Have you ever joined a group in the middle of a conversation? Housing allowance guides can feel like that. Without context and a narrative, nothing really makes sense.

The following article is designed to give you context and a narrative. And our easy-to-read guide on How to Claim a Housing Allowance will help dispel confusion among leadership and staff at your church.

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Housing allowance is confusing because it evolved over 100 years. Every new law made things a little more complicated. This is why joining the conversation now feels so incredibly daunting.

If you want the Cliff notes version, stick to the main path. If you want to go down some cool historical rabbit holes, click on the Explore questions.

100 Years of Changes

1776 – 1912: Amendments and Compromises

In 1913, the United States of America ratified the Sixteenth Amendment to the Constitution. This amendment gave the federal government broad power

“to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several States, and without regard to any census or enumeration.”

Explore >> Why did the US government need a Constitutional amendment to collect taxes?The short answer is the Three-Fifths compromise. Yes, this is tied to slavery. We’re not making this up, and we don’t have an agenda. These are just the facts. Read the long answer if you want to go deep.

The long answer is that in 1776, the Continental Congress initially proposed to tax and grant votes to each colony based on their entire population: all ages and people equally represented, including slaves. Some slave-owning Southern states didn’t like this proposal. For example, Benjamin Harrison of Virginia proposed counting “two slaves … as one freeman.” Eventually, an early compromise was reached in the Articles of Confederation where each State would get one vote and taxes would be based on an assessment of land and buildings instead of people.

Unfortunately, because this language was too vague, the federal government struggled to collect taxes and some States refused to pay their share.

So, when it came time to write the US Constitution in 1787, the question of representation and taxation was resurrected. Virginians showed up to the party with a proposal to determine taxes and seats in Congress based on the “whole number of white and free citizens … and three fifths of all other persons [Black slaves].” This kicked off an epic and heated debate over slavery, representation, and taxation between the populous Southern slave-owning states and smaller Northern states.

A “Great Compromise” was reached on July 5, 1787, by a committee. The committee’s proposal tied representation in Congress and something called “direct taxes” together. Today, this is known today as Three-Fifths Compromise. It gave the federal government power to levy two kinds of taxes:
1. “Indirect taxes on exports and imports” based on “consumption” and
2. “Direct taxation … to be proportioned to representation.”

This “Great Compromise” on taxation and representation was so fragile that no one wanted to publicly say that it was based on the three-fifths ratio. As a result, nobody bothered to define “direct taxation.” A man named Gouverneur Morris, who came up with the phrase “direct taxes,” hoped that it would be removed when the Constitution was written. The awkwardness was so intense that when Rufus King, a delegate from Massachusetts, asked someone to define the “precise meaning of direct taxation” on August 20, 1787, “no one answered.”

The definition was so ambiguous that someone challenged a federal tax on horse-drawn carriages in a very early Supreme Court case (Hylton v. United States, 1796) on the basis that direct taxes needed to be “apportioned.” In that case, in his argument before the Supreme Court, Alexander Hamilton concluded that “we shall seek in vain for any … settled legal meaning” or “distinction between direct and indirect taxes” because ... “there is none.”

Because nobody wanted to say the quiet part out loud, in 1787, the US suffered through 150 years of laws and court cases. In the end, the only solution was an amendment to the Constitution itself in 1913.

Even though the Sixteenth Amendment settled the question of what kinds of taxes the federal government was able to levy, it created more legal questions. Specifically, what does the phrase “from whatever source derived” mean? And what does it apply to?

1913 – 1921: Parsonages, Manses, and Vicarages, Oh My!

In the early 1900s, many churches provided a home where their pastor could live rent free. As you might imagine, this was a huge financial benefit. Today, the names of these church-owned houses sound very old-fashioned: parsonage, manse, rectory, and vicarage.

Because the government was newly empowered to tax income “from whatever source derived,” regardless of “apportionment” (without any restrictions tied to the population of individual states) many people felt that parsonages were fair game. Others disagreed.

