In 2013, the American Atheists Inc., Atheists of Northern Indiana Inc., and Atheist Archives of Kentucky Inc. (collectively, the “Atheists”) filed a lawsuit in federal district court in Kentucky, claiming certain Internal Revenue Code provisions preferentially benefit churches and religious organizations. According to the Atheists, the tax code treats religious organizations more favorably than non-religious charities, and this favorable treatment represents an unconstitutional preference for religion in violation of the First Amendment’s prohibition of an establishment of religion.
Although the Atheists did not specifically identify the statutes and regulations they were challenging, the court surmised that the following provisions of the tax code probably were the ones the Atheists were challenging:
Churches are not required to file an application for recognition of tax-exempt status.
In order to receive exemption from federal income tax under section 501(c)(3) of the tax code, organizations must file Form 1023 with the Internal Revenue Service. However, churches are not required to file Form 1023, although many have done so in order to more easily establish their tax-exempt status to assist donors in substantiating charitable contributions and to qualify for various exemptions under state and local laws. Many other churches are covered by a group exemption ruling issued by the IRS to a parent denomination.
Churches are not required to file an annual information return.
Generally, tax-exempt 501(c)(3) public charities must file an annual informational tax return with the IRS on Form 990. Section 6033 of the tax code exempts churches, and some other religious organizations, from the Form 990 filing requirement.
Form 990, with related schedules, is nearly 100 pages, and requires the disclosure of highly confidential financial and operational information, including, but not limited to, the following:
compensation, including deferred compensation, nontaxable benefits, and bonuses, paid to officers, directors, and the highest-compensated employees;
all current and former employees who received more than $100,000 in compensation;
all current and former board members who received more than $10,000;
all first-class travel;
reimbursement of spouses’ travel;
the existence of any “discretionary funds”;
all housing allowances;
club dues;
personal services (maid, chauffeur, and so on);
whether adequate substantiation is required for expense reimbursements;
existence of a compensation committee or consultant;
use of compensation surveys;
whether the board approved all compensation arrangements;
severance agreements;
compensation arrangements based on a percentage of revenue;
number of employees;
number of board members;
number of volunteers;
unrelated business income;
all charitable contributions received from donors;
political activities;
investment income;
financial statements;
loans paid to officers or employees;
itemized noncash contributions of more than $25,000;
recent, substantial changes to governing documents;
minutes of membership and board meetings;
contact information for all board members;
a written conflict-of-interest policy;
a written whistleblower policy;
a records retention policy.
3. Ministers of the gospel are able to receive a tax-free parsonage allowance.
Section 107(1) of the tax code excludes the rental value of a home furnished as part of the compensation of a “minister of the gospel” from his or her gross income. Section 107(2) excludes a housing allowance paid as part of the compensation of a “minister of the gospel” from his or her gross income.
Salaries of ministers of the gospel are exempted from income tax withholding and FICA taxes.
Sections 1402, 3121, and 3401 of the tax code provide exemptions from the income tax withholding requirement and from the Social Security and Medicare tax (collectively, “FICA taxes”) for wages paid for services performed by a minister of the gospel in the exercise of his or her ministry.
The IRS is required to follow specific procedures when examining a church.
Section 7611 of the tax code requires the IRS to follow specific procedures when conducting a “church tax inquiry” or a “church tax examination.” Generally, a “church tax inquiry” is a determination as to whether that entity meets the qualifications to be exempt from federal income tax. A “church tax examination” is an examination of a church’s records or activities.
The IRS may commence a church tax inquiry only if an appropriate high-level Treasury official reasonably believes, on the basis of facts and circumstances recorded in writing, that the church may not be exempt from tax, or may be carrying on an unrelated trade or business, or otherwise may be subject to tax. The heightened requirements outlined in section 7611 only apply to churches and not other tax-exempt organizations.
The court concluded that the Atheists failed to allege an injury-in-fact and their assertion that they would not qualify as a church or religious organization was mere speculation. The court noted that the IRS cited a number of cases where state and federal law have recognized non-theist organizations as tax-exempt religious organizations.
The Atheists’ lawsuit asserted that the tax code’s differing treatment of churches violates the Fifth Amendment’s guaranty of the equal protection of law, and the First Amendment’s ban on any establishment of religion. The Atheists conceded that they had never sought recognition as a religious organization or church under section 501(c)(3). Rather, they asserted that it would violate their sincerely held beliefs to seek classification as a religious organization or church from the IRS. They further claimed that they “suffer from unconstitutional discrimination and coercion arising from their inability to satisfy the IRS test to gain classification to secure the same treatment as religious organizations or churches” under the tax code.
