Court Strikes Down Clergy Housing Exemption

It is a section of the tax Code that goes back to 1954, yet a judge in Wisconsin has determined that the section is unconstitutional.

Makes one wonder how we survived all these years, doesn’t it?

It is the Freedom from Religion Foundation Inc v Lew decision by District Judge Barbara Crabb in November 2013. It deals with parsonages.

Parsonages are related to a church or religious organization. The Code section addressing parsonages is Section 107, and it goes back almost to the passing of the income tax itself. The provision started life in a humble way, allowing ministers of the gospel to exclude in-kind housing (i.e., the “parsonage”) from taxable income. Fast forward a few decades, and the section expanded in 1954 to include cash allowances, wherein one is provided tax-free cash to apply to housing one selects (rather than a house owned by the church).

You have to admit, it is a sweet tax break. I would not mind if such a break existed for practicing tax CPAs.

Would my tax wish be discriminatory? Well, yes. One would have to be a CPA specializing in tax and in practice in order to get the exclusion. What if you were a CPA but did not work in tax? Too bad. You would not qualify under my tax exclusion. 

In tax talk, the Foundation went after section 107 on the Constitution’s “establishment” clause. Judge Crabb found that: 

[Section] 107(2) violates the establishment clause under the holding in Texas Monthly, Inc v Bullock 489 U.S. 1 (1989), because the exemption provides a benefit to religious persons and no one else, even though doing so is not necessary to alleviate a special burden on religious exercise.”

           

Let’s backtrack a bit. Here is Code section 107:

In the case of a minister of the gospel, gross income does not include—

107(1)   the rental value of a home furnished to him as part of his compensation; or

107(2)   the rental allowance paid to him as part of his compensation, to the extent used by him 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.

The judge is looking at Section 107(2), which is the cash allowance parsonage. What about the in-kind parsonage of 107(1)?

           

Initially the Foundation went after both 107(1) and 107(2), but the government motioned for summary judgment. The Foundation backed off, pressing only on Section 107(2).

Why?

It has to do with having “standing” to challenge a law. In brief, one is required to show injury, or the possibility of injury, traceable to the defendant and subject to remedy by the court.  As the Foundation did not have a parsonage of its own, it could not claim standing under Section 107(1). It did however change its compensation policy to pay a cash allowance to its “ministers of the gospel” (I admit, I do not understand that combination of words in reference to this Foundation), thereby bringing it into the orbit of Section 107(2). Since Foundation employees could not benefit from Section 107(2), the Foundation obtained standing.

I am not certain this lawsuit is really about taxation as opposed to hate politics, but it does have dramatic tax repercussions.

The clergy housing exemption benefits approximately 44,000 priests, ministers, rabbis and imams. It is estimated to “cost” $700 Treasury million per year. For many, it is not an insignificant piece of their compensation.  It may mean the difference between continuing in religious leadership or curtailing or abandoning their work because of financial strain.

Then there are others, such as the pastor of Elevation Church in North Carolina, who have to push the matter. The pastor is building a 16,000 square foot house, which, when completed, will be one of the largest homes in Charlotte.

My thoughts?

The tax code has long recognized that some employees are not in control of where they live, and the code has provided breaks accordingly. For example, innkeepers are usually not taxed on their accommodations, nor persons working in remote areas, nor – for that matter – the President of the United States for residency in the White House. This is the “convenience of the employer” doctrine, and it has been around as long as Section 107 itself.

Does a parsonage meet the “convenience of the employer” standard?

We don’t know, as Judge Crabb did not go there. Her decision is based on the establishment clause.

To her credit, Judge Crabb has said her ruling would not take effect until all appeals are concluded.

We can expect the politicians to step in before this story is done.

I do like the idea of a President paying taxes for living in the White House, though.

Mormon Tithing and Caesar

George Thompson (GT) lives in New Jersey. He is the president of Compliance Innovations, Inc, which is owned by a trust. He and his wife are the trustees. He is a lifelong member of the Church of Jesus Christ of Latter-Day Saints (Church). He is a shift coordinator and a stake scouting coordinator with the Church. The Church does not pay him, however. He is married and has five children, two of whom are or were in college.

GT got himself into tax problems. He owed payroll trust fund penalties of over $150,000 for payroll periods in 2004, 2005 and 2007.

