united-states tax-law
Parsonage deduction on top of a parsonage: any limit?
<p>Is there a limit to the amount of money a church can give a religious leader for housing? </p>

<p>A church is planning to offer a contract in which the leader is given an house with all expenses paid plus a substantial parsonage allowance.</p>

<p>What are the legal considerations that should be considered?  Is this likely to get anyone into trouble? Is the legitimacy of the substantial financial parsonage allowance called into question by the contract clause that provides the house and all associated expenses?  (This is in the USA.)</p>

<p>The statute in question is <a href="https://www.law.cornell.edu/uscode/text/26/107" rel="nofollow noreferrer">Internal Revenue Code Section 107</a> (a.k.a. 26 U.S.C. Section 107) which states:</p>

<blockquote>
  <p>In the case of a minister of the gospel, gross income does not
  include—</p>
  
  <p>(1) the rental value of a home furnished to him as part of his
  compensation; or</p>
  
  <p>(2) the rental allowance paid to him as part of his compensation, to
  the extent used by him to rent or provide a home and to the extent
  such allowance does not exceed the fair rental value of the home,
  including furnishings and appurtenances such as a garage, plus the
  cost of utilities.</p>
</blockquote>

<p>Generally speaking you get either an exclusion from income of the use of a parsonage, in kind, or you get an exclusion of a payment in lieu of an actual in kind parsonage, but not both. </p>

<p>But, as long as the benefits don't overlap and constitute double dipping (e.g. you might get "in kind" use of a condominium paid for by the church and a money housing allowance to allow you to rent a parking space to use in connection with the church owned condominium where you live), it is conceivable that you could receive some of each.</p>

<p>This is officially interpreted in <a href="https://www.law.cornell.edu/cfr/text/26/1.107-1" rel="nofollow noreferrer">Treasury Regulation 1.107-1</a> (26 CFR 1.107-1) which states:</p>

<blockquote>
  <p>§ 1.107-1 Rental value of parsonages. (a) In the case of a minister of
  the gospel, gross income does not include (1) the rental value of a
  home, including utilities, furnished to him as a part of his
  compensation, or (2) the rental allowance paid to him as part of his
  compensation to the extent such allowance is used by him to rent or
  otherwise provide a home. In order to qualify for the exclusion, the
  home or rental allowance must be provided as remuneration for services
  which are ordinarily the duties of a minister of the gospel. In
  general, the rules provided in § 1.1402(c)-5 will be applicable to
  such determination. Examples of specific services the performance of
  which will be considered duties of a minister for purposes of section
  107 include the performance of sacerdotal functions, the conduct of
  religious worship, the administration and maintenance of religious
  organizations and their integral agencies, and the performance of
  teaching and administrative duties at theological seminaries. Also,
  the service performed by a qualified minister as an employee of the
  United States (other than as a chaplain in the Armed Forces, whose
  service is considered to be that of a commissioned officer in his
  capacity as such, and not as a minister in the exercise of his
  ministry), or a State, Territory, or possession of the United States,
  or a political subdivision of any of the foregoing, or the District of
  Columbia, is in the exercise of his ministry provided the service
  performed includes such services as are ordinarily the duties of a
  minister.</p>
  
  <p>(b) For purposes of section 107, the term “home” means a dwelling
  place (including furnishings) and the appurtenances thereto, such as a
  garage. The term “rental allowance” means an amount paid to a minister
  to rent or otherwise provide a home if such amount is designated as
  rental allowance pursuant to official action taken prior to January 1,
  1958, by the employing church or other qualified organization, or if
  such amount is designated as rental allowance pursuant to official
  action taken in advance of such payment by the employing church or
  other qualified organization when paid after December 31, 1957. The
  designation of an amount as rental allowance may be evidenced in an
  employment contract, in minutes of or in a resolution by a church or
  other qualified organization or in its budget, or in any other
  appropriate instrument evidencing such official action. The
  designation referred to in this paragraph is a sufficient designation
  if it permits a payment or a part thereof to be identified as a
  payment of rental allowance as distinguished from salary or other
  remuneration.</p>
  
