Dec 05, 2013

Exemption for Rental Allowance to Ministers Ruled Unconstitutional

In the recent case of Freedom From Religion Foundation, Inc. v. Lew, the U.S. District Court for the Western District of Wisconsin ruled that the statute-sanctioned tax exemption for a rental allowance used to rent or provide a home paid to “ministers of the gospel” is unconstitutional. The lawsuit was brought by the Freedom From Religion Foundation (the “FFRF,”) and Richard Bolton, the FFRF’s attorney, held firm that “[t]he Court’s decision does not evince hostility to religion – nor should it even seem controversial.”

Section 107 of the Internal Revenue Code (the “Code”) provides for two parsonage tax exemptions for ministers: (i) an exemption for the value of in-kind housing provided to ministers and (ii) an exemption for a rental allowance provided to ministers.

Judge Barbara Crabb, who authored the decision, maintained that the rental allowance portion of this law has no secular purpose and that a reasonable observer would interpret the tax exemption as an “endorsement of religion.” Specifically, Judge Crabb wrote that the rental allowance “violates the establishment clause … because the exemption provides a benefit to religious persons and no one else, even though doing so is not necessary to alleviate a special burden on religious exercise.”

Of note is that the decision did not address the other important tax exemption in Code Section 107, which provides an income tax exclusion for the rental value of a home provided to a minister (as opposed to a rental allowance). Presumably, therefore, the in-kind housing exemption remains in effect. The Joint Committee on Taxation estimates that the total exclusion under Code Section 107 (e.g., the in-kind exclusion and the cash allowance exclusion) costs taxpayers approximately $700,000,000 annually. Though there is no breakdown between ministers claiming in-kind exclusions and those claiming cash allowance exclusions, presumably a majority of claims under Code Section 107 relate to the rental allowance.

Finally, and as is typical with significant decisions, Judge Crabb’s decision will not take effect until all appeals have been exhausted.

Please contact your tax counsel at Smith, Gambrell & Russell for more information.

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