Warren Case Questions & Answers

Q. Does the current law exempt clergy from paying self-employment taxes on the fair rental value of a parsonage?

A. Most taxpayers owe two kinds of federal taxes on their income: federal income tax and FICA taxes. "FICA" stands for Federal Insurance Contributions Act and covers Social Security and Medicare. "SECA" stands for Self-Employment Contributions Act, and is the same thing for self-employed persons (except that the rates are higher, since a self-employed person must pay both the employer and employee portions of the tax). Ministers generally owe SECA taxes on their entire income, including amounts designated as a housing allowance. Internal Revenue Code Sec. 107, which provides the basis of the housing allowance and was the section amended by the recent legislation, affects only federal income taxes. It has nothing to do with FICA or SECA taxes. It never did and does not now. The Code Sec. 107(2) rental allowance (aka housing allowance) was never an exclusion from FICA or SECA taxes.

Separate from the Warren case and the amendment to Code Sec. 107, it is possible for a minister to be exempt from FICA and SECA. FICA generally does not apply to a minister's earnings for services performed as a minister because ministers are considered self-employed for FICA/SECA purposes. SECA generally does apply to such services, but there are 3 exceptions:

1. Members of a religious order who have taken a vow of poverty.
2. Ministers who have asked the IRS to be exempt and have been approved by the IRS.
3. Ministers who are subject to the social security laws of another country and who are exempt from US Social Security by reason of a social security agreement between the US and that other country.

1 and 3 will generally not apply to Methodist clergy in the US. Under exemption 2, there are 4 subcategories of persons who can request the IRS to exempt them from SECA taxes (and SECA coverage, meaning that they will not get Social Security or Medicare benefits):

1. A Minister.
2. A member of a religious order who has NOT taken a vow of poverty.
3. A Christian Science practitioner.
4. A member of a recognized religious sect.

Methodist ministers generally will fall into category a. For such ministers to qualify for an exemption from SECA tax, the minister will have to satisfy all of the following:

1. S/he must file Form 4361 with the IRS.
2. S/he must be conscientiously opposed to public insurance: 
   1. because of individual religious considerations (not merely his/her general conscience) [Some Methodist clergy could meet this test.], or
   2. because the minister is opposed because of the principles of his/her religious denomination.
3. S/he files Form 4361 for other than economic reasons.
4. S/he informs the ordaining, commissioning, or licensing body of his/her church that s/he is opposed to public insurance.
5. S/he establishes that the organization that ordained, commissioned, or licensed him/her is a tax-exempt religious organization.
6. S/he establishes that the organization is a church or a convention or association of churches.
7. S/he has not previously made an irrevocable election to be covered by Social Security.
8. S/he signs and returns the statement that the IRS requires, certifying that s/he is requesting a SECA exemption on the grounds listed in the statement.

Q. What is the effect of the new law on retired clergy?

A. The effect is merely that the rules long promulgated by the IRS have been confirmed by Congress by a clarifying amendment to Internal Revenue Code Sec. 107(2). Clergy, whether retired or active, can exclude from income the LEAST of three amounts:

1. The rental (housing) allowance declared by the clergyperson's church for the year in question. (In the case of retired UMC clergy the IRS has ruled in a number of private letter rulings from the 1980s that the entity to declare a rental allowance for retired clergy is the Annual Conference whose Bishop appointed the retired clergyperson to retirement status.)
2. The actual expenses of the clergyperson to provide a home in the year in question.
3. The fair rental value of the clergyperson's home, including furnishings and appurtenances (such as a garage), plus the cost of utilities for the year in question.

Q. Does the Clergy Housing Clarification Act of 2002 limit the housing allowance benefit to the fair market value or can clergy deduct the amount they actually spend?

A. The IRS has long provided in a Revenue Ruling from the 1970s that the housing allowance exclusion is limited to the least of three amounts:

1. The rental (housing) allowance declared by the clergyperson's church for the year in question. (In the case of retired UMC clergy the IRS has ruled in a number of private letter rulings from the 1980s that the entity to declare a rental allowance for retired clergy is the Annual Conference whose Bishop appointed the retired clergyperson to retirement status.)
2. The actual expenses of the clergyperson to provide a home in the year in question.
3. The fair rental value of the clergyperson's home, including furnishings and appurtenances (such as a garage), plus the cost of utilities for the year in question.

The new law clarifies the parsonage allowance exclusion by amending Section 107 of the Internal Revenue Code of 1986, adding "and to the extent such allowance does not exceed the fair rental value of the home, including furnishings and appurtenances such as a garage, plus the cost of utilities." The amendment applies to taxable years beginning after December 31, 2001.

