Summary: Ministers who are BUYING A HOUSE to live in
By Keith Drury, Professor,
TO THE CLASS: In our week’s focus on Ministers and taxes you will receive all kinds of details on taxes besides the following, and you will actually do a minister’s income taxes in class. However before coming to the first class on taxes read the following summary on how a ministers taxes differ from what you’re used to. Come to class prepared to take a quiz on the following introductory summary.
1. My BEST ADVICE is: use TurboTax software each year. At the beginning it will ask you if you earned any income from being a minister—when you answer yes to this question the software will take you down the minister’s track and all you have to do is answer the questions. As a minister do NOT trust the local H & R Block office, do NOT trust your sister-in-law or the person in every church who is an accountant and offers to help you. They seldom know the complications of a minister’s taxes…and, as you will see soon, the arrangements for ministers (and members of the military) look unfair and might even seem illegal. Thousands of ministers pay thousands of dollars extra every year using friends and family who do not know ministers taxes. This is why you should use TurboTax and just answer the questions and presto you’ll have a minister’s tax expert at your side for less than $25 a year (My own personal taxes which include minister’s income and some really complicated business deals usually are longer than 50 pages each year and I use only the $19.95 cheapest version of TurboTax—that’s probably all you need as well.) Now for some unique things about minister’s taxes:
2. Ministers do NOT pay income taxes on housing expenses --either your parsonage or if you own a house the money you spend on housing is income tax-free including the following: loan principle, interest, utilities, furniture, grass-cutting and all other housing “appurtenances” (generally whatever a priest would get for free as part of his housing). All these costs are tax-free—which seems unfair but “it’s the law.” Ministers who have their church members do their taxes sometimes pay $5000+ taxes a year extra for years because they do not know this law. Again, use TurboTax or some other well-made software and answer the “Are you a minister” question up front with a yes. When you get your W2 form from the church it will not show your housing allowance as wages—as if it is “underground income.” It isn’t though and you must treat it properly as you’ll see. However the W2 may seem as if you never got this money and it passed right through to housing like they owned the house you are actually buying yourself. But the money you spend for buying and maintaining a house is tax free. HOWEVER the housing amount you spend for housing is limited by two things:
a. LIMITATION #1: It must be DESIGNATED IN ADVANCE by the church—a simple letter with the amount designated from the church is all that is needed—but it must be done before spending it (e.g. in December). If the church does it later, expenses do not count up until the time it was designated. Some churches forget to designate then pre-date a letter later but that is illegal though typical of some church’s light-handed ethics. Do it right—get your housing designed in writing in advance—as part of the budget, or in the minutes of the church board, or with a letter. If your DS or District is worth anything they will remind the church and even send a sample every year to your church’s treasurer. Example: What this means is if a church designates $20,000 as housing and you spend $24,000 you can’t take more than the $20,000. And if they designate $20,000 and you only spend $15,000 then you can only take $15,000 off, and the other $5,000 will get added back to regular income by your software (who will ask you “do you have unused housing allowance?” Remember: get your church to designate in advance the part of your salary they set as housing allowance (they will often ask you to suggest an amount—don’t guess low).
b. LIMITATION #2: It is also limited to the "Fair rental value of the house plus utilities." This is obvious—you can’t charge as housing more than the house is worth on the rental market (plus utilities). For instance if you own a house that is worth $100,000 usually it would rent for $1,000 a month meaning you would be limited to charging housing to $1,000 a month (plus your utilities) as your tax free housing allowance.
HINT: keep all receipts for housing in a box or drawer all year to total them up to get your total. Just because a church has designated an allowance doesn’t mean you don’t have to pay taxes on it. You must keep receipts for paint, lawn mowing, bank payments etc. to show you actually spent it. If you are audited they will want to see these receipts totaling up to what you claim. Whatever you don’t have receipts for you should list as income and pay income taxes on.
3. However, ministers DO pay Social Security taxes on housing. Don’t get this mixed up. While you don’t pay income taxes on housing you do pay Social Security taxes on it. When ministers say “housing is tax-free” they are only half right. Housing is free of income taxes but it is not free of Social Security taxes. Ministers are usually self-employed so Social Security taxes can run above 15% on our housing –quite a wallop for most ministers. Your tax software will ask you for the housing expenses as a minister and it will automatically add it back in for figuring Social Security. Luckily most churches “reimburse” half (or sometimes all) of this self-employment tax so you aren’t really paying it all yourself. (NOTE: when they “reimburse” you what you own as Social security that “reimbursement” must be treated as income by you and it shows in your W2 as ordinary income. Don’t worry you get a benefit as self employed that will even this out)
4. Ministers buying a house also get to take their housing interest as a regular deduction—so called “double dipping.” This sounds really unfair and wrong. It IS unfair (forget the notion that taxes are “fair” the laws are designed to benefit some people and not others). After you have excluded your housing expenses (including the interest on your loan) from income taxes “off the top” you can also take the interest expenses again as a normal deduction—just like you deduct your tithe and medical expenses. Amazing! Go look up the law—this is really true (and an unfair gift to ministers). This means that when you first buy a $100,000 house with maybe 5% down payment your monthly payments might be something like $800 and $700 is interest—totaling $8400 interest a year. You will first exempt this $8400 from your income taxes (along with the principle and other housing expenses) all “off the top” as housing THEN YOU GET TO TAKE THE $8400 AGAIN AS A DEDUCTION. Incredible! This unfair gift from the federal government to ministers ought to be changed some day, but for years it continues as a big break to ministers so, like salvation, it is offered to you freely and it is up to you to take it or not. All this means ministers have a BIG advantage in income taxes that the laity do not have. Unless you want to simply pay more taxes than you owe you are free to take these advantages, mostly designed for ministers who buy their home. (Though a parsonage is (income) tax free too—but you don’t get the “double-dipping” advantage.)
è All this means that very seldom does a married minister buying a home who earns less than $40,000 pay any income taxes at all (but, again, remember they WILL pay Social Security taxes).
There is FAR more to learn about ministerial taxes—this is only an introductory summary for ministers who buy their home. You need to know about the tax law for ministers who live in a parsonage. You will also learn how to keep records of unreimbursed ministerial expenses, the two ways ministerial expenses are treated, how to buy books tax-free, the proper (and the illegal) use of a “tax-number,” depreciation, how the church must report for taxes. Illegal and unethical ways to “give tax receipts” and a dozen other practical things on matters related to the IRS. Canadian students will run on a parallel track and share their differences—which may be the “ghost of Christmas future” for American ministers. While we’ll cover dozens of other things get familiar with the above summary before coming to class Monday –these are the most surprising of all facts and students often do not believe them at first. It all seems so “unfair” and many students imagine that “tax law is fair to everybody.” HA! If you think ministers get an unfair advantage wait until you find out how tax law treats rich people! Welcome to the grown up world!
See you in class next week!
For a good TurboTax summary on minister’s taxes look over this: (You will need to PASTE it in to get there)
The professor in this course and the course itself is not in the business of providing advise or assistance on tax law or doing your own taxes. The course is a helpful introduction to taxes for ministers and you should rely on official publications of the IRS and your tax software for updates from time to time.
*This informational sheet is used in ministerial training and does not represent tax advice but information for preparing ministers at the college level.