• Key point 2-03. Clergy compensation consists of a number of items that often are not well understood. Clergy compensation that is unreasonable in amount may jeopardize a church's tax-exempt status or trigger "intermediate sanctions" in the form of excise taxes that can be assessed against a recipient of unreasonable compensation.
* A Maryland court ruled that it was not barred by the first amendment from resolving a lawsuit brought by church members claiming that their church acted improperly in paying off the home mortgage loans of the church's pastor and his son. A church congregation voted to sell the church property to another church for $900,000 in a duly called special business meeting. The congregation later convened another meeting to determine how to use the sales proceeds. A majority voted to use $400,000 to pay off mortgage loans on homes owned by the pastor and his son. Some of the church's members filed a lawsuit contesting the use of the sales proceeds to pay off mortgage loans on the two homes. The church responded by claiming that the civil courts are barred by the first amendment guaranty of religious freedom from interfering with a church's disposition of its assets. The church also insisted that its payment of the mortgage loans represented compensation for past services for which the pastor and his son had not been adequately paid. A trial court concluded that "what the church tried to do for the pastor was to give him a gift," and that "there is not a shred of evidence that any of this money was payment for his past pastor services, or that he expected to get this money. In short, there was never any agreement that these monies were in lieu of or in addition to salaries, and the court rejects that argument by the church, and finds that these payments, although motivated by apparently the good intentions and good heart of some of the members of the church, were gifts that were earmarked for the individual enrichment and private benefit of the pastor and his son. Accordingly, the court finds that these monies, totaling $400,000, belong to the church, were illegally removed from the church's funds, and have generated the need for an accounting of all of the funds and the need for a receiver to do so." The court appointed a receiver to take possession of the church's assets and retrieve any assets improperly distributed. The church appealed the trial court's ruling.
The first issue addressed by the appeals court was whether the first amendment guaranty of religious freedom barred the civil courts from deciding "how a religious organization uses its funds." The court concluded that it did not, for two reasons. First, the church's payment of the two home mortgage loans "presents a form of church property dispute" which the civil courts have been willing to resolve so long as they can do so without any interpretation of church doctrine. Second, the court referred to several cases in which the courts have determined whether or not religious organizations are in compliance with the requirements for tax-exempt status enumerated in section 501(c)(3) of the federal tax code. The court concluded, "Numerous cases involving an IRS analysis of a religious corporation's operations to determine exemption qualification, or revocation, make plain that there is no bar to such decisions imposed by the [first amendment's] free exercise clause." The court noted that the inquiry into the church's operations undertaken by the trial court in this case did not approach the "degree of review" involved in these other cases.
compensation for services
The church insisted that the mortgage payments were reasonable "deferred" compensation. The court began its analysis by listing the "most frequently cited list" of factors used by the courts in evaluating the reasonableness of compensation:
Although every case of this kind must stand upon its own facts and circumstances, it is well settled that several basic factors should be considered by the court in reaching its decision in any particular case. Such factors include the employee's qualifications; the nature, extent and scope of the employee's work; the size and complexities of the business; a comparison of salaries paid with the gross income and the net income; the prevailing general economic conditions; comparison of salaries with distributions to stockholders; the prevailing rates of compensation for comparable positions in comparable concerns; the salary policy of the taxpayer as to all employees; and in the case of small corporations with a limited number of officers the amount of compensation paid to the particular employee in previous years. The action of the board of directors of a corporation in voting salaries for any given period is entitled to the presumption that such salaries are reasonable and proper. Mayson Mfg. Co. v. Commissioner, 178 F.2d 115 (6th Cir. 1949).
The court concluded that the trial court was too restrictive in determining the reasonableness of compensation paid to the pastor and his son. It observed, "A religious or charitable corporation may take past services into consideration, with the other circumstances described above, in compensating an employee, as may a court when that compensation is challenged. The trial court's standard, that only the unpaid balance of amounts previously contractually promised may be paid in recognition of services previously rendered [was too restrictive]."
In support of its conclusion the court noted that the tax code permits the IRS to assess substantial excise taxes (called "intermediate sanctions") against the officers of a tax-exempt organization who benefit from an "excess benefit transaction," and pointed out that the tax regulations specify that "services performed in prior years may be taken into account" in determining reasonable compensation in the current year. The court also relied on the following conclusion from a previous case addressing the reasonableness of $1,500 "bonuses" paid by a nonprofit hospital to staff physicians in excess of their stated compensation:
The payment of incentive compensation in the form of a bonus to employees who render continuous and efficient services is a common practice of long standing among large employers. While incentive compensation of that kind must bear some reasonable relation to the value of the services rendered, ordinarily a bonus which bears a reasonable relation to the value of the services rendered, which is deemed to further the best interests of the corporation, and which is paid in good faith is not a mere gift, gratuity, or reckless expenditure of which stockholders or shareholders may complain in an action of this kind. It cannot be said that under the facts and circumstances as found by the court, the payment of the [bonus] to the doctors constituted such reckless or extravagant expenditure of funds as to warrant the appointment of a receiver for the corporation or the rendition of a personal judgment against the directors authorizing the payment. Beard v. Achenbach Memorial Hospital, 170 F.2d 859 (10th Cir. 1948).
The court concluded that the church members had established a "prima facie case" of unreasonable compensation "through the substantial sums paid for the benefit of the church's pastor and a member of his family." As a result, it sent the case back to the trial court to further address the question of what was fair and reasonable compensation for all of the services of the pastor and his son, including past services, in light of the purposes of the church. The court admonished the trial court that it was "not faced with a binary choice between zero and the amounts paid for release of the [mortgage] liens," but rather should view the issue of reasonableness as a "spectrum."
Application. This case is important because of the court's enumeration of the factors to be considered in evaluating the reasonableness of compensation paid to employees of churches and other tax-exempt organizations. Also significant was the court's conclusion, based on prior cases and the income tax regulations, that it is appropriate to consider "services performed in prior years" in evaluating the reasonableness of compensation. First Baptist Church v. Beeson, 841 A.2d 347 (Md. App. 2004).
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