Section 107(2) Exclusion of Minister's Rental Allowance Ruled Unconstitutional.
(Parker Tax Publishing December 2013)

The exclusion from gross income for a minister's rental allowance that is paid as part of his or her compensation was ruled unconstitutional as a violation of the First Amendment to the U.S. Constitution. Freedom From Religion Foundation, Inc. v. Lew, 2013 PTC 373 (W.D. Wis. 11/21/13).

Freedom From Religion Foundation, Inc., a nonprofit organization that advocates for atheism, filed suit against the IRS and U.S. Department of Treasury contending that certain federal income tax exemptions received by ministers of the gospel under the Internal Revenue Code violate the establishment clause of the First Amendment and the equal protection clause of the Fifth Amendment to the U.S. Constitution. The Foundation claimed that its two co-presidents do not receive a tax exemption even though a portion of their salaries were designated as a housing allowance. The IRS and Treasury Departments filed a motion for summary judgment to dismiss the action.

Under Code Sec. 107, a minister of the gospel engaged in providing ministerial services is entitled to exclude a parsonage allowance from gross income. This includes, under Code Sec. 107(1), the rental value of a home furnished to a minister as part of the minister's compensation or, under Code Sec. 107(2), a housing allowance, to the extent the payment is used to rent or provide a home and to the extent the allowance does not exceed the fair rental value (FRV) of the home, including furnishings and appurtenances such as a garage, and the cost of utilities (Code Sec. 107). The term "parsonage allowance" includes church-provided parsonages, rental allowances with which the minister may rent a home, and housing allowances with which the minister may purchase a home.

OBSERVATION: Three types of services are considered ministerial: (1) the ministration of sacerdotal functions; (2) the conduct of religious worship; and (3) the control, conduct, and maintenance of a religious organization under the authority of a religious body constituting a church or church denomination.

The Foundation argued that the exemption had the effect of advancing or endorsing religion. The government contended that preferential treatment for religion may be permissible if it alleviates a significant burden on the free exercise of religion.

A district court held that the exclusion from gross income under Code Sec. 107(2) for a minister's rental allowance that is paid as part of his or her compensation violates the establishment clause of the First Amendment because the exemption provides a benefit to religious persons and is not necessary to alleviate a special burden on religious exercise. The court acknowledged the benefit the exemption provides to many ministers and the churches that hire them. However, the court observed, the significance of the benefit underscored the issue that the exemption violated the principle under the First Amendment that, absent the most unusual circumstances, religion should not affect legal rights, duties, or benefits.

The court cited Texas Monthly, Inc. v. Bullock, 489 U.S. 1 (1989), in which the Supreme Court held that an exemption from state sales tax for periodicals that were published or distributed by a religious faith and consisted wholly of writings promulgating the teaching of the faith violated the establishment clause of the First Amendment. A tax exemption that includes religious organizations must have an overarching secular purpose that equally benefits similarly situated nonreligious organizations. Because a primary function of a minister of the gospel is to disseminate a religious message, a tax exemption provided only to ministers results in preferential treatment for religious messages over secular ones, the court found.

The government did not provide evidence on why a requirement on ministers to pay taxes on a housing allowance was more burdensome for them than for other taxpayers who pay taxes on income used for housing expenses. In rejecting the government's argument that the exemption was a permissible accommodation of religion, the court distinguished the exemptions from social security taxes for certain religious persons as limited to those who will receive from their religious sect the benefits the tax is designed to provide.

The court also rejected the government's argument that the rental allowance exemption eliminated discrimination between religious and secular persons by providing an exemption for ministers who could not claim an existing exemption for ministers who lived in parsonages. The court determined that the exemption provided a benefit to ministers who met certain housing criteria. Finally, the court enjoined the government from enforcing Code Sec. 107(2), effective at the conclusion of any appeals filed by the government or the expiration of the government's deadline for filing an appeal, whichever is later.

For a discussion of Code Sec. 107 exclusion from income of housing allowances, see Parker Tax ¶15,500.(Staff Editor Parker Tax Publishing)

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