Designating Housing Allowances - A "Must Do" Step for the Church
Ministers performing qualifying ministerial services may have a portion of their compensation designated as a housing allowance pursuant to Section 107(2) of the Internal Revenue Code. (Terminology varies interchanging such words as housing, parsonage, rental or manse depending on the culture of the church. The Internal Revenue Code and Regulations refer to it as "rental allowance".) Within certain limitations, this portion of a minister's compensation is not subject to federal income tax.
Internal Revenue Regulation 1.107(b) requires that in order to be "rental allowance", the amount must be designated as such pursuant to an official action taken in advance of the payment of the allowance by the employing church or other qualifying organization. Two cases decided in 2013 remind us of the critical need to properly designate housing or rental allowances.
In Ricky Williams v. Comm., pro se TC Summary Opinion 2013-60, the minister entered into an employment contract with his church. The initial contract provided for a housing allowance for a period of six months. Any provision extending beyond the six months would have to be formally decided at a later date. The church never revisited this issue, so none of Reverend Williams' future compensation was designated as housing. During an examination of his 2007 Form 1040, Rev. Williams asserted that over $33,000 of his compensation should be considered as housing allowance. The IRS disagreed, so off to court they went. The court ruled that Rev. Williams could not claim the housing allowance, since the church had never formally designated an amount as housing allowance after the initial six month provision. Therefore, for 2007, no housing allowance existed. Rev. Williams produced a new employment agreement dated in 2012 that included the housing allowance provision, but the court reiterated the requirement of having the designation prior to receiving the funds. The 2012 employment agreement was too little, too late.
In Donald L. Rogers, V. Comm., TC Memo 2013-177, Rev. Rogers' church paid his mortgage payments and utilities directly rather than pay him an allowance for the expenses. Despite making the payments directly, the church failed to formally designate the payments as payments made pursuant to IRC Section 107. Lacking the formal designation, the court agreed with the IRS that the payments represented taxable compensation to Reverend Rogers.
Many churches are lax in their housing allowance designations. I recommend that housing allowance designations be approved every year and be approved by either the appropriate committee, the board of directors or by a high ranking employee that has specifically been granted the authority to make the designations on behalf of the church or other qualified organization. Remember the designation has to be done prior to the payment of the allowance, so beware of late designations or of designations that attempt to reclassify prior payments. In this area, it pays to do it well and do it early in order to provide the maximum benefit to the minister.
Cautionary Note: In Freedom From Religion Foundation, Inc. v. Lew, 112 AFTR 2d 2013-7107, the court ruled that IRC Section 107(2) is unconstitutional. This ruling makes the housing allowance, but not the provision of a parsonage, unconstitutional. The judge delayed the mandate for the IRS to enforce the ruling until the conclusion of the appeals process. The government has appealed the decision to the 7th Circuit Court of Appeals. Therefore, the future fate of this tax provision is in the hands of the U.S. Department of Justice and the 7th Circuit Court of Appeals.