Key point 5-01.02. A “mail order church” is a sham organization that is created in order to reduce or eliminate the founder’s tax liability. Often, such organizations purchase a “church charter” through the mail from an organization that also offers ministerial “credentials.” Such organizations are not recognized as “churches” by the IRS.
In recent years, many taxpayers have attempted to exclude all or part of their income from federal taxation through the creation of a mail order church. The IRS Internal Revenue Manual addresses the subject of mail order churches as follows:
The term “mail order church” refers to organizations set up pursuant to “church charters” purchased through the mail from organizations that claim that the charters and other “ministerial credentials” can be used to reduce or eliminate an individual’s federal income tax liability. Although a “mail order church” is not precluded from exemption, because it is possible for one to be organized operated exclusively for religious purposes, Service experience, as reflected in numerous court decisions, has shown that many are operated for the private benefit of those who control the organization.56 IRS INTERNAL REVENUE MANUAL § 220.127.116.11.11 (1999).
The IRS has challenged the tax-exempt status of several mail order churches on the ground that they fail to meet one or more of the prerequisites of exempt status. The IRS often asserts that mail order churches are ineligible for tax-exempt status since they are not organized or operated exclusively for exempt purposes. This assertion often is based on the following provision in the income tax regulations:
An organization is not organized or operated exclusively for one or more [exempt purposes] unless it serves a public rather than a private interest. Thus, to meet [this] requirement … it is necessary for an organization to establish that it is not organized or operated for the benefit of private interests such as designated individuals, the creator or his family, shareholders of the organization, or persons controlled, directly or indirectly, by such private interests.57 Treas. Reg. § 1.501(c)(3)-1(d)(i)(ii).
A church that exists primarily to serve the private interests of its creator is not serving a public interest and therefore is not organized or operated for exempt purposes. Such a finding will be made whenever a church exists primarily as a means for handling the personal financial transactions of its founder.
Case study. In Revenue Ruling 81-94,58 Rev. Rul. 81-94, 1981-1 C.B. 330. The IRS has stated that its position regarding mail order churches is set forth in this ruling, and, that “numerous court cases have held that, in situations similar to that described in Rev. Rul. 81–94, an organization that serves the private interests of a designated individual rather than a public interest does not qualify for exemption under IRC 501(c)(3).” See IRS INTERNAL REVENUE MANUAL § 18.104.22.168.11 (1999).the IRS denied exempt status to a mail order church founded by a nurse. Following a vow of poverty, the nurse had transferred all of her assets, including her home and automobile, to her church and assigned her secular income to the church’s checking account. In return, all of her expenses, such as her home mortgage and all outstanding credit card balances, were assumed by the church. The nurse also was provided with a full living allowance sufficient to maintain her previous standard of living. The church permitted her to use the home and automobile for personal uses. While the church’s charter stated that it was organized exclusively for religious and charitable purposes, including a religious mission of healing the spirit, mind, emotions, and body, the church conducted few if any religious services and performed virtually no religious functions. The IRS concluded that the church existed primarily as a vehicle for handling the nurse’s personal financial transactions and thus it was operated for the private interests of a designated individual rather than for a public interest.59 See also New Life Tabernacle v. Commissioner, 44 T.C.M. 309 (1982); Solander v. Commissioner, 43 T.C.M. 934 (1982); Self v. Commissioner, 41 T.C.M. 1465 (1981); Basic Bible Church v. Commissioner, 74 T.C. 846 (1980); Southern Church of Universal Brotherhood Assembled, Inc. v. Commissioner, 74 T.C. 1223 (1980).
The IRS often asserts that a mail order church is ineligible for exempt status since its net earnings inure to the benefit of private individuals. A church cannot be exempt from federal income taxes if any part of its net earnings inures to the benefit of a private individual (other than as reasonable compensation for services rendered). Prohibited inurement may be indicated by a number of circumstances, including the following: (1) compensation paid by an exempt organization is excessive in light of services rendered; (2) the value of services performed and of the corresponding compensation paid cannot be established objectively; (3) payments are not compensation for services rendered; (4) material benefits are provided in addition to regular wages; (5) compensation is based on a percentage of a church’s gross receipts; (6) substantially all of a church’s gross receipts come from its minister and are returned to him or her in the form of compensation and reimbursement of personal expenses; or (7) a church exists primarily to facilitate the personal financial transactions of its founder.
