“How do they go about doing this? How would it apply to a lump sum?”
David Powell, Groom Law Group, answers:
First, be aware that the IRS has long treated “whether amounts distributed to a retired minister from a pension or annuity plan should be excludible from the minister’s gross income as a parsonage allowance under section 107 of the Code” as one of its “areas under extensive study in which rulings or determination letters will not be issued.” (See, for example, the most-recent “no-ruling” list in IRS. Rev. Proc. 2012-3.) So you are in an area with little guidance and not a lot of certainty.
That said, in existing guidance, primarily in Rev. Rul. 75-22, which is still an extant revenue ruling that can be relied upon, at least as to its facts, the Service held that the designation as a rental allowance of a portion of the pension paid to an individual retired minister of a denomination by the trustees of a pension fund governed by a board of trustees who are elected by the general convention of the denomination was a valid designation for purposes of section 107 of the Code. In the facts of that ruling, the trustees of the fund were the sole authority of the denomination’s retirement program for its clergy.
On the other hand, the regulations and case law under Section 107 indicate that an amount must be designated as rental allowance pursuant to official action taken in advance of such payment by “the employing church or other qualified organization.”
Because the organization or “polity” of every church or denomination is different, you will need to examine the facts of this particular church and denomination to determine who should make the designation. In many cases, where the answer is not entirely clear, it may be advisable to have multiple entities make the designation, and/or to make it in multiple documents (for example, in church board resolutions, an employment contract and in the plan), as a “belt and suspenders” approach.
However, note that, not only must the payment be designated as eligible housing allowance, to be non-taxable it must also meet the other requirements of Section 107, such as that it must actually be used for eligible housing expenses and cannot exceed the fair rental value of the home for the year.
Thus, designation by itself does not mean the payment is excludable from income tax, and so a lump sum distribution may be only partly excludable from income.
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.