On Thursday, November 21, the district court of the Western District of Wisconsin declared (part of) the parsonage exemption—a special tax provision for certain religious persons—unconstitutional.
What Is the Parsonage Exemption?
To understand the parsonage exemption, we should briefly detour into default tax law. By default, virtually everything you receive from your employer constitutes taxable income, and you are required to pay taxes on it.[fn1] This generally includes housing: for the most part, if your employer provides you with housing, or with a housing stipend, you have to include the rental value of the housing or the amount of the housing stipend in your gross income.
Section 107 of the Code provides a couple exceptions to this general rule. I’ve briefly talked about the parsonage exemption here. In brief, section 107 says that “ministers of the gospel”[fn2] don’t have to include in gross income (a) the rental value of housing provided as compensation, or (b) a rental allowance paid as part of their compensation.
Why Would a Church Provide Housing or a Housing Stipend?
Because it lowers the church’s cost of compensation. Assume, for example, that a minister lives in an area where rent on a 3-bedroom apartment costs $2,000 a month.[fn3] Assume further that the church intends to pay the minister $100,000 a year.[fn4] If the minister is married filing jointly, that puts her in the 25% tax bracket. After taxes, she has $83,142.50 left to spend.[fn5]
Rent consumes $24,000 of the minister’s after-tax income annually. To pay that $24,000, then, the minister has to earn $32,000 before taxes.
So if the church can provide that value on a pre-tax basis, it has to pay significantly less. Specifically, it can pay $68,000 cash and provide an apartment—or it can pay $68,000 cash and, in addition, provide a housing allowance of $24,000—and the minister can enjoy $83,142.50 of after-tax consumption. That is, the church pays, at most, $92,000 (and it could be less if the provision of an apartment doesn’t cost the church $24,000) for the minister to live on the after-tax equivalent of a $100,000 pre-tax income. The parsonage exemption, then, functions economically as a subsidy to churches that employ and provide housing for their minister or minister-equivalent.
So What’s the Problem?
In short, this is a tax benefit provided solely to religious persons. As such, plaintiffs allege, the parsonage exemption violates the Establishment Clause of the First Amendment.
Judge Crabb agreed. While acknowledging that religious organizations can constitutionally receive tax benefits, the judge noted that tax provisions that solely benefit religious organizations violate the Establishment Clause. It’s worth noting, though, that all of the violative provisions she cited were provisions of state tax law; I’m not aware of any provision of the Internal Revenue Code (up until now) that has been struck down as violating the Establishment Clause.
Note that I think she’s right: the parsonage exemption doesn’t make any tax policy sense. It reads as a purely political move; someday, maybe, I’ll look at the legislative history (some of which is cited in the opinion) but, even if it had non-political genesis, it doesn’t appear to have any purpose today, except as a giveaway to religious institutions that hire and house their clergy.
So Is That It? Can the Decision Be Challenged?
I think, on the merits, the decision is pretty sound. But I don’t think the case itself is bulletproof. Specifically, I think the has some procedural problems. (I’m not a procedure person, though: if anybody who knows a lot about Article III standing wants to chime in, that would be great.)
Basically, the parties suing—two employees of Freedom From Religion Foundation and the Foundation itself—never tried to claim the parsonage exemption. Usually in the world of tax litigation, a litigant has to make a claim to the I.R.S. and have that claim rejected before she can sue. Here, Judge Crabb said that doing so could create a catch-22: if the provision were declared unconstitutional, the taxpayers wouldn’t be able to receive the benefit, so their complaint could not be redressed.
But I’m not entirely convinced that this catch-22 overcomes (or meets) Article III standing. If I represented the government, I’d appeal the case alleging that the plaintiffs had no standing to sue, and therefore the court couldn’t hear the challenge, much less declare section 107(2) unconstitutional.
It’s worth noting that the court didn’t declare section 107(1) (which exempts employer-provided housing, as opposed to section 107(2)’s housing stipend) unconstitutional. And the court didn’t rule on section 107(1) on standing grounds: the plaintiffs had no standing to challenge section 107(1)
Like I said, though, I don’t know the intricacies of civil procedure. Still, it feels like a stretch to assert that the plaintiffs had standing to bring this case.
So What Now?