NOTE: We have spoken about these penalties before and referred to them as the “big boy” penalties. These penalties are for not submitting payroll tax withholdings and are some of the harshest penalties in the IRS arsenal.

He also owed regular “income tax” penalties for taxable years 1992, 1995, 1996, 1999, and 2000. These added up to over $730,000.

$150,000 plus $730,000 equals a lot of money. The IRS wanted it. I think you can see the problem.

The IRS begins its offense by sending a Final Notice of Intent to Levy, following up with an off-hand Notice of Federal Tax Lien Filing.  GT called time-out by filing a request for a Collection Due Process Hearing.

Let’s take a moment and explain what happened here. More than 25 years ago, Congress passed what has become known as the “Taxpayer Bill of Rights.” The intent was to introduce some formality to IRS Collections efforts, which too often operated as a Government Agency Gone Wild. GT applied the brake by requesting a CDP hearing. IRS Appeals would now step-in and look at how GT and Collections were behaving.

Before Appeals stepped-in, GT offered a “partial payment” installment agreement. You can guess that “partial payment” means that he is not paying off his tax in full. Collections requested a financial statement – a Form 433-A – providing GT’s income, expenses, assets and liabilities. The IRS wanted to see how much GT could pay.  

GT appeared to be doing well, listing monthly income of over $27 thousand with expenses of $24 thousand. He therefore offered to pay the IRS $3 thousand per month.

Seems fair, right?

The IRS looked at the same numbers and determined that he could pay over $8 thousand per month.

What? How could that be?

Trust me, it is easy – and common. The numbers are just magnified in this case.

When you get into this level of financial detail, the IRS classifies your expenses into two categories:

·        Necessary expenses

·        Conditional expenses

The IRS will generally disallow conditional expenses in a partial pay offer. GT had included approximately $5 thousand per month for Church tithing and college expenses. The IRS considered both to be conditional – and disallowed them. Bam! He could pay $5 thousand more per month.

Off go GT and the IRS to Tax Court.

GT leads off with Malachi 3:8-10:

Will a mere mortal rob God? Yet you rob me.

 But you ask, ‘How are we robbing you?’

In tithes and offering. You are under a curse – your whole nation – because you are robbing me. Bring the whole tithe into the storehouse, that there may be food in my house.”

The IRS fires back with Matthew 22:21:

Render unto Caesar the things that are Caesar’s, and to God the things that are God’s.”

The Court steps between the two with:

While we may be incapable of determining what belongs to God, we believe that we can, and must, decide what is Caesar’s.”

GT presented three different arguments to the Court:

(1) Given his position in the Church, tithing is required by the Internal Revenue Manual to be treated as a necessary expense.

(2) Classifying his tithing as a conditional expense is a violation of his rights under the Free Exercise Clause of the First Amendment.

(3) Classifying his tithing as a conditional expense is a violation of the Religious Freedom Restoration Act.

The Court dives into the first argument. It observes that the necessary expense test has two prongs: the expense must be for

·        The taxpayer’s health and welfare, or

·        The taxpayer’s production of income

For example, the Internal Revenue Manual allows a minister’s tithing as an allowable expense – if it is a condition of employment.

GT trots out a letter from his bishop that GT would have to resign his positions within the Church if he did not tithe. GT has a problem though, as the Church did not pay him. This would appear to present an obstacle. GT, undeterred, argues that the term “employment” in the Internal Revenue Manual is not limited to compensated employment and can include uncompensated employment.

Huh?

The Court observes that it cannot find any case specifically deciding whether the term “employment” as used in the Internal Revenue Manual is limited to compensated employment or can include uncompensated employment.

What? Can it be ...?

The Court reasons that there is a difference between a minister who is required to tithe in order to keep his/her job (and paycheck) and GT’s situation. It decides that the term “employment” must mean compensated employment.

GT argues that being active in the Church contributes to his health and welfare. The Court reflects on the interaction of religious observance and taxation, but does not agree that holding GT to his tax obligations compromises his health and welfare – or, at least, not any more than it compromises the rest of us.

GT next argues that not being able to tithe results in his being booted from Church office, thereby infringing his free exercise of religion.

The Court observes:

...petitioner overlooks the fact that it is his Church who is requiring him to resign his positions if he does not tithe. The settlement officer did not require petitioner to resign ...”

