Friday, August 18, 2006

Housing allowance (part 2)

We've defined the Housing Allowance, so now let's talk a bit about how to determine what you need.

First of all, there are some limits to what can qualify as legitimate Housing Allowance. According to IRS code, a Housing Allowance cannot be more than the smaller of any of the following:
  • The fair market rental value of the home, including furnishings, repair, etc.
  • The amount officially designated (in advance) as rental or housing allowance
  • The actual amount spent to provide a home
What this means is that in the end, you are not allowed to claim as Housing Allowance more than the actual cost of owning or renting your home. Even if you are getting a deal-- for example, you are renting for 75% of the market value of your home-- you can't claim the difference as Housing Allowance. And if you're paying too much in rent, you can only claim the market value. In other words, the IRS doesn't want you to claim more as Housing Allowance than you should actually require.

When you set up your terms of call, you must designate in advance what will be construed as Housing Allowance. If you fail to do this at the beginning, you will lose the right to claim what you spend in the ensuing months until you do designate. That designation must be stated in writing in the terms of call (and subsequent annual changes must also be reflected in writing).

This is the reason behind the second limit: until the year is out, the amount designated in advance is automatically the smallest of the three. You won't know if the actual costs are more or less than the designation until you've paid them all; thus, you won't know how accurate your designation has been until you can't do much about it.

This represents a double-edged sword that can frustrate new pastors: on the one hand, if you designate too few dollars for Housing Allowance, you'll be taxed on money spent for housing when you didn't have to be. On the other hand, if you designate too much, you will be taxed for the difference (per the limits listed above), which may mean a significant tax burden next April 15.

(I'd like to point out that, after the first year or two, you should be able to determine fairly accurately what your costs will be for the coming year-- even with the substantial list of inclusions. If you've remained in the same home this is especially true. The only true variables, ordinarily, would be furnishings, repairs, or improvements such as additions or remodels.)

The key is to target your Housing Allowance to be just above what the actual amount will be; then you will cover all of your housing expenses, but your tax burden will not be substantially increased.

To do this, work through the list of inclusions for a Housing Allowance as carefully as possible, estimating each item based on your budget history (remember doing that exercise when you worked through the cash salary part of the terms of call?). Make adjustments where you know they will exist: perhaps your seminary housing was less expensive than the house you're buying, so the base costs will go up; if you have more square footage in your new place, calculate that your utility costs will increase; and so on. Total these numbers, then add 3-4% to the bottom line.

Don't forget to account for larger variables. If you know that you're going to add on a room, paint the whole house inside and out, and replace the gutters, get professional estimates for these jobs before you designate your Housing Allowance. (Even if you do the work yourself, you're allowed to claim full market value-- but only if you have a written estimate.) If you're going to re-finance your existing home (and thereby lower your payments), include that in your calculations.

Once you've computed what your Housing Allowance will be, you've largely determined your compensation package. Often, churches will view cash salary and Housing as the "payment" and the rest-- insurance, continuing education, expense account, etc.-- as benefits. We'll get to those next, but you should feel great about getting this far.

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