(Note: this is the fourth installment of a series (Part 1: Money for Nothing and the Housing for Free; Part 2: Pastors’ Housing, Take 2; Part 3: Pastors’ Housing Revisited) that spans four years and isn’t over yet.)
Today, a district court in the Western District of Wisconsin ruled that section 107(2) of the Internal Revenue Code is unconstitutional. Again.
So what’s section 107(2)? And what relevance could it possibly have for a Mormon blogging audience? I’m so glad you asked.
Background
Generally speaking, if your employer provides or pays for your housing, you have to include the value of that housing or the amount you receive as a housing allowance in your gross income.
There are a handful of exceptions to this general rule, though. And the one we care about is this: a “minister of the gospel” doesn’t have to include the value of housing provided as compensation in her gross income. If her employing church doesn’t provide housing, but instead provides a “rental allowance” as part of her income, she can exclude that to the extent the amount doesn’t exceed the fair rental value of her housing.
Several years ago, the Freedom From Religion Foundation challenged the constitutionality of the provision. Several of its executives argued that it unfairly benefited religion, because they couldn’t exclude the rental allowance that their employer, the Freedom From Religion Foundation, provided them.
The district court found in their favor, even though, it turned out, they hadn’t bothered to claim the allowance on their tax returns. The Seventh Circuit reversed, holding that the plaintiffs lacked standing (because they hadn’t suffered an injury). In a footnote, it suggested that, if they claimed the exemption on their tax returns and their claim was rejected, they may well have standing.
So they did, and the government didn’t challenge their standing.
So What Just Happened
When I posted on this a year ago, I predicted that the district court would find section 107(2) unconstitutional. And I was right! (Btw, this is relatively important. Because the Freedom From Religion Foundation doesn’t own the housing where its executives live, they didn’t have standing to challenge the exemption for in-kind housing provided to “ministers of the gospel”; the court only ruled that the exemption for rental allowances was unconstitutional.)
I also predicted that, getting to the merits, the Seventh Circuit would probably find the same thing. After reading the new opinion, I’m more convinced of that than I was before. The court sets out an airtight case (or, at least, as airtight a case as an Establishment Clause decision can possibly be) for the unconstitutionality of the parsonage allowance. The case is evenhanded and thorough, and even if the Seventh Circuit wanted to reverse it (and I don’t know whether or not the judges on the Seventh Circuit do), they would have to work to find a way to reverse it.
Interestingly, the court didn’t order any particular remedy. It requested briefing from the parties about what the appropriate remedy would be. Which means that there will be more to this story, and more to this series.
The court also provided a framework for Congress for how they could amend section 107(2) in a manner that would comply both with the reasons given for the allowance (specifically, to help poor ministers and poor congregations) and the Constitution.
How Does This Affect the Church?
Some Mormon leaders get a tax-free rental allowance. So if today’s decision stands, what happens to them?
In the first instance, their after-tax income goes down. Suppose we have a flat tax at a 25% rate. Further suppose that the relevant Mormon leader is paid $100,000.[fn1] If the church designates $10,000 of his pay as a rental allowance, that means he pays $22,500 in taxes (that is, $90,000 x 0.25). After taxes, then, he has $77,500.
If the parsonage allowance goes away, he has to pay taxes of 25% on his full $100,000, leaving him with $75,000 after taxes. In other words, he has $2,500 less in after-tax dollars.
So are church leaders out of luck? Not necessarily. The church can do two things to ensure they have the same after-tax income as before, though both cost money. On the one hand, the church could gross them up. A pre-tax salary of $103,333.33 will leave him with an after-tax income of $77,500.
Alternatively, the church can buy housing for the those church leaders who get a rental allowance. (Remember, the decision only finds the rental allowance unconstitutional; it doesn’t address the in-kind provision of housing.) Then the church could provide the housing and would only have to pay $90,000 (which would leave $77,500 after taxes).
Which is to say, this wouldn’t be cataclysmic for the church. It would either represent additional cost, or a haircut for church leaders, but there are ways to adjust.
[fn1] Note that I’m not suggesting that Mormon leaders earn $100,000, any more than I’m suggesting that we have an income tax with a flat 25% rate. Those two numbers just make the math easier.
By Common Consent, a Mormon Blog 
You may be a step ahead of yourself in suggesting remedies. For example (and as referenced by the court, more or less clearly), in other housing allowance contexts we look to required locations (on campus) or multiple use (required entertainment and business use) or time limits (temporary housing) or income limits (overseas housing). It seems that any or all could reasonably come into play for a corrected parsonage exemption, and would have differing impacts on the variety of ways housing comes into play in LDS practice.
