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The clergy's unique tax issues.


* Ministers are doubly blessed--rather housing allowances are excludible under Sec. 107, while their mortgage interest and real estate taxes are deductible under Sec. 265(a)(6).

* In terms of services performed, the courts and IRS have determined not only who is a minister, but also who is not.

* One major issue is whether a minister is an employee or an independent contractor.

Ministers of the gospel present subtle and challenging tax issues to tax practitioners. Is a parsonage (housing) allowance tax-free? Can mortgage interest and real estate taxes be deducted of a housing allowances is excluded Is self-employment tax due if the minister is not an employee? What are some of the reporting issues? This article examines these and other problems in this unique area.

The clergy ("ministers of the gospel") receive unique tax treatment under the Code. A number of Code provisions and IRS pronouncements must be considered to fully appreciate the tax planning opportunities and pitfalls in this area. This article addresses various income and employment tax issues regarding the clergy. Two primary income tax issues are the clergy's eligibility for fringe benefits not available to other taxpayers and the opportunity to characterize certain payments as gifts rather than as taxable compensation. The major employment tax issues are whether the individual is an employee or an independent contractor; special withholding rules also apply. Finally, the state and local income tax treatment will also be examined.

Income Exclusion

In the case of a minister of the gospel, Sec. 107 excludes from gross income (1) the rental value of a home furnished to him as part of compensation or (2) the rental allowance paid to him as part of compensation, to the extent used to rent or provide a home.

For this purpose, Regs. Sec. 1.107-1(a) states that the home or rental allowance must be provided as remuneration for services ordinarily the duties of a minister of the gospel, including 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. Regs. Sec. 1.107-1(a) also provides that Regs. Sec. 1.1402(c)-5, which defines a "minister" for self-employment (SE) tax purposes, also applies for Sec. 107 purposes. Regs. Sec. 1.1402(c)-5(a)(2) defines a "minister" as one who is duly ordained, commissioned or licensed as a minister of a church.

Defining "Minister"

According to IRS Pub. 525,(1) the Sec. 107 exclusion applies to the rental value of a home provided as payment for duties as an ordained, licensed or commissioned minister. For ministers employed as teachers or administrators, the exclusion is allowed only if employed by a church-owned educational institution; thus, ministers do not qualify for a housing allowance if they work for non-church schools and do not perform religious functions, even if they are part of the religion department. "Ministers of music" and "ministers of education" also do not qualify for a housing allowance if they are not authorized to perform all of the religious duties of an ordained minister.

Theological students serving required internships as assistant pastors are "ministers" for this purpose only if they are ordained, commissioned or licensed. Traveling evangelists, if ordained and providing evangelistic services, can exclude amounts paid by out-of-town churches that are designated as a housing allowance and actually used to maintain a permanent home.(2) The rental value of a home provided rent-free by a church for past services is not income to a retired minister. A housing allowance is also not income to the extent used to maintain a home. Certain pensions and other retirement pay can qualify as gifts, not income, under certain conditions.

The courts and the IRS have also defined "minister" to include the following: an individual who was ordained and performed the duties of a rabbi(3); ordained ministers serving on the faculty of a college that was an integral agency of a religious organization who performed services in the exercise of their ministry(4); a cantor who was not ordained, but commissioned and employed by a congregation to perform Jewish religious functions(5); an ordained minister employed by a nonprofit organization to provide pastoral care for a public hospital(6); and a retired minister paid by his church in recognition of his past services.(7)

The courts and the IRS have also defined who is not a "minister of the gospel" for Sec. 107 purposes:

1. A "minister of music" or "minister of education" who was not ordained, commissioned or licensed.(8)

2. An individual who performed some duties similar to those of a minister, but was not ordained, commissioned or licensed.(9)

3. An ordained rabbi who was employed by an educational organization and did not perform ministerial functions.(l0)

4. An ordained Baptist minister who preached against Communism for a religious educational organization.(11)

5. An ordained minister employed by a nursing home that was affiliated with (but not controlled by) a church.(12)

6. Administrators of nursing homes under the fellowship of the Assemblies of God Church, which exercised no control over the nursing homes.(13)

7. An ordained minister who was the president of an exempt charitable corporation that furnished financial advice to churches, but had no affiliation with a church or religious organization.(14)

8. An ordained minister employed by a nonprofit corporation who spent 5% of his time performing ministerial duties and the balance providing spiritual counseling and general management services.(15)

What Is a "Home"?