Nothing. At least, not for now. Judge Crabb told the I.R.S. that it could no longer enforce section 107(2). But she also delayed her holding until after the conclusion of any appeals. What’s more, even if the Court of Appeals holds it unconstitutional, that holding will only apply in the states covered by the Seventh Circuit.[fn6]
If the Seventh Circuit doesn’t dismiss the case on standing grounds, I suspect it will hold that section 107(2) violates the Establishment Clause. From there? It probably ends up at the Supreme Court.
In the meantime, what can a church do? Honestly, if it’s not in the Seventh Circuit, it can keep doing what it’s always done. In fact, if it is in the Seventh Circuit, it can also keep doing what it’s always done.
If a church provides a housing stipend to its minister, but is worried that section 107(2) will inevitably be declared unconstitutional and wants to get ahead of the inevitability, it could always rent a home for its minister directly. Going with the example above, instead of paying a housing stipend of $2,000 a month, the church could use that $2,000 to rent an apartment for the minister. In the current world, the minister should be indifferent between the two and, in a world where the stipend is taxable but the church-provided housing is not, should actually prefer the direct provision from the church.[fn7] And the church should be entirely indifferent as to whether it gives the money to the minister or the landlord.
Is There Any Particular Mormon Consequence to This Case?
I don’t actually know. But I would imagine there is: certain Church leaders (e.g., the prophet, First Presidency, and Quorum of the Twelve, at least) receive compensation from the Church. They almost certainly qualify as “ministers of the gospel” for tax purposes; if a portion of their compensation isn’t designated as a parsonage allowance (or, alternatively, if the Church doesn’t provide them with housing), somebody’s not doing his or her job very well.
Cross-posted to What We Pay For Civilized Society. [h/t Marc.]
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[fn1] There are, of course, some exceptions. For example, the Internal Revenue Code provides that certain fringe benefits don’t need to be included in an employees gross income. But these exceptions are explicitly laid out and are generally fairly narrow. It’s worth noting that, while gifts generally are excluded from gross income, it’s virtually impossible for an employer to give an employee a tax-free gift.
[fn2] The Tax Court held that Congress didn’t mean “minister of the gospel” to apply solely to Christian clergy. Rather, it held, a “minister of the gospel” is one who is duly ordained, commissioned, or licensed, and who performs sacerdotal functions, conducts religious worship, and/or directs organizations within the church. As such, the Tax Court held that a Jewish cantor was a “minister of the gospel” for these purposes. Salkov v. Comm’r, 46 T.C. 190 (1966). The I.R.S. ultimately acquiesced to the Tax Court’s holding in Rev. Rul. 78-301.
[fn3 I’m using $2,000 mostly because it makes the math easy. But here in Chicago, that’s probably a reasonable (and possibly a low) estimate).
[fn4] Yeah, $100,000 is probably way too high. But again, it makes the math easier.
[fn5] Note that I’m ignoring the standard deduction, personal exemptions, and other deductions for the sake of simplicity.
[fn6] That is, Wisconsin, Illinois, and Indiana.
[fn7] Okay, that’s not entirely true. A minister can currently apply the stipend toward her monthly mortgage payment; without section 107(2), the minister would have to make her mortgage payment out of after-tax dollars.
Most parsonages are on the general church property. section 107(1) (which exempts employer-provided housing) is going to swallow up most cases.
Unless there are trends in the 7th that are different. Given tha D&D is equivalent to gang activity in that circuit , I’m not about to speculate on that jurisprudence.
Stephen, that was my initial thought, too. But on further reflection, I’m not sure if that’s the case. True, most churches that provide housing for their minister probably have the housing on the grounds. But do most churches provide housing? My totally non-statistically-significant observation: when we lived next door to a Lutheran church, the pastor didn’t live on the church grounds.
Where that’s the case, there’s no harm to the church in designating some portion of the salary as a housing stipend. It doesn’t cost the church any more than it would already have paid (and, as I showed, may convince the pastor to accept lower compensation).
Two points:
1) You demonstrate how 107(1) can be used for rentals if 107(2) is stricken down, but Footnote 7 only hints at the problems the homeowner-ministers would face. Now, they get tax free income and still get to deduct property taxes and mortgage interest. Footnote 7 correctly points out that striking down 107(2) would make the income taxable. But they couldn’t use 107(1) to get around it either. If the church owned the property, the income would be tax exempt, but the minister would not be able to deduct taxes or interest (nor would the church, being exempt itself).
