One of the benefits of being a pastor is getting to claim an income tax-free housing allowance. Not having to pay income taxes on part of your income can be a great benefit, so it’s one I always recommend that pastors maximize. But how do you maximize it?
What Is The Maximum Allowed Housing Allowance?
The first step in maximizing your housing allowance is knowing how much you’re allowed to claim in the first place. There are limits and some people have ended up in tax court for disregarding them.
Your maximum allowed housing allowance is the least of:
- the amount actually used to provide or rent a home;
- the fair market rental value of the home (including furnishings, utilities, garage, etc.);
- the amount officially designated (in advance of payment) as a housing allowance; or
- an amount that represents reasonable pay for your ministerial services.
How To Calculate Your Housing Allowance Limit
Therefore, to figure out what size of housing allowance you’re eligible for, simply calculate each of the above amounts and go with the lowest. If your mortgage payment is $2,000 a month but you could only rent the home for $1,500, then your housing allowance is limited to $1,500 a month. But, if your church has only designated $1,450 a month for your housing allowance, then that’s the most you can claim.
If you find that the lowest number is your designated housing allowance, that’s an easy fix. Ask your church to designate a higher housing allowance for you. You can start claiming it the moment they have made the designation official.
Your housing allowance is also limited to an amount that represents reasonable pay for your ministerial services. That means that if you only work ten hours a week at the church, then you cannot claim a $75,000 housing allowance. I don’t think the IRS would consider $150 an hour “reasonable” compensation for your service.
Remember, also, that those services only include ministerial services. If you are a bi-vocational minister, you can only claim a housing allowance from your ministerial income. If your expenses can justify it, though, you could claim your entire ministerial income as a housing allowance and use your secular income for all of your other expenses. Also, it doesn’t matter how you are paid for your ministerial services. Whether it’s by W-2 or 1099 does not matter.
How Much Housing Allowance Should You Request?
To determine your housing allowance, you should calculate both your anticipated expenses and the fair market rental value of your home. Then request the lesser amount. When calculating anticipated expenses, it is wise to include an extra 10% or so to cover things that come up unexpectedly, like a new crib or repairing termite damage.
Some pastors regularly request the fair market rental value of their home even when it is higher than their anticipated expenses. They do this to ensure that they maximize the exclusion. The risk with this is that if your expenses are significantly lower, you will have to add the excess to your taxable income when you file your return and could end up owing a lot of taxes.
Also, retirement account contribution limits are often tied to income. Claiming a higher housing allowance reduces your taxable income. That could unnecessarily limit the amount you can save for retirement in a tax-advantaged account. Usually, by the time you realize your taxable income will be higher (because you didn’t use the whole allowance), it’s too late to put more into retirement.
Try out the Pastor’s Wallet Housing Allowance Calculator. Just make sure to include any large purchases that you have planned for the year, such as a new refrigerator or deck. If you live in a parsonage or other church-provided housing, only calculate those expenses that you, yourself, pay for. You can also learn about calculating the fair market rental value of your home here.