To be excludible, the housing allowance must be related to a home and be properly documented. According to Regs. Sec. 1.107-1(b), "home" means a dwelling place (including furnishings) and the appurtenances thereto (e.g., a garage); "rental allowance" means an amount paid to a minister to rent or otherwise provide a home if such amount is designated as a rental allowance pursuant to official action taken in advance of such payment by the employing church. The designation of an amount as a 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. The payment should be designated as a rental or utility allowance to separate it from salary or other remuneration.

Regs. Sec. 1.107-1(c) explains that the rental allowance is excludible only to the extent spent (1) to rent a home, (2) to purchase a home and (3) on expenses directly related to providing a home. Expenses for food and servants do not qualify for exclusion, nor do expenses connected with a farm or business property. Further, a clothing and food allowance in exchange for ministerial services is taxable income, not a rental allowance.(16)

Income Tax Issues

Deducting Interest and Taxes

Rev. Rul. 62-212(17) allowed ministers to deduct real estate taxes and mortgage interest notwithstanding the Sec. 107 exclusion. Rev. Rul. 83-3(18) revoked Rev. Rul. 62-212, stating that the itemized deductions otherwise allowable for interest and real estate taxes had to be decreased to the extent allocable to the tax-free housing allowance. Congress reinstated these deductions in Section 144 of the Tax Reform Act of 1986, for all open tax years, by enacting Sec. 265(a)(6).

Sec. 265(a)(1) and (2) generally disallow a deduction for expenses allocable to tax-exempt income. Sec. 265(a)(6), applicable to tax years beginning before, on or after Dec. 31, 1986, states that Sec. 265(a)(1) does not apply to mortgage interest or real property taxes on a taxpayer's home by reason of the receipt of a Sec. 107 housing allowance.

Thus, a minister receives a double benefit--he can exclude his housing allowance from income and deduct mortgage interest and real estate taxes.

Exclusion Limits

The amount excludible under Sec. 107 is limited to the minister's reasonable compensation. Pub. 525, p. 10, states that the amount of the housing allowance excludible cannot exceed reasonable compensation for services as a minister. Qualified expenditures include the downpayment on the home, mortgage payments, interest, taxes, utilities, repairs, etc. The taxpayer cannot exclude more than the fair rental value of the home plus the cost of utilities, even if a larger amount is designated as a housing allowance. Fair rental value of a home includes the fair rental value of furnishings in it.

Reporting Nonexcludible Amounts

Only that part of the Compensation of the minister which is salary, exclusive of rental allowance, need be reported. According to the IRS, items excluded from gross income (e.g., a rental allowance) should not be reported, lest confusion arise in review of the taxpayer's return. If such items are nevertheless reported, they should be set forth separately and properly described.(19)


In addition to the housing exclusion, clergy may exclude from income amounts received as gifts as long as the facts and circumstances support characterization as a gift and proper documentation exists. Pub. 525, p. 10, states that a member of the clergy must include in income offerings and fees received for marriages, baptisms, funerals, masses, etc., in addition to salary. Regs. Sec. 1.61-2(a)(1) specifically includes in income Christmas bonuses and marriage fees and other contributions received by a clergyman for services; thus, compensation can include any value received for services rendered.

The courts have defined a "gift" as a valid, voluntary transfer of property from one to another without any consideration or compensation therefor(20); usually, this is accompanied by donative intent. As is discussed below, the IRS often looks at the recipient's need to determine whether a payment is a gift or compensation.

Generally, Sec. 102(a) excludes the value of gifts from income. However, Sec. 102(c) states that gross income includes amounts transferred by or for an employer to or for the benefit of an employee. Numerous cases have established that a gift given in exchange for services is taxable compensation for such services.(21)

Whether remuneration received by a minister is taxable compensation or a nontaxable gift depends on the facts and circumstances. Cash gifts given to a minister by members of the congregation, and deposited to his personal account, have been held to be compensation for services.(22) Christmas offerings were taxable income, not gifts, to a minister who conducted a church as his personal business.(23) Retirement benefits were taxable income to a minister who received them pursuant to an established plan that did not take need or merit into account.(24) On the other hand, a congregation's payments to a pastor who was retiring due to ill health constituted a nontaxable gift.(25)

Thus, it appears that whether a payment is compensation or a gift is determined partly by the recipient's need. If there is a special need On the part of a minister (e.g., health problems), a congregation may want to consider making a gift.

