Clergy Taxes- The Special Benefit and Burden of Parsonage - A Primer
Definition of Parsonage
Ministers, rabbis, cantors, priests and other religious officials who work as leaders of religious organizations are entitled to have some of their income excluded from taxation. In particular, the amount spent on housing and furnishing the home is excluded from income taxation. This is called Parsonage.
There are two components of a clergy person's compensation. The amount allocated to parsonage and the residual amount left over after the parsonage allocation (referred to as "Non-Parsonage" compensation in the remainder of this article). Each component has different types of tax liabilities.
Dual-Status for Tax Purposes
Ministers, rabbis and cantors have a unique standing for tax purposes. For income tax purposes they are considered employees (and the rabbi, minister or cantor should have the customary income tax withholding and receive a W-2). For Social Security and Medicare taxes they are deemed to be self-employed. This is a crucial distinction as being deemed self-employed requires the clergy person to essentially pay double for these taxes than if the clergy person would have been a traditional employee (the reason being that as a traditional employee the employer would be required to make matching Social Security and Medicare taxes. Someone who is self-employed has to make up for the missing employer contribution and pay this missing amount). The Self-Employment tax is imposed on both the parsonage and the non-parsonage pieces of compensation. Some institutions will reimburse the minister for Social Security and Medicare taxes on either the non-Parsonage or Parsonage component of the minister's salary. If this does occur, the reimbursement is subject to both income tax and self-employment tax.
The illustration below identifies the types of taxes the minister has to pay based on whether the component of income is deemed Parsonage or Non-Parsonage.
|Federal Income Tax||State Income Tax (if applicable)||City Income Tax (if applicable)||Self-Employment Tax (Federal obligation)|
|Parsonage Compensation ||N||N||N||Y|
Most churches and synagogues do not account for the self-employment tax obligation when determining withholding taxes and this typically leads to the minister, rabbi and cantor under withholding. To insure the proper amount is withheld the clergy person should divide his total compensation (Parsonage plus Non-Parsonage) by the number of pay-periods and multiply by 15.3%. This is the amount that should be withheld as an additional amount for each pay period for federal taxes. The minister should inform the person in charge of payroll withholding about the additional amount that is needed to be withheld (if the religious entity is matching Social Security and Medicare taxes for part or all of the clergy person's compensation, please adjust accordingly).
The computation above slightly overestimates the tax obligation as there is an adjustment for one-half of self-employment taxes.
What can be claimed as part of Parsonage?
If the minister, rabbi or cantor is not living in church or synagogue furnished housing, the amounts spent for the annual cost of the home including furnishing, yard and utilities. If the minister is living in a residence provided to him by his or her church then it would be the market value of the home, furnishing, yard and utilities.
While not an exhaustive list here are some samples of items that may be included in parsonage:
Not included as part of parsonage:
- Principal & Interest Payment for home
- Renovation expenses
- Cleaning Supplies
- Lawn Mower
Limitation on Parsonage
The minister is limited to the lower of the following three valuations:
- The amount actually spent to provide a home, utilities and furnishings
- The amount officially designated as parsonage
- The fair rental value of the home including utilities and furnishings
What Percentage of Minister's Salary can be claimed for Parsonage?
As long as the limitations on parsonage are followed theoretically 100% of the minister's salary can be claimed as parsonage. In the case of a dual-minister couple (that is, where each is an active member of the ministry and both are eligible for parsonage allowance) the combined parsonage cannot exceed the limitation on parsonage. That is, there is no "double counting." The same also applies in a situation where a minister, rabbi or cantor has multiple positions and each position entitles him or her to a parsonage claim.
Mechanics of Declaring Parsonage
Parsonage is not an automatic right but must be awarded by the minister's employing organization. As such, it is crucial that the minister insure the organization is entitled to award a parsonage based on its tax exempt status (churches, synagogues and other houses of worship are automatically granted this right by the Internal Revenue Service ("IRS") even if they have not have officially registered the charity with the IRS).
Once it is established the minister is eligible for parsonage, the formal awarding has to be made part of the church or synagogue records and made part of the minutes of the board of the equivalent. The minister, rabbi or cantor should also get this in writing for his or her records in the event of an audit.
Reevaluating Parsonage Allowance Designation
It is best practice for the minister, rabbi or cantor to reevaluate on an annual basis the amount to be spent on parsonage as the amount of money a person spends on his or her home may change as a result of a move to a larger or smaller home, renovations, major appliance purchases or the purchase of furniture. Since one of the limitations of parsonage is the amount of the parsonage declaration we recommend slightly overestimating the parsonage designation. If the amount actually spent is less than the declaration of parsonage than the excess amount is subject to income taxes. However, this will prevent the minister from not maximizing his or her parsonage allowance.
A minister has to be attentive to the amount designated for parsonage. This is why a separate area of practice called clergy taxes has developed. We would be more than happy to answer any specific questions you may have during the course of the year along with assisting you with the declaration of your parsonage allowance and the preparation of your personal income taxes reflecting the complications of your clergy taxes.