The question arises as to whether or not a minister’s housing allowance or the fair rental value of the parsonage is earned income for purposes of calculating the earned income tax credit, or EIC.
The tax code is clear that ministerial housing, whether a housing allowance or a parsonage provided by the church, is excluded from a minister’s federal taxable income if such is set up under an approved housing allowance designated by the church. On the other hand, the minister is required to pay SECA (Social Security/Medicare) taxes on the housing allowance or the “fair rental value” of the parsonage. Simply put, a housing/parsonage allowance is not taxable for income tax purposes but it is taxable for Social Security/Medicare tax purposes.
Based upon that distinction, one could reasonably assume that the housing allowance or “fair rental value of the parsonage” would not count as income in calculating the “earned income credit.” However, that is NOT the case. The Internal Revenue Service, in Publication 596 – Earned Income Credit (EIC) – clearly points out that ministerial housing is included in determining the earned income tax credit. At page 10 of Publication 596, the following is found:
Minister’s housing. The rental value of a home or a housing allowance provided to a minister as part of the minister’s pay generally is not subject to income tax but is included in net earnings from self-employment. For that reason, it is included in earned income for the EIC (except in certain cases described in Approved Form 4361 or Form 4029).
The exception noted regarding an approved Form 4361 deals with ministers who have opted out of Social Security on their ministerial income. In a strange twist of the law that has not yet been corrected by Congress, ministers who have not opted out of Social Security (i.e. have not exempted themselves from self-employment taxes by filing Form 4361) must treat their housing allowance or fair rental value of their parsonage as earned income in calculating the earned income credit. On the other hand, ministers who have opted out of Social Security should not treat their housing allowance as earned income in computing the earned income credit.
This interpretation by the IRS creates an illogical and confusing situation. However, there seems to be no better interpretation. In the recent edition of the Church & Clergy Tax Guide, Richard Hammar spent more than five pages trying to explain this confusion.