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Ministerial Housing Allowance


Christian

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A new client has come in who is a minister. She lives in her own home and iis given a housing allowance which is designated on her W-2  Box 14. A nephew of mine is also a minister and receives a  small housing allowance which I have reported on Schedule C not deducting any expenses and filing Form SE for his self employment tax. I then deduct the allowance on the other income line of his Form 1040 so he owes no income tax on it. The client receives a much larger allowance and her prior taxperson deducted expenses from it which are not identified and unlike me did not report the allowance on Schedule C. What expenses can be deducted from the housing allowance if reported on Schedule C. The nephew basically had none and in reading I am unclear what can be used as an expense.

 

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I've been reading prior posts on this subject and have yet to gain much clarification. The clients prior taxperson added her church salary (reported on the aforementioned W-2) which no Social Security tax was withheld from and her housing allowance and then deducted expenses from the combined total. The result left the salary fully exposed to SE tax but sharply reduced the housing allowance leaving a small portion of the housing allowance to be added to the salary for inclusion on Schedule SE. The client does incur auto expenses in her ministry but I was unable to define much else. I plan on contacting her former taxperson but she is in bad health and speaking with her may be problematic. She did not report using Schedule C but derived her figures using a worksheet provided with Schedule SE. I examined the one provided by ATX and have yet been unable to quite understand it.

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You shouldn't use Schedule C to report a H&U allowance.  I don't use ATX, but I'll bet it has a worksheet for properly reporting the H&U allowance.  The worksheet should require you to calculate the lower of 1) Actual amount designated, 2) Amount actually paid, or 3) FRV of house (fully furnished & all utilities paid).   The amount designated is then taken directly to Schedule SE, and the amount taxable (if any) is added to W-2 wages & salaries with a notation of "Excess H&U Allowance). 

Drake has an excellent, intuitive worksheet for this.  I assume the ATX worksheet is similar in layout & function to the one Drake uses.  Calculating the H&U correctly is a simple process, but not necessarily easy the first time you use it.  After the first couple of run-throughs it makes perfect sense. 

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I used the method my nephew's then CPA used and never had any problems. That being said the ATX worksheet approximates the one in Pub 517. By FRV of the house do you mean the Fair Resale Value ? This is a rare bird for me so it's incumbent on me to get it correct. The CPA simply put the HA on Schedule C showing him as a minister. He showed the full amount as profit which was carried to the Schedule SE but did not allow the profit to flow to the 1040 and thus avoided income tax on it. This client gets a cash payment each year annually approved by the Board of Deacons and as noted it is shown on the W-2 she receives as a church employee in Box 14.

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ATX does, indeed, have a proper worksheet to use for clergy called 1040 Clergy.  It is pretty good, I think, and puts the right numbers in the right places. 

Schedule C is used when the clergy person has additional income from being a guest minister, is paid separately for officiating at weddings or funerals or other income sources not part of the salary from the church.  Only those expenses related to that income are typically used to offset the income (mileage, other transportation, etc.). Typically mileage directly related to the performance of regular duties is reimbursed by the church as are other professional expenses - books, conferences approved by the governing body, etc. 

As ministers usually exempt themselves from SS and MC, they are subject to SE tax on the salary, any Sch. C net income, and the housing allowance.  Only the housing allowance is not subject to income tax - unless there is excess.  That is the minister must provide proof that the housing allowance was used in total for housing.   In the case of your client, FRV means Fair Rental Value.  A local realtor should be able to provide that  by comparing a house of the comparable size and amenities to the market.  Your client should also provide the total of the actual expenses and utilities.  Actual expenses can be supplies, maintenance, telephone, cable, etc.  This should exceed the housing allowance.  If not, and the fair rental value does not, the excess is taxable income.

I'm a long time subscriber to Church & Clergy Tax Guide, have had several clergy clients, and was church treasurer for many years.  I won't say I know it all but do have resources available should you have questions.  There are also a few others on this forum with a wealth of experience in this area.

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4 hours ago, Christian said:

I used the method my nephew's then CPA used and never had any problems. That being said the ATX worksheet approximates the one in Pub 517. By FRV of the house do you mean the Fair Resale Value ? This is a rare bird for me so it's incumbent on me to get it correct. The CPA simply put the HA on Schedule C showing him as a minister. He showed the full amount as profit which was carried to the Schedule SE but did not allow the profit to flow to the 1040 and thus avoided income tax on it. This client gets a cash payment each year annually approved by the Board of Deacons and as noted it is shown on the W-2 she receives as a church employee in Box 14.

