior
pastor. In spite of Lawrence’s extensive involvement
in church activities, the court held that he was not a minister
within the definition of IRC section 107.
court identified two “ordinances” in Lawrence’s
church that resembled sacraments: baptism, and the Lord’s
Supper or communion. His failure to officiate at these ordinances
was a determining factor in the court’s decision to
disallow the housing allowance. The fact that Lawrence
was not ordained by the church also hurt his assertion that
he qualified as a minister. His “commissioning”
by his church was discounted by the court as a mere formality,
initiated merely to take advantage of the benefits of IRC
section 107. The Lawrence case emphasized the importance
of performing the key duties of a minister. All ministry
duties are not equal in determining who qualifies for a
Wingo v. Comm’r [(1987) 89 TC 911], the Tax
Court specified five factors (three activities and two attributes)
used to identify a minister as defined under IRC section
107. An individual possessing these factors would presumably
qualify as a minister:
Performing sacerdotal functions;
Conducting worship services;
Controlling or maintaining the organization;
Considered a spiritual leader; and
licensed, or commissioned.
addition to the three activities of a minister listed in
the regulations under section 1402, the court affirmed that
the minister must be commissioned, ordained, or licensed,
and considered a spiritual leader. The court concluded that
to qualify as a minister under IRC section 107, all five
requirements must be fulfilled. The Tax Court and the IRS
have frequently referred back to the five factors specified
Knight v. Comm’r [(1989) 92 TC 199], the
Tax Court took a less restrictive approach to defining a
minister than it had two years earlier in Wingo.
Knight was not ordained by his church, could not administer
the sacraments, and could not participate in church government.
The court, however, held that he was a minister because
he was licensed by the church, conducted worship services,
and was considered a spiritual leader, thus meeting three
out of the five factors. The opinion stated that meeting
the definition of a minister is not simply an arithmetical
test; having a majority of the factors in the taxpayer’s
favor may not be sufficient. Instead, failure to meet one
or more of the factors must be weighed by the court in each
case. At a minimum, the minister must be licensed, commissioned,
Haimowitz had worked for Temple Adath Israel for 30 years.
He was hired as executive director, performing mainly administrative
tasks. Over time, he became more involved in religious tasks,
assisting (but never officiating) in various ceremonies.
He was never ordained as a rabbi or commissioned as a cantor,
but he was recognized as a “fellow” by the Synagogue
Tax Court held [Haimowitz v. Comm’r (1997)
T.C. Memo. 1997-40] that Haimowitz was not a minister because
his duties “were mostly secular in nature.”
He never performed the role of a rabbi or a cantor. In addition,
Haimowitz’s designation as a “religious functionary”
did not meet the requirements of being ordained, commissioned,
or licensed. Thus, Haimowitz did not meet any of the five
factors specified in Wingo.
illustrates the danger of granting a housing allowance to
employees with mainly secular duties. Unless a substantial
portion of the employee’s duties fit within the realm
of those listed in Treasury Regulations section 1402(c)-5(b)(2),
the definition of a minister is not met and the benefits
of IRC section 107 are not available. This position was
affirmed in a recent IRS Technical Advice Memorandum (IRS
Letter Ruling 200318002).
Impact of Changes in Church Operations
changes in the way churches operate have raised new issues
in compensating ministers through the use of a housing allowance.
An employee may have the credentials of a minister (e.g.,
a seminary degree) but not fill a traditional ministerial
role. In the following situations, compensation through
use of a housing allowance is more tenuous:
Ministers performing extensive counseling or administrative
Children’s ministry workers, and education directors;
Music ministers, and worship leaders; and
Employees in dual roles (e.g., administrators with ministry
Regulations section 1.107-1 requires that the housing allowance
be provided for performing the duties of a minister. These
duties vary among denominations. Duties that exemplify a
minister in one denomination may not be appropriate in identifying
a minister in another. For example, the sacerdotal functions
identified in Lawrence (baptism and the Lord’s
Supper) were not applicable to the Jewish cantor in Salkov.
claiming a housing allowance have the burden of proving
that their duties exemplify those of a minister in their
faith. Those with extensive counseling or administrative
responsibilities would not qualify as ministers under the
Tax Court’s ruling in Haimowitz. Their duties
would typically not include sacerdotal functions or leading
worship. Exclusion from these roles would probably also
prevent them from being recognized as spiritual leaders.