To illustrate, inurement has been found in the following contexts: church ministers received fees, commissions, royalties, loans, a personal residence, and a car, in addition to ordinary wages;60 Founding Church of Scientology v. Commissioner, 412 F.2d 1197 (Ct. Cl. 1969), cert. denied, 397 U.S. 1009 (1970).a church devised a formula for determining the percentage of its gross receipts that would be payable to its minister, under which formula the minister received 63 percent of the church’s gross receipts in one year and 53 percent in the next;61 People of God Community v. Commissioner, 75 T.C. 127 (1981). The court concluded that “paying over a portion of gross earnings to those vested with the control of a church organization constitutes private inurement. …”a boilermaker was ordained and chartered as “a church personally” by a mail order organization, took a vow of poverty, continued to work full time in secular employment, assigned his salary to his church account over which he maintained complete control, paid all of his personal expenses out of the church account, and claimed the maximum charitable contribution deduction for the amounts he transferred to the church account;62 Hall v. Commissioner, 41 T.C.M. 1169 (1981). See also McGahen v. Commissioner, 76 T.C. 468 (1981).a married couple was ordained by and received a church charter from a mail order organization, established a church in their home, conducted religious services for between 3 and 10 persons, paid all of their secular income to the church, and received such income back in the form of compensation and a housing allowance;63 Church of the Transfiguring Spirit v. Commissioner, 76 T.C. 1 (1981). In all of the following cases, individuals were ordained by and received a church charter from a mail order organization, established a church in their homes, conducted few if any religious services, assigned their secular income to the church checking account out of which they paid most of their personal expenses, and attempted to claim the maximum charitable contribution deduction allowable for the income assigned. An IRS finding of inurement was upheld in each case. Basic Unit Ministry of Schurig v. Commissioner, 670 F.2d 1210 (D.C. Cir. 1982); Solander v. Commissioner 43 T.C.M. 934 (1982); Riemers v. Commissioner 42 T.C.M. 838 (1981); Southern Church of Universal Brotherhood Assembled v. Commissioner, 74 T.C. 1223 (1980); Bubbling Well Church of Universal Love v. Commissioner, 74 T.C. 531 (1980); Rev. Rul. 81-94, 1981-12 I.R.B. 15.a married couple took a vow of poverty and established a religious order in which they and their children were the only members, assigned all of their secular income to the order, and claimed a charitable contribution deduction for the income assigned;64 Greeno v. Commissioner, 42 T.C.M. 1112 (1981); Granzow v. Commissioner, 739 F.2d 266 (7th Cir. 1984).a taxpayer was ordained by and received a church charter from a mail order organization, established a church in his home, declared himself and two others to be its ministers, assigned all of his secular income to the church, and received substantially all of it back in the form of wages, a housing allowance, loans, and travel allowances;65 Unitary Mission Church v. Commissioner, 74 T.C. 507 (1980). Besides finding the amount of ministerial wages paid by the church to be excessive, the court observed that housing allowances also may be so excessive as to constitute unreasonable compensation. In either case, inurement occurs. The court rejected the church’s argument that the First Amendment prohibits the courts from inquiring into the reasonableness of church salaries, at least where such inquiries involve no analysis of religious doctrine. See also Universal Life Church v. Commissioner, 83 T.C. 292 (1984); Church of Ethereal Joy v. Commissioner, 83 T.C. 20 (1984); Self-Realization Brotherhood, Inc. v. Commissioner, 48 T.C.M. 344 (1984).a church made substantial cash grants to its officers without provision for repayment;66 Church in Boston v. Commissioner, 71 T.C. 102 (1978).and a mail order church could not support substantial payments made to its founder.67 Bubbling Well Church of Universal Love v. Commissioner, 74 T.C. 531 (1980). See also Truth Tabernacle v. Commissioner, 41 T.C.M. 1405 (1981).
Predictably, standards that are comprehensive enough to deal effectively with the abuses of mail order churches may be sufficiently broad to affect adversely some legitimate churches. For example, the Tax Court denied exempt status to a church having 56 members that conducted regular evangelistic worship services, performed baptisms, communion services, weddings, and burials; whose beliefs included the infallibility of the Bible; and whose pastor testified that “we do not have a creed but Christ; no law but love, no book but the Bible.”68 Truth Tabernacle v. Commissioner, 41 T.C.M. 1405 (1981). But cf. Truth Tabernacle, Inc. v. Commissioner of Internal Revenue, T.C. Memo. 1989-451.The IRS contended that the church was not entitled to exempt status since it had not established that (1) its charter or bylaws provided for the distribution of church property to another exempt organization upon dissolution, (2) it was operated exclusively for religious purposes, (3) it was operated for public rather than private interests, and (4) its net earnings did not inure to the benefit of private individuals. In another case, the Tax Court observed: “Until recent years, a mere declaration that an organization was a church was almost enough to assure its treatment as such under the revenue laws. The cynical abuse of the church concept for tax purposes in recent years, however, has made necessary the same critical analysis of organizations claiming exemption on that ground as organizations engaged in admittedly secular activities.”69 Church of Ethereal Joy v. Commissioner, 83 T.C. 20, 27 (1984). An excellent summary of the abuses of mail order churches is contained in the congressional history to the Church Audit Procedures Act.
