Churches, other houses of worship, and their closely related ministries enjoy automatic Section 501(c)(3) tax-exempt status. May the IRS nevertheless reject their tax-exempt status, such as if a religious organization affirmatively seeks such recognition? As one court recently ruled in the Iowaska Church of Healing v. U.S. tax case, the answer is yes - if the organization seeks to engage in illegal activity. The accompanying legal backdrop provides fascinating pivotal insights for religious organizations seeking to operate fully and freely within Section 501(c)(3) tax-exemption parameters.
Defining “Charity” Under Section 501(c)(3) – Nothing Illegal
A longstanding requirement of Section 501(c)(3) tax-exempt qualification is that the organization’s purposes must be charitable – generally speaking, with more specific categories like religious, charitable, and educational included within the statute. The term “charitable” under Section 501(c)(3) is derived from and associated with common law standards of charity and charitable trusts, based on the general concept that such organizations hold charitable assets in trust.[1]
Correspondingly, the accompanying tax regulation provides:
The term charitable is used in section 501(c)(3) in its generally accepted legal sense and is, therefor, not to be construed as limited by the separate enumeration in section 501(c)(3) of other tax-exempt purposes which may fall within the broad outlines of charity as developed by judicial decisions.[2]
An organization seeking to qualify as tax exempt under Section 501(c)(3) thus must be organized and operated exclusively for enumerated appropriate purposes - and not for illegal purposes.[3]
As exemplified in the IRS’ Revenue Ruling 75-384, with trust law as the “main source” of the “general law of charity,” no tax-exempt organization may be created for illegal purposes. Rejecting tax exemption for an organization sponsoring acts of illegal civil disobedience to protest war, this Revenue Ruling further instructed:
The purpose is illegal if the trust property is to be used for an object which is in violation of the criminal law, or if the trust tends to induce the commission of crime, or if the accomplishment of the purpose is otherwise against public policy. . . . Thus, all charitable trusts (and by implication all charitable organizations, regardless of their form) are subject to the requirement that their purposes may not be illegal or contrary to public policy.[4]
While specific tax cases involving issues of illegality seldom arise, the IRS has denied exempt status to organizations conducting illegal activities such as advocating in favor of polygamy, seeking to distribute marijuana, and advocating in favor of the repeal of laws prohibiting the sexual exploitation of minors.[5]
“Fundamental Public Policy” Tax Aspects and Religious Liberty Too
Notably, the above-cited Revenue Ruling contains the phrase “contrary to public policy” In the landmark 1983 Bob Jones University vs. United States ruling, the U.S. Supreme Court upheld the IRS’s revocation of two religious schools’ Section 501(c)(3) tax-exempt based on their racially discriminatory practices – as contrary to public policy. More specifically, as set forth in the majority opinion, approving tax-exempt status to racially discriminatory schools violated fundamental public policy. As further clarified through the concurring and dissenting opinions too, no organization qualifies for Section 501(c)(3) tax-exempt status if it has illegal purposes.[6] Since the Bob Jones ruling, law scholars and practitioners have spilled a lot of ink debating distinctions (if any) between “fundamental public policy” and the illegality requirement for Section 501(c)(3) qualification.
Additional religious liberty considerations apply within this tax-exempt context too – namely, to what extent should organizations be accorded Section 501(c)(3) status if their religious practices violate the law or otherwise contravene what is considered to be “public policy”? Significantly, religious organizations have enjoyed tax-exempt recognition since before our country began, consistent with worldwide historical treatment of religious institutions as exempt.[7] Such beneficent recognition dovetails with religious liberty protections under the federal First Amendment and corresponding state constitutions, which have long been part of our country’s legal fabric, as well as more recent religious freedom restoration laws under federal and state statutes. The US Supreme Court has chimed in repeatedly as well, clarifying and strengthening First Amendment rights including those of nonprofit organizations.
Ample questions thus may be raised as to how First Amendment protections for speech, religious practice, and the right of assembly intersect with concepts of illegality and public policy within Section 501(c)(3) parameters. For example, could the illegality or established public policy doctrines be utilized to revoke the exempt status of organizations that advocate for or against abortion, gun control, government insurrections, or LGBTQ practices? To what extent does it matter that such issues, which are often hotly contested as legitimate or not, may change in terms of legality (e.g., marijuana – legal under many state laws, but illegal under federal law)?
How About Ayahuasca – Sacramental, Illegal, Both?
