Chaplain for the State Dept of Corrections

[Jesse]

New client is a chaplain for a State of WI prison. He is paid as an employee and FICA & Medicare are taken out of his pay and just like any other employee the state mathches this. $35,000 is reported in box 1 of his W-2.

With his W-2 he received a letter that says:

To Whom it May Concern:

Mr. C is employed as a chaplain with the Dept of Corrections at the XXX Correctional institution. Chaplain C is not furnished a residence by the state and therefore pursuant to WI Statute he is eligible for $1,800 or 20% of his chaplain's salary, whichever is greater, to be designated as the housing allownace.

Chaplain C's 2007 earnings were $35,000 and therefore $7,000 should be designated as the housing allowance. If you have any questions, please contact So and So at ####.

I called the number and they could not tell me anything except this is what they had been instructed to do by the State.

Has anyone else run across this or have any ideas as to what to do?

Do I make an adjustment for the $7,000 on his Federal and state income subject to income tax because normally the housing allowance is not subject to income tax but is subject to SE tax?

Do I "pretend" he received this $7,000 and subject it to SE tax? That makes no sense at all but I'm dealing with taxes.

Do I just say "oh that's nice" and do nothing?

Any opinions welcomed!!

[Peggy Cobb]

Yes, housing is subject to Sef-employment taxes, but not income taxes, with one exception. If his housing expenses were less than the housing allowance, then the difference is subject to income taxes. If you are using ATX there is a pastor's income worksheet. I have not used it this year, so I can't say how it works. But in the past you opened an Sch SE and used the bottom buttons to add the housing amount. Then on the 1040 under line 21 you add housing allowance in excess of housing expenses.

[Peggy Cobb]

I forgot to add, that as a minister he can "double dip". This means that he does not report the housing allowance as income (except for Schedule SE) and he can also take any mortgage interest and property taxes as an itemized deduction. In the IRS rules a pastor is an employee, but for Social Security he is self-employed. So when you do a minister's tax return you are report to two different agencies with two different set of rules. Social Security receives the Sch SE information and under normal pastor/church setting he would pay SE on his salary and housing. But because he is not working for a church they withhold SS and Medicare. If he were working for a church you would only see box 1 and possibly box 2 of the W-2 filed in. If he were working for a church you would have to report salary and housing on the SE. But because he is not working for a church, you only need to report housing on the SE.

Hope this is clear as mud.

Peggy Cobb

[cpabsd]

I actually have a client that was a chaplain for the State of Maryland. Since the full $35,000 has been subject to SS, there is no need to complete the from SE. Line 21 then has a subtraction for the amount of the housing allowance as it is not subject to income tax. I also e filed this clients return. We had to use the form 8453 and send a copy of the letter to the IRS. I have done this for four years and have never heard from the IRS. It sounds like your letter is exactly like the one I see every year.

[Jesse]

I actually have a client that was a chaplain for the State of Maryland. Since the full $35,000 has been subject to SS, there is no need to complete the from SE. Line 21 then has a subtraction for the amount of the housing allowance as it is not subject to income tax. I also e filed this clients return. We had to use the form 8453 and send a copy of the letter to the IRS. I have done this for four years and have never heard from the IRS. It sounds like your letter is exactly like the one I see every year.

Thank you. This is what I was looking for.

Peggy, thank you also, but in this case as cpabsd pointed out the amount has already been subject to SS. What I was questioning is how to report and if indeed it should be subtracted from the wages.

[MAMalody]

To qualify for clergy housing, you must be qualifed for what is called dual status. The dual status is that you are considered an employee for income tax purposes and self-employed for SS/med purposes. Hence you should receive a W-2 with not deductions. If there are deductions you have a contradiction in status and are considered an employee not eligible for the clergy housing allowance. The fact that a letter was attached to the return, doesn't really mean much since they are essentially never reviewed unless there is an audit situation. I'm not sure what happens when you send the clergy worksheet with the F8453. My guess is that there is not matching program. It is probably possible to file in the manner mentioned before, however, in the event of audit I believe there will be a problem. I have run a scenario similar to this past a tax attorney who specializes in clergy taxes and his feeling was they did not qualify for the housing allowance.

