Academic journal article Journal of Accountancy

Tax Planning for Servants of God: Unique Tax Rules Apply to Members of the Clergy

Academic journal article Journal of Accountancy

Tax Planning for Servants of God: Unique Tax Rules Apply to Members of the Clergy

Article excerpt

With today's complex and ever-changing rules, annual tax planning is increasingly important for all taxpayers. However, it's especially important for members of the clergy because of three unique rules that apply to the income and Social Security taxes they pay: the housing exemption allowance, the treatment of employee clergy as self-employed for Social Security tax purposes and the exemption from withholding income tax from wages (but not from paying income tax on wages). This article discusses tax-planning opportunities for clergy that CPAs in public practice need to know to best counsel this special group of clients.

HOUSING EXEMPTION ALLOWANCE

A housing allowance is an important tax benefit for clergy because it can be excluded, within limits, from gross income for federal tax purposes. It provides a way for many religions to supplement, tax-free, the usually low salaries they pay their clergy. Continuing this tax-free status has strong bipartisan support, and in 2002 Congress passed legislation aimed at settling the issue of what amount can be excluded from gross income.

IRC section 107, as amended by The Clergy Housing Allowance Clarification Act of 2002, states that "in the case of ministers ..., gross income does not include the rental allowance paid to him as part of 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." The housing allowance must actually be used to maintain or provide a furnished home and cannot be used for other purposes.

In addition IRS Publication 17, Your Federal Income Tax, states that clerics who own their homes can exclude the lesser of the following:

* The amount actually used to provide a home.

* The amount designated as a rental allowance.

* The annual rental value of the home, including furnishings.

For clerics who own their own homes, actual expenses include mortgage interest payments, down payments, real property taxes, insurance, utilities, furnishings, repairs and improvements. The limitation on the excludability of the clergy housing allowance generally is effective for taxable years after December 31, 2001.

A cleric can receive a housing allowance for only one home, and the cleric's church, temple or mosque must actually designate, in advance, payments made for housing or utilities as housing allowances so there is no question these payments are excludable from gross income. Ministers living in church-provided parsonages, for example, do not have to include the fair rental value of their homes in their gross income and may exclude a designated allowance for utilities and upkeep to the extent of actual expenses. According to revenue ruling 87-32, those who receive a housing allowance still are allowed to deduct mortgage interest and property taxes on their federal tax returns as itemized deductions.

The Clergy Housing Allowance Clarification Act applies only to housing allowances and parsonage allowances for federal income tax purposes. Housing and parsonage allowances have always been, and continue to be, included in income for self-employment taxes. In addition, since the housing allowance is a part of total compensation, religious organizations must be careful to avoid paying their clerics "unreasonable compensation," which could jeopardize their tax exempt status. While there is little guidance on what is considered reasonable, CPAs should recommend that compensation packages above $125,000 be reviewed by the board or documentation for support be provided.

DETERMINING FAIR RENTAL VALUE

Since clergy housing allowances are excludable only up to the maximum of fair rental value, the determination of what that constitutes is of utmost importance. Figuring the fair rental value of a property would be simple if there were fixed formulas, rules or methods. …

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