How to designate your housing allowance for next year: a step-by-step guide

Many churches set the coming year's budget in the fall, which makes October through December a natural time to decide the housing allowance for next year. The timing matters. According to IRS Publication 517, the church must officially designate the payment as a housing allowance before it makes the payment, and it cannot decide the amount at a later date. This guide walks through the steps for pastors and the treasurers and boards who support them.

What the IRS says a designation must be

From Publication 517, in plain terms:

• In advance. The church must designate the payment before it makes the payment.
• A definite amount. The designation must be for a definite amount. It cannot be worked out later.
• Official action. It can be shown in an employment contract, in the minutes of the church, in a budget, or in another official action taken in advance of payment. Informal discussions do not count.

Because it must be a definite amount, a common approach is a specific dollar figure for the year. If you are considering anything else, such as a percentage, ask your CPA whether it meets the "definite amount" requirement.

Step 1: Gather three things

The designation is one of three numbers that limit the exclusion, so it helps to look at all three before the meeting. Our guide to how the limit works explains why.

1. Last year's actual housing expenses, and anything you expect to change next year: a new mortgage rate, a repair project, a move.
2. A current fair rental value estimate, furnished and including utilities. See fair rental value for clergy.
3. The current designation, so the board can see what it is changing from.

Step 2: Choose a definite dollar amount

Your CPA can help you think through the amount. A few things to keep in mind:

• The exclusion is limited to the smallest of the three numbers. A larger designation does not raise the ceiling on its own; the actual expenses or the fair rental value may still be lower.
• A designation that is lower than your real costs can cap the exclusion, because the designated amount is one of the three limits.
• Any part of an allowance that is more than the smallest of the three is included in gross income, so overshooting is not free.

This guide does not suggest an amount. That depends on your home, your costs, and your market.

Step 3: The church takes official action

The board or governing body adopts the designation in a way that matches your church's governing documents. A written resolution recorded in the minutes is the most common route, and Publication 517 also lists an employment contract or a budget. If your designation lives in an employment contract that carries forward from year to year, still review the amount every year. We have a free sample resolution you can edit as a starting point. Have your church's attorney or CPA review the final wording.

Step 4: Record it and keep copies

• The secretary records the action in the minutes.
• The pastor gets a copy, and the treasurer keeps a copy with the payroll or compensation records.
• Keep the copy with your tax records for the year. It is the first thing your preparer will ask for. The year-end checklist lists the rest.

Housing Allowance Helper asks for the designated amount and the date it was designated during setup, so it can compare the three numbers for you.

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Step 5: Make sure payments match

The designation covers payments made after it is adopted. For a new pastor, that means adopting it before the first payment. If the amount needs to change during the year, a church can generally adopt a new designation going forward, but a change does not reach back to payments already made. Ask your CPA how to handle it rather than guessing.

If a designation was missed

Because the designation has to come before the payment and cannot be set at a later date, a designation generally cannot be applied backward to payments already made. What a church can usually do is adopt one now, so that payments after that date are covered. What that means for the earlier payments is a question for your CPA, so talk to them soon rather than at filing time.

Checklist for the meeting

• Last year's actual housing expenses, plus expected changes
• A current fair rental value estimate
• The current designation
• A definite dollar amount for the year, reviewed with your CPA
• A written resolution adopted before the payments it covers
• The action recorded in the minutes, with copies to the pastor and treasurer

Sources: IRS Publication 517 (opens in a new tab); Internal Revenue Code section 107.