Why can’t the remedy be that all similarly situated non-profits get the exemption, not that Mormons lose it?
Chris, that’s a good point. Church leaders still have access to standard housing exemptions, provided they can qualify (though the for the convenience of the employer test might be hard to meet).
Carolyn, that would certainly be permissible. It would have to be a legislative change, though; it’s not something the courts can do on their own. It would be expensive, though, and pretty unnecessary and distortive. I can’t see a strong justification for it.
For example, mission presidents (away from home, relatively short period, multiple uses for the residence) seem most likely to survive any new test. But mission presidents are also the most likely to be provided church owned housing in the first place. I suspect that the 107(2) cash allowance rule will ultimately collapse completely, as case-by-case analysis reveals that when you take away the subsidy to religion aspect there’s nothing left that we care to fund.
As the author previously noted, “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.”
The exemption seems a relic of an earlier era, when most people at least claimed that religion (implicitly some or most forms of Christianity) was a good thing and that ministers generally helped people (by providing advice, comfort, sacraments, etc.), and legislators therefore thought it would be a good idea to help them financially in this way. I wonder if the exemption for housing directly provided for ministers was in some sense justified by a notion that having ministers housed in a known and convenient location such as a parsonage helped people contact them when they had need.
Since the last time I posted, I have spent a bunch of time with the history of these provisions. The in-kind provision has its genesis in some Treasury decisions in the late-19-teens, early 1920s. Treasury found that a number of different types of workers could exclude housing from their gross income when housing was provided for the convenience of the employer (the first, I believe, was seamen). Treasury decided unequivocally, though, that ministers didn’t qualify. Congress legislatively reversed the decision.
Then, in the 1950s, Congress became concerned that the provisions discriminated against poorer religions that couldn’t afford a formal parsonage. That’s when they added in the tax-free rental allowance.
With both parts, Congress overshot their goal, but in neither case was the goal to explicitly favor religion as compared with nonreligious employees (though arguably, rhetoric aside, the 1950s version did, in fact, want to favor religion).
@ Sam Brunson
In your research, did you run across the details as to why “basketball ministers” have been mentioned so often in the FFRF litigation and in the Forbes.com coverage of this issue?
I think Judge Crabb’s ruling may be the first time any Court ever made reference to the Jobe case, and even now it is somewhat indirect because of Judge Crabb’s reference via the Adam Chodorow article.
I thought the case could be made for FFRF “standing” in the earlier case, but the FFRF was not prepared at that time to file for Supreme Court review.
In this case, I again hope “standing” will survive and the appeals court will deal with the merits.
I am not a lawyer or the son of a lawyer, but I am fearful that the appeals court might rule that the FFRF/Gaylor/Barker have “standing”, but only for purposes of determining whether or not they get the refund; not whether IRC 107 is UNconstititonal.
In other words, the Court could decide the refund case without reaching the constitutional issue; that also might set up an opportunity for the FFRF to appeal to the Supreme Court.
Of course, if the FFRF position survives the expected appeal, then the Government would be expected to move the case to the Supreme Court for review.
If you’re interested in a quick take on the potential remedies parties have suggested for this case, I have a new post up at Surly.
And Robert, I suspect that the reference to basketball coaches who are considered ministers for this purpose is because of the outrageousness that a religious person who coaches basketball can claim to be a “minister of the gospel,” while a nonreligious coach can’t. The provision is, if not abused, at least horribly stretched in a large handful of cases; that doesn’t add to the unconstitutionality, but it does underscore the problems that inhere to section 107(2).
@ Sam Brunson
I am familiar with the history of the “basketball minister” angle in the FFRF case.
It goes back to the time when George H.W. Bush and Omar Burleson stepped in on behalf of Abilene Christian University to try to help it out with an IRS controversy without having to go to court. It worked. Bush & Burleson, at the highest levels, got the IRS to fold and Rev. Rul. 70-549 was issued.
That history and that ruling ultimately led to Oklahoma Christian’s Jerry Jobe, a “basketball minister” to win his case; which is referenced in Judge Crabb’s ruling via the Chodorow article.
For a little more about how that has worked, see the following article which was written by people who did not actually know the history of why it is that so many “ministers” employed by private schools get the income tax free benefit.
http://pepperdine-graphic.com/what-is-a-minister/
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