Far beyond that of any other year, this year I have spent more time talking to pastors, treasurers, CFO's and administrators about the housing allowance. What is the most common question I have gotten? "How do you report the housing allowance on the minister's tax return?" My answer is usually, "That depends." Unfortunately, reporting it correctly depends on a number of factors such as whether or not the housing allowance is paid, designated, substantiated and recorded. Has the minister applied for self-employment tax exemption? Did he/she fill out a housing allowance statement?
The reason I first ask a milieu of other questions in order to properly answer how someone should report the housing allowance on their tax return is because experience has taught me that when it comes to the housing allowance, the people responsible for properly reporting it are all over the map. Confusion runs deep in this area and CPA's, including tax professionals, are no exception.
How to report it
First of all, the church needs to calculate the housing allowance correctly. We will discuss that later. After the church correctly calculates the housing allowance, it needs to report it on box 14 of the W-2 form. There are two main reasons why reporting it on the W-2 form is important.
- If the pastor has not applied for self-employment tax exemption, the housing allowance on line 14 will need to be reported on schedule SE so that self-employment taxes of 15.3% can be paid on the housing.
- For the purposes of purchasing a home, reporting the housing allowance on line 14 will be considered earned income for banking purposes, which better positions you when a bank is considering approving you for a loan to buy a house.
Now that the housing allowance has been reported on box 14 of the W-2, reporting it on the tax return depends on the status of the pastor in regards to self-employment tax. If the minister has applied to the IRS for self-employment tax exemption, then he/she will not have to report the housing allowance on the tax return. However, if the minister has not applied for the exemption, he/she will have to report the housing allowance on schedule SE. One thing to know is that the minister is able to prepare an adjustments worksheet and deduct unreimbursed business expenses against the housing allowance. Sound confusing?
Why the confusion?
The confusion has to do more with the way a church perceives the housing allowance. It has been around since 1921 and has been amended three times to accommodate the number of ministers that either rent or own their own homes. These three amendments have not been well understood by many pastors, leaders CPA's, and tax professionals, resulting in many ministers either missing out on what the tax code has to offer (by paying more in taxes than they ought) or flat out getting into very serious tax trouble. Let's look at some of the mistakes that churches make in the housing allowance.
- The church and board agree that the pastor shall have a housing allowance but never record it in minutes using the proper language. This mistake alone is big enough that it completely nullifies the housing allowance.
- The church pays a housing allowance set to a definite number. The church often either pays too much or too little. Let me better explain:
Church ABC decides to pay Pastor B a salary of $20,000.00 and an additional housing allowance of $20,000.00. In a perfect world he would only pay taxes on $20,000.00, but he is required to do an annual report to ensure that he can substantiate qualifying housing allowance expenses of at least $20,000.00. So, if he can only document $15,000.00 in qualifying housing allowance expenses the remaining $5,000.00 has to be reported as regular income on his tax return. That could throw out of balance the quarterly 941 returns if the church did not allot for this last minute change.
On the flip side, if Pastor B is able to document qualifying housing allowance expenses that are greater than $20,000.00, he would not be able to benefit from the additional qualifying expenses because his church set a limit on his ability to take advantage of those expenses by officially stating it would pay a housing allowance of $20,000.00.
- The pastor never fills out a housing allowance statement that substantiates the qualifying expenses. Many churches simply fill out box 14 of the W-2 based on the number they set at the beginning of the year without ever verifying it.
We make every effort to educate leaders on the importance of properly reporting the housing allowance because one mistake can lead to serious discrepancies in annual reporting. Yet it seems that on a countrywide basis the number of churches that improperly report it has increased.
The IRS position on the housing allowance
When it comes to the housing allowance, the IRS position is that the church must designate it before the payment is made. There are no exceptions to this rule. Many churches have not made the designation and year after year have been reporting the housing allowance on the pastor's W-2.
Church and Ministry Tax Compliance Conference!