• Key point. Churches are exempt from unemployment tax in most states.
A federal court in Rhode Island ruled that the exemption of churches from unemployment tax did not violate the first amendment's nonestablishment of religion clause. The Salvation Army dismissed an employee for budgetary reasons. The employee applied for unemployment benefits, and was informed that she was not eligible since her former employer was a religious organization that was exempt from unemployment tax. The employee filed a lawsuit claiming that the exemption of religious organizations from the unemployment law violated the first amendment. A federal court disagreed in an important decision that reaffirms the historic exemption of churches from unemployment taxes.
Congress enacted the Federal Unemployment Tax Act (FUTA) in 1935 in response to the widespread unemployment that accompanied the great depression. The Act called for a cooperative federal—state program of benefits to unemployed workers. It is financed by a federal excise tax on wages paid by employers in covered employment. An employer, however, is allowed a credit for "contributions" paid to a state fund established under a federally approved state unemployment compensation law. All fifty states have employment security laws implementing the federal mandatory minimum standards of coverage. States are free to expand their coverage beyond the federal minimum.
Prior to 1970 the Act exempted most nonprofit organizations, including churches, from coverage. This meant that charities were exempt from paying both federal and state unemployment taxes. A 1970 amendment narrowed this broad exemption of nonprofit organizations by conditioning federal approval of state compensation plans on the coverage of all nonprofit organizations except those specifically exempted. The Act was then amended to exempt service performed in the employ of (1) a church or convention or association of churches, or (2) an organization which is operated primarily for religious purposes and which is operated, supervised, controlled, or principally supported by a church or convention or association of churches.