First, pastors are common law employees of their church and should be issued a W-2, even though they are considered self-employed for limited income tax purposes, and are not subject to mandatory federal income tax or employment tax withholding. A pastor is a common law employee of their church if they are subject to supervision, oversight, or control by a board of elders, deacons, a committee of the congregation, a vote of the congregation as a whole, or if they are supervised by a denominational office such as a district superintendent or a bishop. Pastors are only truly self-employed, and would receive a 1099 NEC, if they are not subject to any oversight or control and have complete freedom to set any hours of worship, to determine their own vacations, and set other church policy.
Second, a housing allowance must be designated in advance and in writing by a responsible church authority, such as the treasurer, the finance committee, the board of elders or deacons, etc. The housing allowance is not valid retroactively.
from the above, it is not clear to me that any self-employed pastor can have a legitimate housing allowance. If the pastor is not subject to church control, there is no one in the church to make the designation. However, I have never seen this definitively ruled on by the IRS, so I will assume that a self-employed pastor may have a designated housing allowance for the purpose of this answer.
The pastor may have a designated housing allowance up to 100% of their compensation, as long as it represents fair compensation for their services. The housing allowance may not exceed fair compensation for the pastors services. If the housing allowance exceeds actual housing expenses, the difference must be added back to their taxable income.
The pastor could ask that their entire compensation be designated as a housing allowance going forward, and the designation would be effective on the date that the election is put in writing by the church, but not before.
regardless of whether the pastor receives a W-2 as a common law employee, or receives a 1099 NEC, the pastor will report and pay self-employment tax on schedule SE. The pastor is allowed to deduct ordinary and necessary work related expenses from their income subject to SE tax. (Note that this is true even though W-2 employees are not allowed to deduct work related expenses from their federal taxable income on schedule A.). The pastor is supposed to make the adjustment on schedule SE and then include a letter or spreadsheet explaining and justifying the expense deductions, meaning the pastor must file by mail. I don’t know how often this is enforced, most of the time I think pastors make the adjustment on schedule SE and efile, and save their documentation in case the IRS asks questions later. Only work related expenses may be deducted on schedule SE; that would include things like unreimbursed mileage, unreimbursed books or study materials, and so forth.
Medical expenses and other schedule A itemized deductions are deductions against taxable income. They are not deductions against income subject to self-employment tax.
