Clergy housing allowances: IRS loses battle, wins war.
Congress adopted the longstanding IRS position on housing allowances for clergy when it passed the Clergy Housing Allowance Clarification Act of 2002 (CHACA). Tax practitioners with clergy as clients must clearly understand how to calculate a minister's housing allowance exclusion, deductible expenses and net self-employment (SE) earnings. Unfortunately, these amounts may not be properly calculated by tax preparation software packages.CHACA
Two years before the CHACA, the Tax Court in Warren, 114 TC 343 (2000), rejected the IRS's position and held that the housing allowance exclusion is not limited to the fair rental value (FRV) of a minister's home. The court excluded the actual amounts the taxpayer paid to provide a home, even though they clearly exceeded his home's FRV. After Warren, the Service appealed to the Ninth Circuit. Before a decision was rendered, however, Congress passed the CHACA, which effectively prevented the Ninth Circuit from ruling on Warren. As a result, the court dismissed the Warren appeal, based on stipulations filed by the taxpayer and the IRS; see Warren, 302 F3d 1012 (9th Cir. 2002).
The Congressional Record clearly indicates that Congress passed the CHACA because it Feared the Ninth Circuit was about to strike down the housing allowance exclusion for clergy on the grounds that it violated the doctrine of separation of church and state; see 148 Cong. Rec. H1299-1301 (statements of Rep. Jim Ramstad (R-MN) and Rep. Earl Pomeroy (D-ND)).
Although neither party to the appeal raised Constitutional issues, an amicus, appointed by the Ninth Circuit, was opposed to the exclusion. In fact, he opposed Warren's dismissal and filed a motion to intervene. The Ninth Circuit rejected the motion, because the amicus was not directly affected by the case's outcome, and dismissed the Warren appeal.
By enacting the CHACA, Congress prevented the Ninth Circuit from ruling and, at the same time, conceded to the IRS'S position in Warren. As a result, the Service won the war to limit the housing allowance exclusion to FRV The CHACA applies to tax years beginning after 2001.
Prior to the CHACA, Section 107 read as follows:
Section 107. Rental value of parsonages.
In the case of a minister of the gospel, gross income does not include--(1) the rental value of a home furnished to him as part of his compensation; or (2) the rental allowance paid to him as part of his compensation, to the extent used by him to rent or provide a home.
The CHACA amended Section 107 by inserting the following phrase at the end of paragraph 2: "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."
Post-CHACA Housing Allowances
Under the CHACA, the housing allowance exclusion is now limited to the lesser of: (1) the amount actually used to provide a home; (2) the amount officially designated by the house of worship; or (3) the FRV of the home, including furnishings, appurtenances (e.g., a garage), plus utility costs. If the amount designated (i.e., #2 above) exceeds the smaller of the amount actually paid or the home's FRV, the excess is included in gross income.
Clergy can itemize home mortgage interest and real estate taxes paid, even though they are paid with funds excluded under the housing allowance. However, ministerial trade or business expenses and unreimbursed employee expenses must be allocated between taxable and tax-free (i.e., excluded) ministerial income.
Notably, a common-law employee of a house of worship, who has not applied for an exemption from SE tax, is treated as self-employed. As a result, clergy must include salary and any amount excluded as a housing allowance in calculating SE earnings. In addition, ministerial business expenses are deductible in full when calculating net SE earnings.
Example: P, who is single, is a cleric at U, a house of worship. During 2005, U considered him a common-law employee and did not withhold Social Security and Medicare taxes, although it paid P a 830,000 salary. P was also paid an additional $10,000, which was designated by U as his 2005 housing and utility allowance. P owns a small home, which has a FRV of $9,000 annually, including utilities. He paid the Following amounts related to his home: $7,000 mortgage payments ($6,000 was mortgage interest), $1,000 real estate taxes, $600 insurance, $900 utilities and $500 repairs. P also earned $5,000 presiding over weddings and funerals. His ministerial expenses associated with these sacerdotal earnings consisted of $100 for premarital counseling brochures and 1,000 business miles visiting families at home. He also drove 1,500 miles visiting U members in the hospital, and paid $275 to attend a religious conference, for which U did not reimburse iron. He made $3,000 of charitable contributions to U during 2005.
The exhibit on p. 83 shows how a tax practitioner should account For P's 2005 ministerial income and expenses. Note: $1,000 income (the excess of the $10,000 housing allowance over the home's $9,000 FRV) should be reported in gross income as part of P's wages. Home mortgage interest and real estate taxes are deductible in full on Schedule A, even though part of the designated housing allowance was used to pay these expenses. Schedule C expenses associated with P's sacerdotal function income must be allocated between the $36,000 of taxable ministerial income ($30,000 + $1,000 + $5,000) and the $9,000 of tax-free ministerial income, which is the excluded housing allowance. The same allocation must be made for unreimbursed employee business expenses reported on Form 2106, Employee Business Expenses. Finally, net SE earnings for common-law employee clergy are calculated by adding wages ($30,000), the designated housing allowance ($10,000) and sacerdotal function income ($5,000) and by reducing that amount ($45,000) by the full amount (deductible and nondeductible) of Schedule C and Form 2106 expenses ($1,388).
