Information passed on to me from a fellow pastor, Greg W. Davis..
Housing Allowance is “Social Security” taxable. It along with your net “business ministry” expenses pool down to a “Net Income”. One pays .14 approximately for everydollar of “net income”. The net income than flows to the income section of your personal 1040 less the housing allowance. So if a guy has a 40,000 housing allowance, and 8,000 in ministry expenses (dues, mileage, cell phone, office supplies etc). He will pay social security tax on 40,000 minus the 8,000=32,000. He will pay approximately 32,000 x .14=4,480. for Social Security tax. Then the 8,000 of expenses flow to the front side of the 1040 income section. (Once again the 40,000 is not taxable federally). If he has w-2 wages, the 8,000 will net out of those. For example, if the church pays a 20,000 salary, plus a 40,000 housing allowance. The front side of the 1040 will be 20,000 less 8,000 in ministry expenses. or nets 12,000 in federally taxable income. The government tax code then allows personal deductions (real estate taxes, charitable contributions, state income taxes etc) That amount is the actual amount of the personal deductions or a flat standard amount which ever is higher. So a guy with a house and taxes and tithing may rise above the flat amount. For example a married couples flat standard deduction is approximately 11,150. So the 12,000 income is reduced by 11,250 leaving only 750 exposed to tax.
Then personal exemptions further reduce the tax . $3,500 for each family member. Ie. a married couple would be 7,000. Thus, in this example, now none of the income is subject o federal taxation.
If a guy works a secular job, all the above stays the same, except is W-2 income is added in. So if he makes 10,000 flipping burgers at McDonalds. Now the 10,000 is added into the income.
2 extra caveats to the equation. The housing allowance must be covered by actual expenses. If it doesn’t than the extra is subject to federal taxation. So in the above example, if the ministers actual housing expenses come to 22,000. Then, the 40,000 threshold is $18,000 too high. The 18,000 is added to wages and subject to same formula.
Topic 417 – Earnings for Clergy
For income tax purposes, a licensed, commissioned, or ordained minister is generally treated as a common law employee of his or her church, denomination, or sect. There are, however, some exceptions such as traveling evangelists who may be treated as independent contractors. If you are a minister performing ministerial services, you are taxed on wages, offerings, and fees you receive for performing marriages, baptismals, and/or funerals.
The services you perform in the exercise of your ministry are generally subject to self-employment tax for social security purposes. See Publication 517, Social Security and Other Information for Members of the Clergy and Religious Workers, for limited exceptions from self-employment tax.
Even though, for social security tax purposes, you are considered a self-employed individual in performing your ministerial services, you may be considered an employee for income tax or retirement plan purposes. For income tax or retirement plan purposes, some of your income may be considered self-employment income and other income may be considered wages. Depending on all the facts and circumstances, under common-law rules you are considered either an employee or a self employed-person. Generally, you are an employee if your employer has the legal right to control both what you do and how you do it, even if you have considerable discretion and freedom of action. For more information about the common-law rules, see Publication 15-A (PDF), Employers Supplemental Tax Guide. If you are employed by a congregation for a salary, you are generally a common-law employee and income from the exercise of your ministry is considered wages for income tax purposes. However, amounts received directly from members of the congregation, such as fees for performing marriages, baptisms, or other personal services, are considered self-employment income.
If you itemize your deductions, you may be able to deduct certain unreimbursed business expenses related to your services. You may need to fill out Form 2106 (PDF), Employee Business Expenses, and attach it to your Form 1040 (PDF). Refer to Topic 514 for information on Employee Business Expenses, and Topic 508 for information on the 2% of adjusted gross income limitation. For the offerings or fees you receive for performing marriages, baptismals, and/or funerals use Form 1040, Schedule C (PDF), Profit or Loss From Business, or Form 1040, Schedule C-EZ (PDF), Net Profit From Business, to report these earnings and expenses. The gross income of a licensed, commissioned or ordained minister does not include the fair rental value of a home (a parsonage provided), or a housing allowance paid, as part of the minister’s compensation for services performed that are ordinarily the duties of the minister. If you own your home, you may still claim deductions for mortgage interest and property taxes. If your housing allowance exceeds your actual expenses, you must include the amount of the excess as other income.
A minister who is furnished a parsonage may exclude from income the fair rental value of the parsonage, including utilities. However, the amount excluded cannot be more than the reasonable pay for the minister’s services.
A minister who receives a housing allowance may exclude the allowance from gross income to the extent it is used to pay expenses in providing a home. Generally, those expenses include rent, mortgage interest, utilities, repairs, and other expenses directly relating to providing a home. The amount excluded cannot be more than the reasonable pay for the minister’s services.
The minister’s employing organization must officially designate the allowance as a housing allowance before paying it to the minister.
The fair rental value of a parsonage or the housing allowance is excludable from income only for income tax purposes. No exclusion applies for self-employment tax purposes. For Social Security purposes, a duly ordained, licensed or commissioned minister is self-employed. This means that your salary on Form W-2, the net profit on Schedule C or C-EZ, and your housing allowance, less your employee business expenses are subject to self-employment tax on Form 1040, Schedule SE (PDF), Self-Employment Tax. However, you can request an exemption from self-employment tax, if you are conscientiously opposed to public insurance for religious reasons. You cannot request exemption solely for economic reasons. To request the exemption, file Form 4361 (PDF), Application for Exemption From Self-Employment Tax for Use by Ministers, Members of Religious Orders and Christian Science Practitioners, with the IRS. You must file it by the due date of your income tax return (including extensions) for the second tax year in which you have net earnings from self-employment of at least $400.00. This rule applies if any part of your net earnings from each of the two years came from the performance of ministerial services. The two years do not have to be consecutive tax years.
For more information, refer to Publication 517, Social Security and Other Information for Members of the Clergy and Religious Workers.