By David Middlebrook and Wendi L. Hodges
Most pastors are probably familiar with the provision in the Tax Code that allows pastors and ministers to exempt a parsonage, or housing allowance from their taxable income. However, an opinion filed in mid-December 2010 in the United States Tax Court case, Driscoll vs. IRS, has caused quite a stir.
In this case, a ministry paid to an ordained minister a parsonage allowance which the minister used to provide himself with both a principal home (in town) and a second home (a lake house). The IRS felt that this was a bit greedy and assessed him with additional income and fraud penalties.
The Tax Court, however, has disagreed with the IRS and has ruled that, at least for now, a minister may exclude from his income the housing allowances used to pay the mortgage on multiple houses.
Internal Revenue Code Section 107 permits qualified ministers to exclude housing-related compensation from gross income to the extent it relates to service performed in their ministry. Section 107 allows a tax-free housing benefit for a “minister of the Gospel” in two situations. First, the employer can allow the minister to live rent-free in a home (parsonage) owned by the church.
The value of the parsonage must be clearly distinguished from other compensation. Second, if a parsonage is not provided to the minister, a nontaxable housing allowance can be provided so that the minister can rent or buy a home.
The Tax Court has specified five factors used to identify a minister as defined under Section 107. An individual possessing these factors would presumably qualify as a minister: (1) performing sacerdotal functions (weddings, funeral, etc.); (2) conducting worship services; (3) controlling or maintaining the organization; (4) considered a spiritual leader; and (5) ordained, licensed, or commissioned (required in all cases). Once a church employee is qualified as a minister and is performing ministerial duties, then Section 107 of the Tax Code exempts from income the fair market rental value of a parsonage.
To be excludible, the housing allowance must be related to a home and be properly documented. According to Regs. Sec. 1.107-1(b), “home” means a dwelling place (including furnishings) and the appurtenances thereto (e.g., a garage). Regs. Sec. 1.107-1(c) explains that the allowance is excludible only to the extent spent (1) to rent a home, (2) to purchase a home and (3) on expenses directly related to providing a home (e.g. taxes, utilities, repairs, etc.).
Note that thus far, the regulations keep referring to a “home” (singular). The recent opinion in Driscoll vs. IRS is extraordinary in that it expressly allowed the minister to take a housing allowance on both of his residences.
One home only
In the case, the IRS argued that the use of the word “home” in Section 107 refers only to one home. However, Driscoll countered with the argument that Section 7701(m) of the Code provides that “singular may include plural.” On this particular issue, after working its way through certain phrasing and legislative history issues, the Tax Court ruled in favor of Driscoll and opined that both of the minister’s houses were “homes” for the purposes of Section 107, and both could be excluded from the minister’s taxable income.
This case is a big win for pastors because, for now, it provides legal support for a minister to exclude from income housing allowances used to pay the mortgage on multiple houses. We want to stress, however, that the Tax Court has acknowledged that this was a case of first impression, and members of Congress have already suggested that, in light of this case, Section 107 should be revised to limit income tax benefits to a “primary” residence (i.e. one home).
David Middlebrook is a partner and Wendi L. Hodges is an attorney of Anthony and Middlebrook, The Church Law Group, Grapevine, TX. www.churchlawgroup.com