Pastoral Housing Allowance:
What Every Church Needs to Know

What Is the Pastoral Housing Allowance?

The pastoral housing allowance is a provision under Section 107 of the Internal Revenue Code that allows ordained ministers to exclude a portion of their compensation from federal income tax, specifically the portion used to pay for housing. This means a minister who receives a designated housing allowance does not pay federal income tax on that portion of their pay, as long as certain conditions are met.

To be clear about what this means in practice: if a pastor earns $60,000 per year and the church designates $18,000 of that as a housing allowance, the pastor pays federal income tax on $42,000 rather than $60,000. Depending on their tax bracket that can represent a meaningful savings every year.

This benefit has been part of federal tax law for decades and has been upheld by the courts, though it has faced legal challenges over the years. As of the writing of this article it remains a legitimate and significant tax benefit for qualifying ministers.

Who Qualifies for the Housing Allowance?

Not every church employee qualifies. The housing allowance is specifically available to ordained, commissioned, or licensed ministers performing ministerial services. In general terms this means:

• The person must be ordained, licensed, or commissioned by a religious body
• They must perform ministerial duties such as preaching, administering sacraments, conducting religious worship, or performing other sacerdotal functions
• They must be performing these duties as part of their role with the church

A church administrator who is not ordained typically does not qualify. A children's ministry director who is not ordained typically does not qualify. An ordained pastor who also handles administrative duties does qualify for the ministerial functions portion of their role.

If you are unsure whether a specific position qualifies, this is a question for a CPA or tax professional who works with churches. It is not a guess-and-see situation.

How the Housing Allowance Must Be Set Up

This is where most churches make their most serious mistakes. The housing allowance does not happen automatically. It must be formally designated by the church in advance. There are specific requirements for this designation to be valid.

It must be designated before the money is paid.

The church governing body (board of elders, deacons, vestry, or whatever structure your church uses) must formally designate the housing allowance before the compensation period begins. You cannot retroactively designate a housing allowance for money already paid. If it is December and you are thinking about setting up a housing allowance for January, you need to act now. If it is March and you forgot to do it in January, the allowance can only apply going forward from the point of designation.

It must be done in writing by the church.

The designation must be in writing and must be part of an official church record such as board minutes, a resolution, an employment agreement, or a salary schedule. A verbal agreement does not count. An email between the pastor and an elder does not count. It must be a formal documented decision by the governing body of the church.

It must specify a dollar amount or percentage.

The designation cannot be vague. It must state either a specific dollar amount or a percentage of total compensation that constitutes the housing allowance. A resolution that says the pastor's housing allowance is $18,000 for the calendar year is valid. A resolution that says the pastor may use some of their salary for housing is not.

It must be reviewed annually.

Best practice is to review and re-designate the housing allowance at the beginning of each year. Many churches build this into their annual budget approval process. If the pastor's compensation changes, the designation should be updated accordingly.

How Much Can Be Excluded?

The amount of compensation that can be excluded as a housing allowance is the least of three figures:

1. The amount formally designated by the church as the housing allowance
2. The actual amount the minister spends on housing during the year
3. The fair rental value of the home including furnishings and utilities

This means the pastor cannot simply designate an enormous housing allowance and exclude most of their income from taxes. The exclusion is limited to what they actually spend on housing and what the home would reasonably rent for in the current market.

Qualifying housing expenses typically include rent or mortgage payments, utilities, property taxes, homeowner's or renter's insurance, furniture and appliances, home repairs and maintenance, and in some cases a down payment on a home purchase. They do not include food, clothing, or other non-housing expenses.

The minister is responsible for tracking their actual housing expenses throughout the year and ensuring the amount they exclude does not exceed what they actually spent. This is the minister's responsibility, not the church's, but good church bookkeeping helps set the stage for accurate records on both sides.

How This Shows Up in Church Bookkeeping

From a bookkeeping perspective the housing allowance needs to be handled correctly in several places.

Payroll setup

If the church runs payroll through QuickBooks or another payroll system, the housing allowance needs to be set up as a separate non-taxable payroll item. The designated amount is paid to the minister but is not subject to federal income tax withholding. It should still be subject to self-employment tax unless a specific exemption applies.

W-2 reporting

The housing allowance is not reported in Box 1 of the W-2 (federal wages subject to income tax). However, some churches include the total compensation including the housing allowance in Box 14 as a reference item so the minister has a record of the total amount. Your CPA should advise on how to handle this for your specific situation.

Documentation in church records

The bookkeeper or administrator responsible for church finances should maintain a file that includes the board resolution or minutes designating the housing allowance for each year, the compensation agreement or salary schedule showing the breakdown, and any updates made during the year.

Budget and financial reporting

The housing allowance should appear as a line item in the church budget and in the chart of accounts so it is clearly tracked separately from other compensation. This makes year-end reporting cleaner and provides clear documentation if questions ever arise.

Common Mistakes That Create Problems

After working with churches and faith-based organizations, these are the situations that most commonly create tax problems around the housing allowance:

No written designation in the church records

The pastor and board have an informal agreement but it was never formally documented. This works fine until there is an audit, a change in leadership, or a question about prior years.

Designating more than the pastor actually spends

The church designates $24,000 per year but the pastor only spends $18,000 on actual housing expenses. The pastor can only exclude what they actually spend, so the excess $6,000 is taxable income even if it was designated as housing. The pastor needs to include it on their return and pay the corresponding tax.

Forgetting to re-designate each year

The church set up the housing allowance three years ago and has been paying it consistently but has not formally re-designated it since then. The original designation may not cover all subsequent years depending on how it was worded. Annual re-designation is the safest approach.

Not accounting for self-employment tax

Ministers are generally considered self-employed for Social Security and Medicare tax purposes even when they receive a W-2 from the church. The housing allowance excluded from income tax is still subject to self-employment tax. Many ministers are caught off guard by this and end up owing more than expected at tax time.

Incorrect payroll setup

The church is withholding federal income tax on the housing allowance when it should not be, or not withholding self-employment equivalent taxes when it should. Payroll errors are difficult to correct after the fact and can affect both the church and the minister.

A Note on State Taxes

The federal housing allowance exclusion does not automatically apply at the state level. Some states follow the federal treatment and exclude the housing allowance from state income tax. Others do not. North Carolina has its own rules around this and ministers in the Kannapolis and Charlotte area should confirm the state treatment with a CPA familiar with North Carolina tax law. Do not assume that what applies federally also applies at the state level.

What the Church Should Do Right Now

If your church currently provides a housing allowance to your pastor, here is a practical checklist to make sure you are handling it correctly:

• Locate your written designation. Find the board minutes or resolution that formally designates the housing allowance for the current year. If you cannot find it, that is a problem worth addressing now.
• Confirm the amount is specific. The designation should state a dollar amount or percentage. If it is vague, update it with a new board resolution.
• Check your payroll setup. Make sure the housing allowance is set up as a non-taxable compensation item in your payroll system and that you are not withholding federal income tax on that portion.
• Build annual re-designation into your process. Add housing allowance re-designation to your annual budget approval process so it happens automatically at the start of each year.
• Talk to your CPA. If you have any doubt about whether your setup is correct, a CPA who works with churches can review your documentation and payroll setup. The cost of that review is small compared to the cost of an IRS problem.