Can money in a 403(b) be claimed as a housing allowance in retirement for someone living in a life care facility where the cost includes meals and medical care? How should that situation be handled?
The Apostle Paul told Timothy in 1 Timothy 5:17-18 that “The elders who direct the affairs of the church well are worthy of double honor, especially those whose work is preaching and teaching. For Scripture says, “Do not muzzle an ox while it is treading out the grain,” and “The worker deserves his wages.” (NIV)
I agree. You are worth your wages. But what are your wages?
We commonly think of wages as simply your salary, what you get paid to work. However, compensation can be a whole lot more than just a salary. This is especially true for pastors because of the unique opportunities that you have access to. There are a number of different things that comprise compensation, but they can be broken into two basic categories: income and benefits.
Income is actual money that’s coming to you. It’s something tangible that you can put in your bank account.
A pastor’s salary isn’t much different than anyone else’s salary. It’s money that you get paid for doing a job. You have to pay taxes on the money and you get to do whatever you want with it.
Pastors are dual-status taxpayers for Social Security purposes and thus have to pay both the employee and employer portions of that tax. If you’re not familiar with that, follow the link in the last sentence or none of this will make sense to you.
Some churches feel bad that pastors have to pay the employer portion of the Social Security and Medicare taxes and want to help them cover the cost. They calculate how much an employer would normally pay for the pastor, 7.65%, and pay that as additional salary. It is a nice gesture and definitely helpful to the pastor. Nevertheless, a Social Security and Medicare offset is simply additional taxable income in the eyes of the IRS.
Another type of income unique to ministers is the housing allowance. This site has all kinds of articles related to the housing allowance and I even wrote a book on it.
Basically, the housing allowance is income that is exempt from federal income taxation and can only be used for qualified housing expenses. It is also exempt from most state income taxes as well. Nevertheless, it is not exempt from Social Security & Medicare taxes.
The final type of pastoral income is specific to pastors who live in a parsonage. A parsonage is church-provided housing. As such, a pastor who lives in a parsonage does not have the opportunity to build home equity. When the ministry position is gone, the pastor has to start from scratch with housing.
This is the opposite experience for most Americans who purchase a home. As they pay down their mortgage and home values rise, their equity increases. Many people are able to pay off their mortgage by the time they retire so that they have lower housing expenses in retirement and a valuable asset that they can pull equity from if necessary.
Pastors who live in a parsonage often find themselves at retirement homeless and equity-less. To make up for that, many churches pay their pastors an equity allowance to help build towards purchasing a home in retirement. If they pay it directly to the pastor’s retirement account, it receives tax benefits and the pastor cannot access it for other things until retirement. If it is given as a cash payment, it is treated as taxable income by the IRS.
While income is money that you get, benefits are more of services or products provided to you. They are not cash and will not grow your bank account, but they are still very important to your overall financial life.
One of the most valuable benefits that an employer can provide is health insurance. It is much more expensive to purchase health insurance as an individual than through a group policy. Also, premiums paid through an employer-sponsored health insurance plan are tax-free. Other health-related benefits that churches can provide to all of their employees are dental and vision insurance, health reimbursement arrangements, flexible spending accounts, or health savings accounts if in conjunction with a high-deductible health insurance plan.
Another benefit that is helpful to both the pastor and the church (because they would want to care for the pastor’s family if anything happened) is life insurance. Up to $50,000 of group term life insurance can be provided tax-free and the premiums on any amounts above that are considered taxable income to the pastor (based on specific IRS calculations).
Most pastors are at greater risk of becoming disabled than dying. As such, disability insurance is a very valuable benefit. Like health insurance, it is also much more affordable when purchased as part of a group plan rather than as an individual.
A retirement savings account, usually a 403(b), is a benefit that has multiple advantages for pastors. Not only are pastors able to save for retirement pre-tax, but having a church-sponsored retirement plan makes it possible to claim a housing allowance in retirement and also entirely avoid paying Social Security and Medicare taxes on contributions.
