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September 28, 2010

Case Threatens Pastor Housing Allowances

How a California court may alter a long-standing ministry benefit.

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Earlier this month, we covered eight federal issues that local churches should watch closely during the remainder of 2010 and into 2011, according to recent remarks from Dan Busby, president of the Evangelical Council for Financial Accountability. Busby, one of our editorial advisors, is based near Washington, D.C. His role at the ECFA includes advocating on behalf of ministry interests on Capitol Hill, so he’s uniquely positioned to see national tax and finance developments unfold that can influence church leaders.

We took notice when we heard the first item on Busby’s list: a California lawsuit, filed by the Freedom from Religion Foundation Inc., challenging the constitutionality of tax benefits associated with the housing allowances that churches provide to pastors.

The significance of housing allowances isn’t lost on church leaders. For decades, churches have used them to recruit and retain pastors. It’s an especially handy tool that churches with limited means, especially small congregations, can use to lure a gifted person. And at a time when the country slogs out of a multiyear recession, it’s perhaps as useful of a benefit as ever. The down economy has challenged weekly giving and strained budgets for many congregations, making pay raises remain small, even nonexistent in some places.

As Richard Hammar notes in his 2010 Church & Clergy Tax Guide:

“The three most common housing arrangements for ministers are (1) living in a church-provided parsonage; (2) renting a home or apartment; or (3) owning a home. The tax code provides a significant benefit to each housing arrangement … The rules … represent the most significant tax benefits enjoyed by ministers.”

Given the importance of housing allowances, we asked Hammar to give us a deeper sense for where the California case will land.

At the moment, the signs aren’t favorable. Church leaders should begin thinking now about a future in which housing allowances for pastors do not receive federal tax exemptions.

In May, the government requested the case be dismissed on the grounds the plantiffs’ primary arguments lacked legal standing. The federal district court denied the request. That means the case now moves forward to trial, keeping alive the possibility of a ruling against housing allowances.

“Given the obvious hostility of the federal district court judge to the housing allowance, it is probable that the court will rule that the housing allowance is unconstitutional,” Hammar says.

If that happens, the case would be appealed to the Ninth Circuit Court of Appeals. Many, including Hammar, believe the Ninth Circuit will affirm a decision against housing allowances for pastors. As far back as March 2002, for instance, the Ninth Circuit announced it would review “the constitutionality of the allowance” in a different case, “even though neither side in the related case challenged the exemption,” according to an article in the Baptist Press. In other words, the Ninth Circuit has looked for opportunities to scrutinize the allowance before.

Should an appeal fail, any other intervention to attempt to reverse it is highly unlikely, Hammar says.

“An appeal from the Ninth Circuit to the U.S. Supreme Court is a long shot. The U.S. Supreme Court hears appeals in only a small percentage of cases, probably one percent or so, so one cannot assume that the Supreme Court will “fix” the problem,” he says. “A decision by the courts that the housing allowance violates the nonestablishment of religion clause would be difficult, if not impossible, to “fix” via congressional legislation … Congress cannot directly overturn a federal court’s interpretation of the Constitution, but it can deprive the federal courts of jurisdiction to hear a particular question, such as the constitutionality of the housing allowance. This power has rarely if ever been used, so it, too, is unlikely.”

That leaves the outcome of the upcoming trial as the best hope for preserving housing allowances.

“This case is of immense significance to the hundreds of thousands of ministers who acquired homes in reliance on this benefit,” Hammar says.

Despite the uncertainty of the case’s outcome, and the tendency for legal cases to continue for months, or even years, Busby suggested in his remarks that church leaders identify the consequences of losing the pastor’s housing allowance benefit and develop a contingency plan now.

Related Tags: benefits, compensation, finance, housing, Law, pastors, Richard Hammar, tax

Comments

Articles like this one raise serious concerns both for the church and for the advocates that are working tirelessly to defend the interests of churches and related organizations.

First, it is entirely too early to be calling the game simply because the case is being heard in California. The Freedom From Religion folks are constantly bringing meritless cases that routinely get rebuffed because they lack any credible legal claim. Just because their pleadings are sufficient to survive summary judgement does not mean that the sun is setting on a well-established section of the Internal Revenue Code.

Second, reactions like this simply fuel the fire. If churches immediately concede every point of legal contention with various activist groups every time the fight gets close, the activist groups will effectively have control over the operations of every religious organization in the country. Articles like this should wait until a definite determination has been made and then report the facts of the determination without conceding defeat or giving ground. Making "admissions against interest" (such as "churches should start changing their housing allowance practices") does not help anyone.

It is time for the American church to meditate on the meaning of "wise as serpants."

If the housing allowance is changed and no longer can be claimed it would produce some hardships on the retired pastor who receives his retirement set up as a housing allowance.

Jim, Thanks for your comments. Based on Dan Busby and Richard Hammar's review of the situation, it is a significant one for church leaders to note now. No one is waving a white flag, and no one is recommending churches change their housing allowance policies now. Because of the circumstances surrounding this case, though, and the very real possibility of an unfavorable decision, it is wise for church leaders to develop a contingency plan now.

If the litigation proceeds as the article suggests, a Ninth Circuit ruling that the housing allowance is unconstitutional would be binding only on those states over which the Ninth Circuit has jurisdiction (no small matter, I realize). Also, my guess is such a ruling would create a conflict among circuits, where another circuit has ruled in favor of the constitutionality of the housing allowance. Or, if not, litigation would ensue in order to attempt to create a conflict among circuits. In the case of split circuits (which means federal law is one thing in one jurisdiction and something else in another), there's a much greater chance of the U.S. Supreme Court weighing in on the matter in order to resolve the conflict.