The Atheists’ lawsuit asked the court to issue a judgment “declaring that all tax code provisions treating religious organizations and churches differently than other 501(c)(3) entities are unconstitutional violations of the Equal Protection of the Laws required pursuant to the Due Process Clause of the Fifth Amendment … and the Establishment Clause of the First Amendment of [the] Constitution of the United States of America; and enjoining the IRS from continuing to allow preferential treatment of religious organizations and churches.”
Atheists lacked “standing”
The federal government, which is tasked with the responsibility of defending against challenges to federal laws, including the tax code, asked the court to dismiss the Atheists’ lawsuit on the technical ground that the Atheists lacked “standing” to litigate in federal court.
Standing is a technical requirement in any federal court lawsuit, and derives from Article III of the United States Constitution, which confines the judicial power of the federal courts to actual “cases” or “controversies.” It has been described by the United States Supreme Court as follows:
The party who invokes the power [of the federal courts] must be able to show not only that the statute is invalid, but that he has sustained or is immediately in danger of sustaining some direct injury as a result of its enforcement, and not merely that he suffers in some indefinite way in common with people generally. Doremus v. Board of Ed. of Hawthorne, 342 U.S. 429 (1952).
The Atheists claimed that as a direct consequence of the IRS’s allegedly discriminatory policies, they are injured by being forced “to (1) submit an application for exemption, (2) file Form 1023, or (3) pay the 501(c)(3) application fee that is up to $850,” which establishes their injury is “concrete and particularized, and far from conjectural or hypothetical.”
‘Under the Supreme Court’s holding in ‘Arizona Christian School Tuition Organization v. Winn’, any financial injury that the Atheists allege as taxpayers resulting from the IRS’s purportedly unconstitutional application of the section 501(c)(3) tax exemptions is speculative. Therefore, the Atheists lack standing as taxpayers.’
The court concluded that the Atheists failed to allege an injury-in-fact and their assertion that they would not qualify as a church or religious organization was mere speculation. The court noted that the IRS cited a number of cases where state and federal law have recognized non-theist organizations as tax-exempt religious organizations, and that “a review of case law establishes that the words church, religious organization, and minister, do not necessarily require a theistic or deity-centered meaning.” To illustrate, a federal appeals court concluded that “when a person sincerely holds beliefs dealing with issues of ‘ultimate concern’ that for her occupy a ‘place parallel to that filled by … God in traditionally religious persons’ those beliefs represent her religion.” Kaufman v. McCaughtry, 419 F.3d 678, 681 (7th Cir. 2005). Similarly, another federal appeals court observed, “If we think of religion as taking a position on divinity, then atheism is indeed a form of religion.” Reed v. Great Lakes Cos., 330 F.3d 931, 934 (7th Cir. 2003).
The court also noted that several federal courts have applied a 14-criteria standard introduced in 1977 by the IRS Commissioner to evaluate whether an organization qualifies for church status. The 14 criteria are:
(1) a distinct legal existence; (2) a recognized creed and form of worship; (3) a definite and distinct ecclesiastical government; (4) a formal code of doctrine and discipline; (5) a distinct religious history; (6) a membership not associated with any church or denomination; (7) an organization of ordained ministers; (8) ordained ministers selected after completing prescribed studies; (9) a literature of its own; (10) established places of worship; (11) regular congregations; (12) regular religious services; (13) Sunday schools for the religious instruction of the young; and (14) schools for the preparation of its ministers.
The court noted that the criteria themselves state that “an entity is not required to meet each of the criteria in order to obtain classification as a church for federal tax purposes.”
While the Kentucky court’s ruling will have no binding effect on the appeals court’s consideration, it may be helpful in supporting a reversal of the Wisconsin court’s ruling on two grounds: (1) lack of standing, including taxpayer standing; and (2) the definition of “religion” to include atheism.
As a result, “the Atheists’ assertion that they are subjected to unconstitutional discrimination and coercion due to their alleged inability to gain classification as religious organizations or churches under section 501(c)(3) is mere speculation. At this point, the Atheists have no idea whether they could gain classification as a church or religious organization under section 501(c)(3) because they have never sought such classification. Accordingly, the Atheists have not suffered a particularized injury which is fairly traceable to the actions of the IRS Commissioner.”
