The recent Supreme Court decision in Catholic Charities Bureau, Inc. v. Wisconsin Labor and Industry Review Commission offers critical insights for tax professionals advising religious organizations on unemployment compensation tax exemptions. This ruling underscores the profound interplay between First Amendment principles and state tax laws, particularly when such laws differentiate among religious practices.

Factual Background

Wisconsin law provides an exemption from unemployment compensation taxes for certain religious organizations. Specifically, Wis. Stat. §108.02(15)(h)(2) exempts non-profit organizations that are both "operated primarily for religious purposes" and "operated, supervised, controlled, or principally supported by a church or convention or association of churches". This state statute mirrors a textually parallel religious-employer exemption found in the Federal Unemployment Tax Act (FUTA), 26 U.S.C. §3301 et seq.. Over 40 states have adopted similar exemptions since Congress enacted FUTA in 1970.

The petitioners in this case are Catholic Charities Bureau, Inc. (Bureau), and four of its subentities: Barron County Development Services, Inc., Black River Industries, Inc., Diversified Services, Inc., and Headwaters, Inc.. The Bureau serves as the social ministry arm of the Roman Catholic Diocese of Superior, Wisconsin. Its mission involves providing services to the poor and disadvantaged as an "effective sign of the charity of Christ". The Bureau explicitly does not distinguish clients, staff, or board members based on "race, sex, or religion".

These subentities provide various charitable services, such as helping individuals with disabilities secure employment and providing daily living services to Wisconsinites with developmental or mental health disabilities. The Roman Catholic Diocese of Superior exercises significant control over both the Bureau and its subentities, with the bishop serving as the Bureau’s president. Employees and service recipients are not required to be Catholic, nor do petitioners engage in religious training or proselytization, adhering to Catholic doctrine that prohibits "misus[ing] works of charity for purposes of proselytism".

Taxpayer’s Request for Relief and State Court Proceedings

In 2016, Catholic Charities sought an exemption from Wisconsin’s unemployment compensation tax under Wis. Stat. §108.02(15)(h)(2). While the Wisconsin Department of Workforce Development acknowledged that petitioners were "supervised and controlled by the Roman Catholic Church," satisfying one criterion, it denied the exemption, asserting they were not "operated primarily for religious purposes". This decision was initially reversed by an Administrative Law Judge, then reinstated by the Wisconsin Labor and Industry Review Commission, and subsequently reversed again by a state trial court.

The Wisconsin Court of Appeals ultimately reversed the trial court, holding that the "provision of charitable social services . . . are neither inherently or primarily religious activities". The Wisconsin Supreme Court affirmed, agreeing that petitioners were "operated, supervised, controlled, or principally supported" by the Diocese but failed the "operated primarily for religious purposes" test. The state’s high court interpreted this phrase to require an inquiry into both an organization’s "motivations" and its "activities". It focused on activities like "worship services, religious outreach, ceremony, or religious education". Applying this standard, the Wisconsin Supreme Court found petitioners’ activities "secular in nature" because they did not "attempt to imbue program participants with the Catholic faith," "supply any religious materials to program participants or employees," or limit services to Catholics. The court also rejected petitioners’ First Amendment arguments, including claims of neutrality violation, on the grounds that the statute did not impose a constitutionally significant burden on their religious practice. Justice Rebecca Grassl Bradley, in dissent, warned that the majority’s approach "engages in religious discrimination and entangles the state with religion in violation of the First Amendment" by explicitly discriminating based on religious criteria, such as adherence to Catholic teachings against proselytization.

The Supreme Court’s Analysis of the Law and Application to the Facts

The U.S. Supreme Court, in a unanimous decision, reversed the Wisconsin Supreme Court, holding that its application of §108.02(15)(h)(2) to the petitioners violates the First Amendment.