  <p>(c) <strong>A rental allowance must be included in the minister's gross income
  in the taxable year in which it is received, to the extent that such
  allowance is not used by him during such taxable year to rent or
  otherwise provide a home.</strong> Circumstances under which a rental allowance
  will be deemed to have been used to rent or provide a home will
  include cases in which the allowance is expended (1) for rent of a
  home, (2) for purchase of a home, and (3) for expenses directly
  related to providing a home. Expenses for food and servants are not
  considered for this purpose to be directly related to providing a
  home. Where the minister rents, purchases, or owns a farm or other
  business property in addition to a home, the portion of the rental
  allowance expended in connection with the farm or business property
  shall not be excluded from his gross income.</p>
  
  <p>[T.D. 6500, 25 FR 11402, Nov. 26, 1960, as amended by T.D. 6691, 28 FR
  12817, Dec. 3, 1963]</p>
</blockquote>

<p>So, the exclusion from income for a minster's housing allowance does not have a monetary cap other than the requirement that it reflect the actual cost of housing for him or her. But, you can't double dip and get a minister's housing allowance for something that has already been paid for by the church.</p>

<p>The IRS also interprets Section 107 in web page <a href="https://www.irs.gov/taxtopics/tc417" rel="nofollow noreferrer">Topic 417</a> (the pertinent part of which is quoted below) and audit guidelines available at <a href="https://www.irs.gov/pub/irs-utl/ministers.pdf" rel="nofollow noreferrer">this link</a>. </p>

<blockquote>
  <p><strong>Housing Allowance</strong></p>
  
  <p>A licensed, commissioned, or ordained minister who performs
  ministerial services as an employee may be able to exclude from income
  the fair rental value of a home provided as part of compensation (a
  parsonage) or a housing allowance provided as compensation if it is
  used to rent or otherwise provide a home. A minister who is furnished
  a parsonage may exclude from income the fair rental value of the
  parsonage, including utilities. However, <strong>the amount excluded can't be
  more than reasonable compensation for the minister's services.</strong></p>
  
  <p>A minister who receives a housing allowance may exclude the allowance
  from gross income to the extent it's used to pay expenses in providing
  a home. Generally, those expenses include rent, mortgage interest,
  utilities, and other expenses directly relating to providing a home.
  <strong>The amount excluded can't be more than reasonable compensation for the
  minister's services.</strong></p>
  
  <p>If you own your home, you may still claim deductions for mortgage
  interest and real property taxes. <strong>If your housing allowance exceeds
  the lesser of your reasonable compensation, the fair rental value of
  the home, or your actual expenses directly relating to providing the
  home, you must include the amount of the excess in income.</strong></p>
  
  <p>In order to be able to exclude the housing allowance from income, the
  minister's employing organization must officially designate the
  housing allowance as such before paying it to the minister.</p>
  
  <p>The fair rental value of a parsonage or the housing allowance is
  excludable only for income tax purposes. <strong>The minister must include the
  amount of the fair rental value of a parsonage or the housing
  allowance for social security coverage purposes.</strong></p>
</blockquote>

<p>Topic 417 added a "reasonable compensation" which the IRS asserts is implied when one interprets the law, even though it is not in the text of IRC Section 107 or the associated Treasury regulation.</p>

<p><strong>Application</strong></p>

<blockquote>
  <p>A church is planning to offer a contract in which the leader is given
  an house with all expenses paid plus a substantial parsonage
  allowance.</p>
  
  <p>What are the legal considerations that should be considered? Is this
  likely to get anyone into trouble? Is the legitimacy of the
  substantial financial parsonage allowance called into question by the
  contract clause that provides the house and all associated expenses?</p>
</blockquote>

<p>If housing is provided in kind with all expenses paid, and duplicative parsonage allowance in money terms is probably not within the scope of I.R.C. 107. The mostly likely consequences of providing a parsonage allowance that does not qualify for the exclusion are:</p>

<ol>
<li><p>The monetary parsonage allowance would be included in the minister's income, and interest and penalties would also be assessed on the non-payment of the associated taxes due. (Since the parsonage allowance is only exempt from income taxes and not FICA, the church would also be required to withhold FICA taxes from this amount and would owe employer FICA on this amount, and additional FICA taxes would have to be collected and paid with respect to the "in kind" housing allowance based upon its fair market value.)</p></li>
<li><p>The church could face penalties and interest for failing to pay withholding taxes on monetary parsonage allowance, even though it is "tax exempt". The exemption of a church from taxes is usually only from income tax and not from withholding taxes for employees or FICA taxation in most cases.</p></li>
</ol>