The Atheists also claimed that they had a special kind of standing, known as “taxpayer standing,” that did not require proof of direct injury. In general, taxpayers lack standing to challenge federal laws based on their status as taxpayers, since their “injury” is too remote. But in 1968, the Supreme Court carved out a narrow exception in cases challenging legislation on the basis of the First Amendment’s nonestablishment of religion clause. Taxpayers have standing in such cases to challenge direct transfers of tax revenue to religious organizations since “the taxpayer’s allegation in such cases would be that his tax money is being extracted and spent in violation of specific constitutional protections against such abuses of legislative power.” Flast v. Cohen, 392 U.S. 83 (1968).
The Kentucky court concluded that the Atheists lacked taxpayer standing, relying on a 2011 Supreme Court ruling in which the Court ruled that a group of Arizona taxpayers lacked standing to challenge the constitutionality of a state law that gave tax credits for contributions to “school tuition organizations” (STOs). The STOs provided scholarships to students attending private schools, including religious schools. Arizona Christian School Tuition Organization v. Winn, 131 S.Ct. 1436 (2011). The Court noted that the courts have consistently ruled that standing cannot be based on a plaintiff’s status as a federal taxpayer because the “injury” is too remote or speculative. In rejecting the argument that the Arizona tax credit was, in essence, a governmental expenditure for religion, thereby supporting taxpayer standing, the Court pointed to a “fundamental difference between granting a tax credit to taxpayers, and using tax dollars to directly benefit religion.” It observed:
It is easy to see that tax credits and governmental expenditures can have similar economic consequences, at least for beneficiaries whose tax liability is sufficiently large to take full advantage of the credit. Yet tax credits and governmental expenditures do not both implicate individual taxpayers in sectarian activities. A dissenter whose tax dollars are [diverted to religious organizations] knows that he has in some small measure been made to contribute to an establishment [of religion] in violation of conscience. In that instance the taxpayer’s direct and particular connection with the establishment [of religion] does not depend on economic speculation or political conjecture. The connection would exist even if the conscientious dissenter’s tax liability were unaffected or reduced. When the government declines to impose a tax, by contrast, there is no such connection between dissenting taxpayer and alleged establishment [of religion]. Any financial injury remains speculative. And awarding some citizens a tax credit allows other citizens to retain control over their own funds in accordance with their own consciences.
The distinction between governmental expenditures and tax credits refutes [the plaintiffs’] assertion of standing … . [The Arizona tax credit] does not spend a conscientious dissenter’s funds in service of an establishment [of religion] or force a citizen to contribute … to a sectarian organization. On the contrary … Arizona taxpayers remain free to pay their own tax bills, without contributing to an STO. They are likewise able to contribute to an STO of their choice, either religious or secular. And they also have the option of contributing to other charitable organizations, in which case they may become eligible for a tax deduction or a different tax credit. The STO tax credit is not tantamount to a religious tax or to a tithe. It follows that [the plaintiffs] neither alleged an injury for standing purposes under general rules nor met the exception.
The Kentucky court concluded:
Here, the Atheists have not challenged any specific expenditure made by the government. Rather, the Atheists challenge specific provisions of the Internal Revenue Code, contending that they are unconstitutional because tax-exempt organizations are treated differently based upon a “particular organization’s members’ supernatural religious beliefs or lack thereof.” Thus, under the Supreme Court’s holding in Arizona Christian School Tuition Organization v. Winn, any financial injury that the Atheists allege as taxpayers resulting from the IRS’s purportedly unconstitutional application of the section 501(c)(3) tax exemptions is speculative. Therefore, the Atheists lack standing as taxpayers.
3. Establishment Clause
The Atheists in Kentucky claimed that the provisions in the tax code granting favored treatment of religious organizations constituted preferential treatment for religion in violation of the First Amendment’s prohibition of any establishment of religion. The Atheists relied on a 1989 Supreme Court ruling in which the Court concluded that a Texas sales tax exemption for periodicals “published or distributed by a religious faith and consisting wholly of writings promulgating the teaching of the faith lacked sufficient breadth to pass scrutiny under the Establishment Clause.” In other words, the exemption statute applied only to religious periodicals, as distinguished from state property tax exemptions that the Court has deemed to be constitutional, even though they exempt church property from taxation since such laws apply to a wide range of nonprofit organizations of which churches are merely one category. Texas Monthly v. Bullock, 489 U.S. 1 (1989).
