What is the ministerial housing allowance, and where does it come from legally?

The ministerial housing allowance (also called the parsonage allowance or MHA) is one of the biggest tax benefits available to pastors. It lets a minister exclude from federal income tax the portion of church compensation that is officially designated for housing and actually spent on providing a home.

It comes from Section 107 of the Internal Revenue Code, a law first enacted in 1954. Section 107 says that, for a "minister of the gospel," gross income does not include: (1) the rental value of a home furnished as part of compensation (a church-owned parsonage), or (2) a rental allowance paid as part of compensation, to the extent it is used to rent or provide a home and does not exceed the home's fair rental value, including furnishings and a garage, plus utilities. That fair-rental-value cap was added by Congress in 2002.

In plain terms: if your church properly designates part of your pay as housing allowance, and you spend it on legitimate housing costs, that money never shows up as taxable wages on your federal income tax return. Important caveat: the exclusion applies only to income tax. Unless you have an approved exemption, the housing allowance is still subject to self-employment (Social Security/Medicare) tax, which is covered in another question below.