Even God took time to rest. As such, it is important for pastors to have access to paid leave (and a culture where they are encouraged to take it). It can be broken down in different ways, but paid leave can include sick days, holidays, vacation time, family leave, professional development, outside ministry, and sabbaticals. It is also important for the church to respect the pastor’s time off and pitch in to get work done while the pastor is away.
All of the other benefits (not income) listed here can be given to all church staff but a parsonage is only for ordained, licensed, or commissioned ministers. A parsonage is a church-owned home that a pastor gets to live in income tax-free.
Those are the different pieces that can be fit together to create a ministerial compensation package. Both pastors and their churches should understand these different components in order to create a tax-efficient compensation package that meets the pastor’s needs. Pastors, share this with whoever in your church makes salary decisions, whether it’s a board of directors, stewardship committee, an HR department, or whoever. Sit down and review it together to make sure your church is fulfilling 1 Timothy 5 to the best of its ability.
A look at how the clergy housing allowance works and why you can still claim it even without a mortgage.
The Children’s Health Insurance Program (CHIP) is a government insurance program that provides low-cost health insurance to children from families that earn too much to qualify for Medicaid but not enough to be able to afford private insurance. This includes many pastors’ children.
Like many such programs, eligibility is based on income. That’s simple for most people, but can be a cause of uncertainty for pastors. You start filling out the forms and when you get to the income line, you pause. Your salary is $30,000. Your housing allowance is $20,000. So what’s your income? $30,000 or $50,000? Ugh! No one else has this problem, why does being a pastor have to be so hard?
Being a pastor is hard, I know it. While I can’t fix the people in your church, I can at least solve this little problem for you. CHIP income DOES NOT include the housing allowance. That’s good news for you!
CHIP uses the same methodology for calculating income as most categories of Medicaid and the premium tax credit. This is the calculation used:
Adjusted Gross Income (AGI)
+Non-Taxable Social Security Benefits
+Tax-Exempt Interest
+Excluded Foreign Income
=Modified Adjusted Gross Income (MAGI)
Your AGI comes from your tax return, Form 1040, and does not include the housing allowance. As we can see from the above calculation, it isn’t added back in, either. If you don’t trust me, follow the link above and see for yourself.
To conclude, Pastor, now you can fill out your application with confidence. Your clergy housing allowance is not included in income for the Children’s Health Insurance Program.
Here’s a step-by-step description of how to set a housing allowance for a pastor, what needs to be done throughout the year, how to report it to the IRS, and what to do if you have excess housing allowance.
This is an excerpt from my book, The Pastor’s Wallet Complete Guide to the Clergy Housing Allowance:
The church is not required to report the housing allowance to the IRS. Unless a church includes it in an informational section on Form W-2, the IRS and the Social Security Administration (SSA) are only made aware of the housing allowance when a minister files Schedule SE to pay Social Security taxes under SECA.
You should review your Form W-2 that you receive every year to make sure your church prepared it correctly. Many church treasurers and bookkeepers have received absolutely zero training, they’re just doing it because they’re not good at saying no. So, make sure to double check. This is what it should look like:
Wages excluding housing allowance. This is what the church reports to the IRS as your income. The housing allowance is exempt from income and should therefore not be reported here. If it is, the IRS will think you owe more in taxes and you will have a mess on your hands. If your church accidentally includes your housing allowance in Box 1, have them correct the mistake right away by filing an amended Form W-2.
These boxes are for Social Security and Medicare and, regardless of the housing allowance, should be blank. That is because ministers are considered self-employed for Social Security purposes as we discussed already. It was in that exciting SECA/FICA excursus that you probably skipped. Don’t worry about it, it’s boring stuff, you can just take my word for it.
Again, your income is not reported for Social Security and Medicare purposes on Form W-2 and churches are not supposed to withhold payroll taxes for you. Rather, you have to calculate your own Social Security and Medicare tax payments on Schedule SE and file it with your tax return.
