How To Make The Most Of The Pastoral Housing Allowance
"For many pastors, understanding housing allowances can feel like getting lost on the engineering deck of the Starship Enterprise. Between IRS regulations, church budget considerations, and personal financial planning, it’s easy to get overwhelmed by what should be a helpful benefit. I remember times when I’d be staring down tax paperwork, uncertain if I was making the most of this allowance—or if I was doing it correctly at all.
Without a solid grasp on housing allowances:
- You might miss out on potential tax savings, affecting your family’s budget.
- Confusion over paperwork or tax law could lead to costly mistakes.
- Uncertainty could make it hard to confidently plan your long-term finances.
These challenges happen because housing allowance rules can be tricky, and many pastors don’t have easy access to financial experts. That’s why I’m diving into the basics here—so you can feel confident about making the most of your housing allowance. Let’s break down how it works, common best practices, and some essential tips to keep you on the right track.
While you're here, ensure your church accounting software protocols are operating at optimal efficiency, in alignment with current Starfleet standards.
What Is The Housing Allowance For Pastors?
The Minister’s Compensation & Housing Allowance, better known simply as the housing allowance, is for both active and retired pastors alike to set aside a portion of their income as tax-free. It's an incredibly valuable part of your financial management as a church leader.
The point of the housing allowance is to offset the home you own or rent. This is completely separate from any secular housing tax benefits, low-income tax credits, and more.
How To Qualify For A Housing Allowance
The only people eligible for this housing allowance are pastors, ministers, and certain qualified members of the clergy. You must be able to prove you are ordained, licensed, or commissioned.
Of course, this also means you must work directly in ministerial service no matter the denomination or type of church. This could include senior ministers, global ministers, associate pastors, priests, and even children and youth pastors, such as in my case.
Fortunately, retired ministers are also eligible. That said, you must confirm that your ministerial income counts from a reliable denominational pension board. This means income coming from a church retirement plan, such as a 403(b). Unfortunately, IRA (individual retirement accounts) don’t qualify.
Tax Implications of the Housing Allowance
The housing allowance for pastors only covers federal taxes. The federal income tax, if you pay this in your state, is an additional tax you pay on top of the usual self-employment tax. The tax rate also varies by state and tax bracket.
Scenario: Tim is a pastor in California, earning $60,000 per year.
California’s income tax rates are progressive. For a pastor like Tim, with a salary of $60,000, the applicable rate is 9.3% for income between $56,086 and $286,492. However, the state income tax exemption for housing allowances varies, so Tim should still check with a tax professional or refer to California’s specific guidelines.
If Tim’s church budgets a housing allowance of $25,000, Tim can exclude this from federal income tax, leaving $35,000 subject to federal income tax. This exemption only applies if the amount is within the actual cost of housing or fair rental value.
Pastors like Tim can exclude their housing allowance from federal income tax, but this exclusion doesn’t apply to California state income tax automatically. California has stricter rules than some states, and housing allowance exclusions for state tax vary by jurisdiction.
Now, Tim must still pay Social Security and Medicare taxes on the full $60,000, as housing allowances are not exempt from Social Security and Medicare taxes.
Lastly, it’s essential Tim keeps accurate records of his housing expenses and provides documentation for church finance reporting, but the wording around a "church finance report" is misleading unless it specifically refers to internal church reporting for transparency or compliance.
Scenario: Frank is a retired pastor living in Florida.
Let’s look at Frank, a retired minister living in Florida. Each month, Frank withdraws $2,000 from his 403(b) retirement account, totaling $24,000 annually. As a retired minister, Frank can designate a portion of this income as a housing allowance, which allows him to exclude that amount from federal income tax. In this case, Frank allocates $1,000 per month (or $12,000 per year) to housing expenses like utilities, lawn care, and home maintenance. This exclusion reduces his taxable income, so Frank only pays federal income tax on the remaining $12,000 of his annual distributions.
Living in Florida, Frank benefits further, as he does not owe state income tax on his retirement income or housing allowance. However, he must keep detailed records of his housing expenses and document his allowance designation properly with his former church to meet IRS requirements. By leveraging this housing allowance benefit, Frank can significantly reduce his tax liability in retirement, creating a more favorable financial situation.