Key point. Churches, like any other exempt organization, have the burden of proving that they meet each of the prerequisites to exempt status. The burden of proof is not on the IRS to disprove eligibility for exempt status. Many mail order churches have been denied exempt status because they could not prove that they in fact were organized or operated exclusively for exempt purposes or that none of their net earnings inured to the benefit of private individuals.
Many mail order church schemes involve the assignment of a founder’s secular income to his church’s checking account, and the founder’s claiming the largest allowable charitable contribution deduction on his or her federal income tax return. Since a charitable contribution deduction is available only to donors who make contributions to an exempt organization, the deductibility of charitable contributions to mail order churches often is challenged by the IRS. Unless taxpayers can prove that their contributions were made to a church that satisfies the prerequisites to exempt status listed in section 501(c)(3) of the Internal Revenue Code, their deductions will be disallowed. Occasionally, the IRS challenges a charitable contribution to a mail order church on the ground that such a transfer does not constitute a contribution.
To illustrate, in Revenue Ruling 78-232,70 Rev. Rul. 78-232, 1978-1 C.B. 69 (citations omitted).the IRS disallowed a charitable contribution deduction for any part of a taxpayer’s secular income that he assigned to his mail order church’s checking account, since
[s]ection 170 of the Code provides … a deduction for charitable contributions to or for the use of [exempt] organizations. … Section 170(c)(2) of the Code provides, in part, that the term “charitable contribution” means a contribution or gift to or for the use of a corporation organized and operated exclusively for religious or other charitable purposes, no part of the net earnings of which inures to the benefit of any private shareholder or individual.
The term “charitable contribution,” as used in section 170 of the Code, has been held to be synonymous with the word “gift.” A gift for purposes of section 170 is a voluntary transfer of money or property that is made with no expectation of procuring a commensurate financial benefit in return for the transfer. It follows that if the benefits the donor can reasonably expect to obtain by making the transfer are sufficiently substantial to provide a quid pro quo for it, then no deduction under section 170 is allowable.
In the instant case the money deposited by the taxpayer in the … church account was used or available for use for the taxpayer’s benefit. … Accordingly, the amount of the salary checks deposited by the taxpayer in the bank account maintained in the name of the … church is not deductible as a “charitable contribution” under section 170 of the Code.
The Tax Court has observed that “our tolerance for taxpayers who establish churches solely for tax avoidance purposes is reaching a breaking point. Not only do these taxpayers use the pretext of a church to avoid paying their fair share of taxes, even when their brazen schemes are uncovered many of them resort to the courts in a shameless attempt to vindicate themselves.”71 Miedaner v. Commissioner, 81 T.C. 272 (1982)Similarly, a federal appeals court has lamented that “we can no longer tolerate abuse of the judicial review process by irresponsible taxpayers who press stale and frivolous arguments, without hope of success on the merits, in order to delay or harass the collection of public revenues or for other nonworthy purposes.”72 Granzow v. Commissioner, 739 F.2d 265 (7th Cir. 1984).The court ordered a mail order church to pay the government’s costs and attorneys’ fees incurred in contesting the church’s claim of exemption, and warned that in the future it would “deal harshly” with frivolous tax appeals involving mail order churches. Other courts have sustained additions to tax for negligence or intentional disregard of tax laws pursuant to section 6653(a) of the Code.73 See, e.g., Hall v. Commissioner, 729 F.2d 632 (9th Cir.1984); Davis v. Commissioner, 81 T.C. 806 (1983).
There are many potentially adverse consequences that can befall the founder of a mail order church. These include civil fraud penalties, criminal penalties, sanctions and costs of up to $25,000 for claiming a frivolous position, and substantial understatement penalties.74 All of these penalties are discussed in R. HAMMAR, CHURCH AND CLERGY TAX GUIDE chapter 1 (published annually by the publisher of this text).
The IRS is strictly construing the requirements of section 501(c)(3) when assessing the eligibility of a mail order church for exempt status, and it is threatening criminal prosecution of taxpayers who persist in using these tax evasion schemes.
Mail order clergy encounter difficulties in other contexts as well. For example, they have been denied eligibility to conduct marriage ceremonies by some states.75 See section 3-04, supra.