C6 18 TAMMUZ 5770 Community JUNE 30, 2010 HAMODIA

Feature

Demystifying the Parsonage Exclusion From

Federal Income Tax
amount of $10,000 — and so the
Over the past several months, Agudath Israel of America has initiated the Dina D’Malchusa Dina series of legal seminars project. additional $2,000 of the rabbi’s
Responding to the timely need in the Orthodox Jewish community for substantive guidance regarding a range of legal and tax-relat- salary that went toward housing
ed issues faced by yeshivos, shuls, gemachs, and the general public, Agudath Israel has stepped up to fill that need by coordinating expenses but was not pre-desig-
this initiative. To date, Agudath Israel has presented close to ten seminars in various locations across the United States, including pro- nated is considered taxable
grams in Boro Park, Chicago, Cleveland, Flatbush, Lakewood and Los Angeles, and more are scheduled to come. The initiative has income.
been praised by many as long overdue. It has served as a means of educating the greater Orthodox community regarding the intri- In this last example, should
the rabbi notice during the year
cacies of complicated and often misunderstood legal concepts, and has brought about a keen awareness of pertinent rules and laws that his pre-designated amount
vital to ensure that organizations and individuals act in compliance with state and federal law. The parsonage exclusion from income will fall short, he may ask his
tax is one such topic. Below is an article that seeks to clarify the rules of parsonage, the limits to the exclusion and some of its nuances. employer to amend the designa-
tion to account for the additional
amount, so long as the expenses
By Judah I. Kupfer, Esq. tion would include most shul expenses for the year and sub- ing and home improvements, used at that point have not yet
Rabbanim, rebbeim in yeshivos mits the estimate to the employ- yard maintenance, landscaping, exceeded the original pre-desig-
who teach religious subjects, as er for approval. The designation pest control, snow removal, local nated amount. To the extent they
Introduction well as yeshivah administrators. must be made by “official calls on the home phone, and have, the amount that exceeded
No one likes taxes. Paying One caveat is that the person action” of the employer. more. the pre-designated amount may
them, that is. However, people’s must also be “ordained, licensed Examples of “official action” With so many everyday items not be part of parsonage as tax-
ears generally perk up at the or commissioned.” That would include a designation within an included, it’s important to note free housing expenses.
prospect of keeping more take- not necessarily require the rabbi employment contract, in the some items that are deemed not To take a different example,
home pay and giving less to to have formal semichah, but he minutes of a board of trustees to be housing expenses. Such suppose a rabbi was given the
Uncle Sam. Some Orthodox Jews should have a certificate or meeting, in an employer resolu- items are the cost of purchasing use of a home, rent-free, that was
may legitimately be able to save diploma from the yeshivah he tion — but really any other food, personal toiletries such as otherwise valued at $20,000. If
on their income taxes by taking attended attesting to his qualifi- appropriate document will suf- toothpaste and shampoo, music not for the parsonage exception,
advantage of the “parsonage” cation to act in a rabbinic capac- fice. While a verbal designation CDs, computer software, auto- that amount likely would need
housing-allowance exclusion ity, and that certificate should would count (so long as such des- mobile costs, as well as the cost to be included in the rabbi’s
from federal income tax. be on file with his employer. ignation was made by “official for services such as housekeep- salary as a taxable benefit
The Internal Revenue Code Female teachers conducting action”), it isn’t recommended, ing and babysitting. gained from his employer
provides that a “minister,” or ministerial services (e.g. daven- as it can cause evidentiary issues through the course of his
one who can be classified as a ing or learning with children) later on. Are there any limitations? employment. (Note that there
minister for purposes of the tax can likely take advantage of this Parsonage is a matter of tax There are indeed limitations are certain other limited excep-
Code, may be able to exclude a provision as well. Although they law, and thus, like most tax laws, as to the amount of parsonage an tions when such fringe benefits
portion of his or her income may not be “ordained,” it would it follows the calendar year — employee may exclude. The would not have to be included as
earned in the exercise of per- be sufficient for the female January through December. employee is limited to the lesser taxable income, but we won’t
forming ministerial service that teacher to obtain a diploma or Since the expenses must be pre- of (a) the amount pre-designated explore those in this article.)