Box 14 is for informational purposes only. As such, your church is allowed to use it to report the amount designated as a cash housing allowance. However, this is not required and some churches report it in other ways. If there is nothing in your Box 14, then you should expect other communication from your church regarding your housing allowance amount.
Box 16 is for state wages and would be filled out as per your state’s laws.
Ministers who are not employed by a specific church, such as traveling evangelists, will not receive a W-2. Rather, you may receive a Form 1099-NEC (Form 1099-MISC for tax years prior to 2020). Any church that has paid you over $600 in a year is required to issue you one. For them to be able to do so, you will need to submit Form W-9 to them prior to providing your services. Form W-9 simply contains the basic information they will need to be able to report your income to the IRS.
The $600 trigger does not include a housing allowance that was properly designated in advance, reimbursed expenses, or contributions to a 403(b). Thus, if you claim all of your income from a specific church as a housing allowance, they aren’t required to give you anything to show for it. It is up to you to track the income you receive from various churches and how much of it is eligible for the housing allowance.
Under certain circumstances, you may be able to claim a ministerial housing allowance even during retirement. The next chapter will discuss this in detail.
If you take a housing allowance during retirement, you will receive a 1099-R instead of a W-2. Your housing allowance may or may not be listed on the 1099-R. The form may just say “Taxable Amount Not Determined,” meaning that you have to decide which portion is taxable and which isn’t. If it is listed as a taxable distribution, you can still take it tax-free by including the housing allowance amount on line 4 of Form 1040. (Prior to 2018 it was on line 16.)
Your church treasurer is responsible for providing you the amount of your annual housing allowance in writing at the end of the year. If you haven’t gotten one, try bringing the treasurer homemade brownies. They can really work wonders. A copy of the notification should also be kept in the church’s files.
Notification can simply be a letter stating something along the lines of, “Your designated cash housing allowance for 2018 was $…” This letter goes to the pastor and not to the IRS. It is for informational purposes only. It is not attached to the pastor’s tax return that is sent to the IRS, either. You’ll have plenty of other papers to send them, so keep this one for yourself.
Also, as mentioned above, the housing allowance amount can be included in Box 14 on Form W-2. Box 14 is an informational box that employers use to report various kinds of information to employees, such as retirement contributions and housing allowance. Box 14 would simply say something like, “Housing: 18,000.” If it is included on Form W-2 then it has been reported to the IRS.
You will need this information to fill out Schedule SE and pay your SECA taxes.
Your church will report to you the amount paid as a cash housing allowance. However, if you live in a parsonage it is your responsibility to calculate the fair market rental value and include it on Schedule SE. Since you are the one receiving the tax benefit, it is your responsibility to do the calculations, not your church’s. Go back to the last chapter to learn about how to calculate the fair market rental value of a home.
It is your responsibility as a pastor to track your housing expenses. Your church has no responsibility in this area beyond designating the housing allowance. If you claim an erroneous amount or don’t have the records to back up your claims, it is all on you and has nothing to do with the church.
In fact, it’s really none of their business how you use the housing allowance. That’s between you and the IRS. There is no need for you to submit your itemized expenses to the church or share them in any way. They are confidential.
Some churches have curious board members, but you can let them know that there is nothing in the law that requires them to know how you are spending your housing allowance. Just be nice about it, because they’re the ones that have to designate a housing allowance for you in the first place! If it doesn’t go over very well, go ahead and take them some brownies, too.
As you can see, it is important that you keep your own records. Make sure to keep receipts, mortgage statements, and any other evidence that supports your claim of a housing allowance. These will come in handy if you ever get questioned by the IRS. In an audit, the thicker the paper trail, the better. Digital “paper trails” also work well.
As we all know, nothing went quite as expected in 2020. In fact, for most of us, nothing went anywhere close to expected! Maybe you were planning on doing some work on your home and things got shut down because of COVID-19. Perhaps you were planning on spending some money on items for your home, but COVID-19 made you tighten your budget. Or things just didn’t go according to plan and it had nothing to do with COVID-19! (But we’re blaming everything on COVID-19 these days, right?)
