A Federal Appeals Court Addressed the Significant Issue of IRS Authority to Demand Disclosure of Church Records

An IRS agent became convinced that a church official was soliciting donations of depressed real

An IRS agent became convinced that a church official was soliciting donations of depressed real estate to his church at grossly inflated values, with the church thereafter selling the properties at their substantially lower market values. For example, one property donated to the church and valued at $2.3 million was later sold by the church for only $250,000. Another property valued at $622,500 was sold for $50,000. An advertisement in the Wall Street Journal and New York Times read: "Hard to sell, distressed and other real estate accepted by religious corporation. Will structure contribution of real estate to meet need of donor."

The IRS, convinced that "the administration of the income tax laws regarding charitable contributions" was being impeded, served summons on church attorneys demanding production of all church records associated with real estate transactions. The church claimed that the IRS summonses were invalid since they violated both the constitutional guaranty of religious freedom and the "Church Audit Procedures Act." With regard to its constitutional claim, the church contended that the IRS summonses would dissuade donors from making contributions to the church, thereby restricting the church's exercise of its religion.

A federal district court rejected the church's arguments and ruled in favor of the IRS. A federal appeals court affirmed this decision. The appeals court denied that the Church Audit Procedures Act applied in this case, since that Act was not intended to apply to IRS investigations of donor contributions.

With regard to the church's claim that the IRS summonses violated its constitutional right of religious freedom, the court observed: "Even assuming, however, that the IRS investigation has dissuaded some donors from contributing property to [the church], due to their fears that their names will be publicized or they will face potential investigation by the IRS … the claimed impact on free exercise is incidental; contribution to the church is not forbidden, and the summonses do not directly impinge upon any practice central to the religious beliefs of church contributors or members.

To the extent that some donors may be dissuaded from donating property appraised at unjustifiably inflated values and from taking corresponding charitable deductions, we need simply note that such action … is not immunized from governmental investigation."

Furthermore, the court observed that "any incidental burden on the free exercise rights of the church … must be balanced against the government's interest in enforcing the summonses …. A compelling governmental interest exists here—that of enforcing the tax laws." St. German of Alaska Eastern Orthodox Catholic Church v. United States, 840 F.2d 1087 (2nd Cir. 1988)

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