Hopefully, church leaders will do more than say "How Awefull". Ministers share the housing allowance with many other occupations, such as the military, railroad housing, and storage facility housing provided. None of these receive tax-free housing because of a desire in Congress to further their business or endeaver. They receive housing because they are required to live in a certain place as a condition of employment. The ministerial housing exemption, as with the military exemption was enacted because the lawmakers recognised that the minister is required, either in written form (you will live in the parsonage) or in unwritten form (the pastor must be available for emergency needs at all times). While my office administrator is free to live whereever she wants as long as she gets to work on time, the minister must be available for hospital work, crisis counceling, and a myriad of other duties upon very short notice. All of this has nothing to do with government advancing religion, any more that government is advancing the storage unit business!

We hope that the fight against this lawsuit concentrates on the proper issues, and is done with the finest legal minds possible.

In the past, the church has rolled over and played dead.
This time we need to fund a vigorous defense.

Speaking of the housing allowance as a significant tax benefit for ministers misleads many people into believing that ministers get an unfair tax advantage that leads them to pay less tax than others do. What is usually missed is that ministers are considered dual-status employees, paying income tax like an employee and paying the full social security tax (15.3%) that self-employed persons pay. The housing allowance only reduces income tax and does not reduce social security tax. The net result is that the average minister pays more taxes, not less, than an employee in other professions at the same salary level. If the housing allowance is removed, ministers' taxes will be significantly higher than their parishioners earning similar salaries. I trust someone will point this out to the courts.

Great point Rob. The 15.3% SS tax on the housing allowance is brutal on ministers. Remember, the base salary portion should not be subject to withholding. So a minister making $100k (base and housing) will pay $15,300 in taxes. That is more than a non-minister employee where the church pays 1/2 of the SS tax. This is the real issue that needs to be addressed.

The 15.3% Self Employment Tax can be rectified quite simply is the church desires to cooperate. A church may choose to pay a portion or all of a minister's self employment tax. The only caveat is that the amount paid for the minister's benefit is taxable and would be placed as additional income in box 1 of the minister's W-2 for the following year. This would continue for each taxable year. The last year of a minister's employment at a particular church would be the only issue. Even then, I'd rather pay tax on 15.3% than to pay 15.3%. A taxable benefit is better than no benefit at all.

In my opinion both ministers and churches shouldn't be exempt from paying taxes. There is no reason why they shouldn't pay taxes other than as a financial benefit to themselves.

aaaah,.... and the Son of Man has nowhere to lay his head.

Interesting article. Their arguement that the housing allowance goes against the establishment clause does not make sense. It is a "ministers" housing allownace, not a pastor's or rabbi's or imam's...it is for any "minister" of any religion or religious sect. Therefore it is not the government favoring Christianity.... maybe if they realize they would be taking away this benefit from muslims there will be an outcry from the media!

To respond to an earlier comment, the likelihood that this case will strike down the housing allowance is not based on the fact that it is being litigated in California, but that the federal judge (Shubb) has already stated that he thinks the atheists' arguemtns are persuasive.

The Pacific Justice Institute (www.pji.org) sought to intervene in this lawsuit on behalf of ministers so that it would not be soleley up to the IRS and state tax authorities to defend and appeal it. Judge Shubb denied intervention, and that issue is currently pending at the Ninth Circuit.

I have been receiving a salary from my church since 2009 which 100% is designated as my HA.I just realized I have to pay self-employment tax. How can I correct this error?

Malcolm--Thanks for posing your question. I sent it directly to Richard Hammar. Here is his response:

"This is a very common mistake that ministers make. He is not alone! To correct this, he will need to file an amended tax return for 2009 (Form 1040X) and pay the self-employment taxes with interest. The instructions to this form are available on the IRS website, and they provide all the information required to complete this form."

I hope this helps.

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This case really means nothing in the long-run. Whether or not the housing is "Taxable" is a moot point because we, as ministers, already "Pay" tax on that home expense. It is called "Self-employment Tax" and we cannot deduct anything from it. As a young Pastor I belive this would have helped my situation, to NOT have a housing allowance. With 4 children at home, a $30,000 a year salary means a Pastor is already @ the poverty level. But many people do not know that though a minister does not pay "Income Tax" he does pay "Self-employment Tax" if he is not waived vie., form 4361.
If I am wrong about this please enlighten me.

Brent--I shared your comment with Rich Hammar. Here's his response:

"This comment is incorrect. Whether or not the housing allowance is nontaxable is most definitely not a "moot" point. It will cost many ministers thousands of additional dollars in income taxes if the exclusion is deemed to be unconstitutional. Yes, the housing allowance is taxable in computing self-employment taxes, but so what? The issue here is the impact on income taxes, and that impact will be significant."

I hope that helps.

Best,

Matt

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Is this issue just in California, or national?

My husband and I are both ordained. I am taking time off now so we are down to one income. Without this benefit, I don't know if we could afford to be in ministry.

Isn't the rationale basically that the church is regarding the housing provision for pastors as like a gift, not income? Who is the government to determine that a gift is suddenly taxable?

Kinda scary...

If the housing allowance is removed, this will have a devastating affect on small Churches in the United States. Most of which depend on the housing allowance in order to be able to afford to hire a minister. What I fear will happen in most cases is that the small church will cease to exist at least in the capacity that it does now.

The reason ministers receive housing allowance, theologically speaking, is that they are official servants of King Jesus, whose Kingdom is sovereign over the kingdoms of men. Caesar should not tax the Church's official servants.

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