Tax-free Housing for Pastors Facing Legal Challenge

Ruling Could Affect Churches That Provide a Housing Allowance

A recent legal challenge in Wisconsin to the federal housing allowance for ministers may concern some churches that offer this tax-free benefit to their clergy. If yours is among them, it would be wise to reach out to trusted tax and legal advisors to learn more about the topic. In addition, ministries can do a few things to prepare for potential changes in the law.

What’s the issue?

First, a little background. Churches often give ministers a housing allowance to help pay for expenses related to their apartments, houses, or church parsonages. This money is exempt from federal income taxes, as long as the recipient fits the tax code’s definition of a minister. A group called the Freedom From Religion Foundation sued the Internal Revenue Service, claiming that the tax exemption is unconstitutional because it only benefits religious people.

On October 6, a U.S. District Court judge in Wisconsin ruled in favor of the Freedom From Religion Foundation, saying that the housing allowance violates the Establishment Clause of the First Amendment to the U.S. Constitution.

Judge Barbara Crabb delayed enforcement of the ruling to allow both sides to present options for a remedy. Attorneys are to respond by October 31. The IRS is likely to appeal, so it may be months before courts reach a decision. In 2013, Judge Crabb ruled against the housing allowance for the first time in a similar case brought by the Freedom From Religion Foundation. The ruling was overturned on appeal in 2014.

Who could be affected?

Initially, the court’s decision would apply only to Wisconsin pastors who claim a federal housing allowance exclusion for property they rent or own. It would not affect anyone living in a parsonage provided by a church. Nor would it apply to pastors living outside of the state.

If the Seventh Circuit U.S. Court of Appeals upholds the Wisconsin court’s decision, the ruling would also affect ministers in Indiana and Illinois.

There’s a slim chance that the U.S. Supreme Court could hear the case on appeal and issue a ruling with national ramifications. That process would likely take years. It’s also possible that the IRS could decide to apply the Wisconsin judge’s ruling to all U.S. taxpayers.

There’s also a chance that the ruling could be applied retroactively. If that were to happen, it could prompt the IRS to go back and require amended tax returns of all pastors who claim the housing allowance exclusion between October 6, 2017, and the date the lawsuit is resolved.

What can churches do?

Uncertainty about the future of the housing allowance could cause concern for both churches and the pastors who rely on this exclusion as a part of their compensation. For financial planning purposes, church leaders could consider taking the following actions:

  • Explore the potential of increasing pastors’ compensation. If your staff members face higher income taxes as a result of this case, the increased income could assist them.
  • Communicate a message of assurance and support. Pastors may fear the financial impact that a decision like this could have on them. Indicate that the church will come alongside them, where possible.
  • Seek out sound advice. Stay in close contact with trusted legal and tax advisors for guidance and updates.

What’s the bottom line?

Ministries may continue to designate housing allowances for all pastors who qualify for the tax exemption. It could be several years before anything changes, or the tide could shift more swiftly. It’s important to be aware that the housing allowance is being challenged, and it could affect ministries. Ministry leaders may wish to explore actions that could offset the potential impact on their pastors.