2. The property tax case in Maryland (http://www.forbes.com/sites/peterjreilly/2013/02/07/maryland-exempts-residence-for-mormon-temple-workers-as-convent/) could be relevant here. Could temple workers be taxed on the rental value of their housing? (Or do they actually pay rent to the church?).
Last Lemming, on (1), you’re absolutely right. I just didn’t want to get too deeply into it, but, essentially, with 107(2) gone, homeowner-ministers who bought the biggest house they could afford (factoring in the exempt income) will suddenly be in more house than they can afford.
As to (2), I’m curious about that, too. I suspect that, even without 107(2) declared unconstitutional, most missionaries wouldn’t qualify as “ministers of the gospel.” Temple missionaries might be a different story, though.
I’m actually really curious about the tax status of missionaries. Technically, they’re not self-supporting; rather, the Church pays their living expenses (notwithstanding the fact that they’ve paid into a central fund). That said, Rev. Rul. 62-113 says the I.R.S. won’t treat support of putatively self-funding missionaries as income; to the extent that holds, I suspect that Church-provided housing would also fall under that umbrella, whether or not the parsonage exemption exists and whether or not it’s constitutional. (Frankly, I find the tax treatment of missionaries both fascinating and baffling: it’s basically taxation by ignoring any potential issue.)
On my mission, the Church brokered rental of apartments for the full-time missionaries. I wonder if this kind of thing could have a wide impact on the way the Church has arranged housing for them?
My parents served a number of missions including several temple missions. (And my mother is on one now ). They always paid for their own lodging.
The more I read stuff like this the more I think a flat tax sounds like a good idea.
Exemptions like this can be carved out of a flat tax just as easily as from a graduated tax. If you think a flat tax would necessarily include all sources of income, you haven’t read the proposals very carefully.
Ed, like Last Lemming said, a flat tax would do nothing to address this problem. A flat tax deals with tax rates; the parsonage exemption is a question of tax base. And questions of tax base don’t disappear, whether you make the tax more or less progressive.
I will echo Rob Perkin’s comment. When I was a missionary 10 years ago in NYC I served in the mission office and the mission office paid all of the rent for non-Senior full-time missionaries.
Heck this article makes me wonder about my own tax status while I was on my mission. Did my parents file for me, or did I just not file any taxes those years? What about the monthly payments I made to the Church and the monthly stipend I received while out there, which since I was living in NYC, certainly did not match.
In fact while I’m here, thanks everybody for supporting me on my mission. :) There’s no way what I paid in any way measured up to what the Church had to pay to support me.
Rather than the flat tax, I’d go to a consumption tax to replace 100% of current taxation income. Exempt certain consumables (breads, milk, eggs, meat, etc) so that it doesn’t have a negative impact on low-income people just trying to eat, but have it hit things in the realm of luxuries (vacations, hotels, new vehicles, electronics, junk food, cable service, etc).
“Exempt certain consumables”
No, there should be no exemptions. Otherwise you’re giving power to the state to pick winners and losers. Should soda be exempt? It probably would be, even though it’s a gigantic waste of money and bad for you. What about microwave dinners? What about Pellegrino bottles of water? What about caviar… Clothing? What about Air Jordans? etc.
We can’t simply the tax system if we start out replacing it with a line item tax option on every single product in existence — complete with some kind of Office of Taxable Products and associated paperwork, campaigning, lobbying, bribes, etc, to get your product exempted.
If you want to help the poor out, better than removing a tax on food, you should look at something like an earned income credit perhaps.
But this is all besides the point. All this talk of a nationwide tax on consumption is predicated on simplifying the code elsewhere. If there is one thing we can be sure of, it’s that a consumption tax will come and other tax complications will remain. I wouldn’t think we should vote for any single additional tax without dramatically reforming the system first.
Jax, as with a flat tax, moving to a consumption tax wouldn’t solve the problem of the parsonage exemption.
Sam, if all other taxes were removed how would parsonages not be solved? I understand there would be all sorts of problems switching, and have no actual hope that it would happen, but hypothetically, why wouldn’t this solve the problem of exemptions for taxes that would no longer exist?
Jax, housing is consumption. Thus, it would generally be subject to taxation under a consumption tax. Unless you decided to exempt ministers’ housing. That is, there’s nothing inherent in a consumption tax that answers the question of whether ministers should pay taxes on their housing or whether that’s an Establishment Clause issue.