Another consideration is the donor's intent. If the donor gives the property directly to the minister without taking a deduction and there is donative intent, classification as a gift may be easier than if the donor gave the property to the church for the minister's benefit and then took a contribution deduction. One of the characteristics of a gift is the donor's receipt of no valuable consideration in exchange. Depending on the donor's income tax bracket, a tax deduction could be "valuable consideration."

Employment Tax Issues

One fundamental determination in this area is whether the minister is an employee or an independent contractor. Independent contractors should receive a Form 1099-MISC for annual earned income of $600 or more. If the minister is an employee, the church should send a Form W-2.

Regs. Sec. 31.3401(c)-1 (b) provides that generally the relationship of employer and employee exists when the person for whom services are performed has the right to control and direct the individual who performs the services, not only as to the result to be accomplished by the work but also as to the details and means by which that result is accomplished (i.e., an employee is subject to the will and control of the employer not only as to what shall be done but how it shall be done). The employer does not have to actually exercise control, as long as the employer has the right to do so. Therefore, an employer-employee relationship exists when the employer has the right to control a worker in the details of the job.

SE Tax

Regs. Sec. 1.1402(e)-2A(a)(1) allows a minister to request an exemption from SE tax on income from his duties as a minister on Form 4361, Application for Exemption from Self-Employment Tax for Use by Ministers, Members of Religious Orders and Christian Science Practitioners. According to Regs. Sec. 1.1402(e)-2A(a)(2), to be exempt, the minister must state that he is opposed to the acceptance of any public insurance which makes payments in the event of death, disability, old age or retirement or makes payments toward the cost of medical care. The term "public insurance" refers to government insurance and does not include insurance from a commercial insurance company. One issue is whether the minister belongs to an organization that will care for him in place of Social Security (e.g., the Amish community).

Sec. 1402(a) defines net earnings from SE as gross income derived by an individual from any trade or business carried on by such individual, less the deductions allowed. Sec. 1402(a)(8) explains how an individual who is a duly ordained, commissioned or licensed minister of a church computes net earnings from SE. IRS Pub. 15-A(26) states that ministers are subject to SE tax and exempt from FICA. Included in SE taxable income are earnings reported on Form W-2 for employees, or net earnings reported on Schedule C for nonemployees, plus any allowances received (e.g., housing or utility allowances).

Pub. 525, p. 10, explains that the rental value of the home, and related allowances, must be included as earnings from SE on Form 1040, Schedule SE, for purposes of the Social Security SE tax.

Rev. Rul. 80-110(27) allows a deduction from SE income for an ordained minister-employee's unreimbursed business expenses. However, a minister-employee cannot deduct such expenses (other than travel or transportation expenses) in computing adjusted gross income (AGI); rather, such expenses are miscellaneous itemized deductions. For an independent contractor, these expenses are deductible on Schedule C, and thus, automatically deductible for both AGI and SE tax purposes.

The pension or retirement allowance of a retired minister who is eligible for Social Security coverage is not SE income, nor subject to SE tax.(28)

Abusive Situations

Individuals sometimes try to avoid paying taxes by abusing the "minister" provisions. The courts have repeatedly disallowed deductions and benefits for groups that ordain individuals primarily to avoid taxes. The key issue is whether the individual retains the right and ability to use property and funds in the same way as before the church formation and/or individual ordination.(29) For example, in Larsen,(30) charitable deductions were denied for donations to the Universal Life Church because the funds were used for personal living expenses.

State and Local Taxation

State and local government agencies have their own laws for taxing ministers. At the state level, states that base their tax on Federal AGI (e.g., California, Kansas, New York, Ohio and Virginia) generally automatically allow the Sec. 107 exclusion. On the other hand, states that do not base their tax on Federal AGI deal with a minister's housing and utility allowances differently.

Planning Considerations

Care must be taken in structuring compensation arrangements for ministers to obtain the maximum benefit from the Sec. 107 exclusion and gifts. Further, caution must be exercised in determining whether a minister is an employee or independent contractor, as substantial penalties can apply. The key issues are set forth in the checklist on page 560.


The tax rules regarding the clergy can be a challenging and interesting part of a tax practice. The Code, regulations, cases and IRS pronouncements, as well as state and local tax statutes, should be reviewed regularly to maintain service to this growing part of the business sector.

(1) IRS Pub. 525, Taxable and Nontaxable Income, p. 10.

(2) Id., p. 11.

(3) Rev. Rul. 58-221, 1958-1 CB 53.

