Update on the Housing Allowance Case

Constitutionality of the housing allowance is being called into question.

Warren v. Commissioner, 2002 WL 338145 (9th Cir. 2002)

In one of the most significant clergy tax cases in recent years, the United States Tax Court ruled in 2000 that a housing allowance is nontaxable for income tax reporting purposes so long as it is used to pay for housing-related expenses. Warren v. Commissioner, 114 T.C. 23 (2000). The court threw out the annual “rental value” test that the IRS adopted in 1971, which limited nontaxable housing allowances for ministers who own their homes to the annual rental value of their home. The IRS appealed the Tax Court’s ruling to a federal appeals court, and the court recently issued a preliminary order requiring the parties, and a law professor, to submit legal briefs to the court addressing the question of whether the housing allowance violates the first amendment’s prohibition of the establishment of religion.

In referring to the housing allowance the court observed that “it appears that no similar exemption is afforded any member of any other profession, whether serving a for-profit or non-profit institution.” This off-hand comment certainly suggests that the court has made up its mind that the housing allowance is unconstitutional. This conclusion is reinforced by the court’s reference to the following quotation from an earlier Supreme Court case,

When government directs a subsidy exclusively to religious organizations that is not required by the free exercise [of religion] clause and that either burdens non-beneficiaries markedly or cannot reasonably be seen as removing a significant state-imposed deterrent to the free exercise of religion … it provides unjustifiable awards of assistance to religious organizations and cannot but convey a message of endorsement to slighted members of the community.

One of the court’s three judges passionately dissented from the court’s order, noting that neither the IRS nor the minister had raised the issue of the constitutionality of the housing allowance and therefore the court should not have done so on its own initiative.

For now, the Tax Court’s decision in the Warren case stands. There are several possible outcomes to this case, including an out-of-court settlement, or a ruling by the court that the housing allowance is or is not constitutional. Any decision finding the housing allowance to be unconstitutional could be appealed to the Supreme Court. Any future developments will be reported immediately in this newsletter.

There is one aspect of this case that should be noted. The court’s recent order does not question the constitutionality of the parsonage exclusion (which exempts from federal income tax the annual rental value of a parsonage provided to a minister on a rent-free basis). Presumably this is because employer-provided housing is a tax-free fringe benefit to a wide variety of taxpayers besides clergy. The Supreme Court has ruled in a number of cases that a tax statute that benefits a wide range of occupations or organizations is not rendered unconstitutional by including clergy or churches on the list. To illustrate, the Supreme Court has ruled that state property tax laws that exempt property owned by several categories of non-religious charitable organizations are not rendered unconstitutional because churches are included on the list. The same principle would apply to the parsonage exclusion. While the benefit of tax-free employer-provided housing applies to clergy, it also applies to several other taxpayers as well.

This article first appeared in Church Treasurer Alert, May 2002.

Richard R. Hammar is an attorney, CPA and author specializing in legal and tax issues for churches and clergy.

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