While altering your plans is always annoying, it is a bit more significant for pastors when it comes to housing expenses. At the beginning of the year, you have to carefully estimate your yearly housing expenses in order to avoid paying taxes on them with the clergy housing allowance. You meticulously calculate your anticipated rent, utilities, home purchases, and big projects.
And then something like this happens. The whole world hits pause. Your plans get tossed by the wayside and your expenses were lower than the housing allowance that your church gave you. You should have been paying taxes on some of that money and you didn’t.
Now, what do you do?
What the housing allowance is is a provision that allows you to exclude your housing expenses from gross income for federal tax purposes. At the beginning of the year, you tell your church how much of your income you plan to use for housing and that amount is not reported to the IRS as income.
However, if you don’t use it all for housing by the end of the year, you need to let the IRS know and pay federal income taxes on the rest. Let’s see what that looks like in real life.
Say your church pays you $60,000 a year. You designate $25,000 of that as a housing allowance so your church only reports to the IRS that you had $35,000 of taxable income.
If you only spend $22,000 on housing for the year, you have an extra $3,000 that you should have paid taxes on but didn’t. You need to add that extra $3,000 of housing allowance back into your income and pay taxes on it. Not doing so is tax evasion and will get you into trouble if the IRS audits you.
So, how do you report it as income in order to pay taxes?
Add it in with your other wages on line 1 of your Form 1040. Then, on the dotted line next to it, write, “Excess allowance” and the amount. Here is an example:
Yes, it is as simple as that. Now it is added in with your wages for when your taxes are calculated.
That’s how to include it for income taxes, but what about SECA, your Social Security and Medicare taxes? Well, you don’t have to worry about that at all. Because you always have to pay SECA taxes on your housing allowance, claiming too much won’t make any difference in what you have to pay. You are already paying the full amount on Schedule SE.
Now, while ending the year with excess housing allowance may have made your heart skip a beat and worried you a bit, it wasn’t that bad, was it? With such an easy way to correct it, it’s often better to err on the side of claiming too large an allowance than too small.
Too many pastors don’t claim a large enough housing allowance and end up needlessly paying extra taxes. The best way to avoid that and limit your tax bill is by overestimating your yearly housing allowance.
There is one thing I need to note, though. There is a potential downside to overestimating your housing allowance.
Your housing allowance lowers your gross income for federal tax purposes and there are some important things that are limited by your gross income. The biggest one that most pastors need to watch out for is the refundable portion of the Child Tax Credit. Claiming too much of a housing allowance can actually limit the amount of money you can get. This article explains why. Contributions made to retirement accounts are also calculated and limited based on income. There is a chance that by overestimating your housing allowance you could negatively affect the amount of money that you can save for retirement.
Make sure to look into those two things before blindly following my suggestion that overestimating is better than underestimating. Remember, just because you read something on the internet doesn’t mean it’s necessarily best for your unique situation.
Now that you’ve fixed last year’s housing allowance, what about this year’s? Is it already approved by your church with an accurate estimate or overestimate?
If not, you’d better get on it! The housing allowance cannot be used retroactively, so every day you procrastinate is another day that you are paying taxes on your housing allowance unnecessarily. If you need to make a change, make one. The IRS does not limit the amount of changes you make to your housing allowance or the timing of them, as long as they are done proactively.
This is an excerpt from my book, The Pastor’s Wallet Complete Guide to the Clergy Housing Allowance:
Pastor, when it comes to the housing allowance, you’re the man (or woman). If you want the tax savings that the clergy housing allowance provides, it’s on you. It’s not the church’s responsibility, it’s yours. You are the one who has to calculate your anticipated expenses for the year, submit them to your church, and make sure they approve it in time.
Also, it’s your job to track your expenses throughout the year to substantiate the housing allowance that you claim. Unlike an accountable reimbursement plan where you have to submit receipts to the church, hang onto your receipts. If you get audited by the IRS, you are the one that will have to answer to them, not your church.
