Is a parsonage allowance a way to get around all taxes?

Is a parsonage allowance a way to get around all taxes? Not so fast.

There are a lot of misconceptions on this confusing topic.

Members of the clergy are subject to special rules of taxation in the US.

First let's talk about regular wages:

While the majority of clergymen are employees for federal income tax purposes, they all are considered self-employed for social security purposes.

This means that ministers are exempt from social security and Medicare withholdings (also known as self-employment [SE] tax), even though they report their income taxes as employees and receive a W-2 from their congregation. Wages are exempt from their federal income tax withholding as well.

This will generally cause a big tax bill when filing a tax return, since no social security, Medicare or income taxes have been paid yet, unless there was an election on a W-4 made to have these taxes withheld.

There is a possibility that a clergyman may be exempt from paying the self employment taxes, but only in certain instances:

•The clergyman is a member of a religious order who has taken a vow of poverty.

• The clergyman asked the IRS for an exemption from SE tax for services and the IRS approves the request. They must qualify for one of the conditions of the exception.

Now let's get to the famous parsonage exclusion:

A parsonage by definition is a place of residence provided for the clergyman. If the congregation provides this to their clergyman, the fair rental value, while included in self employment tax calculations, is excluded from income tax, including utilities.

This amount can also be excluded if the congregation did not provide an actual place of residence, but provided a rental allowance.

If a clergyman receives in his salary an amount officially designated as a rental allowance (including an amount to pay utility costs), the amount can be excluded from income tax if:

• The amount is used to provide or rent a home, and:

• The amount isn't more than reasonable pay for the services. The amount excluded can't be more than the fair rental value of the home, including furnishings, plus the cost of utilities.

While parsonage amounts are excluded from income tax, they are still subject to self employment tax, unless an exemption is met, as explained above.

So, while parsonage amounts are excluded from regular income tax, they are still subject to social security tax.