Housing Allowance - Prophet or Historian?
By Raul Rivera
In a recent Ultimate Church Structure Conference, I used an illustration to better teach how the housing allowance ought to be done. I taught that you can do it like a historian or you can do it like a prophet. While it brought a chuckle from the crowd, I also noticed that many eyes lit up with empowering knowledge when they got a much deeper understanding of the housing allowance and its significant tax-saving benefit. I will explain later.
Last year a church in San Diego hired a historian to structure the salary for its pastor. What a big surprise it was to Pastor Anderson three weeks ago when he learned he had to pay taxes on his housing allowance. He discovered that he owed over $4,000.00 of self-employment tax on his housing allowance and over $4,000.00 on his salary. Below is how his compensation package was structured:
Salary: $30,000.00
Housing Allowance $30,000.00
Total Compensation $60,000.00
What you think is not always true
Pastor Anderson was under the impression that the housing allowance is tax-free. Therefore, he expected to get a refund on his tax return. What he did not know is that ministers are subject to federal income tax (FIT) and to the Self Employment Contributions Act (SECA) tax. It is true that the housing allowance is exempt from FIT, but it is NOT exempt from SECA. The current SECA tax rate is 15.3% and no deductions are allowed. This is important to know. Let me explain.
How to compute your tax
As you can see from Pastor Anderson's dilemma, he had a total compensation package of $60,000.00. When figuring out his FIT, he was able to exclude the housing allowance and to also take deductions for interest on his home, donations, and his dependent exemptions. However, what he failed to realize is that he also had to compute his SECA tax on his total compensation. That is when it got sad for Pastor Anderson. Under section 1402 of the Internal Revenue Code, Pastor Anderson had to compute his SECA by adding the salary, plus the housing allowance, but he was not allowed any of the above-mentioned deductions. Below is an example:
Salary: $30,000.00
Housing Allowance $30,000.00
Total Compensation $60,000.00
Total SECA TAX $ 9,180.00 (60,000 x .153)
A historian or a prophet?
There are two types of accountants-historians and prophets. If you ask an accountant, "What is two plus two?" and he answers, "4", he is a historian. He is simply telling you the conclusion of what has already happened. However, if the accountant answers, "What do you need it to be?" he is a prophet. You see, the tax code is sufficiently complicated with a varied number of possible scenarios. The same way goes for the housing allowance. Many churches set the pastor's housing allowance without strategically thinking through the possible scenarios.
3 myths that many historian's believe
Let me share with you three myths that exist concerning the housing allowance and how each one can either short change or cause tax trouble.
Myth #1: The 50% housing allowance rule
I received a call from an accountant in San Diego. She wanted to know why StartCHURCH told her client that he could write off his entire salary as a housing allowance. She had always advised all of her clients that the housing allowance could not be more than 50% of the salary. Like Pastor Anderson's accountant, this accountant believed that a housing allowance could never be more than 50% of the total compensation. In short, I explained to her that section 107 of the Internal Revenue Code allows any and all reasonable, qualifying housing expenses to be excluded from income for FIT purposes. I then proceeded to ask her if she could find a tax regulation, publication, or other IRS instructions that limited the housing allowance to 50% of total compensation. Two weeks later she called me back and said, "I cannot find it anywhere." I then showed her in writing where the IRS states in Tax Topic 417 that the housing allowance " . . . cannot be more than the reasonable pay for the minister's services." The IRS only has one condition. The housing allowance cannot be more than 100% of the total compensation.
Myth #2: You must write a salary check and a housing allowance check
Many churches believe that in order for the housing allowance to be legal, the church must write a salary check and a housing allowance check. That is two checks every pay period. That is not a requirement. While it certainly can be done, we teach pastors at our conferences why doing that can actually short change the minister or get him/her in tax trouble, if he/she does not know how to properly adjust the actual numbers on the W-2 form. Just because the church paid you a housing allowance check, it does not mean that it is considered a qualifying housing allowance exclusion. In order for it to qualify, it must be substantiated using the actual expense formula and the fair rental value formula.
Myth #3 If a housing allowance is all I get from the church, I do not have to report it anywhere
Every year the under-reporting of income by ministers is in the billions of dollars. It is a common mistake made by many churches and leaders, as well as accountants. Unless the minister has opted out of the SECA tax by filling out form 4361, he/she has to pay the 15.3% SECA tax on the entire amount of housing allowance he/she receives from the church.
One minister's testimony
Two years ago, a pastor from Iowa called our office to see how StartCHURCH might be better able to help his church go to the next level of compliance. We had just taken his church through the StartRIGHT program and he wanted to know if his housing allowance at the church was compliant with the law. After reviewing his church's documents and two years of his tax returns, we concluded that his church had it all wrong. In fact, we noticed that had his church properly taken advantage of the housing allowance rules, he should have received at least an $8,000.00 refund, rather than having to pay $3,200.00. That pastor now enjoys a better night's sleep. We took him from being a historian where he simply reported what happened, to a prophet, where he planned for a particular result.