Exclusion from Income of Minister's Housing Allowance Found Unconstitutional

Back in 2014 the Seventh Circuit Court of Appeals sidestepped the question of whether the allowance of an exclusion for a housing allowance for a minister of the gospel under IRC §107(2) was barred by the U.S. Constitution.  But the method the panel used to sidestep left an obvious route for the issue to come back—and now it has returned to the Courts.

Originally in the case of Freedom from Religion Foundation, Inc. v. Lew, 114 AFTR 2d, ¶2014-5425 issued in November of 2014 the panel found that the organization suing to bar ministers from receiving an exclusion from income for housing allowances did not show any harm to the organization.  The panel noted that the organization had not attempted to receive a similar exclusion for its employees from the IRS.  So, it was the organization that voluntarily treated the payments as taxable to its employees rather than the IRS denying that treatment.

At the time I had noted that the obvious next step was for the organization to ask for such treatment and then come back to Court if the IRS did not allow the claim.  The case of Gaylor, et al v. Mnuchin, et al, W.D. Wisconsin, Case No. 3:16-cv-00215 brings the matter back to the courts.  And, in fact, the case is back before the very trial judge that, in the original case, had found that IRC §107(2) violated the U.S. Constitution.  Not surprisingly, since the Seventh Circuit never actually dealt with that question (disposing of the case on a standing issue), the judge came to the same conclusion this time.

The plaintiffs in this case had filed various amended returns claiming refunds based on excluding a housing allowance from employee’s income.  The IRS paid out the first refund claim without explaining why, but failed to act within six months on another claim and disallowed another entirely.  After the taxpayers filed suit, the IRS did disallow the claim on the one amended return they had not acted on.

Standing to sue is discussed in this opinion on two issues, one raised by the Court itself and another raised by intervening parties (ministers with various churches).  The Court’s worry was about the plaintiff who sued before the IRS disallowed the claim—but the Court found that the statute allows for a suit where the IRS fails to act within six months.

The intervenor’s claims were more interesting—they found there was no standing because the plaintiffs had not shown a future harm is likely.  The Court rejected this view, noting that while the IRS had both allowed and disallowed claims for refunds, only for the disallowed claims did they explain their rationale.  The Court found that the denial, which came with a detailed explanation, was the more likely indicator of future IRS action in this area.

The Court went on to again give its conclusion that IRC §107(2) violated the establishment clause of the United State Constitution.

IRC §107, the provision in question, reads as follows:

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

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

(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 Court, citing Lemon v. Kurtzman, 403 U.S. 602 (1971) found that the law had to be invalidated for violating the establishment clause if any of the following are found to be true:

  • The law has no secular purpose;
  • The law’s primary effect advances or inhibits religion; or
  • The law fosters an excessive entanglement with religion.

The Court then went on to note that it was applying a modified version of the test that could be summarized as determining if the government’s purpose was to endorse religion and whether the statute conveys a message of endorsement, viewed from the perspective of a reasonable observer.  The Court concluded that this law was intended as an endorsement of religion and served no secular purpose.

As the opinion summarizes:

…[A]ny reasonable observer would conclude that the purpose and effect of § 107(2) is to provide financial assistance to one group of religious employees without any consideration to the secular employees who are similarly situated to ministers. Under current law, that type of provision violates the establishment clause.

In reaching this conclusion, I do not mean to imply that any particular minister is undeserving of the exemption or does not have a financial need for one. The important point is that many equally deserving secular employees (as well as other kinds of religious employees) could benefit from the exemption as well, but they must satisfy much more demanding requirements despite the lack of justification for the difference in treatment.

However, having gotten to this point the Court did not have an obvious answer as to what the remedy should be in this case.  The opinion ends with:

I am reluctant to make a definitive determination regarding the appropriate remedy because none of the parties developed an argument in favor of a refund, a particular injunction or both or otherwise developed an argument regarding what the court should do in the event that it concludes that § 107(2) is unconstitutional. Accordingly, I will issue declaratory relief and give the parties an opportunity to file supplemental materials regarding what additional remedies are appropriate, if any. In addition, the parties should address the question whether relief should be stayed pending a potential appeal.

So, what should an adviser working with ministers or churches do at this point?  For now, there’s not really anything to do.  As the last sentence in the opinion notes, it is highly likely this decision will again go before the Seventh Circuit and, potentially, end up at the U.S. Supreme Court, especially if the Court of Appeals sustains the finding of the District Court.

As well, since even the judge ruling in the case couldn’t determine how to proceed with “where do we go next” it is going to require waiting to see what the results are in future litigation.  But certainly, advisers must counsel ministers and churches to keep a close eye on future developments in this matter.