The Supreme Court in 1989 concluded, “When government directs a subsidy exclusively to religious organizations … it provides unjustifiable awards of assistance to religious organizations and cannot but convey a message of endorsement to slighted members of the community.”
In the Kentucky case, the court noted that the government claimed that the provisions of the tax code challenged by the Atheists were required by the First Amendment’s guaranty of the free exercise of religion. More specifically, the government argued that these provisions had “the secular purpose of alleviating governmental interference with the ability of churches and certain religious organizations to define and carry out their religious missions.”
The court concluded that it was unnecessary for it to address the Atheists’ Establishment Clause argument since, as the Supreme Court has observed, “standing in no way depends on the merits of the plaintiffs’ contention that particular conduct is illegal.” Warth v. Seldin, 422 U.S. 490 (1975). “Thus,” the Kentucky court concluded, “the fact that the Atheists have properly stated a claim under the Establishment Clause does not obviate the Article III standing requirements.”
Significant relevance to churches and ministers
The Kentucky federal district court’s ruling is not binding legal precedent in any other state, But it still merits attention for the following reasons:
Persuasive precedent
Since the court’s ruling is the first time a federal court has assessed the constitutionality of the tax code provisions providing limited preferential treatment for religious organizations, its opinion may be accorded deference by federal courts in other jurisdictions.
Appeal
The Atheists may appeal the Kentucky court’s ruling. If so, the appeal would be to the Sixth Circuit Court of Appeals, which covers the states of Kentucky, Michigan, Ohio, and Tennessee. The outcome of any appeal will be addressed in a future issue of this newsletter, and in the annual Church & Clergy Tax Guide.
Effects on the housing allowance challenge
Perhaps the greatest significance of the Kentucky court’s decision is its possible relevance to the constitutional challenge to the ministerial housing allowance that remained before a federal appeals court in Chicago as this issue went to press.
In 2013, a federal district court in Wisconsin concluded that section 107(2) of the tax code, which allows ministers to claim a housing allowance exclusion in computing their income tax liability, was an unconstitutional preference for religion in violation of the First Amendment’s ban on any governmental establishment of religion. Freedom From Religion Foundation, Inc. v. Lew, 2013 WL 6139723 (W.D. Wis.2013).
The Kentucky court concluded that the Freedom from Religion Foundation (FFRF) case was inapplicable to the Atheists’ challenge to tax code provisions favoring religious organizations for several reasons. Most importantly, “the plaintiffs in FFRF and the instant case present no facts or authority that establish that an organization expressing atheist beliefs could never qualify as a tax exempt religious organization or church. The FFRF court based its denial of [the government’s] motion to dismiss on the fact that the government admits that plaintiffs could not qualify as ‘churches’ in order to receive the exemption.”
In contrast, the government in the Kentucky case strongly argues that there is no evidence the Atheists could not qualify as a church or religious organization, and the IRS does not admit that the Atheists could not qualify as a ‘church’ in order to receive the exemption. Defendant continually asserts that the Atheists could qualify as a church or religious organization under the challenged tax code provisions. This Court does not find the FFRF court’s finding that “there is no reasonable construction of section 107 [the housing allowance] that would include atheists,” persuasive or applicable to the instant case. Rather, as [the government] points out, in the First Amendment context, atheism is considered a religion because “when a person sincerely holds beliefs dealing with issues of ‘ultimate concern’ that for her occupy a ‘place parallel to that filled by … God in traditionally religious persons,’ those beliefs represent her religion.” Kaufman v. McCaughtry, 419 F.3d 678, 681-682 (7th Cir. 2005). This Court has no basis to presume that the IRS would not adopt the same or similar definition of religion and deny an atheist organization classification due to its alleged lack of supernatural beliefs.
The Wisconsin court’s invalidation of the housing allowance as an unconstitutional preference for religion is on appeal to a federal appeals court in Chicago. While the Kentucky court’s ruling will have no binding effect on the appeals court’s consideration, it may be helpful in supporting a reversal of the Wisconsin court’s ruling on two grounds: (1) lack of standing, including taxpayer standing; and (2) the definition of “religion” to include atheism.
