Church Exemption from Unemployment Tax

Churches are exempt from unemployment taxes in most states.

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.

Rhode Island law exempts from unemployment tax service performed for the same religious organizations exempted under the federal law quoted above. The employee who had been dismissed by the Salvation Army claimed that the exemption of churches was unconstitutional since it singled them out for preferential treatment.

The court's decision

The court applied the United States Supreme Court's so—called Lemon test in determining whether the exemption of churches from the Rhode Island unemployment law constituted an impermissible establishment of religion. Under this test, first announced in a 1971 decision (Lemon v. Kurtzman) , a law challenged as an establishment of religion will be valid only if it satisfies the following three conditions-a secular purpose, a primary effect that neither advances nor inhibits religion, and no excessive entanglement between church and state. The court concluded that all of these tests were met. First, the Rhode Island law had a "clearly secular purpose" which the court described as

the facilitation of the administration of the federal and state unemployment benefits programs by excluding employees who are typically not fully active or permanent members of the stable workforce. The [elimination of the exemption of some nonprofit organizations] does not reflect … an increasing government interest in the promotion of religion. Instead [this reflects] government's recognition of the increasing role that certain nonprofit organizations have in our society as a whole and more specifically in providing members of the stable workforce. Thus, absolutely no sectarian purpose is evinced by these statutes. Any religious benefit that results as a consequence off this secular purpose is purely incidental.

Next, the court concluded that the Rhode Island unemployment law's exemption of churches and certain other charities had a "primary effect" that did not advance religion. The court observed: "It can hardly be said that the government's actions (i.e., unemployment tax exemptions) advance religion. No reasonable person is likely to form a religious belief based in any part on the fact that the organization does not have to pay unemployment tax …. Additionally … the statutes in question provide exemptions to nonreligious groups and services as well. Thus the primary effect of the statutes is not to advance religion." The court pointed out that the exemption of churches actually might be a disadvantage rather than a benefit, since it may discourage persons from wanting to work for them.

Finally, the court concluded that the Rhode Island unemployment law's exemption of churches did not create an excessive entanglement with religion. Quite to the contrary, "rather than promoting entanglement with religion the [law] fosters the separation of church and state that the first amendment requires." Because of the exemption of churches the federal government and state government need not continuously monitor and audit exempt religious organizations to ensure compliance with [the law].

In fact, the Supreme Court addressed this very issue [in 1970], stating that the primary effect of a tax exemption was not to sponsor religious activity but to "restrict the fiscal relationship between church and state" and to "complement and reinforce the desired separation insulating each from the other."

What this means for churches

This case will be a helpful precedent in other states if the exemption of churches from unemployment law is challenged. Unfortunately, the Oregon Supreme Court has ruled that the exemption of churches from the Oregon unemployment law is unconstitutional. Also note that unemployment law and workers compensation are often confused. Churches are exempt from unemployment taxes in most states, but they are covered by workers compensation in many states. Workers compensation is a state program that provides benefits to workers who are injured (or become ill) in the course of their employment. Rojas v. Fitch, 928 F. Supp. 155 (D.R.I. 1996).

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