Housing God’s Ministers: Parsonage Explained
Rabbis and other clergy are less well compensated than comparable professionals with advanced degrees. Yet, clergy have one advantage over most other professions. A portion of clergy salary can avoid income taxation if deemed parsonage. Preferential treatment for clergy raises some questions. Yet, the tax benefit has withstood the tests of time and lawsuits. Perhaps there is something holy about housing God’s ministers.
Since the Puritans landed in Massachusetts, religious leadership has been an integral part of society in the United States. Our taxation system has long acknowledged the unique role of the clergy. Beginning in 1802, Church properties had tax-exempt status. In 1911, Congress extended tax-exempt status to the value of housing provided to clergy (known as “parsonage”). Much controversy and confusion have ensued from the designation of “parsonage” as tax-exempt income.
Why should clergy receive tax-preferred status for income related to housing? Is the government entangled in religious life by offering this tax break? Many are concerned about upholding the first amendment, which requires the separation of church and state.
In 2019, the Courts reviewed a challenge to the parsonage allowance. The Court of Appeals for the seventh circuit examined the basis for exempting clergy’s housing-related income from tax. The Treasury Department and other intervenors pointed to three secular legislative purposes of the statute: to eliminate discrimination against ministers, to eliminate discrimination between ministers, and to avoid excessive entanglement with religion. Gaylor v. Mnuchin, 919 F.3d 420 (7th Cir. 2019). A look at the history reveals some fascinating details.
The parsonage exemption dates to a conundrum posed by the status of employees with work-related housing requirements. For example, some boarding schools require teachers to live at the schools. Similarly, shipping companies provide sailors with living quarters in association with work. How should the tax code treat the value of the housing they receive when living at work as a condition of employment? Persons living abroad for work could exclude or deduct housing expenses, regardless of whether that person lives abroad at the behest of his or her employer (see 26 U.S.C. § 911). In nineteenth and early twentieth-century America, ministers often lived in or near church property in a manor, rectory, vicarage, or parsonage. By this analogy, sailors, boarding schoolteachers, persons living abroad for work, and clergy received the same tax advantages.
Under the parsonage allowance rules, no religious denomination had preferential treatment. Rather, the parsonage allowance leveled the playing field between wealthy and poorer religious groups.
Other arguments against parsonage as a tax-preferred status invoked the First Amendment, requiring separation of church and state. Supporters of parsonage argue that the law avoids religious entanglements. The government should not examine how religious organizations use their properties or engage their clergy. Otherwise, housing provided to clergy would be subject to inquiry and review that might require government evaluation of how each religious organization provides sacerdotal, educational, and social services to its members.
While the parsonage exemption involves some degree of entanglement, the Constitution only prohibits excessive entanglement in religious organizational matters. The government should not be asking what is the church’s business, how are the properties of the church related to its religious functions, and what kinds of worship the church offers. Advocates for parsonage worry that we have government review questions about what constitutes a proper spiritual practice or teaching. Instead, the parsonage exemption remains a neutral tax status as it neither enhances nor constrains religion.
Who Gets the Parsonage Allowance?
By way of review, there are several tax benefits to being in the business of religion. Both the clergy and religious organizations have preferred tax status. These rules are biblical – not always clear and subject to interpretation!
The primary rule of the parsonage allowance relies upon three concepts: ministers, their compensation, and the value of their housing. The term minister is a catch-all for clergy of recognized religions, including such roles as imams, priests, and rabbis. A later court case guaranteed that Cantors received similar tax treatment.
For these purposes, what is the definition of a minister? For tax purposes, the definition stems from training and function. Clergy need not be trained at a yeshiva, seminary, or religious academy. Such institutional approaches to ministerial training are a modern phenomenon. Schools of higher education for clergy are not the sole approach to religious leadership training. The IRS recognizes that a formal course of study does not solely acquire ministerial function.
The minister receiving preferential parsonage treatment must perform duties related to the function of the religious organization. Three types of services are considered ministerial: (1) the performance of sacerdotal functions; (2) the conduct of religious worship; and (3) the control, conduct, and maintenance of a religious organization under the authority of a religious body constituting a church or church denomination. Chaplains employed by the armed services are also eligible for parsonage allowance. IRC Regulations 26 CFR § 1.107-1.
