Ordained, licensed and commissioned ministers have a number of opportunities to minimize their tax liabilities with proper planning, which includes all agreements with their employer, careful record keeping, retirement planning and work-related travel planning. The Internal Revenue Service (IRS) allows some tax breaks specifically for ministers while other deductions apply to all non-reimbursed business-related expenses. Knowing the rules and applying them consistently can save thousands of dollars each year in taxes.
The IRS allows a portion of a minister's total compensation each year to be designated as housing allowance. This amount is excluded from taxable income for income tax purposes. If a parsonage is provided, the fair rental value of the home, including utilities, is deductible from taxable wages but not below zero. If a minister owns or rents his own home, a deduction equal to rent, mortgage interest, utilities, insurance and repairs is allowed as long as the total housing allowance is reasonable and does not exceed total wages. The employer must designate the housing allowance as a separate item from taxable wages. While this allowance is not subject to income taxes, it is subject to self-employment (SE) taxes -- at least until the minister retires.
Auto Expense Deduction
Ministers may deduct either actual expenses or the standard mileage allowance for all driving they do in the course of their duties, including meetings, hospital and home visits to parishioners. Commuting directly to their church or office or directly home from their church or office is not deductible. If a minister uses his vehicle more than 50 percent for his work, other than commuting, he can depreciate the business percentage of the vehicle's purchase price and take a depreciation deduction each year, with some limitations. In this case, only the business percentage of actual vehicle expenses is deductible.
Unreimbursed Employee Expenses
All business-related expenses not reimbursed by the employer can be deducted, These include the costs of texts, study materials, ministry-related business meals (at 50 percent), ministry-related travel, vestments and other ordinary and necessary expenses paid or incurred in fulfilling the duties of a minister. For ministers who receive a W-2, these expenses are reported on Form 2106 on the individual tax return and are subject to a reduction of 2 percent of adjusted gross income. One hundred percent of these expenses and auto expenses are deductible from the housing allowance for SE tax purposes. Ministers who receive a 1099 report both income and expenses on Schedule C of the individual tax return without the 2 percent reduction, but subject to the Deason Rule.
Ministers can often be tripped up by IRS Revenue Code Section 265 (a)(1), called the Deason Rule. This code section requires that the amount of a minister's non-reimbursed expenses be reduced by the percentage of housing allowance to total compensation. For example, a minister who receives a W-2 salary or 1099 ministerial income of $50,000, $25,000 housing allowance and has $6,000 of non-reimbursed business expenses loses $2,000 in deductions (50,000 + 25,000 = 75,000; 25000/ 75,000 = 33.33 percent X 6,000 = 2,000). Ministers who receive a 1099 and report income and expense on Schedule C must make the Deason Rule calculation and add it back to reduce expenses.
Accountable Expense Reimbursement Plan
The Deason Rule reduction can be avoided for ministers who receive a W-2 if the employer establishes an accountable reimbursement plan for the minister and reduces his W-2 salary by this amount. The accountable plan allowance reduction results in no additional cost to the employer. The reduction in W-2 salary effectively allows the expenses to be fully deducted, lowering the minister's tax liability. As with all accountable plans, good record keeping and regular expense reporting to the employer are required. A minister who receives a 1099 is not eligible for this tax strategy because it is only available to employees.
Tax Free Housing Allowance in Retirement
An important tax strategy for the housing allowance is to structure the minister's retirement plan so that a portion of the distributions is designated as housing allowance in retirement. The IRS allows the exclusion of a reasonable housing allowance from both income and SE tax if the minister is fully retired, which means a retired minister can receive retirement income tax free for life with proper retirement planning.
- IRS: Topic 417 -- Earnings for Clergy
- ClergyAdvantage: Clergy Tax Savings Tips – Reduce Audit Potential and Save Tax
- Internal Revenue Service. "Topic No. 417: Earnings for Clergy." Accessed Jan. 8, 2020.
- Internal Revenue Service. "2019 Publication 517: Social Security and Other Information for Members of the Clergy and Religious Workers," Page 3. Accessed Jan. 8, 2020.
- United States Government. "Internal Revenue Code, Title 26, Section 107," Page 452. Accessed Jan. 8, 2020.
- Internal Revenue Service. "Ministers' Compensation & Housing Allowance." Accessed Jan. 20, 2020.
- Internal Revenue Service. "2019 Publication 517: Social Security and Other Information for Members of the Clergy and Religious Workers," Page 9. Accessed Jan. 8, 2020.