<p>It is possible for a church to declare that FICA taxation and withholding taxation are also contrary to its religion (rather than just claiming it is tax exempt by definition since all churches are tax exempt under IRC 501(c)(3)), but this requires additional procedural steps and most churches don't do so because they cannot make that statement in good faith based upon their religious texts.</p>

<p><strong>Footnote Re Unreimbursed Clergy Housing</strong></p>

<p>In the case of employees who would qualify for the exclusion if a housing allowance were paid to them (as opposed to cases where the funds are advanced by the church or self-employment cases), clergy-employees cannot deduct this expense as of January 1, 2018 through the year 2025, even if they might have been able to before the new tax law took effect, because Section 11045 of <a href="https://www.congress.gov/bill/115th-congress/house-bill/1/text" rel="nofollow noreferrer">the new tax law passed by Congress in December as H.R. 1</a>, abolished the miscellaneous itemized deduction for unreimbursed employment related expenses of employees which was previously available subject to a 2% of adjusted gross income floor in some circumstances.</p>

<p><strong>Footnote Re Constitutionality</strong></p>

<p>This provision may not be available forever and has been widely considered unconstitutional for a long time under existing jurisprudence. But, it has been hard to challenge procedurally.</p>

<p>This provision of the tax code has repeatedly been held unconstitutional under the establishment clause of the First Amendment to the United States Constitution, most recently <a href="https://www.forbes.com/sites/peterjreilly/2017/10/07/clergy-housing-tax-break-ruled-unconstitutional-again/#82f40a226fdf" rel="nofollow noreferrer">in October of 2017 by the U.S. District Court for the Western District of Wisconsin</a>. In that case, U.S. District Court Judge Crabb ruled (much as she did four years ago in a decision that reversed on standing grounds) that:</p>

<blockquote>
  <p>....107(2) violates the establishment clause because it does not have
  a secular purpose or effect and because a reasonable observer would
  view the statute as an endorsement of religion.</p>
  
  <p>Although defendants try to characterize § 107(2) as an effort by
  Congress to treat ministers fairly and avoid religious entanglement,
  the plain language of the statute, its legislative history and its
  operation in practice all demonstrate a preference for ministers over
  secular employees. Ministers receive a unique benefit under § 107(2);
  it is not, as defendants suggest, part of a larger effort by Congress
  to provide assistance to employees with special housing needs. A
  desire to alleviate financial hardship on taxpayers is a legitimate
  purpose, but it is not a secular purpose when Congress eliminates the
  burden for a group made up of solely religious employees but maintains
  it for nearly everyone else.</p>
  
  <p>Under my view of the current law, that type of discriminatory
  treatment violates the establishment clause...</p>
</blockquote>

<p>Her decision four years ago was reversed by the U.S. Court of Appeals for the 7th Circuit on the grounds that the Freedom from Religion Foundation didn't have standing to challenge the statute. The fate of this new ruling on appeal also boils down to whether the 7th Circuit and if necessary, the U.S. Supreme Court, will find that the plaintiffs in the renewed case have standing to sue regarding the constitutionality of this tax break.</p>

<p>Incidentally, the IRS has avoided "as applied" challenges to IRC Section 107 by interpreting "minister of the gospel" broadly to include all sorts of clergy from a variety of faiths who cannot legitimately be considered "ministers of the gospel" in the literal sense, such as Rabbis and Muslim Imams. The standing issue in the case of someone claiming an entitlement to I.R.C. Section 107 under the free exercise clause of the First Amendment and the equal protection clause of the 14th Amendment, is much more easily met than the standing issue in the case of someone who wants a determination that the establishment clause of the First Amendment renders a tax break unconstitutional which benefits only the general public through "taxpayer" or "citizen" standing which are much harder to establish.</p>

<p>The economic benefit received by clergy and their churches from Section 107 is <a href="http://mirrorofjustice.blogs.com/mirrorofjustice/2018/01/teleforum-on-the-parsonage-allowance.html" rel="nofollow noreferrer">about $1 billion per year</a>, nationwide.</p>
