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Court Rejects Ministry’s Claim That It Is Exempt from All Taxes and Regulation

Attempts to become a “508(c)(1)(A)” church to avoid taxation and IRS scrutiny could have serious consequences.

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A federal court in California rejected as “frivolous” a religious ministry’s claim that it was exempt from all taxes and regulation because it was a"508(c)(1)(A)" church.

Background

The Internal Revenue Service (IRS) issued a subpoena to a Christian ministry in California as part of its investigation into the activities of the ministry. The ministry attempted to quash the subpoena on the ground that the IRS has no authority to investigate an “unregistered Private Ministry/Church,” which it claimed was exempt not only from filing requirements and taxation, but also from IRS scrutiny or inquiry.

In support of its position, the ministry referenced section 508(c)(1)(A) of the federal tax code among other provisions, which it claimed prevents the IRS from inquiring into its finances.

Court: The religious organization is not “exempt from investigation”

A federal district court summarily rejected the ministry’s position. It noted:

[Section 508(c)(1)(A) of the federal tax code] merely exempts churches and certain other religious bodies from the necessity of applying for recognition of their exempt status under § 501(c)(3) and from requirements that they file tax returns. Nothing in [the] statute suggests that a bank’s financial records concerning the financial activity of a religious organization are exempt from investigation.

The court concluded:

The I.R.S. has broad investigative authority, including the authority to examine records or witnesses in order to determine whether tax liability exists or to make a return where none has been made.

In short, [the ministry’s] arguments have no basis in law, and are frivolous (italics added for emphasis).

What this means for churches

Some religious leaders claim that churches can avoid any taxes, regulation, or liability by reclassifying themselves as a “section 508(c)(1)(A)” church.

This is a flawed interpretation of federal tax law. The fact is, churches are automatically 501(c)(3) organizations. There is nothing they need to do to acquire this status. So, it is not clear how they would renounce their 501(c)(3) status.

A church theoretically could become a for-profit entity, but this would have destructive consequences, including:

  • The church’s net income would be subject to federal income taxation.
  • The church’s net income would be subject to income taxation in many states.
  • Donors no longer could deduct charitable contributions they make to the church.
  • The church would be ineligible to establish or maintain 403(b) tax-sheltered annuities.
  • The church could lose its property tax exemption under state law.
  • The church could lose its sales tax exemption under state law.
  • The church could lose its exemption from unemployment tax under state and federal law.
  • The church’s status under local zoning law may be affected.
  • The church could lose its preferential mailing rates.
  • The church could lose its exemption from registration of securities under state law.
  • Nondiscrimination rules pertaining to various fringe benefits would apply.
  • In some cases, a minister’s housing allowance may be affected.
  • In some cases, the exempt status of ministers who opted out of Social Security may be affected.
  • The significant protections available to a church under the Church Audit Procedures Act would not apply.
  • The exemption of the church under the state charitable solicitation laws may be affected.
  • The exemption of the church from the ban on religious discrimination under various federal and state employment discrimination laws may be affected.
  • The exemption of the church from the public accommodation provisions of the Americans with Disabilities Act (ADA) may be affected.

Clearly, any activity that jeopardizes a church’s exemption from federal income taxation is something that must be taken seriously. And churches should not pursue the dubious “section 508(c)(1)(A)” church status, which the federal court in this case considered “frivolous,” without the counsel of an experienced tax attorney or CPA. Steeves v. IRS, 2020 WL 5943543 (S.D.C. 2020).

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  • October 7, 2021

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