Failure to Designate Parsonage Allowance Precludes Deduction; Penalties Upheld.
(Parker's Federal Tax Bulletin: August 1, 2013)

Because a minister did not establish that the amounts at issue were properly designated as a rental allowance by official church action before payment, he was not entitled to a parsonage allowance. Williams v. Comm'r, T.C. Summary 2013-60 (7/22/13).

Ricky Williams is an ordained minister with a master's in divinity. He began working as a pastor for the St. John Missionary Baptist Church in September 2005. Under the employment agreement, Ricky received a starting salary of $80,000 per year. The agreement specified that the church would provide Ricky with a $500 housing allowance for six months from the date he signed the agreement. That six-month period could be extended with a majority vote of approval of the church's Deacon Ministry. The agreement was otherwise silent with respect to a housing allowance.

Ricky filed a joint federal income tax return with his wife for 2007. The couple reported Mrs. Williams' income from the Young Men's Christian Association as wages on their return. St. John's church paid Ricky as a contract worker. Consistent with this, Ricky reported his income on Schedule C. The couple reported approximately $85,000 in gross receipts on the Schedule C and deducted approximately $82,000 in expenses.

The IRS issued a notice of deficiency for the couple's 2007 tax return. The IRS determined that the couple had unreported Schedule C gross receipts or sales of approximately $18,000 and disallowed the following deductions for lack of substantiation: (1) Schedule C deductions of approximately $30,000 for business use of home, $14,500 for supplies, and $13,700 for car and truck expenses and (2) Schedule A deductions of approximately $2,300 for cash contributions. The notice of deficiency assessed an accuracy-related penalty of almost $5,000.

The couple filed a Tax Court petition, asserting that they had supporting documentation for the amounts reported on their 2007 return. At some point, they submitted to the IRS an amended Schedule C, which included a deduction of more than $33,000 for returns and allowances. Before the Tax Court, the couple did not dispute the adjustments in the notice of deficiency but instead asserted that the $33,000 they had claimed as returns and allowances on the amended Schedule C was a parsonage allowance.

Code Sec. 107(2) provides that the gross income of a minister does not include the rental allowance paid to him as part of his compensation, to the extent used by the minister 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. As a prerequisite for this exclusion, the taxpayer must establish that there was a designation of the rental allowance pursuant to official church action before payment.

The IRS argued that the claimed parsonage allowances were not properly designated and, thus, the $33,000 was not deductible from income.

The employment agreement that Ricky entered into with St. John's in September 2005 provided that the church would assist Ricky with a $500 per month housing allowance for six months from the date he signed the agreement but did not designate any other amount as a rental allowance.

Ricky did not assert that the six-month period was extended. Instead Ricky provided a purported second employment agreement at trial. Although the second employment agreement was dated 2005, it was signed by Ricky and the church in 2012. Before the Tax Court, Ricky argued that the second agreement was intended to clarify the original employment agreement because the original agreement was a generic type layout contract between Ricky and the church in which certain issues had not been defined. The second employment agreement discussed a parsonage allowance and provided that such an allowance would include costs associated with facilitating proper living facilities, including utilities and maintenance.

The Tax Court held that Ricky was not entitled to exclude $33,000 from income as a parsonage allowance because his original employment agreement did not designate a rental allowance, and the second employment agreement was executed in 2012 and therefore could not designate a rental allowance for 2007. The court also held that the couple was liable for the accuracy-related penalty.

For a discussion of parsonage rental allowances, see Parker Tax ¶76,310.

Parker Tax Publishing Staff Writers

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