Clergy Compensation

Tax court decides compensation was reasonable

Truth Tabernacle, Inc. v. Commissioner of Internal Revenue, T.C. Memo. 1989-451

The United States Tax Court addressed the issue of "unreasonable compensation" paid to clergy.

This issue is important for two reasons. First, section 501(c)(3) of the Internal Revenue Code specifies that churches are not eligible for tax-exempt status if they pay unreasonable compensation to any worker. Second, the law does not define "unreasonable compensation," and this makes court rulings interpreting the phrase very significant.

Let's look at the facts of the case. Truth Tabernacle was incorporated as an independent church in 1978. The church was a fundamentalist Christian congregation, and its doctrine included a belief in "the death, burial, and resurrection of the Lord Jesus Christ … the sovereignty of the Church of God … Jesus Christ as the head of the church … resurrection of the dead … and Jesus Christ coming back again to reign as King of Kings and Lord of Lords over all the earth."

The church, which consisted of about 40 members, conducted worship services three times each week. Regular men's and women's Bible classes were held two or three times each month. Sunday School classes were held every Sunday. Saturday night prayer services were conducted each week. The church's pastor (who was an ordained minister) performed sacerdotal functions, including dedications of children, baptisms, funerals, and marriages.

The IRS audited the church in 1986 (the audit covered the years 1983, 1984, and 1985). At the conclusion of the audit, the IRS revoked the church's tax-exempt status retroactively. The IRS alleged that (1) the church was not operated exclusively for religious purposes, and (2) the church paid "unreasonable compensation" to its minister. The Tax Court rejected the IRS position, and ruled in favor of the church.

In rejecting the IRS claim that the church was not acted exclusively for religious purposes, the Court observed: "Petitioner was a small church operating on a modest budget provided by the weekly contributions of its members. Essentially all of its contributions during the audit years were used to pay the mortgage, utility and maintenance expenses on the church building. Its activities primarily consisted of various worship services conducted in the church building and the performance of sacerdotal rites. In our view the [church is operated exclusively for religious purposes]."

The Court noted that in 1983, the church received contributions of $10,700 and incurred expenses of $12,200. In 1984 it had contributions of $13,700 and expenses of $13,500. In 1985 it had contributions of $16,200 and expenses of $16,200. The major expenses each year were the mortgage payments, utilities, and repairs on the church building. The mortgage alone amounted to $5,000 of the church's annual budget.

In rejecting the IRS claim that the church paid "unreasonable compensation" to its minister, the Court noted that the pastor was provided a car and an apartment free of charge (a custodian and a caretaker received rent-free apartments on the church's property in exchange for 20 hours of service each week), but otherwise received no salary. The Court observed that in determining "whether compensation is reasonable or excessive … one factor to consider is whether comparable services would cost as much if obtained from an outside source in an arm's-length transaction.

Applying that standard to the present case, and considering the meager benefits received by the [church's] minister and grounds keepers in return for services that they performed, we find that the benefits were within the bounds of reasonable compensation for those services. Accordingly, there was no inurement of [the church's] net earnings to any private individual …."

It is difficult to comprehend why the IRS challenged the tax-exempt status of a church that so clearly qualified for exempt status. Clearly, if the exempt status of Truth Tabernacle could be challenged, then few churches are beyond challenge.

The Tax Court's decision will be a useful tool in combatting similar efforts in the future.

Charitable Contributions

Another federal appeals court has ruled that payments made to the Church of Scientology for “auditing” and “training” services were properly deductible as charitable contributions.

Another federal appeals court has ruled that payments made to the Church of Scientology for "auditing" and "training" services were properly deductible as charitable contributions.

The IRS had argued that the payments were not deductible contributions since the donors had received a benefit in return for their payments. The appeals court agreed with the IRS that "a payment of money generally cannot constitute a charitable contribution if the contributor expects a substantial benefit in return."

However, it specifically held that "a strictly spiritual or religious return is simply not enough" to make a contribution nondeductible. To hold otherwise would "present not only the problem of determining value but also the problem of excessive entanglement in the affairs of a religious institution," since courts would be required to monitor church records and activities in an attempt "to place a monetary value on the benefit of church services, group programs, and pastoral counseling."

The court observed that "any other conclusion has ominous implications for all religious institutions." Does this ruling lend support to the deductibility of "contributions" made to churches by persons who receive professional counseling from a staff counselor?

A growing number of churches are hiring staff counselors, and many of these churches require counselees to pay an hourly "contribution" for the counseling provided. Could not the Scientology case be cited as precedent in support of the deductibility of these payments? The answer is probably no, since it is likely (though not certain) that a court would conclude that counseling services provided by a staff counselor (particularly one with formal training in psychology) are not "spiritual" or "religious" benefits received in exchange for payments.

The court based its opinion in part on the fact that the "auditing" and "training" services provided by the Church of Scientology were not available from private businesses. If they had been available outside of the Church, the court observed, then it is difficult to characterize the services as "spiritual or religious" in nature. Similarly, it is entirely possible that a civil court would conclude that counseling services provided by a staff counselor in a church are services that could be obtained outside of the church.

If so, such services cannot be characterized as spiritual or religious, and therefore payments made in exchange for such services are not deductible as charitable contributions. The United States Supreme Court has agreed to determine whether payments made to the Church of Scientology for auditing and training services are deductible as charitable contributions. A decision is expected later this year. Neher v. Commissioner, 88-2 U.S.T.C. para. 9430 (6th Cir. 1988).

Clergy – Part 3

Taxation

Church Law and Tax 1988-09-01 Recent Developments

Clergy – Taxation

Representative Leon Panetta (D-CA) has introduced a bill (H.R. 4779) in the House of Representatives that would include housing allowances in clergy compensation for purposes of calculating benefits payable under “defined benefit” pension plans. Many ministers have discovered that maximum annual contributions to a pension plan are tied to a percentage of income. If income is reduced by the amount of a housing allowance, this often will reduce the annual contribution to a pension plan. The Panetta bill, if enacted, would provide clergy with much-needed relief in this area. Unfortunately, however, the bill is limited to “defined benefit” pension plans, which, while popular, do not comprise the only kind of pension plan utilized by clergy.

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