Conclusion
When it passed the CHACA, Congress adopted the IRS's long-standing position on clergy housing allowance exclusions. By default, the Service won the war to limit the housing allowance exclusion to FRV. Now, tax practitioners are left with the task of properly calculating ministerial income and expenses for their clergy clients.
Exhibit 1: P's ministerial income and expenses Schedule C Schedule A income and Income or deduction item deductions deductions Form W-2 income Housing allowance exclusion: smaller of $10,000 designated; or $9,000 FRV; or $10,000 actual expenses Gross income: Excess allowance over FRV ($10,000-$9,000) Schedule C earnings from sacerdotal $5,000 functions Expenses: Brochures $100 Mileage: (1,000 x $0.405) 405 $505 Exclusion allocation: ($9,000/$45,000 x $505) (101) Inclusion allocation: ($36,000/$45,000 x $505) $404 (404) Net Schedule C profit $4,596 SE tax: SE earnings: Salary $30,000 Housing allowance 10,000 Sacerdotal functions 5,000 Less expenses: Schedule C (in full) (505) Form 2106 (in full) (883) Net SE earnings $43,612 SE tax deduction: ($6,162/2 = $3,081) Adjusted gross income (AGI) Itemized deductions: Mortgage interest $6,000 $6,000 Real estate taxes 1,000 1,000 Contributions 3,000 3,000 Unreimbursed expenses Mileage: (1,500 x $0.405) 608 Conference fee 275 $883 Exclusion allocation: ($9,000/$45,000 x $883) (177) Inclusion allocation: ($36,000/$45,000 x $883): $706 706 2% AGI (650) 56 $10,056 Personal exemption Taxable income Income tax SE tax Total Federal taxes due Schedule SE tax Form 2106 Income or deduction item calculation deductions Form W-2 income Housing allowance exclusion: smaller of $10,000 designated; or $9,000 FRV; or $10,000 actual expenses Gross income: Excess allowance over FRV ($10,000-$9,000) Schedule C earnings from sacerdotal functions Expenses: Brochures $100 Mileage: (1,000 x $0.405) 405 $505 Exclusion allocation: ($9,000/$45,000 x $505) (101) Inclusion allocation: ($36,000/$45,000 x $505) $404 Net Schedule C profit SE tax: SE earnings: Salary $30,000 Housing allowance 10,000 Sacerdotal functions 5,000 Less expenses: Schedule C (in full) (505) Form 2106 (in full) (883) Net SE earnings $43,612 $43,612 x 0.9235 $40,276 x 0.153 $6,162 SE tax deduction: ($6,162/2 = $3,081) Adjusted gross income (AGI) Itemized deductions: Mortgage interest $6,000 Real estate taxes 1,000 Contributions 3,000 Unreimbursed expenses Mileage: (1,500 x $0.405) 608 Conference fee 275 $883 Exclusion allocation: ($9,000/$45,000 x $883) (177) Inclusion allocation: ($36,000/$45,000 x $883): $706 $706 Personal exemption Taxable income Income tax SE tax Total Federal taxes due Form 1040 Excluded income, income deductions Income or deduction item and expenses and tax due Form W-2 income $30,000 Housing allowance exclusion: smaller of $10,000 designated; or $9,000 FRV; $9,000 or $10,000 actual expenses Gross income: Excess 1,000 allowance over FRV ($10,000-$9,000) Schedule C earnings from sacerdotal functions Expenses: Brochures $100 Mileage: (1,000 x $0.405) 405 $505 Exclusion allocation: ($9,000/$45,000 x $505) (101) (101) Inclusion allocation: ($36,000/$45,000 x $505) $404 Net Schedule C profit 4,596 SE tax: SE earnings: Salary $30,000 Housing allowance 10,000 Sacerdotal functions 5,000 Less expenses: Schedule C (in full) (505) Form 2106 (in full) (883) Net SE earnings $43,612 SE tax deduction: (3,081) ($6,162/2 = $3,081) Adjusted gross income (AGI) $32,515 Itemized deductions: Mortgage interest $6,000 Real estate taxes 1,000 Contributions 3,000 Unreimbursed expenses Mileage: (1,500 x $0.405) 608 Conference fee 275 $883 Exclusion allocation: ($9,000/$45,000 x $883) (177) (177) Inclusion allocation: ($36,000/$45,000 x $883): $706 (10,056) Personal exemption (3,200) Taxable income $19,259 Income tax 2,524 SE tax 6,162 Total Federal taxes due $8,686
FROM MARY BADER, CPA, J.D., LL.M., MINNESOTA STATE UNIVERSITY MOORHEAD, MOORHEAD, MN (NOT AFFILIATED WITH GRANT THORNTON LLP)
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| Author: | Bader, Mary |
|---|---|
| Publication: | The Tax Adviser |
| Date: | Feb 1, 2005 |
| Words: | 1674 |
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