Minister’s Housing Allowance and Retirement Plan Contributions
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 serves as a partner in the Indianapolis office and as the firm’s Employee Benefit Plan Services Director. Emily has 20 years of experience providing audit and tax services for employee benefit plans, with a primary focus on 403(b) plans. She currently oversees approximately 70 benefit plan audits and related filings. Emily also is a member of the AICPA Employee Benefit Plans Audit Quality Center Executive Committee.