Subsidyscope

Exclusion of Housing Allowances for Ministers

All text from: Congressional Research Service (CRS). “Tax Expenditures: Compendium of Background Materials on Individual Provisions.” December 2008. GPO: Washington DC.

Description

Under an exclusion available for a “minister of the gospel,” gross income does not include: (1) the fair rental value of a church-owned or church-rented home furnished as part of his or her compensation, or (2) a cash housing/furnishing allowance paid as part of the minister’s compensation. The housing/furnishing allowance may provide funds for rental or purchase of a home, including down payment, mortgage payments, interest, taxes, repairs, furniture payments, garage costs, and utilities. Ministers receiving cash housing allowances also may claim deductions on their individual income tax returns for mortgage interest and real estate taxes on their residences even though such expenditures were allocable, in whole or in part, to tax-free receipt of the cash housing allowance. While excluded from income taxes, the fair rental value or cash housing/furnishing allowance is subject to Social Security payroll taxes.

Impact

As a result of the special exclusion provided for parsonage allowances, ministers receiving such housing allowances pay less tax than other taxpayers with the same or smaller economic incomes. The tax benefit of the exclusion also provides a disproportionately greater benefit to relatively better-paid ministers, by virtue of the higher marginal tax rates applicable to their incomes.

Further, some ministers claim income tax deductions for housing costs allocable to the receipt of tax-free allowances.

Rationale

The provision of tax-free housing allowances for ministers was first made a part of the Internal Revenue Code by passage of the Revenue Act of 1921 (P.L. 98 of the 67th Congress), without any stated reason. The original rationale may reflect the difficulty of placing a value on the provision of a church-provided rectory. Since some churches provided rectories to their ministers as part of their compensation, while other churches provided a housing allowance, Congress may have wished to provide equal tax treatment to both groups. Another suggested rationale is that originally the provision was provided in recognition of the clergy as an economically deprived group with low incomes.

The Internal Revenue Service reversed a 1962 ruling (Ruling 62-212) in 1983 (Revenue Ruling 83-3) providing that, to the extent of the tax-free housing allowance, deductions for interest and property taxes may not be itemized as a tax deduction. This change was based on the belief that it was unfair to allow tax-free income to be used to generate individual itemized deductions to shelter taxable income.

In the Tax Reform Act of 1986 (P.L. 99-514), Congress reversed the IRS ruling because the tax treatment had been long-standing, and some Members were concerned that the IRS might treat tax-free housing allowances provided to U.S. military personnel similarly.

The Internal Revenue Service’s position (Revenue Ruling 71-280) is that the exclusion may not exceed the fair rental value of the home plus the cost of utilities. The Tax Court held that amounts used to provide a home are excludable even if the amount received exceeds the fair market rental value of the home (Richard D. Warren, et ux. v. Commissioner; 114 T.C. No. 23 (May 16, 2000)). In that case, 100 percent of compensation was designated as a housing allowance ($77,663 in 1993, $76,309 in 1994, and $84,278 in 1995). The court dismissed the IRS’s argument that its position prevents unequal treatment between ministers for whom housing is provided and excluded and those ministers receiving a rental allowance. That decision was appealed to the Ninth Circuit Court of Appeals, which directed parties to submit briefs on whether the court should address the constitutionality of the parsonage exclusion.

In order to forestall action by the Ninth Circuit by making the underlying issue in the Warren case moot, Congress clarified the parsonage housing tax allowance with passage of the Clergy Housing Allowance Clarification Act of 2002 (P.L. 107-181). In large part Congress adopted the more conservative IRS position such that the “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 Act says that it is intended to “minimize government intrusion into internal church operations and the relationship between a church and its clergy” and “recognize that clergy frequently are required to use their homes for purposes that would otherwise qualify for favorable tax treatment, but which may require more intrusive inquiries by the government into the relationship between clergy and their respective churches with respect to activities that are inherently religious.”

Assessment

The tax-free parsonage allowances encourage some congregations to structure maximum amounts of tax-free housing allowances into their minister’s pay and may thereby distort the compensation package.

The provision is inconsistent with economic principles of horizontal and vertical equity. Since all taxpayers may not exclude amounts they pay for housing from taxable income, the provision violates horizontal equity principles. For example, a clergyman teaching in an affiliated religious school may exclude the value of his housing allowance whereas a teacher in the same school may not. This example shows how the tax law provides different tax treatment to two taxpayers whose economic incomes may be similar.

Ministers with higher incomes receive a greater tax subsidy than lower- income ministers because of their higher marginal tax rates. Vertical equity is a concept which requires that tax burdens be distributed fairly among people with different abilities to pay. The disproportionate benefit of the tax exclusion to individuals with higher incomes reduces the progressivity of the tax system, which is viewed as a reduction in equity.

