Like the old Herman’s Hermit’s song, “I’m Henry the Eighth I Am,” some legal complaints just don’t seem to go away. Over the years, Section 107 of the Internal Revenue Code, which excludes from income tax a clergy person’s “parsonage or housing allowance,” has come under legal attack in a number of cases. Up until now, the legal challenges have been struck down, leaving the important clergy housing allowance exemption intact. As recently as 2014, the Seventh Circuit Court of Appeals struck down one such case. However, this year, and in response to that case, a new carefully crafted and schemed lawsuit attacking Section 107 has again been filed.
Should churches, synagogues and other worshipping groups be alarmed? Or is this most recent case just another identical verse of the same old doomed song? At this point, the answer is unclear, and the issue is likely at least a couple of years from being decided. But worshipping bodies should be mindful as this case progresses through federal court appeals.
Background - Section 107 Tax Benefits for Clergy
Section 107 of the Internal Revenue Code (“Code”) provides for two different but related exemptions for ordained clergypersons of all faiths (dubbed “Ministers of the Gospel” in the Code). Section 107(1) exempts from taxation the fair market rental value of a home provided as part of a clergy person’s compensation. Section 107(2) exempts from taxation, the allowance paid to clergy persons for housing, up to the fair market value of the housing, including generally, furnishings, improvements, garage, plus the cost of utilities. Constitutionally, the two sections are viewed as a paired set. Without both sections, the government runs the risk of providing tax advantages to the clergy of only some types of religious organizations and not others (i.e., religious groups that can provide housing versus those that can only provide, or choose to provide, a housing allowance). Such allowance also parallels tax benefits provided for others such as those in the military.
Plaintiffs’ First Verse – Section 107 is Unconstitutional
In 2012, Freedom from Religion Foundation, Inc. mounted a challenge to the constitutionality of both parts of Section 107. See Freedom from Religion Found., Inc. v. Lew, 11-CV-626-BBC, 2013 WL 6139723 (W.D. Wis. Nov. 22, 2013). The Plaintiffs were atheists who argued that the benefit of excluding the housing allowance from taxation was an unconstitutional governmental endorsement of religion, in violation of the First Amendment’s Establishment Clause. The Western District Court of Wisconsin agreed and ruled in favor of plaintiffs.
However, as reported in this blog nearly two years ago, that challenge failed on appeal to the Seventh Circuit, on the procedural ground of “standing.” As a general rule, courts will not consider generalized grievances. For a plaintiff to have standing to sue, a particularized harm must have been suffered.
In the 2012 case, the Seventh Circuit Court of Appeals held that the Plaintiffs did not have standing to sue under either section of Section 107:
- Plaintiffs did not receive housing from their employer as a part of their compensation.
- Plaintiffs did not receive a housing allowance, they never requested the exemption related to the allowance, and they were never denied the exemption.
Given the above, the Court found that Plaintiffs suffered no actual particularized harm. Plaintiffs merely objected to Section 107, based on the legal argument that it unconstitutionally endorsed religion. That argument alone wasn’t enough. It was merely a “generalized grievance,” which is not sufficient to bring a claim. Because the case failed on standing-related grounds, the Seventh Circuit never reached the merits of the case, and did not consider whether or not Section 107 violates the First Amendment’s Establishment Clause.
Plaintiffs’ Second Verse: Section 107 is Unconstitutional + Standing
This year, Freedom from Religion Foundation, Inc. has spearheaded a new legal effort to undermine Section 107. In Annie Laurie Gaylor, et al v. Jacob Lew, et al, 3:16-cv-00215-slc, W.D. Wis.), plaintiffs again argue that Section 107 violates the Establishment Clause. Specifically, plaintiffs contend that Section 107 “discriminates against the individual plaintiffs who are denied the same tax benefits because they are not practicing religious clergy.” The complaint also alleges that Section 107 “violates the equal protection rights of the individual plaintiffs under the Due Process Clause of the Constitution.”