Thus, administrators and counselors would typically fail
to meet at least three of the five factors specified in
Wingo. These employees would not qualify as ministers
under IRC section 107 without a preponderance of other duties
that exemplify those of a minister.
ministry workers and those supervising Christian education
(e.g., Sunday school classes or small groups) may be recognized
as spiritual leaders in a church, but may be excluded from
leading worship and performing sacerdotal functions. Worship
leaders would appear to be in position where they can claim
at least some role in conducting worship services, but in
many churches they would not be recognized as spiritual
leaders unless they perform sacerdotal functions or preaching
duties. Thus, it is more difficult for those involved in
these areas of ministry to claim the housing allowance exclusion.
employees can take the position that they qualify as ministers
if their duties include key ministerial functions. Regular
involvement (at least quarterly) in preaching and sacerdotal
functions substantiates a position as a spiritual leader.
Assuming the employee is ordained, commissioned, or licensed,
involvement in these key duties can provide evidence that
they meet four of the five factors described in Wingo.
management should assist in this area by specifying the
required ministerial duties prior to the year that an employee
is granted a housing allowance. In addition, it is important
to produce job descriptions and schedules documenting that
those individuals leading children’s and music ministries
and supervising education are regularly performing the duties
of a minister.
some cases, employees have been assigned a dual role. An
individual’s employment may specifically allocate
time between ministry and nonministry duties. This approach
allows churches to control payroll costs while assuring
that necessary functions are carried out. For example, employees
with expertise in nonministry areas, such as marketing or
computers, may be assigned these secular duties along with
more than 50% of an employee’s time is devoted to
nonministry duties, granting a housing allowance is a tenuous
position. At the same time, it seems unfair to exclude employees
from the benefits of a housing allowance if part of their
job involves performing the typical duties of a minister.
In the eyes of a court, it appears that all employees are
measured under the same standard; if most of their duties
are secular, they probably fail to meet the definition of
a minister. This assignment of employees to dual roles is
becoming more common. Future legislation should consider
whether employees in this situation should be granted a
limited housing allowance for the ministry portion of their
Issues Unique to Ministers
qualified ministers, other issues make compliance with tax
law complex and cumbersome. Because these issues are unique,
ministers and even practitioners may be unfamiliar with
them. Two key issues encountered by ministers are the documentation
of housing expenses and the impact of self-employment tax.
housing expenses. IRC section 265(a)(6) provides
that mortgage interest and real estate taxes qualify as
itemized deductions even though these expenses are paid
out of funds from the minister’s housing allowance.
Thus, ministers derive a double benefit by excluding housing
allowance income under IRC section 107 while receiving a
deduction for interest and taxes paid with funds from the
other taxpayers, ministers that itemize deductions must
maintain documentation to support them. Ministers must also
maintain documentation showing that the housing allowance
claimed was actually used to maintain a home. In addition
to statements supporting property tax and mortgage-interest
payments, ministers must track mortgage principal payments,
the cost of maintenance and repairs, utilities, insurance,
furnishings, cleaning supplies, and amounts spent on home
improvements. Thus, the recordkeeping burden required to
support the housing allowance exclusion is beyond that required
of the typical homeowner.
are well advised to take advantage of electronic recordkeeping
programs to aid in documenting itemized deductions and housing
allowance expenses on a contemporaneous basis. Because expenses
related to home maintenance are incurred frequently, meticulous
recordkeeping is necessary. Records should contain the amount,
date, location, and purpose of the expense. The benefits
of maintaining timely and detailed records are time saved
when filing tax returns, assurance that all material expenses
have been included, and avoidance of IRS adjustments if
returns are subject to audit.
tax. Perhaps the most confusing aspect of
tax law for ministers is that most qualify as employees
for federal income tax purposes while being classified as
independent contractors for self-employment tax purposes.
A minister meets the definition of an employee when the
employer has the right to direct and control how the work
is performed (e.g., setting work hours and location), not
just the end result. Under common law, an employer typically
exercises enough control over a minister to classify him
as an employee for federal income tax purposes. Thus, withholding
on taxable compensation is required, and the minister receives
Form W-2 for tax-return filing purposes.
an independent contractor, a minister’s housing allowance
and other compensation for ministry duties are subject to
self-employment taxes at a 15.3% rate. This represents a
substantial increase in payroll taxes for those entering
the ministry. Planning is required so that the minister’s
tax withholding is increased or quarterly estimated payments
are established to meet the higher employment-tax liability.
employment-tax issue is the option for ministers to request
exemption from self-employment tax under Treasury Regulations
section 1.1402(e)-2A(a)(1). By requesting exemption, the
minister asserts opposition to the acceptance of public
insurance payments for retirement, disability, death, or
medical care. Form 4361 must be filed before the due date
(including extensions) of the tax return for the second
year in which the minister has at least $400 of net self-employment
earnings. If the exemption is granted, all compensation
for ministry is excluded from self-employment tax.
the current legal climate, any hint of government endorsement
of religion is viewed suspiciously. The removal of the Ten
Commandments from courthouses, the elimination of prayer
at school events, and challenges to the mention of “God”
on currency and in the Pledge of Allegiance reflect an environment
that seeks to sever all ties between government and religion.