To settle the debate over what counted as income for a host of workers, Congress passed the Revenue Act of 1921. This now 100-year-old law “exempted from taxation … the rental value of a dwelling house or appurtenances furnished to a minister of the gospel as part of his compensation.”This is why parsonages are valued based on their rental value.

This meeant that anyone who qualified as a “minister of the Gospel” didn’t have to count the value of the church’s parsonage as part of their “gross income.”

At this point in history, it is worth pointing out that because parsonages were almost always owned by the church and located on (or near) the church property, pastors didn’t even have the option of simply declaring their house to be a parsonage on paper to save money on their taxes.

1935 – 1943: The Great Depression and World War II

Image: Social Security Administration

A Monthly Check to You (1936)

In 1935, Congress passed the Social Security Act. At first, Social Security only applied to people working for large companies or employers. To fund this program, the government passed the Financial Contributions Act of 1935 (or FICA). FICA required employers and employees to split the cost of Social Security—employers pay one half and employees pay the other.

For a host of reasons, clergy were not included in the Social Security program in 1935, along with many other groups of “self-employed” workers like doctors, dentists, and agricultural workers. This why ministers now pay self-employment or SECA taxes.

In 1943, the government needed cash for World War II so badly that they enlisted Disney to create cartoons where Donald Duck pays his taxes. This is not a joke. You can watch them here.

For some reason, cartoons didn’t cut it. So, the US passed the Current Tax Payment Act and created a “pay-as-you-go” system. Under this law, rather than waiting until the end of the year for individuals to pay their taxes, employers are required to withhold and send a portion of every paycheck on behalf of employees to the federal government.

As you might guess, churches were not required to withhold the wages they paid to individuals “for services performed as a minister of the gospel.” This is why, if a pastor wants his church to withhold income taxes, they need to sign and submit a W-4 as a voluntary tax withholding agreement.

1954 – 1965: Suburban Expansion and Changes

Clergy Started Buying Homes

In the aftermath of the World War II, (for a lot of reasons which we won’t discuss here) countless city dwellers and churches migrated out of city centers and into the suburbs. All of this suburbanization and the relocation of many churches made church-owned parsonages less and less common. Because pastors who owned their own homes could not claim a housing allowance, this created a noticeable financial gap between them and pastors who lived in a parsonage.

Clergy Wanted Social Security Benefits

Additionally, by the mid 1950s, waves of Americans who entered the Social Security system that began in 1935 started to retire and receive benefits. Suddenly, groups of workers that were originally classified as “self-employed” and excluded from the program wanted to be included. Clergy made the list, as Congress began to consider which of these self-employment groups should be allowed to participate in Social Security. For a number of complicated reasons, though, the response from pastors and churches about being included in Social Security was mixed.

To address both the housing and Social Security issues, several changes were made to the tax code in 1954.

First, Congress passed the Self-Employment Contributions Act (SECA). This new SECA law gave clergy the ability to participate as individuals in the system, exempting churches from covering the other half of Social Security taxes. This alleviated fears that clergy participation would force churches to collect and “pay employment taxes” on behalf of the government in a way that would “interfere with the principle of separation of church and State.”

Clergy were originally given a two-year window to “opt-in” to the Social Security system (until 1956). Because it was so popular and clergy were bad with paperwork, this “opt-in” window kept getting extended until it eventually became an “opt-out” window in 1965.

Pastors who chose to participate in Social Security had to pay the full SECA tax themselves (both the employer and employee portions). But they were able to deduct half of this SECA tax from their taxable income (as if they were their own employer).

This is why churches cannot collect or pay SECA taxes on behalf of pastors. Instead, pastors must pay their own SECA taxes because they are participating as an individual in Social Security and Medicare.

Second, Congress expanded the original IRS provision to include a second clause for pastors who rent or purchase housing. This expansion, which was designed to address the gap between pastors living in the suburbs and those who lived in parsonages, created three housing allowance types.

