In our last article about the Clergy Housing Allowance, we discussed the fact that if you don’t properly designate and document a Housing Allowance, IRS could end up disallowing it. Even when you properly document a Housing Allowance, there is an additional risk that we should discuss: designating too little.
Consider the following scenario:
- A church takes time in January to review and revise their housing allowance for Pastor Smith.
- Pastor Smith estimates that he will need an allowance of $25,000 for the year.
- The board approves the allowance and records it in the minutes and the budget.
- Pastor Smith’s pipes burst in late December, causing $5,000 of emergency repairs.
- Pastor Smith spends a total of $30,000 on his home for the year.
- The home has a fair rental value of $35,000.
Unfortunately, the Internal Revenue Code limits the Housing Allowance to the lesser of:
- The amount designated
- The amount actually used to provide a home (rent, mortgage, furnishing, repairs, etc)
- The fair rental value of the home
Even though Pastor Smith had to spend $30,000 on his home, only $25,000 of his income was excluded from income tax. The allowance designation was too low. If they had designated $30,000 at the beginning of the year, then $30,000 of his income would have been excluded from gross income for calculating income tax. As you can see, underestimating the housing allowance can result in a larger tax bill.
There doesn’t even need to be an emergency to fall short on your housing allowance. Clergy often underestimate their future housing expenses out of frugality or forgetting to account for inflation. It’s a good idea to pad your estimate a little bit to account for unexpected expenses or increases in utilities. In the case of emergency repairs, you can also request a housing allowance change for one or two months to account for the difference (though you will definitely want to make sure it is done correctly!).
If you need assistance estimating your future Housing Allowance or making an emergency change to your allowance, Clergy Financial Resources offers Pro Advisor Support for your questions. Visit our site at https://www.clergytaxnet.com/resources/proadvisor/ for more details.
Clergy Financial Resources serves as a resource for clients to help analyze the complexity of clergy tax law, church payroll & HR issues. Our professionals are committed to helping clients stay informed about tax news, developments and trends in various specialty areas.
This article is intended to provide readers with guidance in tax matters. The article does not constitute, and should not be treated as professional advice regarding the use of any particular tax technique. Every effort has been made to assure the accuracy of the information. Clergy Financial Resources and the author do not assume responsibility for any individual’s reliance upon the information provided in the article. Readers should independently verify all information before applying it to a particular fact situation, and should independently determine the impact of any particular tax planning technique. If you are seeking legal advice, you are encouraged to consult an attorney.
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