Appeals court upholds federal tax exemption for clergy housing expenses

Decision could be appealed to the Supreme Court

By Mary Frances Schjonberg
Posted Mar 18, 2019

[Episcopal News Service] In the latest installment in a nearly decade-long effort to have the Internal Revenue Service’s clergy parsonage exemption declared unconstitutional, the 7th U.S. Circuit Court of Appeals has ruled just the opposite.

A three-judge panel said March 15 that the principal effect of the tax exemption is “neither to endorse nor to inhibit religion, and it does not cause excessive government entanglement.”

Judge Michael B. Brennan of the 7th Circuit, writing for the unanimous panel, said, “Any financial interaction between religion and government – like taxing a church, or exempting it from tax – entails some degree of entanglement.” But, he wrote, only “excessive entanglement” violates the U.S. Constitution’s Establishment Clause. The clause in the First Amendment prohibits the government from establishing an official religion, unduly favoring one religion over another, favoring religion over non-religion or vice versa.

The opinion marked the second time that 7th Circuit has overturned Judge Barbara Crabb of the U.S. District Court for the Western District of Wisconsin, who has ruled that IRS Code Section 107(2) is unconstitutional. That section allows the exclusion from taxable income of cash housing allowances to “ministers of the gospel,” if certain conditions are met. Certain nonreligious housing allowances also are exempted from tax, such as for military personnel.

The Justice Department called the ruling a win for the religious protections enshrined in the Constitution.

“The tax code treats ministers the same as hundreds of thousands of nonreligious workers who receive tax-exempt housing for their jobs – that’s not special treatment, it’s equal treatment,” Luke Goodrich, vice president and senior counsel at Becket Fund for Religious Liberty, a nonprofit law firm that intervened in the lawsuit on behalf of various ministers, told the Milwaukee Journal Sentinel.

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 religious leaders. (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.”

Reacting to the latest ruling, Gaylor called the exemption “so clearly a handout to churches and clergy, and it so clearly shows preferential treatment and discriminating in favor of ministers.”

Brennan, a President Donald Trump appointee who has been on the court since May 2018, wrote that the foundation says the exemption “‘renders unto God that which is Caesar’s.’ But this tax provision falls into the play between the joints of the Free Exercise Clause and the Establishment Clause: neither commanded by the former, nor proscribed by the latter.”

The foundation said the court’s reasoning “shows that ministers are not entitled to the benefit, therefore Congress could repeal it.”

“It’s an injustice not just to us, but to taxpayers who have to pay more than their share because clergy pay less,” Gaylor said.

Gaylor told the Associated Press that the foundation was weighing whether to ask the full Seventh Circuit to review the case or take it to the U.S. Supreme Court.

U.S. Department of Justice spokeswoman Kelly Laco called the ruling “a win for the religious protections enshrined” in the Constitution, the Milwaukee Journal Sentinel reported.

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 Russian Orthodox Church Outside of Russia’s Diocese of Chicago and Mid-America 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 other judges on the panel were William Bauer and Daniel Manion.

How the tax exemption works

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.

Clergy may use the exemption for rent or mortgage as well as for home improvements and maintenance up to the fair market rental value of their home. Congress’s Joint Committee on Taxation has estimated that the exclusions allowed to ministers for housing costs amounted to $3.8 billion between 2013 and 2017.

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 2019 tax guide offered by the Church Pension Group.

The case, which will be litigated for several years and could reach the U.S. Supreme Court, does not apply to clergy who live in church-owned housing, such as rectories. Loss of the tax exemption would have a major financial impact on clerics of all faith traditions who do not live in church-owned housing.

– The Rev. Mary Frances Schjonberg is the Episcopal News Service’s senior editor and reporter.