The church or denomination is responsible for officially designating the housing allowance before paying it. Until the official designation has been made, all payments count as taxable income. To make it official, the church must put it in writing as a part of an employment contract, in the church’s budget, in meeting minutes, in a church resolution, or “in any other appropriate instrument evidencing such official action.” (Treasury Regulation § 1.107-1(b)) The designation must simply identify a payment as a housing allowance as opposed to salary or other remuneration (pay).
Once the church has made the official designation, their only responsibility is to pay the housing allowance and record it properly. The allowance should be paid along with the minister’s regular wages, but the amount is not included with wages on Form W-2. In fact, the church does not report the housing allowance to the IRS at all. If it’s on the W-2 as wages, it’s taxable, so make sure your church does it right. That’s why you need to be extra nice to whoever does your church’s payroll. If you get on their bad side, it could cost you big time.
At the end of the year, the church needs to let the pastor know the total housing allowance for the year and it is the pastor’s responsibility to report that to the IRS on Schedule SE. If the pastor is exempt from self-employment taxes, then the housing allowance is never reported to the IRS at all. Isn’t that nice?
To inform the pastor of the housing allowance amount, the church may include it in an official letter or show it on Form W-2 in box 14. Box 14 is an informational box only, so employers have some flexibility in how they use it. The church can report the pastor’s housing allowance by writing something like “Housing: 20,000” in that box. The housing allowance should never be included with wages in Box 1. (If it is, have your church fix it and send you an amended Form W-2.)
Here is a breakdown of how the housing allowance works:
This process should be repeated annually. If you have pretty steady housing expenses, you can request the church to designate your housing allowance in an open-ended manner. An example would be, “First Church designates a housing allowance of $25,000 a year for Pastor John. This designation shall be effective for the current year and all subsequent years unless otherwise provided.” That way, you don’t have to go through the process of requesting the housing allowance every year. Instead, you can skip steps 1-3 and only go back to them when your housing expenses change. Steps 4-7 must still be followed every single year, though.
Even if you use open-ended wording, you should still calculate your housing allowance on a regular basis. Housing costs creep up gradually and if you’re not careful, you’ll end up paying taxes on a significant portion of your income unnecessarily. You can find sample housing allowance designations, worksheets to help you calculate your housing expenses, and an online calculator at pastorswallet.com/free-resources.
If you want to learn more about the clergy housing allowance, pick up a copy of The Pastor’s Wallet Complete Guide to the Clergy Housing Allowance on Amazon today!
I don’t know about your neighborhood, but in mine, real estate is on fire. Houses that usually take several months to sell are now under contract within a matter of days. This sudden housing boom has caught a lot of people by surprise, especially since everywhere else you look the economy is struggling under the weight of COVID-19. However, with interest rates at record lows and people spending a lot more time at home with their families, it does make sense.
In addition to the houses on my street selling quickly, I have also been getting questions from readers who are jumping into the fray and buying homes. The big question for pastors is, Does a down payment qualify for the housing allowance? The answer is yes, but with a few caveats.
First of all, the minister’s housing allowance is always proactive, never retroactive. It must be designated in advance for expenses to qualify. You cannot buy a home and then adjust your housing allowance to cover the purchase. Once you’ve spent the money, you can’t go back and call it a housing allowance.
If you’re planning to buy a home, you need to have your housing allowance changed BEFORE you make the purchase. It must be officially designated by your church or employing organization, so you need to make a request in advance. How far in advance depends upon how quickly they work.
Remember, it is easy to adjust for excess housing allowance at the end of the year, but there’s no second chance if you do not claim enough. Thus, it’s usually better to cover your bases and ask for an increased allowance even if you are not 100% sure that your purchase will go through.
Even though it is an eligible expense, your entire down payment may not qualify for the clergy housing allowance. That is because the government has placed limits on how much you can claim. The allowed housing exemption is limited to the LESSER of:
The one that gets most pastors is the second point, the fair market rental value of the home. In most cases, a down payment will push your actual housing expenses above the fair market rental value of the home because it is such a large chunk of money. Want to see how it works?