(4) IRS Letter Ruling (TAM) 9144047 (6/3/91).

(5) Rev. Rul. 78-301, 1978-2 CB 103.

(6) IRS Letter Ruling (TAM) 8519004 (1/28/85).

(7) Rev. Rul. 63-156, 1963-2 CB 79.

(8) Rev. Rul. 59-270, 1959-2 CB 44; Robert D. Lawrence, 50 TC 494 (1988).

(9) W. Astor Kirk, 425 F2d 492 (DC Cal. 1970) (25 AFTR2d 70-771, 70-1 USTC [paragraph] 9265), aff'g 51 TC 66 (1968).

(10) Marc H. Tanenbaum, 58 TC 1 (1972).

(11) James D. Colbert, 61 TC 449 (1974).

(12) Rev. Rul. 72-606, 1972-2 CB 78.

(13) Jesse A. Toavs, 67 TC 897 (1977).

(14) Rev. Rul. 78-172, 1978-1 CB 35.

(15) IRS Letter Ruling 9231053 (5/6/92).

(16) David Kalms, TC Memo 1992-394.

(17) Rev. Rul. 62-212, 1962-2 CB 41, revoked by Rev. Rul. 83-3, 1983-1 CB 72.

(18) Rev. Rul. 83-3, id.

(19) Special Ruling, 9/1/55, CCH '54 Code Tr. Binder [paragraph] 37,361.

(20) See, e.g., Est. of David R. Daly, 3 BTA 1042 (1926); Banner Bldg Co., Inc., 46 BTA 857 (1942).

(21) See, e.g., Lester E. Braddock, 434 F2d 631 (9th Cir. 1970)(26 AFTR2d 70-5946, 71-1 USTC [paragraph] 9103); Est. of J. Shirley Sweeney, TC Memo 1979-387; Byrnece S. Green, TC Memo 1987-503, aff'd, 846 F2d 870 (2d Cir. 1988) (61 AFTR2d 88-1193, 88-1 USTC [paragraph] 9349).

(22) Charles E. Banks, TC Memo 1991-641.

(23) Charles M. Grace, 1941 P-H BTA Memorandum Decisions [paragraph] 41,448.

(24) Alvin T. Perkins, 34 TC 117 (1960).

(25) Charles Schall, 174 F2d 893 (5th Cir. 1949) (37 AFTR 1536, 49-1 USTC [paragraph] 9298), rev'g 11 TC 111 (1948), and Jason Leon MacMillan v. Crenshaw, DC Va., 1954 (48 AFTR 1288, 54-2 USTC [paragraph] 9535).

(26) IRS Pub. 15-A, Employer's Supplemental Tax Guide (Supplemental to Circular E, Employer's Tax Guide, Publication 15), p. 17.

(27) Rev. Rul. 80-110, 1980-1 CB 190.

(28) Rev. Rul. 58-359, 1958-2 CB 422.

(29) See, e.g., Carol L. Troyer, TC Memo 1989-218; John E. Shadduck, TC Memo 1985-265; John Lynn Stephenson, 79 TC 995 (1982).

(30) Warner M. Larsen, 765 F2d 939 (9th Cir. 1985)(56 AFTR2d 85-5487, 85-2 USTC [paragraph] 9537).

RELATED ARTICLE: Checklist: Key Issues

Sec. 107 Exclusion

1. Does the minister meet the definition of "clergy" under Regs. Sec. 1.107-1(a)?

2. Is the compensation related to the minister's home, rather than to food, services, etc.?

3. Is there documentation far the housing allowance in the employment contract, board minutes or budget?

4. Is the allowance limited to reasonable compensation and fair rental value of the home?

5. Are disqualified amounts properly reported in accordance with information reporting requirements?

Gift Planning

1. Is the gift made by the church or an individual?

2. Is there need on the part of the minister and donative intent on the part of the donor?

3. Is the gift properly documented?

SE Tax

1. Does the church have the right to control the activities of the minister; has Rev. Rul. 87-41, 1987-1 CB 296, been reviewed?

2. If the minister is determined to be an employee, have the exceptions to the Social Security and income tax withholding rules been considered?

3. If the minister is determined to be an independent contractor, have the reporting requirements been followed?

4. Have fringe benefits been considered and handled properly?

5. Has the housing allowance been included for purposes of determining SE taxes?

State and Local Taxes

1. Have state and local tax issues been considered?
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Author:Miller, Sandra K.
Publication:The Tax Adviser
Date:Aug 1, 1998
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