[Episcopal News Service] A federal district judge in Wisconsin has once again ruled that the Internal Revenue Service’s clergy parsonage exemption is unconstitutional, a decision that ultimately could have profound financial effects on many Episcopal clergy members and congregations.

Judge Barbara Crabb, sitting in Madison in the U.S. District Court for the Western District of Wisconsin, said recently that “the plain language of the statute, its legislative history and its operation in practice all demonstrate a preference for ministers over secular employees.”

She rejected the defendants’ claim that the exemption was an effort by Congress to treat ministers fairly and avoid religious entanglement, and was part of a larger effort by Congress to help employees with special housing needs.

“A desire to alleviate financial hardship on taxpayers is a legitimate purpose, but it is not a secular purpose when Congress eliminates the burden for a group made up of solely religious employees but maintains it for nearly everyone else,” Crabb wrote.

“A reasonable observer,” she said, “would view the statute as an endorsement of religion.”

The judge gave all parties until Oct. 30 to suggest what remedies would be appropriate, based on her ruling.

Freedom from Religion Foundation leaders Annie Laurie Gaylor, Anne Nicol Gaylor and Dan Barker have claimed for years that the IRS “parsonage exemption” violates the U.S. Constitution by providing preferential tax benefits to those whom the agency defines as “ministers of the gospel.” (Anne Nicol Gaylor has since died and been replaced in the suit by the personal representative of her estate, Ian Gaylor.)

The plaintiffs say that although the foundation gives them a housing allowance, IRS rules deny their attempts to claim the related expenses under the parsonage exemption because they were not deemed “ministers of the gospel.” Annie Laurie Gaylor is a layperson, as was Anne Nicol Gaylor, her mother. Barker, the foundation’s public relations director, is an ordained minister who the foundation says “gradually outgrew his religious beliefs.”

The case, originally titled Freedom from Religion Foundation v. Geithner and Shulman, was filed in September 2011. The original suit named then-U.S. Treasury Secretary Timothy Geithner and IRS head Douglas Shulman as defendants. The current filing replaced them with their successors, Steve Mnuchin and John Koskinen.

There are also intervenor-defendants: the Diocese of Chicago and Mid-America of the Russian Orthodox Church Outside of Russia and a minister of one of its churches, the Chicago Embassy Church and its pastor, and Holy Cross Anglican Church in Waukesha, Wisconsin, and its rector, the Rev. Patrick Malone.

The court’s decision, which will be litigated for several years and no doubt reach the U.S. Supreme Court, does not apply to clergy who live in church-owned housing, such as rectories. Those clerics can continue to exclude the fair rental value of that home from their income for tax purposes under Section 107(1) of the federal tax code.

The employers of most but not all clerics who do not live in church-owned housing designate a portion of a cleric’s salary as a housing allowance. However, if such clerics plan to seek the IRS-allowed parsonage exemption, they must have their employers officially declare (by way of a resolution passed by the organization’s governing body) a specific amount of money that the cleric intends to claim on his or her taxes in the following year.

If the cleric can later document the amount of eligible expenses, that amount may be deducted from the cleric’s taxable income. Those expenses include furnishings, maintenance and repair, and certain supplies. For instance, if the enabling resolution sets the amount at $10,000 but the cleric can only document $9,000 in allowed expenses, then only the smaller amount can be deducted. If the cleric had $11,000 in allowed expenses, only $10,000 can be deducted. There is no tax penalty for overestimating the parsonage allowance.

Retired and disabled clergy can continue to claim the annual exemption and, in fact, all retirement benefits from the Church Pension Fund come to recipients with the IRS-required housing allowance designation.

More information about how parsonage allowances work is available in the current Church Pension Group tax guide on pages 12-16.

The federal government appealed Crabb’s original 2013 ruling, and the Court of Appeals for the Seventh Circuit vacated her judgment on the grounds that plaintiffs did not have standing to sue because they had not “personally claimed and been denied the exemption.” In her latest ruling, Crabb said the IRS, the foundation and its representatives all agreed that this had since happened and seemed likely to happen again.

“The practical effect of any ruling will be delayed until the appeals are exhausted, which could take several years,” the Church Alliance – a coalition of 38 church benefit programs that serve mainline Protestant denominations, two branches of Judaism and Catholic dioceses, schools and institutions said in a statement on its website. The group filed an amicus curiae brief when the federal government appealed Crabb’s first ruling.

“As the litigation proceeds, the Church Alliance will assess the viability of legislative options to remedy, if possible, or mitigate the impacts on clergy retirement and welfare benefits of such a ruling,” the group said.

Congress’s Joint Committee on Taxation has estimated that the exclusions allowed to ministers for housing costs amount to $3.8 billion between 2013 and 2017.

Although Church Pension Group has also predicted that the lawsuit will be litigated for years, it warned in its latest tax guide that “ministers and churches should be aware that the housing allowance remains under attack, and one day may be invalidated.”

If that happens, CPG said two things must be done immediately. Because ministers covered by the disputed tax code section “will experience an immediate increase in income taxes,” they would need to increase their quarterly estimated tax payments to avoid an underpayment penalty. Most clerics make such quarterly payments because the IRS treats them as self-employed. CPG also noted that “many churches will want to increase ministers’ compensation to offset the financial impact.” Such an increase could be phased in over a period of years to minimize the impact on the church, CPG suggested.

— The Rev. Mary Frances Schjonberg is interim managing editor of the Episcopal News Service.