Monday, January 31, 2011

Housing Allowance for Vacation Homes

In a remarkable decision by the full Tax Court, the Court has ruled that Phil Driscoll should be allowed to utilize the housing allowance provisions under IRC Sec. 107 for both his primary residence and his lake home. Utilizing a technical provision in the law, the Court has agreed that the term "a home" should not be interpreted as purely singular in nature, but should also apply in the plural. The result is that the housing allowance utilized to provide the Driscoll's lake home is excluded from their income. Writing the dissenting opinion, Judge Gustafson noted that there was insufficient evidence to state that Congress intended multiple homes to be covered under this provision. Additionally, he points out that the court's job is to narrowly construe the exclusions from income and not to throw open the door to excluding expenses for two, three, or four homes. These are valid points and will more than likely be the basis for an appeal by the IRS. What does this mean for ministers today? A Tax Court decision is binding on the IRS. Therefore, at this moment, it is the law in regards to this provision. However, it is more than likely that the IRS will appeal this ruling. It is not one that they can easily agree to. In the event that the appeal rules in favor of the IRS, then it will be as if this current case was never law. However, in the event the IRS does not appeal or loses the appeal, this case stands as binding on the IRS. It seems that "caution" would be the best watch word for the day. However, there are some actions that ministers should take today to capture this tax benefit in the event the case is allowed to stand. Ministers should consider the following actions: For 2011: Preparing for the Future

  • Housing allowance cannot be changed at the end of the year, so ministers with current second homes should consider increasing their housing allowance for 2011 to cover the expenses of the second home. If the decision of the Tax Court is not reversed by an appellant court, it would be too late to fully benefit from this change in the law at the end of a tax year.

For 2010: To Claim or Not To Claim

Ministers with excess housing allowance for 2010 should consider if they are ready to follow this ruling and claim expenses on a second home for 2010. This is a serious decision that should be fully explored with a tax professional. There are two viable options to be considered:

  • Use the expenses associated with the second home to determine the amount of housing allowance to be excluded from income and do not report any excess housing allowance on the 2010 Form 1040. This is an acceptable provision under current law. However, in the event the case is overturned on appeal, the IRS will have the ability to adjust the Form 1040 and assess all related taxes, penalties, and interest associated with the tax savings from this particular provision. Depending on the amount of the tax involved, ministers taking this route may wish to invest the additional taxes saved in order to preserve the funds in the event of a reversal.

  • Do not use the expenses associated with the second residence to determine the amount excluded from income and file as would be normal. As a second step, the minister may file a protective refund claim stating that they are due a refund based on this particular case. If the Driscoll case is on appeal, the IRS will more than likely hold the refund claim until a decision has been issued by the appellant court. This will take an estimated 2 to 3 years.

As previously stated, these are very serious decisions to consider and require an understanding of the ramifications of each decision. However, with the assistance of a tax professional, a minister should be able to make a decision that aligns both with the law and with his/her risk tolerance level.

Driscoll v. Commissioner of Internal Revenue, 135 T.C. No. 27.