To avoid the procedural difficulties that doomed their last attempt, Freedom from Religion Foundation, Inc. provided housing allowances to two of the plaintiffs for 2012 and 2013. Plaintiffs filed amended tax returns, seeking refunds stemming from the housing allowance component of their compensation. The IRS denied the refund. Armed with this “particularized harm,” plaintiffs are now back, this time perhaps with standing, at least with respect to Section 107(2), claiming that they are being denied benefits available to other individuals on the basis of religion – and in violation of the First Amendment’s Establishment Clause.
Government’s Preliminary Response: Second Verse, Same as the First… Sort of
On August 12, the United States Department of Justice (DOJ) filed a brief in support of the IRS’s motion to dismiss plaintiffs’ claims related to Section 107(1) – the part of Section 107 that exempts the fair market rental value of a home provided to a clergy person as part of her compensation. In their brief, the DOJ argues that because the plaintiffs did not receive employer-provided housing, the exemption under subsection (1) was inapplicable. As in the 2012 lawsuit, DOJ argues that plaintiffs failed to state a particularized harm, because they were never a denied a benefit they did not apply for. In fact, the DOJ continues, under the doctrine of res judicata, the Seventh Circuit’s prior ruling on this barred their claim: “In short, this Court has already entered a final judgment on the very same legal issue in a suit involving the very same litigants.”
Notably, however, the DOJ brief does not contest standing regarding Plaintiff’s claims based on 107(2) the section related to housing-allowance. As discussed above, this time around, plaintiffs have sought to cure the fatal defect in their last attempt by paying two employees a housing allowance, for which a refund has been denied. Apparently, the DOJ is willing to concede that plaintiffs’ efforts have satisfied the constitutional claim for standing with respect to Section 107(2).
What’s Next? District Court Decision and Then Likely Appeals
The current complaint is being heard by the same federal district court judge who ruled on the 2012 claim. In that case, Judge Barbara Crabb dismissed Plaintiffs’ claims related to Section 107(1) for lack of standing. We think it likely that Judge Crabb will reach the same conclusion regarding that part of the Plaintiffs’ new case, again at the trial court level. As the DOJ argues, Plaintiffs have still not received housing as a part of their compensation package, so it is difficult to see how they would have standing on the part of the claim dealing with subsection (1) of Section 107.
That leaves subsection (2). In the next few months, we expect parties to file motions for summary judgment on the merits of the case, directly addressing the issue of constitutionality. Significantly, in the 2012 litigation, Judge Crabb ruled that Section 107(2) was an unconstitutional violation of the First Amendment’s Establishment Clause. Given that the Seventh Circuit never reached the constitutional question, but reversed her lower court decision only on the procedural issue of standing (now cured), we expect that Judge Crabb will again rule that Section 107(2) is unconstitutional.
In that event, a DOJ appeal of Judge Crabb’s decision is almost certain. On appeal, expect substantial filings from both parties in the Seventh Circuit over the next year or two. The appellate court will have the opportunity to directly consider the constitutionality of Section 107(2). As in the last case, expect several amici curiae (friends of the court) briefs, that is legal memoranda to the court from groups who both support and oppose Plaintiffs’ complaint. Whatever the outcome in the Seventh Circuit, an appeal to the Supreme Court of the United States is not out of the question.
While churches, synagogues and other worshipping bodies should continue to track this important litigation, no change to the law affecting the clergy housing-related exemptions is imminent (that is, expected within the next year or two). In fact, during the 2012 litigation, even though Judge Crabb ruled Section 107(2) to be unconstitutional, she stayed IRS enforcement of her decision, until all appellate efforts had been exhausted. We expect a similar stay in this case. Another potential resolution may be for the IRS to grant the housing allowance, although such result seems unlikely given the DOJ’s current posture.
For now, and for at least the next year or two, the clergy housing and housing allowance exemptions should remain intact. Our law firm will continue to monitor the progress of this important case, and provide updates through this blog as they become available.