has been pre-designated and certificate from her seminary designated, the designation by the employer, (b) the amount However, given the parsonage
actually used for the minister’s attesting to her qualifications to should ideally take place each of housing expenses actually rules afforded a rabbi by the tax
housing expenses that year. This teach Jewish religious subjects. December, or earlier, for the fol- used that year, and (c) the fair Code, the $20,000 gain will not
income is excluded, and will Although, generally, the lowing calendar year. (If based rental value of a furnished home be subject to federal income
thus not be reported for purpos- employer will be a shul or on the school year, care should while adding the employee’s taxes. In such an instance, aside
es of federal income taxes (and be taken that the designations actual cost of utilities incurred from not reporting the $20,000
most state and local taxes too) for the school years involved that year. gain, the rabbi may also desire to
but will still be subject to social
security tax.
The parsonage cover the entire calendar year.)
When starting a new job mid-
To illustrate how these limita-
tions work, suppose a rabbi esti-
have his employer pre-designate
a portion of his salary as a hous-
The parsonage exclusion exclusion clearly year, the designation should mated in January that he would ing allowance so that other hous-
clearly affords a huge tax break occur as soon as the employee require $10,000 in housing ing expenses used that year
to a group that generally doesn’t
affords a huge tax starts working, if not before. expenses for the year and the would also not be included in
bring home all that much pay to break to a group that A designation can technically school went through the process taxable income for federal
begin with and can certainly use be made for future years, but of pre-designating by official income tax purposes.
the extra cash. Although the par- generally doesn’t because pre-designation of hous- action that amount from his Suppose a rabbi decided in
sonage exclusion has faced chal-
lenges over the years on consti-
bring home all that ing expenses should be as accu-
rate as possible, a new designa-
salary of $40,000. The school
would pay the rabbi the entire
January that this year will be the
year that he purchases a home.
tutional grounds and continues much pay to begin tion would likely be needed at $40,000, but the rabbi’s W-2 Knowing his expenses for the
to be challenged (notably, as the beginning of each calendar would only show $30,000. (The year will be quite significant, he
recently as a May 21, 2010 deci-
with. year. parsonage amount of $10,000 designates his entire salary of
sion from a California federal may be detailed in Box 14 for $85,000 toward his housing
court that allowed such a chal- What kinds of items are consid- “other income,” but there is no allowance. (As it turns out, actu-
lenge to move forward). yeshivah, there is no require- ered “housing expenses”? requirement that this be done.) al housing expenses for the year
At the time of this writing, the ment that the employer be a reli- “Housing expenses” includes When tax time comes, assuming may end up being even greater
parsonage exclusion is still the gious organization. For example, basically everything that has to the rabbi actually used $10,000 than his entire salary.) In this
law, and, as long as it continues a rabbi working in a rabbinic do with housing. A non-exhaus- on housing expenses during that case, the fair-rental value limita-
to remain the law, those who are capacity (e.g. conducting shi- tive list includes various expens- calendar year, he will only report tion kicks in. The rabbi would
eligible can take advantage of it. urim, running the shul, counsel- es in buying or owning a home need to evaluate the fair-rental
Outlined below are some of the ing patients on religious mat- such as the down payment on a value of a fully-furnished home
basic concepts and procedures ters) at a nursing home or hospi- home, closing costs, mortgage such as his (let’s say it is
for how the parsonage exclusion tal would also qualify. If you are payments including interest and The parsonage $35,000), and add to that his
works. It should be noted at the unsure whether you qualify, it is principal, home equity payments actual cost of utilities for the
outset that it is important to important to seek professional (as long as the loan proceeds exclusion merely year (let’s say it’s $10,000), and
seek professional guidance to guidance before using the exclu- were used for other housing applies to federal the sum of those figures would
ensure eligibility and to ensure sion. expenses), real estate tax and be the maximum amount of par-
that its requirements are being property insurance. For those income tax. sonage he may take tax-free for
applied correctly. What do you need to do? renting, rental payments are also that year, even though he pre-
The parsonage allowance, i.e. considered housing expenses. designated a larger amount and
Who is eligible? an estimate of how much of his Other applicable housing and pay federal income tax on although he actually spent more.
