A taxpayer did not pay federal income taxes or self-employment taxes for six years. He was audited by the Internal Revenue Service (IRS) and was assessed back taxes and penalties. The IRS rejected his defense that he was “functioning as a church."
On appeal, the US Tax Court agreed with the IRS. The Court observed:
No provision in [the tax code] exempts an individual functioning as a church from the obligation to pay tax on his taxable income. Ministers may be entitled to exclude the rental value of a parsonage from gross income . . . but they are taxable on the income they earn from ministering . . . and section 501(c)(3) exempts religious organizations from income tax. But, again, there is no exemption from the . . . income tax for income earned by individuals from religious activities.
Imposition of penalties
The Court concurred with the imposition by the IRS of the following penalties for the six years under review (references are to the tax code):
- Unpaid back taxes of $400,297.
- Section 6651(a)(1) imposes an addition to tax for failure to file a timely tax return. The addition equals 5 percent of the amount required to be shown as tax on the delinquent return for each month or fraction thereof during which the return remains delinquent, up to a maximum addition of 25 percent for returns more than four months delinquent. The IRS concluded that this penalty amounted to $90,061.
- The IRS determined that the taxpayer was liable for an addition to tax for each year under either section 6651(a)(1) (for failure to file a timely return) or section 6651(f) (which imposes an increased addition to tax when a taxpayer's failure to file is fraudulent). The IRS conceded that the section 6651(f) addition to tax does not apply in this case.
- Section 6654 provides for an addition to tax in case of any underpayment of estimated tax. The IRS assessed section 6654(a) additions to tax of $14,387 for all of the years at issue.
- Section 6673(a)(1) imposes a penalty of up to $25,000 if the taxpayer has instituted or maintained proceedings before the Tax Court primarily for delay or the taxpayer's position in the proceeding is frivolous or groundless. A taxpayer's position is frivolous if it is contrary to established law and unsupported by a reasoned, colorable argument for change in the law. The purpose of section 6673 is to compel taxpayers to conform their conduct to settled principles before they file returns and litigate. The Court noted that it could, on its own initiative, require a taxpayer to pay a section 6673(a)(1) penalty. It noted that the taxpayer “failed to report substantial amounts of income for six years and his argument that the Code is null and void is frivolous. . . . We need not decide whether his other argument, that he is functioning as a church (which, in the context of this case, we reject), is also frivolous. A taxpayer who makes frivolous arguments is not immune from penalty just because some of his arguments may not be frivolous. . . . He was warned by the IRS . . . that he was making frivolous arguments in challenging the constitutionality of the federal income tax system. He ignored those warnings at his peril.” The Court imposed a penalty of $2,500.
What this means for churches
This case affirms that a church’s tax-exempt status does not extend to its ministers. Additionally, it contains a good summary of the substantial tax penalties the IRS can impose on taxpayers who fail to file a tax return or pursue frivolous tax positions. Lloyd v. Commissioner, T.C. Memo 2020-92 (2020).