Incidentally, when computing the housing allowance it is the smaller of three figures (not two as indicated in one of the prior posts):

1. designated amount

2. actual spent

3. fair rental value

Also, the OP never indicated if this amount was desigated ahead of time, although, I suspect, it is a written policy of the state so it probably his. The post just never confirmed this.

Technically, the way out of this is to have the W-2 corrected to reflect either clergy status, or, leave it like it is and the chaplain would be an employee. (For discussion purposes above, I am assuming the chaplain qualifies for the housing allowance - all of them do not.)

[jainen]

>>they did not qualify for the housing allowance<<

This is a valid parsonage allowance, designated by statute. Normally we think in terms of "dual status," but that's not exactly what Reg §1.1402(a)-11 actually says. It doesn't say he MUST be treated as self-employed, just that if he IS then the housing allowance is not excluded from SE tax.

However, you don't take $7000 off the $35,000. Box 1 of the W-2 is supposed to show the taxable net AFTER exclusion. See the example starting on page 11 of Pub 517. In other words, Wisconsin apparently pays an exempt housing allowance in addition to the taxable salary. The result is that the minister does not get any reduction from the W-2. In fact, he must show housing costs exceeding $7000 to avoid having excess allowance ADDED on Line 7.

The taxpayer should be able to explain all this. State employees usually know every detail of their benefits; why else would he go to the prison every day? Don't you require last year's return for any new client? Surely he knows if he gets $35000 or 20% more than $35000. You can check for yourself whether FICA withholding was 6.2% of $35K or 6.2% of $42K, but frankly I wouldn't worry about that part being right or wrong. Basically just enter the W-2 the normal way. I'm sure he uses up the $7000.

[Jesse]

>>they did not qualify for the housing allowance<<

This is a valid parsonage allowance, designated by statute. Normally we think in terms of "dual status," but that's not exactly what Reg §1.1402(a)-11 actually says. It doesn't say he MUST be treated as self-employed, just that if he IS then the housing allowance is not excluded from SE tax.

However, you don't take $7000 off the $35,000. Box 1 of the W-2 is supposed to show the taxable net AFTER exclusion. See the example starting on page 11 of Pub 517. In other words, Wisconsin apparently pays an exempt housing allowance in addition to the taxable salary. The result is that the minister does not get any reduction from the W-2. In fact, he must show housing costs exceeding $7000 to avoid having excess allowance ADDED on Line 7.

The taxpayer should be able to explain all this. State employees usually know every detail of their benefits; why else would he go to the prison every day? Don't you require last year's return for any new client? Surely he knows if he gets $35000 or 20% more than $35000. You can check for yourself whether FICA withholding was 6.2% of $35K or 6.2% of $42K, but frankly I wouldn't worry about that part being right or wrong. Basically just enter the W-2 the normal way. I'm sure he uses up the $7000.

According to paystubs his gross indeed is $35,000, that is why I don't understand the "phantom" housing allowance. FICA was actually based on $37,000, only because $2,000 was deferred Comp. If his actual housing does not exceed the $7,000 something that was not received can't be taxable. In 2007 this is his only employment, previously he was a pastor at a local church, so for 2007 he was no longer self employed.

[jainen]

>>his gross indeed is $35,000<<

I made a brave stab at slaying the beast, but she is a wiley devil. I only see two possible actions now. The first is to run away -- assume the W-2 is correct as filed and the inconsistent letter is just a general explanation of intent. If you feel heroic (or get cornered) fight back by slicing off the $7k with one hand and punching up a disclosure form with the other.

[MAMalody]

I answered this question on TTB board.

I did some additional research and here is what I found. This situation is a little different that what I had. I had a church pastor where the church made all the normal employee deductions and that apparently is different that a state employee here. According to Richard Hammer in the instant case, he could qualify for the housing allowance and have the full normal employee deductions. That would also mean that he could deduct on line 21 the smaller of the amount spent, the amount designated or the fair rental value. Go for it.

Mike

[Jesse]

Thanks for the help really appreciate the feedback.