For a “minister of the gospel” to qualify for the rental allowance exclusion from income, the home or rental allowance must be provided as remuneration for services which are ordinarily the duties of a minister of the gospel. A minister’s gross income doesn’t include the rental value of a home (parsonage) provided, or the rental allowance paid, as part of compensation for ministerial services. Thus, a minister can exclude from income the Fair Rental Value (FRV) of the parsonage, or a rental allowance, for income tax purposes.

Code § 107(1): The rental value of a home furnished to him as part of his compensation, or

Code § 107(2): The rental allowance paid to him as part of his compensation, to the extent used by him to rent or provide a home, and to the extent such allowance does not exceed the fair rental value of the home, including furnishings and appurtenances such as a garage, plus the cost of utilities.

In US District Court for the western district of Wisconsin, Judge Barbara B. Crabb, in Gaylor v. Mnuchin (the Treasury Secretary at the time) concluded that IRC Sec. 107(2) is unconstitutional. Specifically, the judge concluded that IRC Sec. 107(2) violates the establishment clause of the First Amendment. On appeal, the Seventh Circuit overturned the district court, ruling on March 15, 2019, that the Code Sec. 107(2) provision is constitutional on the grounds that it has a secular legislative purpose; its principal effect is neither to endorse nor to inhibit religion; and it does not cause excessive government entanglement.

Examples of specific services the performance of which will be considered duties of a minister of the gospel for the purpose of the Sec. 107 exclusion include: sacerdotal functions, conduct of religious worship, administration and maintenance of religious organizations and their integral agencies, and teaching and administrative duties at theological seminaries (Reg § 1.107-1(a)).

The rental allowance is not excludable to the extent it exceeds reasonable compensation for the minister’s services. Rev Rul 78-448, 1978-2 CB 105 said that where a minister had a full-time outside job and performed only occasional services for a small church, only 1/15 of his church compensation was excludable.

To qualify for income exclusion of a rental allowance by the minister, his/her employing organization must designate the allowance by official action in advance of the payment (Reg § 1.107-1(b)). For a minister employed by a local congregation, the designation must come from the local church instead of the church’s national organization. A national church agency may make the allowance designation for ministers it employs. The minister must qualify as a “minister of the gospel,” as defined above.

The tax-free parsonage or rental allowances can present a problem for deduction of a minister’s expenses.  The portion of the expenses attributable to tax-free income is not deductible (this rule does not apply to home mortgage interest or taxes, which are deductible in full, subject to the usual acquisition debt limitation and SALT cap for years 2018-2025, if the minister itemizes deductions).    

The IRS successfully appealed the Tax Court decision in Driscoll, (2010) 135 TC No. 27 which had ruled that a minister may exclude under Code Sec. 107 the parsonage allowance he received for a second residence as well as his principal residence. In overturning the tax court ruling the Appeals Court concluded that the word “home” in Code Sec. 107 is not plural, especially when the statutory context of the word does not support a plural connotation. The consistent use of the singular in the legislative history of Code Sec. 107 demonstrated that Congress intended for the parsonage allowance exclusion to apply to only one home.  (P.A. Driscoll, CA-11, 2012-1)