The Hidden Housing Allowance Trap

For many ministers, the housing allowance—sometimes called the parsonage allowance—feels like a financial blessing. After all, it allows you to exclude from your gross income the cash housing allowance paid by your church or the rental value of a home provided in-kind, up to the amount actually used to provide a home and not exceeding the fair rental value (including utilities and furnishings) [1] [4].

But there’s a hidden trap that catches many ministers off guard: while the housing allowance is income tax-free, it is not self-employment tax-free. This means you could be facing a significant tax bill if you don’t plan ahead.

Why the Housing Allowance Is Not Entirely Tax-Free

Under Internal Revenue Code Section 107, ministers can exclude a properly designated housing allowance from their gross income for income tax purposes. However, for self-employment tax purposes, the rules are different. Section 1402(a)(8) specifically includes the housing allowance in net earnings from self-employment, unless you have an approved exemption [4].

In other words, even though you don’t pay federal income tax on your housing allowance, you must still pay self-employment tax (Social Security and Medicare) on it—unless you have filed for and received an exemption from self-employment tax by submitting Form 4361 and meeting strict religious criteria [3].

The Self-Employment Tax Surprise

The self-employment tax rate is 15.3% (12.4% for Social Security and 2.9% for Medicare) [3]. For many ministers, the housing allowance is a substantial part of their compensation. If you’re not making estimated tax payments or having enough withheld, you could be in for a shock at tax time.

Example:

Suppose you receive a $40,000 salary and a $20,000 housing allowance. Even if the entire $20,000 housing allowance is excluded from your income for income tax purposes, you must still pay self-employment tax on the full $60,000 (salary + housing allowance) [4].

Can Refundable Credits Help?

Refundable tax credits, such as the Additional Child Tax Credit (ACTC) or the Earned Income Credit (EIC), can help offset your total tax liability—including self-employment tax—if you qualify [2]. However, eligibility and the amount of these credits depend on your income, family size, and other factors. These credits can sometimes cover all or part of your self-employment tax, but you should not rely on them without a careful, personalized analysis.

Avoiding the Trap: Withholding and Planning

Because ministers are generally exempt from federal income tax withholding, it’s easy to overlook the need to make estimated tax payments or arrange for voluntary withholding. The IRS allows ministers to request that their church withhold federal income tax from their pay, which can be used to cover both income and self-employment taxes [3]. This is done by submitting a Form W-4 to your church.

If you don’t have enough withheld or don’t make estimated payments, you may owe a large sum at tax time, plus potential penalties for underpayment.

Key Takeaways

The housing allowance is income tax-free, but not self-employment tax-free. You must include it in your self-employment income unless you have an approved exemption.

Refundable credits like the ACTC can help, but eligibility varies and should not be assumed.

You can request voluntary withholding from your church to help cover your tax liability and avoid surprises.

Consult a tax professional for a personalized analysis. Every minister’s situation is unique, and professional advice can help you optimize your tax position and avoid costly mistakes.

Don’t let the hidden housing allowance trap catch you off guard. Plan ahead, understand your obligations, and seek expert guidance to keep your finances on solid ground.

Cited sources:

[1] Sec. 107 Rental value of parsonages

[2] Rev. Proc. 2023-34

[3] Publication 517 (2024)

[4] https://thetaxadviser.com/issues/2015/jun/campbell-june2015

Additional relevant sources:

Publication 1828 (8/2015)

Publication 525 (2024)

ECC 201035022

TAM 9033002