Church Law and Tax 1990-09-01 Recent Developments

Audits – churches

A federal district court in Massachusetts addressed the issue of IRS audits of churches, and ruled that the IRS had exceeded its authority in seeking to subpoena a church’s records. In 1988, an IRS regional commissioner sent a “notice of tax inquiry” to the Church of Scientology of Boston, stating that he had reason to believe that the church might have lost its tax-exempt status because of substantial commercial activities and distribution of funds to private individuals. After receiving written responses from the church to several questions, the IRS determined that an examination of the church’s books, records, and activities was necessary. Accordingly, the IRS sent the church a “notice of church examination.” Following a conference with church officials, the IRS issued a subpoena ordering the church to produce some 200,000 pages of materials. When the church refused to respond to the subpoena, the IRS sought a court order compelling the church to respond. The court began its opinion by noting that “the IRS has broad authority with respect to tax inquiries.” However, this authority is limited in at least three ways. First, Congress “scaled back” this authority when it enacted the Church Audit Procedures Act in 1985. This legislation was enacted “to insure that the IRS does not embark on an impermissibly intrusive inquiry into church affairs.” The Act provides churches with several protections. For example, a “church tax inquiry” can only begin if “a high-level [IRS] official reasonably believes (on the basis of facts and circumstances recorded in writing) that the church may not be exempt, by reason of its status as a church … or may be carrying on an unrelated trade or business … or otherwise is engaged in activities subject to taxation.” Proper notice, including an explanation of the concerns which gave rise to the inquiry, and a statement of the general subject matter of the inquiry, must be given to the subject church. The church also must be apprised of its constitutional and legal protections. Both church records and activities may be examined, but only to the extent necessary to determine either liability for tax or whether the organization in fact qualifies as a church. Examinations must be completed within two years. Second, in addition to the requirements of the Church Audit Procedures Act, several federal court rulings have required that an IRS subpoena of church records must satisfy the following three tests (in addition to satisfying the provisions of the Act): (1) the investigation is being conducted pursuant to a valid purpose, (2) the requested information is necessary to that purpose, and (3) the requested information is not already in the possession of the IRS. Third, federal law provides that if the IRS wants to retroactively revoke the tax-exempt status of a church, then it must show either that the church “omitted or misstated a material fact” in its original exemption application, or that the church has been “operated in a manner materially different from that originally represented.” The court in this case emphasized that the IRS violated both the second and third protections. The second protection was violated since the IRS failed to establish that its massive document request was “necessary” to accomplish its intended purpose. The third protection was violated since the IRS had attempted to retroactively revoke the church’s tax-exempt status without alleging that the church had “omitted or misstated a material fact” in its original exemption application, or that the church has been “operated in a manner materially different from that originally represented.” Accordingly, the court refused to enforce the IRS subpoena. It stressed that “the unique status afforded churches by Congress requires that the IRS strictly adhere to its own procedures when delving into church activities.” The safeguards afforded churches under federal law prevent the IRS from “going on a fishing expedition into church books and records.” United States v. Church of Scientology of Boston, 90-2 U.S.T.C. para. 50,349 (D. Mass. 1990).

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