In a case garnering immense attention, a federal trial court recently upheld the IRS’ denial of Section 501(c)(3) tax-exempt status to an applicant organization that characterized itself as a church, because the organization’s planned religious worship activities included the use of ayahuasca, which is controlled substance illegal under federal law. Iowaska Church of Healing (Iowaska) is a nonprofit organization incorporated in Iowa that desires to use ayahuasca in its religious ceremonies. Iowaska’s articles of incorporation identify its corporate purpose as to "offer the public access to spiritual growth, development, and healing through the sacred Sacrament of Ayahuasca" and "provide necessary information to all participants of sacred healing ceremonies involving the consumption of the Sacrament of Ayahuasca."
Ayahuasca is a plant-based psychedelic drug with deep roots in Amazonian shamanic traditions, but its use is illegal in the United States under the federal Controlled Substances Act (CSA). The legal landscape surrounding ayahuasca’s religious use became more complicated following the 2006 Supreme Court case Gonzalez v O Centro Espirita Beneficente Uniao do Vegetal, in which the Court unanimously approved exceptions for “sincere religious Ayahuasca use” but did not specify when this exemption might apply. Consequently, Iowaska and other religious groups have initiated legal challenges in their pursuit of exemptions for ayahuasca use in spiritual practices.[8]
Iowaska’s Legal Journey Thus Far – No “Church” Recognition
In January 2019, Iowaska applied for tax-exempt status as a church based on its religious activities and described its planned use of ayahuasca. Churches and other houses of worship may lawfully organize and operate under Section 501(c)(3) and as long as they stay within the IRS regulations of a church. They are not required to obtain an IRS determination letter, though may find it advantageous for administrative or other reasons to do so.[9] Apparently, Iowaska wanted the IRS’ official recognition and therefore submitted an application.
In February 2019, Iowaska also applied for a CSA exemption for use of ayahuasca for religious purposes with the DEA, which the DEA has yet to process. Pending these approvals, Iowaska did not participate in its religious ayahuasca activities. The IRS denied Iowaska’s request for exemption before the DEA issued a decision, stating that Iowaska doesn't meet the requirements under Section 501(c)(3) because the use of ayahuasca without the DEA exemption is illegal under federal law.
Iowaska sued the IRS, relying on the Supreme Court’s 2006 O Centro decision. Specifically, Iowaska argued that O Centro established that, “sacramental consumption of Ayahuasca is a sincere and lawful exercise of one’s religion,” and, therefore, Iowaska is organized and operated for religious purposes under Section 501(c)(3). Notably, the IRS had stated that but for the proposed use of ayahuasca, the organization would have qualified as a bona fide church.
On March 31, 2023, the D.C. District Court issued an opinion affirming the IRS’ denial of tax-exempt status. The Court held that, until Iowaska receives its CSA exemption from the DEA, it is not organized or operated exclusively for proper purposes because its promotion and use of ayahuasca is illegal under federal law. Therefore, it is not entitled to Section 501(c)(3) tax-exempt recognition. The court’s ruling detailed the organizational and operational tests, which are determinative for organizations seeking exemption under section 501(c)(3).[10]
Ultimately, the court held that Iowaska was not organized for tax-compliant purposes because its “substantial purpose remains in violation of federal law.” As mentioned above, Iowaska was organized to promote healing through its religious use of ayahuasca. Additionally, the court held that Iowaska was not operated properly either because, “absent a CSA exemption,” Iowaska’s activities amount to the “illegal distribution and promotion of the use of a controlled substance, a non-exempt purpose.”
Iowaska’s Implications – Illegality, Religious Liberty, and More Questions
The court’s Iowaska ruling affirmed the IRS’ continued application of the illegality doctrine and did not interpret the Supreme Court’s holding in O Centro to provide an unqualified exception to the rule. The case may be further appealed, or others may similarly try to obtain approval – perhaps through other courts (and probably better with DEA exemption approval).
At this stage, the Iowaska ruling raises several questions. For example, what practical steps can religious organizations like Iowaska take to ensure the ability to practice their faith legally? As mentioned above, Iowaska had applied for an ayahuasca exemption from the DEA, but has yet to receive it, and has now been denied tax-exemption and recognition as a church by the IRS. It would appear that Iowaska is waiting on the government to act so that the church can operate, but the government is not acting. Relatedly, should First Amendment religious exercise rights be contingent on government approval? The IRS has indicated that Iowaska probably would have been approved for tax-exempt recognition if it had presented a valid DEA exemption. However, the DEA not only remained silent on Iowaska’s initial application, it also still has not issued such an exemption.[11]
Consider too that Iowaska was not revoked because it was advocating for activities or purposes that were contrary to “established public policy.” Rather, the church was proposing to engage in illegal activity as a significant portion of its overall religious purposes. The distinctions between the illegality and established public policy doctrines remain important to track and differentiate, to the extent feasible.