What are the sacerdotal and worship functions included in this definition? The religious order or movement itself determines those. “Whether service performed by a minister constitutes the conduct of religious worship or the ministration of sacerdotal functions depends on the tenets and practices of the particular religious body constituting his church or church denomination.” 26 CFR § 1.1402(c)-5.
As we know, not all clergy lead services. The IRS has an expansive view of the duties included. Revenue Ruling 70-549 and Revenue Ruling 71-7 hold that ministers who serve on the faculty of a college that is an integral agency of a church but does not perform any ecclesiastical duties are engaged in performing services in the exercise of their ministry.
Circumstances under which a rental allowance will be deemed to have been used to rent or provide a home will include cases in which the allowance is expended (1) for the rent of a home, (2) for the purchase of a home, and (3) for expenses directly related to providing a home. Expenses for food and servants are not considered for this purpose to be directly related to providing a home. Where the minister rents, purchases, or owns a farm or other business property beside a home, the portion of the rental allowance expended in connection with the farm or business property shall not be excluded from his gross income.
A licensed, commissioned, or ordained minister who performs ministerial services as an employee may be able to exclude from gross income the fair rental value of a home provided as part of compensation (a parsonage) or a housing allowance provided as compensation if it is used to rent or otherwise provide a home. A minister who is furnished a parsonage may exclude from gross income the fair rental value of the parsonage, including utilities and other expenses. However, the amount excluded can’t be more than reasonable compensation for the minister’s services.
The tax authorities offer a broad definition of home-based expenses. Generally, those expenses include rent, mortgage interest, utilities, garage, real property taxes, and other costs directly relating to providing a home.
The fair rental value of a parsonage or the housing allowance is excludable only for income tax purposes. The minister must include the amount of the fair rental value of a parsonage or the housing allowance for social security or self-employment tax purposes.
To exclude the housing allowance from income, the minister’s employing organization must officially designate the housing allowance as such before paying it to the minister. The payments officially designated as a housing allowance must be used in the year received.
The parsonage or housing allowance is typically set at the beginning of the organization’s fiscal year. Evidence of the designation of an amount as rental allowance may be an employment contract, minutes, a resolution or budget by a church or other qualified organization, or any other appropriate instrument recording such official actions [section 1.107-1(b) of the Income Tax Regulations]. The organization’s leadership and clergy are guessing the amount set as a housing allowance.
Often the housing allowance is less than the amount of actual compensation. Other times, the fair rental value of the parsonage is less than the compensation. The agreed-upon housing allowance sometimes exceeds actual expenses directly relating to the home owned by the minister. In these cases, the compensation paid over the housing allowance is taxable income to the minister.
An individual cannot exclude the amount designated as a rental allowance from gross income if the amount received during the taxable year is either greater than the amount used to rent or provide a home during the taxable year or the fair rental value of the house (including furnishings and appurtenances) plus the cost of utilities for the taxable year.
Annuities and Pensions
Another advantage of parsonage applies to 403(B)(9) plans for the religious organization, commonly known as “church plans.” Several such retirement plans exist, most of them associated with a movement. Also available to clergy is the Rabbis and Cantors Retirement Plan (RCRP). Full disclosure, I am a member of that organization’s oversight board.
The church plan provides multiple benefits and advantages to participating clergy. The contributions that qualify as parsonage also grow without tax on the gains. The law shields plan distributions from federal income tax. In this way, the contributions to the 403(b)(9) plan are never subject to federal and state income taxation.
In an IRS publication, treatment of the distributions from the 403(b)(9) plan are tax-preferred as “a retired minister may exclude from gross income a parsonage allowance provided as compensation for past services (Revenue Ruling 63-156, 1963-2 C.B. 79). In addition, the governing body of a religious denomination may set up a retirement fund that designates a portion of a retired minister’s pension as a parsonage allowance as compensation for past services.” The IRS stated in Revenue Ruling 75-22, 1975-1 C.B. 49, that a national governing body of a religious denomination having complete control over a retirement fund can designate a portion of a retired minister’s pension as a rental allowance.
For these purposes, retired clergy’s 403(b)(9) distributions are rental allowance exclusions applied to the retired minister’s current gross income because of past work. The fiction is completed by assuming that the general pension plan’s trustees act on behalf of churches where the retired clergy performed services.
From first residence as clergy to retirement from the ministry, the parsonage allowance is available to our rabbis, cantors, ministers, priests, and imams as a well-considered method to support our country.
Evan Krame