Q. Can the housing allowance benefit be determined unconstitutional after passage of the Clergy Housing Allowance Clarification Act of 2002?

A. The passage of the clarifying legislation will not prevent another case from arising to challenge the constitutionality of Internal Revenue Code Sec. 107 (which grants the clergy housing benefits). The Church Alliance's purpose in sponsoring and supporting the adoption of the legislation is merely to try to withdraw the Warren v. Commissioner case from the 9th Circuit Court of Appeals. Two of the three judges hearing that case seem clearly poised to declare Code Sec. 107(2) (relating to the housing allowance exclusion) unconstitutional. (Code Sec. 107(1) grants the parsonage tax exclusion.)

The Church Alliance tried to get the IRS to withdraw its appeal of the Warren case once it appeared that that court planned to attack the constitutionality of the statute. The IRS was sympathetic on the constitutionality issue, but could not let the Tax Court decision stand. That decision held that the statute did not support the IRS's Revenue Ruling limiting the housing allowance exclusion to fair rental value. The only way to get the IRS to withdraw its appeal in Warren was to uphold the IRS fair rental value limitation by clarifying the statute. The amendment to Code Sec. 107(2) has the effect of prospectively reversing the Tax Court's Warren decision. We couldn't leave that to the 9th Circuit because they would likely go much further and declare Sec. 107(2) unconstitutional.

The Warren victory may turn out to be short-lived. Some other case might arise, brought either (i) by the ACLU, American Atheists, or some similar group or (ii) by a misguided clergyperson seeking to get a declaration that Code Sec. 107 is constitutional. If another case does arise, we are hopeful that it will arise in a less liberal court than the 9th Circuit and that it will arise in a case that has more sympathetic facts than those present in the Warren case. (Rev. Warren's pastoral earnings of $80,000 to $100,000 in the three years at issue in his case and overall earnings (including book, tape, and lecturer's earnings) of $200,000-$300,000 make for an unusual clergyperson who does not represent the typical more modestly paid minister in most denominations.) Maybe with the right case and the right court(s), we can get a favorable constitutionality ruling for Code Sec. 107. On the whole, however, given what is at stake, we would rather not have to fight the fight.

Q. Has the General Board of Pension prepared a statement interpreting the new law and its application?

A. The General Board has not prepared an interpretive statement regarding the new law, but the amendment to Internal Revenue Code Sec. 107 (2) merely confirms the rules long promulgated by the IRS. That is, clergypersons who do not have a parsonage, whether retired or active, can exclude from income the LEAST of three amounts:

1. The rental (housing) allowance declared by the clergyperson's church for the year in question. (In the case of retired UMC clergy the IRS has ruled in a number of private letter rulings from the 1980s that the entity to declare a rental allowance for retired clergy is the Annual Conference whose Bishop appointed the retired clergyperson to retirement status.)
2. The actual expenses of the clergyperson to provide a home in the year in question.
3. The fair rental value of the clergyperson's home, including furnishings and appurtenances (such as a garage), plus the cost of utilities for the year in question.

Q. Is there an IRS rule for determining fair market rental value?

A. The legislation you refer to (the Clergy Housing Allowance Clarification Act of 2002, which amended Internal Revenue Code Section 107(2)) is still quite new. In a way, however, the legislation is not new. It merely codifies in the Internal Revenue Code a limitation on the clergy housing allowance that has been part of the IRS's rules (by means of a revenue ruling) since the 1970s. A clergyperson can exclude from income each year the smallest of three amounts:

1. the housing allowance declared by his/her church
2. his/her actual housing expenses; or
3. the fair rental value of his/her home.

Since this rule was first announced in the 1970s, however, the IRS has never issued any guidance on exactly how to determine what the fair rental value of the clergyperson's home is. The common sense answer is that the clergyperson should get a periodic appraisal from a realtor or a real estate appraiser. Most clergy have such persons in their congregations. If the IRS audits a clergyperson's return, presumably the IRS would also hire a local realtor or appraiser to determine the fair rental value of the clergyperson's home.  It seems unlikely that the IRS could establish a centralized valuation guideline when real estate values are so different from place to place.

In response to your specific question, the IRS has not issued any regulations related to the new law, nor have they announced any plans to issue such regulations. Years can go by while the IRS catches up on regulations, however, so it would not be surprising if nothing is issued soon, for a long time, or even ever.  IRS Publication 517 has a small section on the housing allowance, and it is possible that future revisions of this Publication may mention how to determine the fair rental value, although that has not been done to date.  In the absence of such guidance, reasonableness is the only guideline.