The Tax Court recently ruled that personal transfers from church members to their pastor constituted taxable income even though not receipted by the church.

A church’s founding pastor received no salary for 13 years. He was financially sustained in three ways:

• Members made donations that exceeded $200,000 annually. The church used blue envelopes for donations by members to the pastor. The pastor first told his congregation about the blue envelopes at the church’s annual business meeting. He explained that if members were so inclined they could donate to him in blue envelopes but they wouldn’t get a tax deduction. All the blue envelopes were handed over to the pastor unopened.
• The pastor also received a housing allowance of $6,500 per month.
• The pastor received fees from speaking engagements in other churches of up to $40,000 annually.

The pastor did not report any of the “blue envelope” donations from members of his church as taxable income on his Form 1040. The IRS audited the pastor’s tax returns, and claimed that these offerings were taxable income rather than nontaxable gifts. The pastor appealed to the Tax Court.

The Court began its opinion by noting that the tax code defines taxable income to include compensation for services. The Court conceded that the tax code exempts gifts from taxation, but noted that this exclusion does not apply to “any amount transferred by or for an employer to, or for the benefit of, an employee.” IRC 102(c). But the IRS did not press this point, and the Court concluded that “it’s unclear whether it could apply” since “we can’t say that the individual church members are [the pastor’s] employers.”

Donations to clergy

The Court noted that prior cases involving donations to clergy demonstrate that the following four factors are important in distinguishing between taxable payments and gifts:

1. Whether the donations are objectively provided in exchange for services. The court concluded that this factor supported taxation of the blue envelope offerings: “We cannot find objective signs that the blue-envelope donations were unrelated to future services. This case isn’t anything like those with retiring ministers, for example, where the congregations quite clearly understood that the additional retirement payments had nothing to do with services” (referencing the Mutch and Schall cases described further below). . . .” The pastor founded the church and was a devoted pastor. “Although he didn’t explicitly agree to provide future services only in exchange for blue-envelope donations, we don’t think that that proof of his subjective intent is required either. . . . We do therefore find that by this measure the contributions made in blue envelopes were not gifts as that term has developed in tax law, but are rather—from an objective perspective—meant to keep [the pastor] preaching where he is.”
2. Whether the minister (or other church authorities) requested the personal donations. The Court stressed that the pastor “introduced the blue envelopes at the church’s annual business meeting, where he explained that members could use them to make personal donations to him but that there would be no tax deduction if they did. It seems that that was the last time anyone from the church talked about the blue envelopes with the congregation.”
3. Whether the donations were part of a “routinized, highly structured program,” and given by individual church members or the congregation as a whole. “There are things about the donations here that show a routinized, highly structured program. The blue-envelope system in and of itself is evidence of a structured program: The envelopes say ‘pastoral gift’ on them, and they list all the necessary information about [the church] and how to make checks out to [the pastor] personally. Donations made in these envelopes are objectively different from the occasional twenty dollar gift spontaneously given by a church member after an inspiring sermon. . . . We also can’t ignore the sheer size of blue-envelope donations in 2008 and 2009, or the fact that they are very similar in amount in both years—within 10% of each other. We find it more likely than not that this means there was a regularity of the payments from member to member and year to year, which indicates that they were the result of a highly organized program to transfer cash from church members to the pastor. These are regular, sizable payments made by people that [the pastor] provides a service for, and they are therefore hard to distinguish from compensation.”