Denominational Preference and Strict Scrutiny The Court reiterated that the First Amendment mandates government neutrality between religions and subjects any state-sponsored denominational preference to strict scrutiny. A law that differentiates between religions along theological lines is considered "textbook denominational discrimination". The Wisconsin Supreme Court’s interpretation of the statute imposed such a preference by differentiating based on theological lines. Petitioners’ eligibility for the exemption hinged on inherently religious choices, namely, whether to proselytize or serve only co-religionists. The Court found this akin to a law exempting only organizations that perform baptisms or worship on Sundays, as it establishes a preference based on religious doctrine.

The State argued that strict scrutiny should only apply if the accommodation’s eligibility criteria are the product of "invidious discrimination," drawing on Gillette v. United States, 401 U. S. 437 (1971). However, the Court found Gillette inapposite because the conscientious objector status there was "available on an equal basis" to members of all religions. In contrast, Wisconsin’s interpretation "facially differentiates among religions based on theological choices" (e.g., requiring proselytization or exclusive service to co-religionists). The State’s alternative argument—that petitioners were excluded because they engaged in no "distinctively religious activity" (meaning activities that "express and inculcate religious doctrine")—also failed. The Court clarified that decisions about whether to "express and inculcate religious doctrine" while performing charitable work are "fundamentally theological choices driven by religious doctrine," and a statute excluding organizations on such grounds facially favors some denominations over others.

Failure to Satisfy Strict Scrutiny Since Wisconsin’s law, as applied, granted denominational preferences, it had to be "closely fitted to further a compelling governmental interest". The State put forth two principal interests:

Ensuring unemployment coverage for its citizens: The Court found that Wisconsin failed to show how the theological lines drawn by the statute were narrowly tailored to advance this interest. Petitioners already operate their own unemployment compensation system providing largely equivalent benefits. Moreover, the regime was underinclusive, exempting other religious entities that provide similar services without proselytizing or differentiating based on religion, simply because the work is done directly by a church or its ministers rather than a separate nonprofit. This underinclusiveness "belies the State’s claim of narrow tailoring".
Avoiding entanglement with employment decisions based on religious doctrine: The State argued that resolving misconduct disputes for employees tasked with inculcating religious faith might require deciding compliance with religious doctrine. However, the Court found the exemption overinclusive in relation to this interest. It operates at an organizational level, covering all employees (e.g., the janitor and the priest) equally, rather than being limited to employees actually tasked with inculcating religious doctrine. The poor fit between the State’s asserted interest and the distinctions drawn could not satisfy strict scrutiny.

The Supreme Court’s Conclusions

The Court concluded that Wisconsin had transgressed the fundamental constitutional principle of "neutrality between religion and religion". Because the government distinguished among religions based on theological differences in their provision of services and failed to satisfy strict scrutiny, the judgment of the Wisconsin Supreme Court was reversed and remanded.

Concurring Opinions Offer Additional Insights

Justice Thomas’s Concurrence: The Church Autonomy Doctrine Justice Thomas concurred, arguing that the Wisconsin Supreme Court’s initial holding regarding the definition of the "organization" was also erroneous. He emphasized the First Amendment’s guarantee of church autonomy, which grants religious institutions the right to define their internal governance structures without state interference. Under this doctrine, a religious institution is not solely defined by the corporate entities it chooses to form.

He highlighted three sources for this protection:

The right of association, which gives religious organizations a greater right to control their own affairs.
The close link between matters of religious "faith and doctrine" and "matters of church government".
The understanding that church and state are "two rightful authorities," each supreme in its own sphere.

Justice Thomas explained that while corporate entities are essential for managing temporal affairs, the church autonomy doctrine forbids treating religious institutions as nothing more than these corporate forms. He cited historical examples, such as the New York 1784 Act and President James Madison’s 1811 veto of a bill that attempted to define a church’s internal government through corporate form, illustrating that the corporation is made for the church, not vice versa.