The question of whether providing tax benefits to ministers
is an unconstitutional subsidization of religion is a contentious
attacking the constitutionality of IRC section 107 may well
be forthcoming. Strong opinions against providing benefits
to ministers have been voiced in the past [see Taft, “Tax
Benefits for the Clergy: The Unconstitutionality of Section
107,” Georgia Law Journal 1261 (1974)]. Recently,
the Ninth Circuit Court questioned the constitutionality
of the housing allowance (Richard D. Warren, 282
F3d 1119). The court appointed law professor Erwin Chemerinsky
to serve as amicus curiae. His brief argued that the housing
allowance violated the Constitution’s establishment
clause. Congress responded quickly to this challenge, endorsing
the constitutionality of the housing allowance in the Clergy
Housing Allowance Clarification Act of 2002. Future legislators
and presidential administrations may be less willing to
take such a strong stand on this issue.
involved in granting and claiming housing allowances should
be aware of increased risk in this area and take steps to
“audit-proof” this benefit. Parties that can
assist in this process include church administrators and
leadership boards, and those serving as advisors to churches
for Church Administrators and Church Boards
administrators and leadership boards should be aware that
this benefit may be subject to closer examination in the
future and that the IRS may attack cases where individuals
have been more aggressive in claiming the housing allowance
without facts that are convincingly in their favor. In the
past, ministers in the areas of education and music have
been prime targets, because their duties place them outside
traditional minister roles. This trend toward nontraditional
roles will continue as churches seek innovative approaches
can preserve this benefit for qualified employees by educating
staff on the requirements for claiming a housing allowance.
Strict adherence to guidelines, such as documenting the
amount of the allowance and approving the allowance prior
to the year in which it is paid, is crucial. Ensuring that
ministers continue to perform ministerial duties, and documenting
this, would be ideal.
related issue for church leadership is determining the appropriate
amount of compensation. The total compensation amount is
usually set first, followed by designating a portion of
the total as housing allowance. Underpaying staff can undermine
employees’ personal finances and cause morale problems.
Paying excessive compensation to a minister can threaten
the church’s tax-exempt status. Loss of tax-exempt
status has onerous consequences. The church’s net
income is subject to income taxes, and donors’ contributions
are no longer deductible. In addition, the church could
lose benefits such as preferential postage rates, exemption
from sales and property taxes, and housing allowance exclusions
determining compensation, church leaders should take advantage
of surveys that provide compensation levels paid by other
churches (e.g., 2005 Compensation Handbook for Church
Staff, Christian Ministry Resources, July
2005). These surveys provide compensation ranges based on
minister qualifications such as experience, education, and
tenure, as well as church characteristics such as revenues
and number of members. This information can be used to develop
objective benchmarks for compensation, so that employees
are treated equitably. In addition, the use of survey data
protects against the accusation of excessive compensation.
for Tax Preparers
is important for tax preparers to ascertain whether individuals
that claim the benefits of a housing allowance are qualified
to do so, because disallowance of the benefit in an IRS
audit can result in substantial tax liabilities at both
the federal and state level, along with interest and potential
negligence penalties. At a minimum, ministers should be
commissioned, ordained, or licensed. Ministers should be
made aware that their housing allowance is dependent on
regular performance of duties as defined in IRC section
1402. If the minister does not have the strongest evidence
in support of her claim to the housing allowance, the performance
of ministerial activities during the year should be documented.
Documentation may be the one factor preventing adjustments
in an IRS audit that occurs years later.
finances are frequently as complex as those of for-profit
entities. Churches are now more likely to have a person
with accounting expertise as a board member or an outside
consultant. Addressing the housing allowance and other compensation
issues is an opportunity to provide valuable advice that
can protect the church and its employees from IRS examinations,
and may present opportunities to generate consulting revenues.
Church administrators may be open to enlisting an outside
advisor’s expertise to address housing-allowance issues
in instances where employees perform duties outside the
traditional minister role.
though the benefits of tax-free housing provided under IRC
section 107 have been a fixture of the tax law for over
50 years, the changes in church operations that have placed
ministers in nontraditional roles make complying with the
provisions of this tax law more challenging. Church administrators
and leadership boards should be aware of key issues that
determine which employees should be granted a housing allowance.
Accounting professionals and tax advisors have an opportunity
to use their expertise in this area to enhance tax-law compliance
and to ensure that valid housing-allowance claims withstand
G. Schloemer, PhD, CPA, is an associate professor
at Ashland University, Ashland, Ohio.
Ryan Wilson is an interdisciplinary studies
major, also at Ashland University.