Church Finances and Business: Further on the Housing Allowance

I get emails —

A 2005 presentation (Tax and Legal Guide for Elders: Tax Law for Church Leaders) of yours led me to a question I am hoping you can answer. On page 6 you write —

“c) Housing allowances are OK for retired clergy. d) BUT not for surviving spouses.”

Do you know if there is any legal way for a church to pay $500 a week to a retired minister and, upon his death, continue paying $500 a week to his surviving widow for the rest of her life? My impression is that it would be illegal to do this, but I am unclear on whether or not it is illegal only if you call it Housing Allowance or if it is illegal under any circumstances. If the church wants to pay her and not call it Housing Allowance is it a simple matter of her having to declare it on her taxes and pay taxes on it? Would the church not be in legal hot water and not incur penalties for having paid her $26,000 per year?

Thanks for considering this. (If you need to bill me for considering it for whatever reason, please let me know how much and where to send a check and I will gladly send payment for your time and expertise).

May God bless you today.

Thanks for the question, because it leads into an area that is largely unknown to attorneys and even CPAs — but not to the IRS. I’ll explain.

The Internal Revenue Code allows you to pay a “minister of the gospel” a housing allowance that it not includible in his or her taxable income. It says nothing about whether it’s legal to pay such an allowance, only whether an allowance is taxable.

Therefore, while a payment to a minister’s widow won’t qualify as tax free as a housing allowance, it’s perfectly legal to agree to make such a payment. It’ll just be taxable.

Payments from an “unqualified” plan have some peculiar features —

* They are subject to Self-employment Tax (SET) when paid to the retired minister. If the minister has elected out of the SET, there’d be no SET due as to him. Years ago, nonqualified deferred compensation was exempt from FICA and SET, but that rule was changed by Congress some time ago. The widow’s benefit is exempt from FICA and she shouldn’t have an SET as she’s not a minister of the gospel.

* Even though the payments are subject to SET (unless he’s elected out), they won’t count as earnings that prevent him or her from qualifying for Social Security benefits — if they qualify (many ministers do not). The W-2 has to be correctly filled out to communicate this to the IRS. Read the instructions carefully. (If you comply with IRC section 409A, this is not reported as taxable under section 409A! See below.)

* It’s not entirely clear how to treat the widow, but she’s presumably not a minister of the gospel and so surely not subject to SET, and 26 USC 3121(a)(13) exempts her from FICA.

* Here’s the complicated part. Nonqualified deferred compensation is subject to IRC section 409A, effective for benefits vested or new arrangements made in 2005 or later. This section requires that the plan be in writing and that the schedule for payments be fixed. Very little flexibility is allowed. If you violate these rules, the benefits become immediately taxable (not when paid but when no longer subject to a substantial risk of forfeiture) at present value, plus a 20% penalty tax. It’s bad to mess up, and the rules are technical beyond all imagining.

* The plan may not be secured with escrowed funds or collateral. It has to be an unsecured promise to pay. The benefits must be unassignable, that is, the contract must say the minister and his wife can’t sell or otherwise transfer their rights to these payments.

* As a church plan, the plan is exempt from the labor law portions of ERISA, and so doesn’t have to have the ERISA appeal process or notice to the Department of Labor.

As you can see, a certain level of expertise is required to do this right. But it’s perfectly legal to do, and if you know the rules, not that hard to comply. But you need qualified tax assistance to draw the papers correctly.

All legal discussions are informational only, do not create a lawyer-client relationship, and may not be relied on. Unless expressly stated otherwise on this website, (1) nothing contained in this website was intended or written to be used, can be used by any taxpayer, or may be relied upon or used by any taxpayer for the purposes of avoiding penalties that may be imposed on the taxpayer under the Internal Revenue Code of 1986, as amended; (2) any written statement contained on this website relating to any federal tax transaction or matter may not be used by any person to support the promotion or marketing or to recommend any federal tax transaction or matter; and (3) any taxpayer should seek advice based on the taxpayer’s particular circumstances from an independent tax advisor with respect to any federal tax transaction or matter contained in this website. No one, without our express written permission, may use any part of this website in promoting, marketing or recommending an arrangement relating to any federal tax matter to one or more taxpayers.

About Jay F Guin

My name is Jay Guin, and I’m a retired elder. I wrote The Holy Spirit and Revolutionary Grace about 18 years ago. I’ve spoken at the Pepperdine, Lipscomb, ACU, Harding, and Tulsa lectureships and at ElderLink. My wife’s name is Denise, and I have four sons, Chris, Jonathan, Tyler, and Philip. I have two grandchildren. And I practice law.
This entry was posted in Uncategorized and tagged , , . Bookmark the permalink.

2 Responses to Church Finances and Business: Further on the Housing Allowance

  1. And some people think the government should run health care!!!

  2. Jay Guin says:

    David,

    Until 2005 unqualified deferred compensation was pretty easy. The enactment of 409A makes it quite complex and for reasons no one knows. The guys at Treasury evidently think this is an area filled with abuse, but it's not. They've imposed over 300 pages of regulations on how to write what was once a simple contract — for no good reason.

    And, yes, these are the same people who will be writing the tax rules for health care.

Comments are closed.