The constitutionality of the ministerial housing allowance benefit is again in question, thanks to one organization’s ongoing efforts to challenge it.
On November 22, 2013, federal district court judge Barbara Crabb of the District Court for the Western District of Wisconsin struck down the ministerial housing allowance as an unconstitutional preference for religion. Freedom From Religion Foundation, Inc., v. Lew, 983 F. Supp. 2d 1051 (W.D. Wis. 2013). The ruling was in response to a lawsuit brought by the Freedom From Religion Foundation (FFRF). The federal government, which defended the housing allowance since it is a federal statute, asked the court to dismiss the lawsuit on the ground that the plaintiffs lacked standing to pursue their claim in federal court.
Standing is a constitutional requirement of any plaintiff in a federal case and generally means that a plaintiff must have suffered some direct injury as a result of a challenged law. The Wisconsin court concluded that the plaintiffs had standing on the ground that they would have been denied a housing allowance exclusion had they claimed one on their tax return. The government appealed this ruling to a federal appeals court (the Seventh Circuit Court of Appeals in Chicago).
On November 13, 2014, the appeals court issued its ruling reversing the Wisconsin court’s decision. Freedom From Religion Foundation, Inc., v. Lew, 2014 WL 5861632 (7th Cir. 2014). It concluded that the plaintiffs lacked standing to pursue their challenge to the housing allowance. The plaintiffs had asserted that they had standing due to their “injury” of being denied a tax-free housing allowance should they claim one on their tax returns. But the appeals court refused to base standing on theoretical injury. It concluded: “Only a person that has been denied such a benefit can be deemed to have suffered cognizable injury. The plaintiffs here have never been denied the parsonage exemption because they have never requested it; therefore, they have suffered no injury.”
It suggested that this deficiency could be overcome if the FFRF’s officers filed tax returns claiming a housing allowance that was later rejected by the IRS in an audit: “The plaintiffs could have sought the exemption by excluding their housing allowances from their reported income on their tax returns and then petitioning the Tax Court if the IRS were to disallow the exclusion. Alternatively, they could have … paid income tax on their housing allowance, claimed refunds from the IRS, and then sued if the IRS rejected or failed to act upon their claims.”
The FFRF responded to the appeals court’s ruling by designating a housing allowance for two of its officers. The officers reported their allowances as taxable income on their tax returns, and thereafter filed amended tax returns seeking a refund of the income taxes paid on the amounts of their designated housing allowances. FFRF claims that in 2015 the IRS denied the refunds sought by its officers (one of whom had died, and was represented by the executor of her estate).
Having endeavored to correct the standing problem, the FFRF renewed its legal challenge to the housing allowance in the federal district court in Wisconsin where the litigation began. Two developments are noteworthy.
First, the US Department of Justice, which defends the constitutionality of federal legislation (such as the housing allowance), filed a brief with the court asking it to dismiss FFRF’s challenge to the constitutionality of the parsonage exclusion. The Department of Justice noted that section 107 of the tax code grants tax exclusions both for the rental value of parsonages provided to clergy as compensation for the performance of ministerial services, and for housing allowances provided to clergy who own or rent their home. But, since none of FFRF’s officers were living in housing owned by FFRF, they lacked standing to challenge the constitutionality of section 107’s exclusion of the rental value of church-owned parsonages.
Second, the Department of Justice brief states that “the United States does not contest plaintiffs’ standing to sue under section 107(2)” (i.e., the housing allowance). This concession means that the federal appeals court will now have the opportunity to address the merits of FFRF’s constitutional challenge to the housing allowance. The appeals court ultimately may rule that the housing allowance is constitutional. Or it may decide that it is not. Either way, the ruling likely will be appealed to the United States Supreme Court.
Should FFRF and its two officers ultimately prevail in their quest to strike down the housing allowance as an unconstitutional preference for religion, what would be the effects for churches and pastors? A ruling by the Seventh Circuit Court of Appeals would apply to ministers in that circuit, which includes the states of Illinois, Indiana, and Wisconsin. It would become a national precedent binding on ministers in all states if affirmed by the Supreme Court—an unlikely outcome because the Supreme Court accepts less than one percent of all appeals. Note, however, that the IRS would have the discretion to follow or not follow such a ruling in other circuits and might be inclined to follow it to promote consistency in tax administration.
Ministers and churches should be aware that the housing allowance remains under attack and one day may be invalidated. Should that occur, two actions will then need to be implemented quickly:
- Since ministers will experience an immediate increase in income taxes, they should be prepared to increase their quarterly estimated tax payments to reflect the increase in income taxes in order to avoid an underpayment penalty. Note that there will be no effect on self-employment taxes for which the housing allowance is not tax-exempt.
- Many churches will want to increase ministers’ compensation to offset the financial impact. Such an increase could be phased out over a period of years to minimize the effects on the church.
For a complete analysis of several tax developments that affect tax reporting by ministers, church staff, and churches, see “Understanding the 2017 Tax Season” in the January/February issue of Church Law & Tax Report—also available on ChurchLawAndTax.com.