Applying this, Justice Thomas noted that Catholic Charities and its subentities are, "as a matter of church law," an "arm of the Diocese of Superior". The Wisconsin Supreme Court disregarded this structure by relying on their separate corporate incorporation to treat them as distinct, non-religious organizations. This failure to defer to the Bishop’s religious judgment violated the church autonomy doctrine, especially since the Diocese itself would qualify for the exemption.

Justice Jackson’s Concurrence: Interpreting "Primarily for Religious Purposes" Justice Jackson also concurred, agreeing with the majority’s application of the neutrality principle. She offered a distinct interpretation of FUTA’s "operated primarily for religious purposes" phrase in §3309(b)(1)(B), which Wisconsin’s statute tracks. She posited that this phrase refers to an organization’s function (what it does), not its motivation (how or why it does it).

Her reasoning included:

Textual analysis: While "purposes" can mean "intent," it can also refer to "an end or aim to be kept in view," or "the object for which anything is done or made". A motivation-only reading would render the first prong of §3309(b)(1)(B) (operated primarily for religious purposes) largely superfluous, given that the second prong (operated, supervised, controlled, or principally supported by a church) already implies religious motivation. A functional understanding avoids this superfluity.
Legislative history: The House and Senate Reports accompanying the 1970 FUTA amendments provided examples differentiating between exemptible church-related organizations performing ministerial functions (e.g., colleges for ministry, novitiates, houses of study) and non-exempt general charitable functions (e.g., orphanages or homes for the aged). These examples indicate that what the entity does was paramount for the exemption.
Anti-entanglement justification: A function-based reading better aligns with the goal of avoiding state entanglement in church doctrine. Adjudicating unemployment disputes for entities like novitiates, which prepare individuals for religious life, is more likely to involve entanglement (e.g., assessing an employee’s prayers or scriptural teaching) than for general charitable organizations. A motive-focused inquiry, conversely, could also lead to intrusive judicial evaluation of an entity’s "true motivations".

Implications for Tax Professionals

This Supreme Court decision reaffirms that state tax exemptions for religious organizations must be carefully scrutinized to ensure they do not create unconstitutional denominational preferences. For tax professionals, key takeaways include:

Scrutinize Exemption Criteria: Be vigilant in reviewing state tax exemption statutes to identify any language that differentiates among religions based on theological choices or practices (e.g., requiring proselytization, limiting services to co-religionists, or mandating specific "religious activities" in a way that disadvantages certain faiths). Such criteria are highly susceptible to strict scrutiny under the First Amendment’s Establishment Clause.
Understand "Compelling Interest" and "Narrow Tailoring": If a state law appears to create a denominational preference, the burden is on the state to demonstrate a compelling governmental interest and that the law is narrowly tailored to achieve that interest. Tax professionals should be prepared to challenge the state’s rationale if it fails to meet this high bar, particularly concerning underinclusiveness or overinclusiveness in the law’s application.
Church Autonomy is Key: Justice Thomas’s concurrence highlights the importance of the church autonomy doctrine. When advising hierarchically structured religious organizations, ensure that state definitions of "religious organization" or "church" do not impermissibly disregard the internal governance structure as defined by church law. An organization’s corporate structure should not be used by the state to redefine its religious character or relationship to a broader church.
Distinguish Function from Motivation: Justice Jackson’s concurrence provides a valuable framework for interpreting "primarily for religious purposes" in FUTA-parallel state statutes. This interpretation suggests focusing on what the organization does (its function, e.g., preparing individuals for religious life) rather than why it does it (its motivation) or how it does it (its specific activities, e.g., proselytizing). This functional approach is intended to better align with the anti-entanglement goals of such exemptions.

In essence, this ruling serves as a vital reminder that tax exemptions for religious organizations are not merely administrative classifications but are deeply entwined with fundamental constitutional protections for religious freedom and neutrality. Tax professionals must therefore possess a nuanced understanding of these constitutional principles to effectively advise their clients.

Prepared with assistance from NotebookLM.