1. Parsonage
2. Rent
3. Own

In the same way that churches provided a parsonage to pastors, churches were required to approve a housing allowance amount on behalf of qualifying pastors. Today, because this allowance is paid in the form of cash or wages, it is often called a “cash housing allowance.”

Image: Social Security Administration

Near 65?

The Creation of Medicare

Over time the Social Security system grew to cover more and more types of self-employed workers and the benefits grew to cover the family members and spouses of deceased pastors. By 1960, about 70% of eligible pastors had chosen to “opt-in” to Social Security.

In 1965, the government created Medicare. With the creation of this new program the participation system for clergy switched from voluntary to compulsory—from “opt-in” to “opt-out.” Pastors who chose to “opt-out” would get no benefits: no Social Security, no Medicare, and no disability if they are injured.

Explore >> Why did Congress allow clergy to “opt-out?” And what does it entail?Congress initially created the “Exemption of Amish and other religious sects” mainly for Old-Order Amish ministers whose religion taught them to be opposed to the concept of Social Security and “death insurance.”

The Amish theology that led Congress to create this “opt-out” provision is worth discussing.

The main theological concept that Congress and consultants identified, which justified an exemption for Old-Order Amish and other religious sects was a community-oriented theology that rendered government programs necessary.

First, the Amish believe that 1 Timothy 5:8 teaches that not providing for elderly members of their community is a sin: “Anyone who does not provide for their relatives, and especially for their own household, has denied the faith and is worse than an unbeliever.”

Second, most Amish and Mennonites have been historically opposed to any form of insurance: fire, life, death, etc. They believe that buying insurance is a sinful choice to trust in the world for provision rather than God.

Because of this, the Amish and other religious sects neither need nor want Social Security and Medicare because they share “any of their possessions” with the community like the earliest believers in Acts 4:32-35. This is why the original exemption specified that ministers who are exempt “must be” part of a “sect” that “make(s) provision for their dependent members.”

When a minister opts-out on Form 4361, ministers must sign a statement claiming they are:

“… conscientiously opposed to … the acceptance of any public insurance that makes payments in the event of death, disability, old age, or retirement; or that makes payments toward the cost of, or provides services for, medical care.”

To learn more about this exemption, grab a copy of our How to Claim a Housing Allowance book.

1966 – Present: Paradoxical Policies

This series of laws (and court cases we skipped over) created a “dual tax status” for ministers in which the IRS “considers” ministers to be two different things at the same time. The apparent paradox this creates in people’s minds has created a lot of confusion for church leaders over the years.

• Most ministers are considered to be employees of the church (or denomination) with regard to their income taxes. Because they are consider employees with respect to the non-housing allowance portion of their salary, the part subject to income taxes, most pastors should receive a W-2.
• Many ministers participate in Social Security and Medicare as individuals. Because ministers pay both the employee and employer portions of their self-employment taxes they are treated as if they are self-employed when it comes to paying their Social Security and Medicare taxes.

Because the participation of pastors falls under the Self-Employment Contributions Act and they pay self-employment or SECA taxes, many church leaders wrongly conclude that ministers at their church are contractors and should be paid with a 1099 form. In reality, while some ministers are contractors, the majority of pastors are technically employees and should receive a W-2. They are just responsible for paying their own Social Security and Medicare taxes because the government didn’t include them in the initial FICA (Federal Contributions Act) bill. To learn more about the nuances on whether a pastor is a contractor or an employee, we recommend getting a copy of Church Law & Tax’s Church & Clergy Tax Guide.

Finally, just to clarify any additional confusion (and we are simplifying here—deal with it CPAs), ministers pay income tax on their income minus housing allowance (“base salary”), but they owe self-employment taxes on all of their income, including their housing allowance (base + housing).

• Income Tax: Base Salary
• Self-Employment Tax: Base Salary + Housing Allowance

Stated another way, self-employment taxes apply to both parts of a pastor’s salary package (base + housing) and income tax only applies to the base or non-housing portion.

That should equip you to take the next step and claim a housing allowance. For a practical, step-by-guide download a copy of How To Claim a Housing Allowance by ChurchSalary.