What Happens Next?
Should churches or other religious organizations weigh the adverse ruling chances involved with applying for Section 501(c)(3) tax-exempt recognition, relying instead on their automatic tax-exempt status? Should Iowaska have waited on the DEA for unknown and lengthy time periods, or do such waiting periods amount to infringements on religious liberty interests? And as the ultimate question: who gets to decide (and who should decide) what is a “church”? The implications may be substantial given the benefits of Section 501(c)(3) status such as tax deductibility of charitable contributions, exemption from IRS Form 990 filings, “church” status for retirement plans, employment-related religious freedom, beneficial zoning classifications, and other important attributes available through our pluralistic yet increasingly divisive American society. Courts and the IRS will surely continue to grapple with the issues raised through Iowaska, O Centro, and other tax-exemption applicants seeking to avail themselves of such significant advantages.
[1] For more information on Section 501(c)(3)’s historical background, including “charity” definitional aspects and the Internal Revenue Code’s background, please see S. Wagenmaker, Why Religious Organizations Shouldn’t Lose Tax-Exempt Status Based on Public Policy, Post-Obergefell at pp. 4-7.
[2] 26 C.F.R. 1.501(c)(3)-1(d)(2).
[3] More specifically, Section 501(c)(3) identifies qualifying organizations as follows: “Corporations, and any community chest, fund, or foundation, organized and operated exclusively for religious, charitable, scientific, testing for public safety, literary, or educational purposes, or to foster national or international amateur sports competition (but only if no part of its activities involve the provision of athletic facilities or equipment), or for the prevention of cruelty to children or animals.”
[4] Rev. Rul. 75-384, 1975-2 C.B. 204. (citing IV Scott on Trusts, Sec. 377 (3d ed.1967); Rev. Rul. 71-447, 971-2 C.B. 230. See also Restatement (Second) of Trusts (1959), Sec. 377, Comment (c) (“A trust for a purpose the accomplishment of which is contrary to public policy, although not forbidden by law, is invalid.”).
[5] See IRS Public Letter Rulings: 201323015; 01325015; 201310047, 201615018; 201333014; 201224026, and Mysteryboy, Inc. v. Comm’r. See also Why Religious Organizations at pp. 21-23 (addressing such decisions in further detail).
[6] For a fuller explanation of the Bob Jones’ ruling and its extended treatment of “fundamental public policy” as a tax concept, see Why Religious Organizations at pp. 10-15.
[7] See, e.g., S. Diamond, Efficiency and Benevolence: Philanthropic Tax Exemptions in 19th Century America; E. Brody, Legal Theories of Tax Exemption: A Sovereignty Perspective; D. Dessingue, The Special Case of Churches, all collected in Property-Tax Exemption for Charities (E. Brody, ed.) (2002). As the U.S. Supreme Court observed in the landmark case of Walz v. Tax Commission:
"Few concepts are more deeply embedded in the fabric of our national life beginning with pre-revolutionary colonial times, than for the government to exercise at the very least this kind of benevolent neutrality toward churches and religious exercise generally, so long as none was favored over others and none suffered interference."
Walz v. Tax Commission, 397 U.S. 664, 676 (1970). As U.S. Supreme Court Justice O’Connor further observed, the early American leaders “accorded religious exercise a special constitutional status,” with all agreeing that “government interference in religious practice was not to be lightly countenanced.”[7] City of Boerne v. Flores, 521 U.S. 507, 564 (1997) (O’Connor, J., dissenting) (citing A. Adams and C. Emmerich, A Nation Dedicated to Religious Liberty: The Constitutional Heritage of the Religious Clauses, at 31 (1990)).
[8] See also, e.g., Church of the Holy Light of the Queen v. Mukasey (2008), Santo Daime Church v. Gonzales (2009), Native American Church of North America v. United States (2010).
[9] For more information about defining “church” for Section 501(c)(3) purposes, please see our blog article.
[10] For further details about this test, see: Do Something (Right)! How to Pass the Section 501(c)(3) Operational Test.
[11] See also Psychedelics, the DEA, and Regulating Religion, Cato Institute.