 And here is my favorite quote from the Court:

 “Petitioner’s claimed exemptions stems from the contention that an incrementally larger tax burden interferes with their religious activities. This argument knows no limitation.”

OBSERVATION: We know about Congress, taxes and “no limitation,” don’t we?

Let’s fast forward: GT loses his case. The Court is simply not going to let him treat his tithing and college expenses as a necessary expense when determining his partial payment installment offer.

My thoughts?  There are rules and guidelines when negotiating payment plans with the IRS. The more you want them to budge, the stricter the rules. The IRS did not budge an inch.  

I believe GT lost his case before he even went to Court. Why? Consider this quote from the Court:

Petitioner has a long history of not paying his taxes. As of the date of trial petitioner still had not paid his income tax liabilities for the taxable years 1992, 1995, 1996, 1999, and 2000.”

The Court was looking at GT as a deadbeat.

Here is the Court again:

Additionally, respondent has assessed trust fund recovery penalties under section 6672 against petitioner for seven different tax periods.”

Looking at? Nah. The Court had concluded that GT was a deadbeat.  

A Church Contribution Story: Durden

Our next two blogs discuss tax fails involving charitable contributions.

What each has in common is congressional resolve to address an area considered subject to tax abuse. How so? How many times has someone overvalued a Goodwill clothing donation, for example? Congress therefore placed restrictions – primarily documentation requirements – on one’s ability to deduct contributions. The general tax rule is simple: no documentation equals no deduction.  The key is to understand what Congress considers documentation, as your understanding may be different from theirs.

Let’s talk about Durden.

David and Veronda Durden contributed $25,171 in 2007 to the Nevertheless Community Church. With the exception of five checks (totaling $317), all checks were over $250.

FIRST RULE: Under Code Section 170(f)(8)(A), no deduction is allowed for any contribution of $250 or more unless taxpayer has contemporaneous written acknowledgment of the contribution by the charity organization that meets specified requirements.

The Durdens cleared the first rule, as they had a letter from the church dated January 10, 2008.

SECOND RULE: Under Code Section 170(f)(8)(B), the charity must state in the acknowledgment whether it provided any goods or services as consideration for the contributed property or cash. If so, it must include a description and good faith estimate of the value of any goods or services provided.

There is a problem: the church did not include language “no goods and services have been provided” in their letter.

The Durdens obtained a second letter dated June 21, 2009 containing the same information found in the first letter, plus a statement that no goods or services were provided in exchange for the contributions.

THIRD RULE: Code Section 170(f)(8)(C) considers the acknowledgment as contemporaneous if obtained on or before the earlier when the tax return is due or the actual filing date.

The IRS disallowed all but $317 of the charitable deduction for insufficient documentation. The Durdens go to Tax Court. Their argument is reasonable: we substantially complied with the spirit of the law. We had a letter. It might not be exactly the letter the IRS wanted, but we had a letter. When the IRS wanted more, we got them more. The IRS went too far in disallowing the deduction when everyone knows we gave to the church. We even showed them cancelled checks.  The wording in Code Section 170(f)(8)(C) is only one way – a safe harbor maybe – of meeting the “contemporaneous” standard.

The Tax Court disagreed. It noted that Congress intended to tighten the rules in this area and placed specific language in the Code requiring and defining “contemporaneous.” This was not the IRS’ doing; it was Congress’ doing.  The Court in the past had been lenient in cases involving substantial procedural compliance. This was not procedure. This was legislative compliance, and the matter was outside the Court’s hands.

The Durdens did not have the correct letter when they filed their return. That is the last possible date according to the law. There is no deduction. The Court did let them deduct $317, however. Since those individual contributions were under $250, those didn’t require a letter.

MY TAKE: I can understand Congress passing near-incomprehensible tax law to address complex and sophisticated tax issues. Those taxpayers are likely to have expert tax advisors and planners. This is not one of those issues. This is someone donating to a church. I strongly disapprove of routine activities triggering tax rules that make no sense to an average person.  

Congress should have included a “sanity” clause in this statute. They could have given the IRS discretion to accept “other but equal” documentation. True, the IRS could refuse to do so, but at least there would be a chance that the IRS – or a court reviewing the IRS – could blunt the capriciously sharp edge of this tax law.

Next time we will talk about Mohamed.