The parsonage allowance may salary the employee will use for expenses include the cost of util- $30,000 of his salary. In our example, his parsonage
only be provided as payment for housing expenses that year, must ities (e.g. electricity, heat, water, Let’s say the rabbi only used amount is limited to $45,000. The
services that are the “duties of a be designated by the employer, non-business telephone line, gas, $8,000 of the pre-designated additional $40,000 of his income
minister.” This includes “the and that designation must hap- sewer charges), cost of furnish- $10,000 for housing expenses. ($85,000 – $45,000 = $40,000)
ministration of sacerdotal func- pen prospectively, meaning ings and appliances, household He would be required to report would be taxable.
tions, the conduct of religious before the income is earned, in goods (including dishes, cook- and pay federal income tax on As far as designating one’s
worship, and the control, con- order for an employee to take ware, linens, lawn-care tools, the leftover $2,000. Suppose the entire salary, that, too, is fine.
duct and maintenance of reli- advantage of the tax break. The cleaning supplies, electrical sup- rabbi ended up using $12,000; he Just remember that the above
gious organizations.” This defini- employee estimates his housing plies), building repairs, remodel- is limited to the pre-designated limitations would apply.
HAMODIA
Does the employee have to pay
social security/Medicare tax on
his income?
Here is the more troubling
news. Indeed, the parsonage
exclusion merely applies to fed-
eral income tax (as well as any
local and state taxes that base
their taxable income on the
employee’s federal “adjusted
gross income”). Social security
taxes are a different story. The
employee is required to pay
social security and Medicare tax
on his entire income, both the
parsonage as well as the non-par-
sonage amounts. Not only that,
this burden of paying it falls
completely on the employee —
all 15.3% of it. If you’re thinking
it’s strange — that’s because it is.
The tax code classifies “minis-
ters” with respect to ministerial
services they perform as “dual-
status employees.” That means
they are considered employees
for all purposes (so they general-
ly receive a W-2 at year’s end
from their employers), except
when it comes to social security
tax.
For social security purposes,
ministers are considered “self-
employed.” The rule is that
employees pay half their social
security and Medicare obliga-
tions (also known as FICA, which
stands for Federal Insurance
Contributions Act) while
employers are required to kick in
the other half at their own
expense, which will not be tax-
able to employees. Since minis-
ters with respect to their minis-
terial services are exempt from
FICA, there is no obligation for
the employer to kick in half of
the FICA. Indeed, should the
employer decide to pay half
regardless, such amount is con-
sidered additional taxable
income to the employee.
Instead, ministers fall under
the SECA system (which stands
for Self-Employment
Contributions Act), which
requires them to pay the entire
15.3% of their entire salary
themselves (parsonage and non-
parsonage), just like any other
self-employed person. The minis-
ter would also be required to
make quarterly estimated pay-
ments towards the SECA obliga-
tion and report those payments
on Schedule SE to the Form
1040. (Boxes 3 through 6 on the
employee’s W-2 should be left
blank, as those apply only to
FICA amounts, not SECA.)
One saving grace, perhaps, is
that a self-employed person is
allowed an adjustment on his
Form 1040 of 7.65% of his entire
salary (also known as an “above-
the-line deduction”).
If, prior to reading this, an
employer had the practice of
paying half of the rabbi’s social
security tax as though the rabbi
were an ordinary employee, and
now decides to no longer cover
any of the rabbi’s SECA obliga-
tion, to maintain the understand-
ing between the employer and
rabbi it is suggested that the
employer increase the rabbi’s
salary by the 7.65% that the
employer was previously paying,
so that the rabbi is not left with
a net loss.
One further thing to remem-
ber is that the social security
ramifications just discussed are
a by-product of a taxpayer being
18 TAMMUZ 5770 Community JUNE 30, 2010 C7
deemed a “minister,” and do not incurred for each home and mul- sonage may affect whether the rely upon this article or infor-
vary based on whether the rabbi tiplying each sum by the per- employee would be entitled to mation it contains as a substi-
elects to accept parsonage. So centage of the year in which the other tax benefits. Thus, an tute for competent individual-
long as the rabbi is deemed a rabbi occupied that home. Only employee should be sure to ized legal advice about their
minister who is conducting min- the proportion of expenses check with a qualified tax advi- specific circumstances.
