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.