Let’s say you buy a home on January 1. Your regular monthly expenses will total $2,500 (use this calculator to figure regular expenses). However, if you were to rent out the home with everything in it and cover the utilities, you could get $3,500 a month. The fair market rental value of the home for the year is $42,000 ($3,500*12). You can’t claim any more than that.
Your normal expenses will cost $30,000 for the year ($2,500*12), so you can claim $12,000 ($42,000-$30,000) of your down payment as well. Any down payment that you pay in excess of $12,000 will have to come from taxable income. If you purchase a home mid-year, you will do all of the calculations on a prorated basis, just as you would if you simply changed homes mid-year without buying.
I know that some people try to work around this by having a smaller down payment and higher monthly payments. That could make sense in some situations, but it isn’t a sure thing. You need to look at how much more you are paying in interest over the life of the loan, how much your interest rate is affected by the size of your down payment (which could lead to paying more in interest), and things like whether or not you will have to pay private mortgage insurance (PMI). All of those things could make it more financially beneficial to have a big down payment, even if it does not qualify for tax exemption as a housing allowance.
Remember, the housing allowance is just one tool (albeit a powerful one) in your financial toolbox whose purpose is to assist you in being a wise steward of that which God has entrusted to you. You must balance your use of the housing allowance, and the effort that you put into squeezing every last cent out of it, with the overall health of your finances and your relationship with money.
It’s that time of year again when college students all over the country are filling out the Free Application for Federal Student Aid, more commonly known as the FAFSA. While technically you have from October 1, 2019, until June 30, 2021, to fill out the FAFSA for the 2020-2021 school year, many are getting it done right now. Now is a good time to do it if you want to see the different award packages available to you and start making plans for the fall.
If you’re new to this, let me give you a little bit of background. The FAFSA is the form that college students use to apply for government student aid, such as grants, loans, or work study programs. In addition to federal aid, many states and colleges use the FAFSA to award student aid as well. The general rule is that if you want any help at all with school, fill out the FAFSA.
Since a lot of student aid is needs-based, the FAFSA collects financial information. The student will have to provide information from their own personal tax returns. If under age 24, then the parents’ financial information must be included as well. That information is used to calculate an Expected Family Contribution (EFC). The EFC in turn affects how much aid a student can get.
One big question that pastors and their college-age kids often have is how the housing allowance fits into everything. The income that you report on the FAFSA is your adjusted gross income (AGI) from your tax return. Your AGI does not include the housing allowance. Does that mean the FAFSA ignores the housing allowance?
Sorry, but no. While the housing allowance does not appear as a part of AGI, it is added back in further down the form. Both the cash housing and parsonage allowances must be reported under the Untaxed Income section. So, yes, the housing allowance counts as income for the FAFSA.
There are a number of FAFSA calculators online that can be very helpful in estimating your EFC. However, if you are using a FAFSA calculator it may seem that the housing allowance affects you negatively. Pastors sometimes find that if they plug in their housing allowance as part of their AGI instead of as untaxed income it lowers the EFC.
Why is that? Because taxes paid are subtracted from income when calculating the EFC. If you were to pay taxes on your housing allowance, it would lower your available income and therefore lower your EFC.
Because of the way the calculator works, having a tax-free housing allowance can appear unfavorable. Keep in mind, though, that that doesn’t take into account the tax savings that you initially receive from not paying income taxes on the housing allowance. Even if you have a higher EFC and receive less aid for college, the federal income tax savings will likely make up for it. You wouldn’t want to pay $1,000 in taxes just to be eligible for half that amount in student loans, would you?
In summary, the clergy housing allowance is, in fact, included in the FAFSA. It is added under the Untaxed Income section and not with AGI. Also, it may appear to have a negative effect on the FAFSA. That’s only because it doesn’t take into account the original tax savings, though. Have fun filling out your forms!
