1. No, you are not required to take the deduction. In general, you should normally take all allowable expense deductions, for several reasons. However, the requirements of the home office deduction are fairly strict. It would not be a problem to simply say that you haven't kept enough adequate records to prove you meet the "exclusivity" test, for example, so you wouldn't qualify.
2. You would reduce your qualified expenses. This may or may not make the clergy housing allowance taxable.
More specifically, you can exclude a housing allowance from taxable income (assuming it is designated in advance and in writing by the church), up to the amount of your actual qualified housing expenses. Suppose your qualified expenses (fair rental value of the home, plus utilities, insurance, and other items) is $25,000, and suppose you claim $3000 as a home office expense. That reduces your qualified expenses for the housing allowance to $22,000 (because that $3000 is an "office" expense for your side business, and is no longer an expense for your "home"). Then, if your housing allowance is, for example, $20,000, no further adjustment is needed and the housing allowance is excludable because it is less than your qualified expenses. If your housing allowance was $2000 per month or $24,000, for example, then $2000 is taxable income because it is more than your qualified expenses.
In Turbotax, you would need to figure your home office deduction first, either using the safe harbor ($5 per square foot) or the actual expense method. Then, enter your W-2 later, after you know your office deduction. When you check the box for religious wages, you will be prompted to enter the amount of your housing allowance and the amount of your qualified expenses. Your qualified expenses are your actual qualified expenses reduced by the home office deduction. If your housing allowance is more than your qualified expenses, the difference will be added back to your taxable income.
