Gross income, deductions, and business expenses – the secular framework of the ministerial housing allowance.

Out of context, it might be jarring to see a tax break for “ministers of the gospel.” Certainly, it has irked the Freedom From Religion Foundation for years.

But as we said in our earlier post, the ministerial “housing allowance” provision of 26 USC 107(2) isn’t really a deduction, or a special break for the religious. In fact, it’s unremarkable if you treat churches and ministers like secular businesses and employees.

First, we’ll back up. The mother of all income tax questions is “what is income?” It’s not sales. It’s not property. It’s not capital gains. It’s not (believe it or not) whatever the IRS says. But what is it?

Let’s start at the beginning. The 16th Amendment allows an income tax. The Code imposes a tax on “taxable income.” Taxable income, in return,is “gross income” less applicable deductions. Gross Income gets a somewhat circular definition: “all income from whatever source derived.” 26 USC 61. The space inside this circularity is responsible for the modern Congress and regulatory state, but, to vastly oversimplify, income is sometimes defined in terms of “gain.” It might be as broad as “anything that comes in,” or “receipts.” In a 1955 case, the Supreme Court discussed income in terms of “accessions to wealth, clearly realized.” Comm’r v. Glenshaw Glass Co., 348 U.S. 426, 431 (1955).

But note, the law specifically differs between “gross income” and a “deduction.” At the “gross income” level, the question is something like, “did this person recognize an accession to wealth?” Personal injury verdicts for pain and suffering are treated as “not income.” Deductions and credits, however, are more like policy questions. Should we encourage homeowners by providing a mortgage interest deduction? Should we allow medical (or charitable) expenses to be deducted? Congress and the IRS regularly violate this theory, but it’s a loose rubric.

Now, let’s apply it. John Doe sells widgets retail. He buys them at $5 from a supplier, and sells them at $10. What is John’s gross income? Is it total sales of $10, or just the gain of $5? Well, according to the IRS, gross income in this kind of business is calculated by subtracting cost of goods sold from total sales. Reg. 1.61-3(a). Doe’s gross income is $5, not $10.

But Doe’s business probably has other expenses, too. What if he has to make a sales call out of town? Doe’s travel costs are probably not subject to income tax; they might be excluded from gross income, or part of a deductible travel expense.

Of course, Doe might really enjoy that trip. He might stay at a nice hotel. He might rent a better car than he drives at home. He might socialize with glamorous people in a big city. But, the IRS isn’t taxing “fun,” it’s taxing Income. Within reason, the IRS treats bona fide business expenses as expenses of the business, and not as income or expenses of John Doe.

That’s different from what Doe’s company pays him in salary or compensation. If Doe’s company pays him a $1 in royalties for every widget, that’s Doe’s income. If, instead, Doe’s company gives him a free widget for every ten that he sells, the value of that widget is added to Doe’s income, and Doe will pay income tax on that amount.

Doe, not wanting to pay taxes, quickly recognizes the value of devoting his life to business expenses. But the more closely the expense resembles something that average people do to fulfill their basic needs, the more closely the IRS looks for a real business purpose.

For example, eating. Everyone eats. Doe would like to eat with money that isn’t subject to income tax. And there’s some truth to the fact that Doe gets more work done when he’s working at his desk, or eats during a meeting with customers or executives. The company might view the benefit of the extra work as a small price to pay. And for decades, the IRS allowed a full deduction of such food expenses. This led to the era of luxurious executive dining rooms with private chefs. Up until 1986, no one even had to discuss business at the meals to receive a deduction. The IRS has eliminated some of this deduction, and capped other aspects of it. Today, the question is about the value of employee meals provided by companies like Google. But the question, for tax purposes, isn’t whether Doe enjoys his job, or Google employees like free food. The question is whether meals can be business related expenses — and in many cases, with proper documentation, the IRS allows some kind of deduction for them.

What about housing? Everyone needs shelter. And, at least until the Internet, you had to be near the job to hold the job. If you wanted to work at the Ford plant, Ford required you to show up at 9 a.m. So, you’d need to live within commuting distance of the plant. It’s not a “business expense” that you live within commuting distance of the job.

But sometimes, an employer asks for more than showing up at 9 a.m. What if the employer wants you to live in a place where there is no housing market? Say, a company town in Alaska? Or an oil derrick in the Gulf? What if you’re required to be in a particular place overnight, like a two- or three-day shift? Or a member of the armed services? Or, say, the manager of a resort who is required to be on site 24/7? Or required to take a short-term assignment for a month, or a year? The answers to those secular business questions led to the ministerial housing being excluded from income. More on that in the next post.