Margaret and Lion provided excellent additional detail on the subject. I'll just add that your nephew's then CPA you referenced was handling it incorrectly. He likely achieved the same result, so there was no negative tax consequence.  But he must have been doing some sort of override of the software (unless the return was prepared by hand...).  😳

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Margaret has pretty much cleared the clouds on this one. I'm going to print the entire disussion and place it in the client file.The client provided utility bills for her home and this along with the FRV will likely just about exempt the HA from any tax. Many thanks to all as I was in the weeds on this one. ( I am sure there are some that feel I stay in the weeds.)  😄

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18 hours ago, Christian said:

Margaret has pretty much cleared the clouds on this one. I'm going to print the entire disussion and place it in the client file.The client provided utility bills for her home and this along with the FRV will likely just about exempt the HA from any tax. Many thanks to all as I was in the weeds on this one. ( I am sure there are some that feel I stay in the weeds.)  😄

Did you mean "income tax" or "any tax"?  The HA is subject to SE tax (unless she filed the 4361 that some do).

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My confusion with regard to this stems in large degree from the info received from the client's former taxperson who did not provide all the info I needed and the fact she is ill with some form of cancer and really bad off. The client had no prior tax records which clearly indicated exactly how she handled this. I plan to use the Clergy 1040 form provided by ATX and go from there. I need time to look it over but it shows deductions allowabe against the HA which look to me will reduce the amount exposed to SE tax.

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I don't use that worksheet, but it appears that it is comparing the FRV from a third party with the HA voted by the church with the actual expenses (line 4f) to arrive at the lowest of those three amounts to use as the income-tax free housing allowance for tax purposes. Line 4f is his actual housing expenses. They are to compare to the other two amounts. They are NOT deducted from anything or deducted anywhere.

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I see exactly what you mean. I may simply pass on this one. I don't read that there are any expenses which reduce the full HA from SE tax. I think the former taxperson made significant errors in this regard. She somehow deducted unreimbursed employee expenses from the HA whereas these would apply only to income such as fees and other incidental income reportable on Schedule C. She is showing a leftover NOL from the income taxed on the SE with no Schedule C attached to the return. I am going to get the client to bring me her 2015 and 2016 returns to see if I can make sense of what she did but regretably I doubt I will succeed. 

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There should not be a schedule C if the only clergy income was W-2 wages plus the housing allowance. The prior tax preparer may have schedule C as some sort of template or as a way to flow the HA to Sch SE depending on her software or even due to some actual income such as honoraria. Or, she may've been doing it wrong. Clergy taxes are a specialty that I've not tried. A different beast. I think of clergy taxes as kinda a backwards statutory employee, and I don't specialize in those either. But, you could have yourself a long-time client if you prepare her returns correctly. Get the resources cited above, especially any books by those three authors; take webinars; get the resources available from your client's national church. Find a mentor to point you in the right direction; it'll be worthwhile to pay for outside expertise if you gain a long-time client. If your mentor uses your software, that's even better, because some of your questions are how to do it in your software and not just tax law questions. A few tips on how to enter data and then a review at the end by an experience clergy tax preparer can give you a new client and a new niche. 

See what you can find for your client's church. Here's a brief page from the Church Pension Fund of the Episcopal Church that gives an overview plus a couple of publications, one specific to the Episcopal Church:

https://www.cpg.org/active-clergy/learning/finance/taxes/clergy-taxes/

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Christian, the housing allowance is excluded from income tax only (unless the documented expenses are less than that amount).  The allowance is included in the SE calculation unless the minister is retired. IRS 1402(a)(8); Treas. Reg. 1.1402(a)-11(a); Flowers v. Commissioner, T.C. Memo. 1991-542.

As mentioned in my earlier response, "Actual expenses can be supplies, maintenance, telephone, cable, etc."  That would be on line 4d. So 4a would be the allowance, say, $5000.  Probably 4b is blank but you have to ask.  4d. would be as mentioned and could add up to a fair amount. 4e is pretty clear but know what all the utilities are.  It's quite likely that 4f then could be $6000+.  Sometimes the utilities alone could be as much as the allowance.  And often the FRV of the home is much higher than either the HA or the expenses.  As Lion said then see that the lowest amount is the HA making none of it taxable for INCOME purposes.  If the amount is higher than the others, the excess must be included on line 1 with wages.  Click on that link and you will see Non W-2 Wages, Salaries, Tips, etc. line 16 Clergy excess allowance.  This has happened to my clergy clients just once.