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How To Calculate Your Housing Allowance
If you are an active or retired minister, calculate your housing allowance based on the lowest of the following:
- Church Housing Allowance: The amount formally designated by your church.
- Actual Housing Expenses: Total out-of-pocket housing costs such as rent, mortgage, and utilities.
- Fair Market Rental Value (plus utilities and furnishings): This is relevant for homeowners and represents what a similar home would rent for in your area (check out Tax-Brackets and NerdWallet: Finance smarter for more detail).
When a church provides a parsonage (housing) for free, ministers can still claim a housing allowance on any additional expenses they cover personally, such as utilities or home maintenance, as long as these expenses are properly documented (Sources: Sweeney & Michel, LLC | Chico, CA, and Robert Hall & Associates)
Eligible Expenses
Typical expenses eligible for a housing allowance include:
- Rent or Mortgage: Depending on if you rent or own your home.
- Utilities: Costs like electricity, gas, water, and trash.
- Insurance: Renter’s or homeowner’s insurance.
- Furnishings: Furniture and other household essentials.
- Repairs and Improvements: Any necessary repairs or improvements to the property.
- Other Costs: Pest control and property maintenance.
If you don’t pay rent or mortgage, only out-of-pocket costs like utilities are claimable, and this is capped by the fair market rental value. For example, if you spend $400 on utilities and maintenance, you may exclude that amount from federal taxes. This exclusion helps ministers free up resources to focus on their calling, supported by biblical principles like 1 Corinthians 12:7-11, which speaks to using spiritual gifts for the common good.
For pastors who own their own homes, calculating the fair market rental value is crucial as it may be the lowest amount. Obtain this from a professional, unbiased source like a local real estate agent or a clergy-focused tax agency such as Share the Harvest or Clergy Financial Resources to ensure accuracy.
5 Simple Steps To Designate And Report Your Housing Allowance
Below, you’ll find my five quick and easy steps for how to handle the housing allowance designation for pastors from start to finish that I personally used in the past. Pastors and church boards alike can use these steps to document, prepare, and conduct the best possible church financial management practices.
Step 1: Determine If You Rent or Own a Home
The first step is the easiest: determine your eligibility for the minister’s housing allowance. Do you rent a home, pay mortgage, or does the church pay for it? Are you an active minister or a retired one?
Step 2: Find the Lesser Amount for the Housing Allowance
Once you know your eligibility, it is time to find the lowest amount applicable to your designated housing allowance. This could be the flat designated amount you receive each month, your total living expenses, or even the fair market value.
Step 3: Keep Receipts of Everything
Every single part of your income, expenses, and allowance needs documentation for federal income tax purposes. Have the church board note in your income what is your allowance. Keep mortgage payments, utility bills, home repair invoices, every tax return, and the like in a nice and neat folder with easy access.
Step 4: Carefully Document the Housing Allowance Every Month
Prepare and document the housing allowance in whatever form you receive it. This is to know the correct distributions and exact amount you are exempt from in your taxes. If you need a church accountant or tax advisor for this, get one.
Step 5: Report the Housing Allowance on the Correct Tax Form
Finally, when tax season comes around, report your housing allowance in the correct place. Active ministers use line 1h on Form 1040 while retired ministers use line 1h on Form 1040-SR to indicate any amount you can’t exclude as wages.
In addition, your church can report your housing allowance in Box 14 of the W-2 you receive labeled “Other,” but this is not a requirement. However, implore your church staff or board to do this as an extra layer of evidence in case of an audit.
Avoid THESE Common Housing Allowance Mistakes
Don’t be the church pastor the IRS investigates for possible tax fraud. Avoid the most frequent mistakes clergy make so you can truly benefit from the housing allowance, prevent unnecessary financial burdens, and keep your church finances on the right track.
1. Don’t Confuse Federal Income Tax and Self-Employment Tax
Don’t confuse federal income tax with self-employment tax. The housing allowance helps with federal taxes, but not SECA.
2. Don’t Forget to Plan Ahead
Prepare in advance for the entire year to come. Know exactly how much your expenses and housing allowance will be.
3. Avoid Lacking Preparation for Potential Audits
Keep track of everything you do in case of an audit, including receipts, utility bills, pay stubs, etc.
4. Don’t File Alone
Hire a dedicated church accountant who knows the best possible practices for church accounting to avoid these common mistakes in the first place and create an effective church finance committee.
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