Housing IMO is something that once paid for should have no taxation at all. I don’t think anyone should be taxed for things repeatedly simply because they own something. Taxing it changes the nature of ownership to something that the gov’t allows to happen, “If you don’t pay us for the right to have that property, then we’ll take it away. And you have to pay us year after year after year…” Seems like bad gov’t to me. I can see a one time tax upon purchase (out-right, or by mortgage), after that it is yours – churches can let a minister live there if they like, no exemption required.
I’d like to see this even in our current tax code actually. Wishful thinking I know!!
And yet, Jax, by owning a House, you are consuming city services: fire, police, and ambulance services. School services for whatever school you are zoned for. Here in Europe, on some old houses, there were plaques on the outer wall saying they paid for fire insurance [i.e. property tax]. If that plaque wasn’t there, they wouldn’t put a fire out in your house. Surely as a house owner, you’d like to pay for that service? Hence, a property tax just by owning property.
Anon, as earlier stated, I’d like to see that shift to a consumption tax instead of property tax. Then everyone would be covered without question and this business of the fire department not showing up would be ridiculous. Schools could be funded the same way. I’m not saying I don’t want to pay the taxes to support them, just that I think it would be more fair to simplify the process where everyone pays something, and everyone knows what the rules actually are – rather than the current situation where cronyism has special rules for everyone with enough money to buy them.
Jax — you mean something like the VAT that they use in Europe (which while it is called a “value added tax” is really a segmented sales tax)?
So are nuns supposed to pay income taxes on the value of living in a convent? Monks pay for living in a monastery? Usually when a full time minister is serving a congregation, any house he or she is provided is also an adjunct facility for congregational functions, such as leadership and board meetings, more intimate gatherings for youth, and an office where the minister prepares sermons, conducts church business, and meets with individual members to counsel them.
Most mission presidents live in a “mission home”, a building that includes not only the residence for the mission president’s family, but also for the missionaries assigned there, and those who are transiting in or out of the mission, in addition to the offices where the business of the mission is administered. It can also be used as lodging for visiting General Authorities. The Missionary Training Centers house missionaries for weeks at a time; when I was there, I was not charged rent.
It is not all that unusual for housing to be provided by an employer as a nontaxed benefit, or for substitute payments to be exempt fromo taxation. The US Armed Forces operate government-owned housing, and service members and their families live in it rent free, from dormitories, to the rooms of cadets at the service academies, to three and four bedroom houses and apartments. In areas where there is not sufficient military owned housing, service members receive tax-free allowances to pay for housing, whether an apartment or a purchased house, including supplemental payments for higher cost of living areas.
When you are traveling on business, the cost of lodging is compensated by your employer, as a business expense of the employer, not as income to you, even if it is for weeks at a stretch.
Similar government provided housing is used by forest service National Park Service rangers, and scientists at remote locations like Antarctica. Sailors on board ships, both military and civilian, are provided a bed, where they live for months on end, usually without paying rent for the privilege. People who work on the North Slope in Alaska live for weeks at a stretch in dormitories in those remote locations. Since providing housing as a non-taxed part of employment is so ubiquitous, why should it be problematic when it is done by a church rather than a large corporation or the government itself?
Raymond,
My mission president’s offices were not anywhere near the mission home. Not sure how other missions work, though.
As far as taxing housing goes, there’s a tax difference (if I remember my tax law class) when it’s necessary that an employee sleep in a certain location for his job. If your job requires you to sleep in a certain place, the employer-provided place where you sleep isn’t counted as taxable income. Otherwise, minus certain exceptions, it is taxable.
RTS,
More or less what Tim said. The Internal Revenue Code already allows an employer to live in employer-provided housing tax-free, provided it is (a) on the premises of the employer, (b) for the convenience of the employer (not the employee), and (c) the employee is required to accept the housing as a condition of his or her employment.
Even if (or when) the district court’s opinion is upheld, a church that meets those three requirements will be able to offer tax-free housing to its minister. And, actually, as long as the court doesn’t declare section 107(1) unconstitutional, ministers still have it better than other employees, because they can get tax-free housing even if it’s not on the premises of the church and not required as a condition of their employment. All this opinion addresses is the provision of a housing allowance, tax-free, to ministers.
That is, the issue isn’t that churches won’t be able to do what other employers do; the issue is, they won’t be able to do something no other employer is currently permitted to do.