Unemployment Tax

Church Law and Tax 1989-11-01 Recent Developments Unemployment Taxes Richard R. Hammar, J.D., LL.M., CPA

Church Law and Tax 1989-11-01 Recent Developments

Unemployment Taxes

In a highly controversial decision that eventually may affect churches in other states, the Oregon Supreme Court ruled that all religious organizations, including churches, are subject to state unemployment taxes. Here are the facts. The Federal Unemployment Tax Act (FUTA) contains a set of guidelines that a state’s unemployment tax program must meet in order to avoid federal unemployment taxes. Although compliance with the federal guidelines is optional, states normally comply in order to avoid subjecting local employers to double taxation (under both federal and state law). One of the federal guidelines with which states must comply exempts services performed in the employ of a church, a convention or association of churches, or certain church-controlled organizations from unemployment tax. There is no exemption for religious organizations not affiliated with a church or convention or association of churches. Accordingly, under FUTA, states must subject non-church-affiliated religious organizations to state unemployment tax or risk losing their exemption from federal unemployment tax. However, the Oregon Supreme Court previously had ruled that the state could not make distinctions between church-affiliated and non-church-affiliated religious organizations, since such a distinction “contravenes the equality among pluralistic faiths and kinds of religious organizations embodied in the Oregon constitution’s guarantees of religious freedom.” How should these conflicting provisions be reconciled? The Employment Division of the Oregon Department of Human Resources (the agency responsible for enforcing the Oregon unemployment law) took the position that it had to assess unemployment taxes against all religious organizations—including churches—in order to keep Oregon in compliance with the FUTA guidelines and the Oregon constitution. The Oregon Supreme Court agreed. It emphasized that in order to satisfy the state constitution’s requirement of “treating all religious organizations similarly” it had two options: (1) completely exempt all religious organizations (whether or not church-affiliated), or (2) eliminate the exemption of all religious organizations (including churches). The court elected the second alternative, since the other option would have led to a broader exemption then permitted by FUTA and accordingly would have subjected Oregon employers to double unemployment tax under both state and federal law. The court acknowledged that taxing all religious organizations “creates potential constitutional problems involving the free exercise of religion.” However, it concluded that its decision did not violate the constitutional guaranty of religious freedom. It observed: “When governmental action is challenged as a violation of the free exercise clause of the first amendment it must first be shown that the governmental action imposes a burden on the party’s religion. Assuming that imposing unemployment payroll taxes on all religious organizations will burden at least some of those groups (although not necessarily their freedom of belief or worship), that assumption is only the beginning, however, rather than the end of the inquiry. Not all burdens on religious liberty are unconstitutional. The state may justify a limitation on religion by showing that it is essential to accomplish an overriding governmental interest. In the present case the state of Oregon has two governmental interests which, when taken together, are sufficiently important to support the burden on religion represented by unemployment payroll taxes. There are few governmental tasks as important as providing for the economic security of its citizens. A strong unemployment compensation system plays a significant role in providing this security. Given the existence of FUTA, any state’s unemployment tax must, as a practical matter, comply with FUTA’s requirements or the state’s employers would face a double tax. Such a double tax would, in turn, create a very undesirable business climate in the state. This, combined with Oregon’s constitutional interest in treating all religious organizations equally, creates an overriding state interest in applying the unemployment payroll taxes to all religious organizations. Our construction of the coverage of Oregon’s unemployment compensation taxation scheme does not offend the first amendment’s free exercise clause or … the Oregon constitution.” Perhaps most disturbing is the court’s insensitivity to the imposition of a direct tax upon churches. For example, the court observed that the state “can draw its tax line anywhere it desires” and “may require the Catholic church to pay unemployment taxes for the work performed by nuns and monks.” The court’s ruling is sufficiently flawed that one can hope for a reversal by the United States Supreme Court or the Oregon legislature, or at the least a repudiation by the courts of other states. Employment Division v. Rogue Valley Youth for Christ, 770 P.2d 588 (Ore. 1989).

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