A very common question in Clergy Tax Preparation is “If I designated X as my housing allowance, and I overspend it, what happens?” Many believe that overspending your housing allowance will result in a penalty or getting into trouble with the Internal Revenue Service. This is not true.
Let’s look at a scenario to show what happens when you overspend your housing allowance.
- Pastor Todd designates a housing allowance of $20,000.
- His home has a fair rental value of $50,000.
- He spends $30,000 on housing expenses.
- In this scenario, Pastor Todd has overspent his housing allowance by $10,000.
IRS rules say that the housing allowance is limited to the lesser of
- your designated housing allowance
- the fair rental value of your home, or
- your actual expenses.
In this case, the designated amount is the lowest of the three, so he gets to exclude $20,000 of his salary from income tax, even though he spent $30,000.
As you can see, overspending doesn’t have any particularly bad consequences for overspending the housing allowance. The only downside is that his tax benefit could have been bigger if he had designated more than the $20,000 he spent.
What if he underspends the Housing Allowance?
Take the same scenario, but instead of spending $30,000 on housing expenses, let’s say that he only spent $15,000. The IRS limitation still applies- the lesser of the three categories is $15,000 now. That means that Pastor Todd only gets to exclude $15,000 of his income from income taxes, even though he designated $20,000. The $5,000 difference is just included in taxable income.
Whether you overspend or underspend the housing allowance only determines how much you get to exclude from federal income taxes.
Do you have more housing allowance questions? Clergy Financial Resources can help. We offer Pro Advisor services so you can get the answers you need. Visit our website at https://www.clergyfinancial.com/resources/proadvisor/ for more details.
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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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