Ministers who have church-provided homes do not receive the same tax benefits as those who purchase their homes and also have the tax deductions for interest and property taxes available to them. Code Section 265 disallows deductions for interest and expenses which relate to tax-exempt income except in the case of military housing allowances and the parsonage allowance. As such, this result is inconsistent with the general tax policy principle of preventing double tax benefits.

Selected Bibliography

• Anthony, Murray S. and Kent N. Schneider. “How to Minimize Your Minister’s Taxes,” National Public Accountant, v. 40 (December 1995), pp. 22-25.
• Aprill, Ellen P. “Parsonage and Tax Policy: Rethinking the Exclusion,” Tax Notes, v. 96, no. 9 (Aug. 26, 2002), pp. 1243-1257.
• Bednar, Phil. “After Warren: Revisiting Taxpayer Standing and the Constitutionality of Parsonage Allowances,” Minnesota Law Review, v. 87 (June 2003), pp. 2101-2131.
• Dwyer, Boyd Kimball. “Redefining ‘Minister of the Gospel’ To Limit Establishment Clause Issues,” Tax Notes, v. 95, no. 12 (June 17, 2002), pp. 1809-1815.
• Frazer, Douglas H. “The Clergy, the Constitution, and the Unbeatable Double Dip: The Strange Case of the Tax Code’s Parsonage Allowance,” The Exempt Organization Tax Review, v. 43. (February 2004), pp. 149-152.
• Foster, Matthew W. “The Parsonage Allowance Exclusion: Past, Present, and Future,” Vanderbilt Law Review, v. 44. January 1991, pp. 149-178.
• Harris, Christine. “House Unanimously Clears Parsonage Exclusion Bill,” Tax Notes, v. 95 no. 4 (April 22, 2002), pp. 474-475.
• Hiner, Ronald R. and Darlene Pulliam Smith. “The Constitutionality of the Parsonage Allowance,” Journal of Accountancy, v. 194. (Nov 2002), pp. 92-93.
• Johnston, David Cay. “From Holy Men to Houses, A World of Tax Breaks,” New York Times, March 1, 1998.
• Koski, Timothy R. “Divine Tax Opportunities for Members of the Clergy,” Practical Tax Strategies, v. 63 (October 1999), pp. 207-208, 241- 246.
• Martin, Vernon M., Jr. and Sandra K. Miller. “The Clergy’s Unique Tax Issues,” The Tax Adviser, v. 29 (August 1998), pp. 557-561.
• Newman, Joel S. “On Section 107’s Worst Feature: The Teacher- Preacher,” Tax Notes, v. 61. December 20, 1993, pp. 1505-1508.
• O’Neill, Thomas E. “A Constitutional Challenge to Section 107 of the Internal Revenue Code,” Notre Dame Lawyer, v. 57. June 1982, pp. 853- 867.
• Raby, Burgess J.W. and William L. Raby. “Some Thoughts on the Parsonage Exemption Imbroglio,” Tax Notes, v. 96, no. 11 (Sept. 9, 2002), p. 1497.
• Rakowski, Eric. “The Parsonage Exclusion: New Developments,” Tax Notes, v. 96, no. 3 (July 15, 2002), pp. 429-437.
• Stokeld, Fred. “No Surprises in Ninth Circuit’s Decision in Parsonage Case,” Tax Notes, v. 96, no. 10 (Sept. 2, 2002), pp. 1318-1319.
• U.S. Congress, Joint Committee on Taxation. General Explanation of the Revenue Provisions of the Deficit Reduction Act of 1984, H.R. 4170, 98th Congress, Public Law 98-369. Washington, DC: U.S. Government Printing Office, December 31, 1984, pp. 1168-1169.
• — . General Explanation of the Tax Reform Act of 1986, H.R. 3838, 99th Congress, Public Law 99-514. Washington, DC: U.S. Government Printing Office, May 4, 1987, pp. 53-54.
• Warren, Steven E. “Tax Planning for Clergy,” Taxes, v. 72, January 1994, pp. 39-46.
• Zelinsky, Edward A. “Dr. Warren, Section 107, and the Court-Appointed Amicus,” Tax Notes, v. 96, no. 8 (Aug. 26, 2002), pp. 1267-1272.
• Smole, David P., et al., The Higher Education Opportunity Act: Reauthorization of the Higher Education Act, Library of Congress, Congressional Research Service, Washington, D.C., (2008).
• Solomon, Eric, Assistant Secretary for Tax Policy, Department of the Treasury, “Letter to Honorable Sander Levin on the income tax treatment of student loans forgiven under the Higher Education Act,” (Sep. 19, 2008).
• Revenue Ruling 2008-34, Law School Loan Repayment Assistance Programs, U.S. Treasury, Internal Revenue Service, (July 14, 2008).

All text from: Congressional Research Service (CRS). “Tax Expenditures: Compendium of Background Materials on Individual Provisions.” December 2008. GPO: Washington DC.