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Pastor Couldn't Exclude Payments as Parsonage Allowances or Gifts from Congregants

(Parker Tax Publishing June 2019)

The Tax Court held that a pastor and his wife were required to include in gross income (1) payments they claimed were personage allowances because the couple provided no evidence that the funds were used solely for housing expenses, and (2) purported gifts from church congregants because the donations were given with the hope that the pastor would continue as their pastor and were part of a routinized, highly structured program. However, the court did allow the couple to deduct expenses from a restaurant business because it found that the couple met the requirement for material participation under Reg. Sec. 1.469-5T(a). Brown v. Comm'r, T.C. Memo. 2019-69.


Mikel Brown is the founder and longtime pastor of the Christian Joy Center (CJC), an independent church headquartered in El Paso, Texas. Reverend Brown's wife, Debra, was the church's administrator. In addition to his ministerial work, Reverend Brown hosted and participated in public speaking engagements and ran a business training program.

The Browns received what they claimed was a parsonage allowance from the CJC for each of the years 2007 through 2009. In 2007, the allowance was made in the form of two payments of $1,750 deposited into the Browns' personal checking account each month. The payments in 2008 and 2009 were less consistent. The CJC also paid the Browns' utility bills and other personal expenses.

Like many churches, CJC used an envelope system to collect and record offerings from its members. CJC had a single envelope for this purpose with spaces for different contribution categories next to which the congregants could list a dollar amount. The categories included tithe, offering, building fund, and special gift. Contributions designated for the first three categories were always recorded as contributions to the church. Special gifts designated for Reverend Brown went first into CJC's bank account, and the bookkeeper would later make a check out to the Browns. Not all contributions made to Reverend Brown were made through the envelope system, and therefore not all were recorded by CJC.

In March of 2008, the Browns helped their friends and members of the CJC, Cynthia and Brian Harris, open a restaurant called A Taste of Buffalo (ATOB) in Alamogordo, New Mexico. The Harrises had the restaurant equipment and experience, while the Browns had capital and business experience. The Harrises managed the restaurant's day-to-day operations. The Browns were at the restaurant two to three times a week to bring supplies from El Paso, plan and draft advertising, and perform other tasks. Reverend Brown also handled ATOB's finances. He ordered and tracked supplies, paid bills and handled payroll. Mr. Harris estimated that the Browns spent 50 hours per week, onsite and offsite, on ATOB during the years at issue. The Browns claimed to have spent more than 714 hours at ATOB in 2007. ATOB never earned a profit and closed in 2010.

On their tax returns, the Browns deducted losses from ATOB of around $30,000 for both 2007 and 2008. They also claimed deductions for car expenses. The IRS audited the Browns and determined that they had more than $150,000 in underreported income for 2007, $200,000 for 2008, and $120,000 for 2009 resulting from the parsonage payments and donations from CJC congregants. The IRS disallowed the Browns' deductions for their ATOB losses and expenses on the basis that they did not materially participate in the business. The car expense deductions were also disallowed for lack of substantiation. The Browns challenged the notice of deficiency in the Tax Court.

Applicable Law

Code Sec. 107(2) allows a minister to exclude from gross income the rental allowance paid as part of his or her compensation, to the extent used by the minister to rent or provide a home. Under Reg. Sec. 1.107-1(c), the exclusion may not exceed the fair rental value of the home plus utilities. Reg. Sec. 1.107-1(b) requires a parsonage allowance payment to be clearly designated as the payment of a rental allowance and distinct from a salary or other compensation.

Code Sec. 102 excludes the value of property acquired by gift from gross income, but Code Sec. 102(c)(1) eliminates the exclusion for any amount transferred by an employer to an employee. The most important consideration in determining if a payment is a gift is the transferor's intent. When considering the intent of congregants making donations to a pastor, courts focus on the objective evidence, including: (1) whether the donations are provided in exchange for services, (2) whether any church authorities requested the donations, (3) whether the donations were part of a routinized, highly structured program, and (4) whether the pastor receives a separate salary from the church and the amount of the salary compared to the donations.

Code Sec. 469 limits the deductibility of business expenses when they arise from passive activities. A passive activity is one involving the conduct of a trade or business in which the taxpayer does not materially participate. Material participation means involvement on a regular, continuous, and substantial basis. Reg. Sec. 1.469-5T(a) lays out seven ways a taxpayer can prove material participation.

Tax Court's Analysis

The Tax Court held that the Browns' income from CJC was not excludable as a parsonage allowance and the donations from congregants were not excludable as gifts. The court found that, even though some of the checks from CJC were designated as parsonage allowance payments, the Browns failed to show that they used the payments for housing alone and that the allowance did not exceed the sum of their mortgage payments and utilities. In the court's view, there was insufficient evidence to determine the Browns' actual housing expenses, and the court reasoned that it could not be sure if the Browns were spending their allowance on food, vacations, or even the cash needs of Reverend Brown's unrelated businesses.

The court also found that the offerings to Reverend Brown from the CJC faithful were not excludable as gifts. The court found that the contributions were intended to keep Reverend Brown preaching at CJC. The court noted that CJC had two major days for giving, which were broadcast to, and well known by, the congregants, and that these special days, plus the single envelope system, created an expectation to make contributions. The court found that CJC's bookkeeping system was evidence of a routinized, highly structured program, with a high rate of giving on the special giving days. Finally, the court said that the large sums of money received by the Browns as donations in relation to their salaries could not be gifts, especially considering its other findings.

The Tax Court allowed the Browns' ATOB deductions for both 2007 and 2008 because it found that the couple participated in the restaurant business on a regular, continuous, and substantial basis and concluded that their participation in the activity exceeded the 100-hour threshold test in Reg. Sec. 1.469-5T(a). The court noted that the Browns spent a lot of time working on menus, advertising, and dand that Reverend Brown handled most of ATOB's finances. The court concluded it was more likely than not that the Browns spent more than 100 hours combined on these tasks and such tasks were integral to ATOB's operation.

The Tax Court disallowed the Browns' deductions for car expenses, finding that the couple failed to establish the place and time, amount, and purpose of the expenses as required under Code Sec. 274.

For a discussion of the taxation of minister income, see Parker Tax ¶15,520. For a discussion of the material participation rules for trade or business losses, see Parker Tax ¶247,115. For a discussion of the substantiation requirements for vehicle deductions, see Parker Tax ¶91,130.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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