The clergy's unique tax issues.

• Author: Martin, Vernon M.

EXECUTIVE SUMMARY

* Ministers are doubly blessed--rather housing allowances are excludible under Sec. 107, while their mortgage interest and real estate taxes are deductible under Sec. 265(a)(6).

* In terms of services performed, the courts and IRS have determined not only who is a minister, but also who is not.

* One major issue is whether a minister is an employee or an independent contractor.

Ministers of the gospel present subtle and challenging tax issues to tax practitioners. Is a parsonage (housing) allowance tax-free? Can mortgage interest and real estate taxes be deducted of a housing allowances is excluded Is self-employment tax due if the minister is not an employee? What are some of the reporting issues? This article examines these and other problems in this unique area.

The clergy ("ministers of the gospel") receive unique tax treatment under the Code. A number of Code provisions and IRS pronouncements must be considered to fully appreciate the tax planning opportunities and pitfalls in this area. This article addresses various income and employment tax issues regarding the clergy. Two primary income tax issues are the clergy's eligibility for fringe benefits not available to other taxpayers and the opportunity to characterize certain payments as gifts rather than as taxable compensation. The major employment tax issues are whether the individual is an employee or an independent contractor; special withholding rules also apply. Finally, the state and local income tax treatment will also be examined.

Income Exclusion

In the case of a minister of the gospel, Sec. 107 excludes from gross income (1) the rental value of a home furnished to him as part of compensation or (2) the rental allowance paid to him as part of compensation, to the extent used to rent or provide a home.

For this purpose, Regs. Sec. 1.107-1(a) states that the home or rental allowance must be provided as remuneration for services ordinarily the duties of a minister of the gospel, including the performance of sacerdotal functions, the conduct of religious worship, the administration and maintenance of religious organizations and their integral agencies, and the performance of teaching and administrative duties at theological seminaries. Regs. Sec. 1.107-1(a) also provides that Regs. Sec. 1.1402(c)-5, which defines a "minister" for self-employment (SE) tax purposes, also applies for Sec. 107 purposes. Regs. Sec. 1.1402(c)-5(a)(2) defines a "minister" as one who is duly ordained, commissioned or licensed as a minister of a church.

Defining "Minister"

According to IRS Pub. 525,(1) the Sec. 107 exclusion applies to the rental value of a home provided as payment for duties as an ordained, licensed or commissioned minister. For ministers employed as teachers or administrators, the exclusion is allowed only if employed by a church-owned educational institution; thus, ministers do not qualify for a housing allowance if they work for non-church schools and do not perform religious functions, even if they are part of the religion department. "Ministers of music" and "ministers of education" also do not qualify for a housing allowance if they are not authorized to perform all of the religious duties of an ordained minister.

Theological students serving required internships as assistant pastors are "ministers" for this purpose only if they are ordained, commissioned or licensed. Traveling evangelists, if ordained and providing evangelistic services, can exclude amounts paid by out-of-town churches that are designated as a housing allowance and actually used to maintain a permanent home.(2) The rental value of a home provided rent-free by a church for past services is not income to a retired minister. A housing allowance is also not income to the extent used to maintain a home. Certain pensions and other retirement pay can qualify as gifts, not income, under certain conditions.

The courts and the IRS have also defined "minister" to include the following: an individual who was ordained and performed the duties of a rabbi(3); ordained ministers serving on the faculty of a college that was an integral agency of a religious organization who performed services in the exercise of their ministry(4); a cantor who was not ordained, but commissioned and employed by a congregation to perform Jewish religious functions(5); an ordained minister employed by a nonprofit organization to provide pastoral care for a public hospital(6); and a retired minister paid by his church in recognition of his past services.(7)

The courts and the IRS have also defined who is not a "minister of the gospel" for Sec. 107 purposes:

1. A "minister of music" or "minister of education" who was...