“We sponsor a 403(b) plan that provides employer contributions to these ministers. Can our plan’s definition of compensation include housing allowance, even though it is not taxable income to the minister? If so, are there any other restrictions/limitations that would affect our ability to make an employer contribution on compensation designated as housing allowance? We live in an area where the cost of housing is high, so some of these amounts designated as housing allowance are quite large.”
David Powell, with Groom Law Group, answers:
The Internal Revenue Service (IRS) has taken the position for a number of years that amounts nontaxable as housing allowance are not compensation for purposes of the 415 definition of compensation. Thus, they cannot be counted as compensation for purposes of the 100% of compensation limit. See Private Letter Ruling (PLR) 200135045. However, for purposes of making employer contributions, a different definition of compensation could be used that includes nontaxable housing allowance. Contributions must still satisfy the 415 limit based on the narrow definition excluding them, though. And the plan documents must so provide.
Note, too, that church plans often include a designation of plan distributions as eligible for housing allowance. As with the housing allowance in general, there must be a proper designation by the employing church. Old rulings address how this is done for denominational plans. See, for example, Rev. Rulings 75-22 and 63-156. Mere designation does not make the distribution per se nontaxable—it only makes it eligible. It is nontaxable only to the extent used to pay housing expenses, as to which there is a long history of what expenses qualify and what do not. Also, frequently, the full distribution will still be reported as taxable on the 1099-R for the distribution. If part of it is nontaxable because it is used for housing, the minister will typically deduct that above-the-line on line 16a and b of the minister’s Form 1040. Some denominational plans follow different reporting practices, however.
Keep in mind, too, though, that the subject of pension distributions as eligible for housing allowance has been a “no-ruling” area for the IRS, indicating they are re-thinking the old rulings where they said it applies to pensions, and there is ongoing litigation trying to hold the housing allowance in its entirety to be unconstitutional. So stay tuned.
NOTE: This feature is to provide general information only, does not constitute legal advice, and cannot be used or substituted for legal or tax advice.
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