Nonprofit Resources
Minister’s Housing Allowance and Retirement Plan Contributions
The ministers’ housing allowance is a unique tax component that can provide substantial benefit to qualifying employees. However, many nonprofits don’t realize that including this nontaxable allowance when calculating retirement plan contributions could have significant consequences.
Your plan document governs many aspects of your retirement plan. It provides many different definitions of compensation, including for:
- Determining limits,
- Performing non-discrimination testing, and
- Calculating contributions
For the purposes of this post, we are referring to compensation used to calculate contributions. Many plan documents provide a generic Internal Revenue Code definition of compensation to be used to calculate contributions, such as W-2 wages or Section 415 compensation.
When getting into the details of these Code definitions, there are virtually none that include the nontaxable ministers’ housing allowance in compensation. However, many nonprofits consider the ministers’ housing allowance part of a gross compensation package and factor it in when calculating contributions. Some try to justify this treatment by including the ministers’ housing allowance on box 14 of the W-2. However, as cited in an IRS Letter Ruling, reporting the ministers’ housing allowance on a W-2 is optional; it is not required by Sections 6041 or 6051 of the Code. Therefore, simply including the ministers’ housing allowance on the W-2 does not mean you may include it in compensation.
Let’s say, for example, that Mr. Minister earns $3,000 in wages and $2,000 in housing allowance. He elects to have 5% of his compensation withheld. The plan document defines compensation as W-2 wages. However, the organization withholds $250 (5% of 5,000).
The bad news? The plan is not operating in accordance with its plan document, and that is an operational failure. Left uncorrected, the plan’s tax-exempt status is in jeopardy.
The good news? It is fixable.
Prior to Revenue Procedure 2013-12, the best guidance available was the IRS 401(k) Fix-It Guide. IRS 401(k) Fix-It Guide #3 specifically discusses the issue of plan compensation not lining up with the definition in the plan document, and recommends correction via distributions from the plan. In our example above, the correction is to take $100 out of Mr. Minister’s participant account, tax it, and distribute it to him. This is problematic not only because the participant’s retirement fund is being reduced, but also because he is now being taxed on compensation that wasn’t taxable to begin with.
However, in a more recent Revenue Procedure 2013-12, the plan sponsor could use the Voluntary Compliance Program (VCP) to retroactively amend the plan, thereby keeping participants’ assets intact. This is a viable option for organizations that believe the plan is operating in the best interests of the participants, and is operating as intended.
Our risk-based audit* approach evaluates individuals that may be at risk of violating this issue. The purpose is not to “catch you” but to help you bring the plan into compliance, avoiding costly penalties down the road. You can learn more about our Employee Benefit Plan audit services for nonprofits here.
Emily Toler
Emily is a partner in the Indianapolis office and serves as the firm’s Employee Benefit Plan Services Director. With over 20 years of experience in audit* and tax services for employee benefit plans, Emily specializes in 403(b) plans and currently oversees more than 60 benefit plan audits and related filings. She is also an active member of the AICPA Employee Benefit Plans Expert Panel, contributing her expertise to the advancement of audit quality in the industry.
7 Comments
Hi Emily, My husband recently learned that if he leaves his retirement IRA in our denomination’s ministerial fund, he will be able to pull our housing expenses, in retirement, tax free? Is this true, and must it remain in the ministerial fund or can we put it in a higher yielding rollover account?
Linda,
Thank you for your question.
Since we work with organizations rather than individuals, we recommend that you seek the advice of a certified financial planner who is experienced with the ministers’ housing allowance.
Thanks,
Emily
Emily,
I understand the above related to the pastor’s withholding for retirement and calculating that % based on taxable wages. However, if the employer matches up to a certain percentage, can the employer contribution percentage be based on the total compensation (taxable wages plus housing allowance)?
I would love to know the answer to this question. I just found out I’m not receiving benefits from the church on the housing amount even though it’s part of my salary.
The same would apply for employer contributions. Compensation used to calculate employer contributions would depend on how eligible compensation is defined in the plan document. Plan documents may provide different definitions of eligible compensation for deferrals versus employer contributions, but most plans do not. It’s important to review your plan document for these details.
If I am understanding this correctly, the employer based on the contribution rate for employee deferrals on taxable wages PLUS housing allowance, when the plan’s definition of compensation did not include housing allowance. The “fix” was for the employer to amend the plan to include housing allowance in its definition of compensation. Is that right? If this is correct, I have a plan in a similar situation, and it wants to know where to find in the regs that a plan may include non-taxable housing allowance in the definition of compensation for purposes of calculating deferrals based on a %. Are you able to provide a citation for this? TIA!
KJ,
There are two contexts in which a definition of compensation is required for 403(b) plans in which ministers may participate. One context is the definition of compensation in the plan document for such purposes as a minister-employee’s elective deferral of wages expressed as a percentage of wages. A second context is the definition of “includible compensation” for the purpose of applying the contribution limits under section 415(c).
In the second scenario, the IRS ruled in PLR 200135045 that the minister’s housing allowance is not “includible compensation” for purposes of the application of the contribution limit set forth in section 415(c). Section 415(c) limits contributions (both elective deferral and employer contributions) to a 403(b) plan (or any defined contribution plan) to the lesser of a 2026 inflation adjusted amount of $70,000 or 100% of the participant’s compensation. In reaching its conclusion, the IRS considered alternate readings of the regulations under section 415(c) defining compensation and determined that the minister’s housing allowance could not be included in “includible compensation.” However, this ruling is limited only to the application of the section 415(c) contribution limit context.
However, what constitutes “wages” in a plan document for the purpose of elective deferrals and employer contributions expressed as a percentage of compensation is a different question and is not subject to the section 415(c) “includible compensation” definition. Rev. Rul. 73-258 held that a minister’s housing allowance is includible in a defined benefit plan’s definition of compensation for the purpose of determining a defined benefit plan’s normal retirement benefit that was measured as a percentage of compensation for each year of service. This ruling hinged in part on the plain language of section 107 that “gross income does not include– (2) the rental allowance paid to him as part of his compensation” (emphasis supplied in Rev. Rul. 73-258). Similarly, in Rev. Rul. 73-381, the IRS ruled that the value of meals and lodging provided to members of a religious order were includible in their compensation for determining the amount of their pension benefit under the religious order’s defined benefit plan.
While the rulings cited above were directed to defined benefit plans and a 403(b) plan is a defined contribution plan, there is little reason to conclude that the IRS would not apply this same reasoning to the compensation definition in a defined contribution plan. In fact, many providers of 403(b) plan preapproved plan documents include such a provision in their plan adoption agreements to permit plan flexibility where ministers are members of the sponsor’s participant pool. These preapproved plan documents must undergo IRS review before approval. Accordingly, there is de facto IRS acknowledgment of the propriety of this practice in several examples.