Minister’s Housing Allowance Under Fire
It’s not often that my past career as a tax accountant intersects with my future career as a minister, but the recent 7th Circuit Court decision does exactly that. An anti-religious group challenged the minister’s housing allowance, and won. That won’t be the end of the story. The decision will be appealed, perhaps all the way to the Supreme Court. In the mean time, while ministers will suffer in the 7th Circuit, which covers IL, IN and WI, it’s unlikely the IRS will change the rules for the rest of the country until the matter is resolved by the courts.
The problem is, there’s a world of misunderstanding behind the suit and the decision. As one opponent of the decision said,
“This tax provision ensures that faith leaders like South Side, Chicago-based pastor Chris Butler receive the same tax treatment as other employees who must live in the communities they serve-like military service members, teachers, and overseas workers.”
And there’s the rub: secular employees who are required to be on-call, on-site are entitled to tax-free housing allowances. This includes not only teachers and emergency workers, but dairy farmers, factory specialists, and others. The key is the requirement is that they are on-call on-site, 24 hours a day.
The clergy housing allowance actually applies not only to “ministers of the Gospel,” as indicated in the original law, but to clergy of any religion. Why do they require a special law? Because their’s is a special case. Unlike most employees, IRS regulations specify that most ministers are to be paid as self-employed workers–sort of. They receive a W-2 from their church (not a 1099), but the church does not withhold taxes (including social security) from the minister’s check. The minister pays these taxes on Schedule C, just like a self-employed person. Presumably this is because IRS knows the part-time, probably volunteer church treasurer has no idea how to figure payroll taxes, and hiring a professional can be burdensome.
Like a self-employed person, a minister gets to deduct his or her business expenses. Oddly, though, if a minister makes extra money from performing weddings and funerals, for example, these must be reported on a separate Schedule C, along with their related expenses. Yet this extra income and expense is combined with their primary Schedule C to calculate the tax.
Unlike most self-employed people, but like an employee, a minister is allowed a housing allowance that is exempt from income tax (but not FICA taxes) if they are on-site on-call. And on their Schedule C, they are required to reduce their business expenses by the proportion of their income that comes from the housing allowance (so long as that housing allowance was actually used for housing)– but only for income tax purposes, since the housing allowance is taxed for social security.
For example, let’s say a minister earns $10,000 in a year, and she gets an additional $5,000 for housing. She has $750 of expenses. For self-employment (FICA) tax purposes, she earned $15,000 and gets to deduct $750. Her taxable income is $14,250. But for income tax purposes, 33.3% of her income came from housing allowance which is exempt from income tax, so she has to reduce her expenses by 33% and can only deduct $500 in expenses. Her taxable income is $9,500.
If this sounds complicated, it is. This is one of the most difficult calculations I’ve encountered in the arena of individual and small business taxes. And it gets worse once the minister is semi-retired and has pensions and other sources of income.
Moreover, it’s up to the church (or other employer) to determine whether the minister will even get a housing allowance. This differs from an employee, in which circumstances (i.e. on-call on-site) dictate whether a housing allowance is involved.
So, are ministers getting a benefit denied to secular employees–or are they burdened in a way secular employees aren’t for the same benefit? It’s hard to tell. There are some benefits to clergy, such as deducting their business expenses without having them subject to the 2% haircut on Schedule A. On the other hand, they pay both parts of their FICA (social security) taxes, twice as much as an employee. And they’re going to pay as much as 3 times more to have their tax return prepared!
The judge in this case recommended simplifying the law so that employees of any 501(c) organization are subject to the same laws. I concur. They will still have to address the status of ministers as statutory employees taxed as self-employed persons. But at least the system would be consistent.
Back to the original argument: The issue here is not that secular employees are denied this benefit–it’s that ministers by their nature are a special case.
Further reading: “5 Takeaways from the Clergy Housing Allowance Ruling“