It's hard for me to imagine an NOL without a Sch. C and I don't think any unreimburse employee expenses could ever by offset by the housing allowance which is just that - for housing.  It may be that the prior preparer was trying to save the unreimbursed expense deduction when 2106 went away. 

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18 hours ago, Christian said:

I see exactly what you mean. I may simply pass on this one. I don't read that there are any expenses which reduce the full HA from SE tax. I think the former taxperson made significant errors in this regard. She somehow deducted unreimbursed employee expenses from the HA whereas these would apply only to income such as fees and other incidental income reportable on Schedule C. She is showing a leftover NOL from the income taxed on the SE with no Schedule C attached to the return. I am going to get the client to bring me her 2015 and 2016 returns to see if I can make sense of what she did but regretably I doubt I will succeed. 

Since the exodus of Form 2106, clergy reduce SE tax on Line 2 of Sch SE, per Instructions to Sch SE.  Right click on Line 2, there's a worksheet where you can enter business expenses, if any.    

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I want to thank each and everyone of you who responded to my sos call. The client brought me three years prior tax returns. My confusion stemmed from the Lacerte software her taxperson used. It like ATX has a worksheet although more abrieviated than the ATX one which is a carbon copy of the one in Pub 517. It referenced unreimbursed employee expenses from Form 2106. The 2018 copy I got had no Form 2106 to reference. I realized that Form 2106 had been changed in the last tax reform legislation. The earlier returns had the Form 2106 and the expenses referenced were mostly mileage at the standard rate and minor other pastorial expenses like dry cleaning etc. In looking at the ATX worksheets mileage is denoted on the second worksheet. On each prior return the FRV is simply the full amount of the HA. So now what it comes down to is precisely what John pointed out aways back namely fill out the worksheets and I feel sure I  can handle that. Although the client did in fact provide actual bills for her home expenses I saw no evidence her taxperson added any of them up. She simply reported the full HA as the home's expense so needless to say I am going that route. And now dear forum buddies the sun has come out , the Wrens in my backyard box are going crazy over their soon to be gone brood, and I thank the Lord I am just about done with the 2020 tax season. Lion I very muchh appreciate the University of Illinois Tax School info. I looked for an IRS webinar on the HA but found nothing satifactory although their written material was helpful. 

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Remember that the income tax-free housing allowance is the lessor of the three detailed in earlier posts. You should compare the three to make sure you're using the right amount. Actually, if ATX's worksheet follows those in the IRS's directions and you make use of the ATX worksheet, you should be fine. But you do have to know the Fair Rental Value (something like a letter from a local realtor on her letterhead) and the actual expenses (add up your client's receipts) to know for sure which amount to use.

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This may not be in issue for your client, but for future reference remember that most real estate agent estimates only provide the FRV for the residence as it sits.  There needs to be an upward evaluation to allow for what would be charged to a renter with the home being fully furnished and with all utilities & maintenance expenses paid.  That can be a useful calculation in some situations. 

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Course description -  https://onlinetaxuniversity.com/product/clergy-and-minister-taxation/     Compare it to UI.

The UI course that Lion posted is only 1 unit for $25.  I don't think that one hour would be enough to cover this topic.

There is also an issue with UI.   A few years ago, they published a pamphlet on preparing an OiC.  There were some really egregious errors in it. The worst of these was they way they calculated the two payment options as that part was completely wrong.  

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In response to John. The church bookeeper evidently reviews the clients yearly expenses and comes up annually with a close approximation of what the church should pay. Any shortfall can be adjusted or so it would appear as the HA matches the FRV of the client's home for years. This has evidently been ok as it has not been questioned in prior years. I worked through the worksheets and now have a new client. Thanks to all for your assistance. This is a good example of the value of this forum.

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I think the bookkeeper should have no role in the calculation of the H&U allowance request, especially with respect to determining the FRV.  The pastor should submit a H&U allowance request to the church based on his/her own calculations of actual vs FRV. After all, it's the minster (not the bookkeeper), who is ultimately responsible for what is reported on the tax return.  

My personal opinion & general rule is that if the minister is not pulling some portion of the H&U allowance back into taxable income, then the H&U allowance is set too low and tax savings are being left on the table. Bookkepeers often pride themselves in getting things correct to the penny, but that isn't the objective with respect to this clergy benefit. 

There are lots of suggested H&U allowance forms available online. One important point about the H&U allowance request - it should contain wording to the effect that it remains in effect until another request is submitted.  That way, if a year slips by and everyone forgets to renew it, the old amount is still in effect. 

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