DEFINITION of Parsonage Allowance
Parsonage allowance is an allowance designated by the governing board of a church to its clergy or ministers for the expenses of providing and maintaining a home. This allowance is exempted from the minister’s gross income for tax purposes.
Parsonage allowance is also called rental allowance or housing allowance.
BREAKING DOWN Parsonage Allowance
Parsonage allowance is basically a housing allowance for ministers of the gospel. As compensation for ministerial services provided, a minister may receive ministerial income, a portion of which includes a rental or housing allowance. Section 107 of the Internal Revenue Code (IRC) allows ministers of a religious body to exempt some or all of their housing allowance from gross income for income tax purposes. As long as the amount of the allowance is not more than reasonable pay for his or her services, the pastor or minister can exclude from gross income the lesser of the following amounts:
- the amount officially designated (in advance of payment) as a housing allowance;
- the amount actually used to provide or rent a home; or
- the fair market rental value of the home (including furnishings, utilities, garage, etc.)
If the governing authority of a church designates to a minister more than s/he can claim as parsonage allowance, the minister is responsible for reporting and paying taxes on the correct amount of income. Any excess or unused portion of the housing allowance should be reported on the minister’s annual tax return as income on line 7 of Form 1040, U.S. Individual Income Tax Return. In addition, the payments officially designated as parsonage allowance must be used in the year received.
Parsonage allowances only apply to a minister’s primary residence, and does not include commercial property or vacation homes. Housing expenses that are eligible to be excluded from income include:
Ministers living in parsonages provided by the church may have part of their compensation designated as a tax-free parsonage or housing allowance to cover the cost of furniture purchase and repair, as well as other expenses related to the maintenance of the home which are not reimbursed by the church employer. If a home equity loan is used to pay for expenses related to the parsonage, it can be included as part of the minister’s parsonage allowance. However, if the home equity loan is used to cover post-secondary tuition expenses or other costs not eligible as a parsonage expense, the loan cannot be included as parsonage allowance. In addition to home equity loans used to pay off non-housing expenses, the cost of food, clothing, domestic help, and cleaning services are not part of a minister’s parsonage allowance.
A minister who has parsonage allowance and itemizes deductions may also deduct mortgage interest and property taxes from his or her income. The difference between the provisions is that parsonage allowance is a tax exemption from income, while mortgage interest and property taxes are tax deductions from income.
Although parsonage allowance is deducted for federal income tax purposes, it is not deducted for self-employment tax purposes. Parsonage allowance and/or the fair market rental value of a parsonage provided to a pastor, including the cost of any utilities and furnishings provided, must be included as self-employment earnings subject to the self-employment tax. For example, assume a minister receives annual income of $50,000 from the church which provides him with a parsonage. If the rental value of the parsonage is $15,000 annually, the minister’s gross income is $50,000 for federal income tax purposes and $65,000 for self-employment tax purposes.
Note that although someone in a church may be referred to as a minister, the Internal Revenue Service (IRS) may not regard that individual as a minister for tax purposes. While ordained ministers are more likely to be eligible for a parsonage allowance exemption, commissioned and licensed ministers are less likely to be treated as ministers by the IRS. Also, secular employers cannot give an employee working in a non-ministerial role a tax-free housing allowance, even though the employee is a minister in the church. Furthermore, the IRS does not differentiate an active church minister from a retired one. Thus, retired ministers may request that distributions from their 403(b) Plan be designated in whole or in part as parsonage allowance.