isterial services and is thus eligi- incurred given the time spent sor before electing to accept Attorneys advertising prior
ble for parsonage, the social living in that home may be con- parsonage, to ensure that, given results do not guarantee a simi-
security rules discussed above sidered tax-free expenses for the totality of the employee’s lar outcome.
will apply to him — regardless of parsonage purposes. specific financial circumstances, IRS Circular 230 Disclosure:
whether he actually receives accepting parsonage would be To ensure compliance with
parsonage. in his best financial interest. requirements imposed by the
On that note, once we’ve men- IRS, we inform you that any
tioned a ramification of being For social security Conclusion U.S. federal tax advice con-
classified as a “minister,” another Although parsonage amounts tained in this document is not
important ramification is that the
purposes, ministers are not completely tax-free, intended or written to be used,
employer of a minister is exempt are considered “self- they nonetheless provide a sig- and cannot be used, for the pur-
from its obligation to withhold nificant tax break to many fam- pose of (i) avoiding penalties
federal income tax, whether or employed.” ilies that may be eligible. under the Internal Revenue
not the rabbi is receiving parson- However, in actual practice, Code, or (ii) promoting, market-
age. (If receiving parsonage, this it is important to keep in mind ing, or recommending to anoth-
would apply only to the non-par- What about local and state the above principles and the er party any transaction or mat-
sonage amount, as the parsonage income taxes? need to seek guidance from a ter that is contained in this doc-
amount is already excluded from tax advisor to ensure the exclu- ument.
federal income tax.) In such a Most local and state taxes sion is applied correctly.
case, the rabbi would be required base taxable income on the
to pay quarterly estimated feder- “adjusted gross income” report- *** Judah I. Kupfer, Esq., is a staff
al income tax on any non-parson- ed on the employee’s federal tax This article is provided for counsel at Agudath Israel of
age amount, just as he must do return. Since parsonage is an general information and educa- America. He previously practiced
for social security tax. exclusion from gross income, it is tional purposes. Neither its dis- as an associate at the law firm of
The rabbi may request that not included in the employee’s tribution to any party nor any Allen & Overy LLP in New York.
his employer voluntarily with- adjusted gross income. Thus, for statement or information it con- Mr. Kupfer is a summa cum laude
hold federal income tax on his most jurisdictions, the parson- tains is intended to or shall be graduate of Touro College, a magna
behalf (on any non-parsonage age amounts would also be construed as establishing an cum laude graduate of Brooklyn
amount) so that he need not excluded from state and local attorney-client relationship or Law School and an LL.M. taxation
bother arranging and filing quar- taxes. to constitute legal advice. candidate at New York University
terly estimated federal income Readers also are cautioned that School of Law. To contact the
taxes. Should one who is eligible always the information in this article author, please email ykupfer@agu-
One last note about social elect to accept parsonage? may not apply to all situations. dathisrael.org. Questions and com-
security tax: Besides being the Not always, as accepting par- Consequently, readers must not ments are welcome.
law and thus obligatory, as a
practical matter, paying into
social security serves as a sensi-
ble long-term investment, as it
allows the payer to receive
income after retirement.
Additionally, although there is
the option for certain clergy
members to opt out of social
security, based on their opposi-
tion to public insurance for per-
sonal religious considerations,
many tax professionals have seri-
ous questions about the avail-
ability of this exemption for
Orthodox Jews.
May both a husband and wife
claim parsonage?
Sure, keeping in mind that
the above limitations apply:
Actual (and pre-designated)
housing expenses used that year
that do not exceed the fair rental
value of the home (including fur-
nishings plus actual cost of utili-
ties).
Thus, if a rabbi’s entire salary
won’t cover all of his housing
expenses, so long as the wife is
also eligible to receive parson-
age, her salary, too, may be pre-
designated to cover the remain-
der of their housing expenses,
keeping in mind the fair rental
value limitation previously dis-
cussed.
May one claim parsonage for a
summer home?
The parsonage exclusion may
only be used to exclude housing
expenses incurred for one home.
However, should the rabbi incur
expenses for more than one
home, such expenses incurred
while living in that other home
may be treated as housing
expenses for the parsonage
exclusion. The catch is that dur-
ing that time, any housing
expenses incurred in connection
with the rabbi’s primary resi-
dence are taxable. A slightly dif-
ferent way of structuring this
arrangement is by adding the
total amount of expenses