The Gift of Religious Tax Exemptions, On Balance

Introduction

Christmas is the season for gift-giving as Christians around the world celebrate Jesus’ birth. More broadly, all religions within the United States enjoy the gift of tax exemption.  But just how far does tax exemption extend – and is it truly a gift, or a right?  Does tax exemption extend only under Section 501(c)(3)?  What other taxes also affect churches?  Tax scholar and law professor Edward Zelinsky answers these questions in the newly published book Taxing the Church (Oxford University Press 2017), addressing the diversity of which houses of worship are taxed, the normative question of whether they should be taxed, and provides a fourfold framework for understanding church taxation.

Zelinsky’s treatment of various taxes affecting churches and other religious institutions (collectively “churches”) is quite extensive, covering both federal income tax law and providing a digest of a host of state tax laws.  In doing so, he focuses on “entanglement” concerns – that is, how much government must be (or should be) involved with churches in order to enforce their taxation, or alternatively to protect their tax exemption.  Such terminology comes from the famous 1971 U.S. Supreme Court of Lemon v. Kurtzman (and thus sometimes known as the “Lemon test”) in which the Court ruled that educational aid from state government to private schools violated the First Amendment’s Establishment Clause through “excessive government entanglement,” because such aid necessarily involved government oversight to ensure that no funds were used for religious instruction.

As Zelinsky observes, “[t]axing churches and religious institutions leads to church-state enforcement entanglement while exempting churches and sectarian entities leads to borderline entanglement over the boundaries of the exemption.”  He then applies this observation to various forms of taxation in turn.  In addition, Zelinsky addresses tax policy, which he finds “invariably involves choices among conflicting goals, such as revenue-generation, administrability, public acceptability, economic neutrality, valuation considerations, and liquidity concerns. “ Finding that “[n]one of these goals can ever be achieved in toto,” he departs from absolutist perspectives involving “subsidization” of religion (i.e., government automatically supports religion by virtue of tax exemption) and – on the other end of the spectrum – wholesale religious tax exemption that leaves churches alone.  Zelinsky concludes instead that “taxing the church or exempting the church involves imperfect trade-offs among competing and legitimate values.”  And therefore, “[o]n balance, our federal system of decentralized legislation makes these trade-offs reasonably, though not perfectly.” 

From this foundation, Zelinsky develops four central themes.  First, as Zelinsky frames it, entanglement considerations are significant to tax policy and should be cautiously avoided if possible: “Minimizing church-state entanglement should be a critical, often controlling, consideration in the decision to tax or exempt sectarian institutions.  In practice, the minimization of entanglement helps to explain current patterns of taxing and exempting the church.”  Second, the judiciary’s role should be limited to addressing only thorny borderline entanglement issues, as rarely as possible and sometimes with no “purely disentangling choice,” as disentangling in one direction may lead to entangling in another through such judicial policing.  Third, tax exemption laws are most acceptable, constitutionally and otherwise, when they apply simultaneously to both religious and nonreligious organizations.  And fourth, while the term “subsidy” may be used to argue against religious tax exemption, such exemption instead “may serve a nonsubsidizing purpose and properly help to define the tax base.”  This four-pronged paradigm provides a helpful lens through which to consider federal and state tax exemption laws, particularly to better understand why some laws work better than others in application and to provide alternative, non-ideological grounds for evaluating tax exemptions. 

A Tour of Tax Exemptions

Avoid Excessive Entanglement

Zelinsky begins his tax exemption tour with the landmark U.S. Supreme Court cases of Murdock v. Pennsylvania (1943) and Follett v. Town of McCormick (1944), in which the Court struck down municipal ordinances that imposed flat licensing fees on persons selling goods and merchandise, as an unconstitutionally intrusive burden on Jehovah’s Witnesses’ exercise of religious rights to canvass, and not as any tax subsidy favoring religion (particularly since such activity need not have been taxed in the first place).   Zelinsky moves on with the 1970 Walz v. Commissioner decision, in which the Court upheld a New York state property tax exemption law, in large part because the exemption law applied broadly to both religious and nonreligious organizations.  As Chief Justice Burger wrote, a primary goal in such cases is “to avoid excessive entanglement” of government and religious institutions,” in order to “prevent[] the kind of involvement that would tip the balance toward government control of churches or government restraint on religious practice.”  The Court thus respected state legislature’s policy decision to exempt a broad class of property owned by nonprofits, including hospitals, libraries, patriotic groups and, yes, religious institutions, too. 

Sales Tax Exemptions

Zelinsky continues applying his four themes to additional U.S. Supreme Court decisions addressing state sales tax schemes for religious organizations, particularly the extent to which nonreligious organizations are likewise exempt or not.  As he observes, sales taxes for religious organizations’ purchases involves little or no “entanglement”; as purchasers, they simply pay tax as part of their purchase, like any other retail buyer.  On the other hand, sales tax exemption for religious organizations’ sales may raise questions of what kinds of goods are sold (religious or other?), why (to further their religious purposes?), and how frequently (as a reflection of their potentially more commercial nature).   But as Zelinsky finds, state laws vary quite widely for religious organizations, as both sellers and buyers, reflecting our country’s federalist principle of allowing experiments among states – and experiment they do!  (One is thus wise to closely check specific state laws before venturing to answer whether a nonprofit, much less a religious one, enjoys sales tax exemption for purchases and sales.)  Put differently, to the extent such religious tax exemption may be constitutionally permitted and not constitutionally prohibited, states are free to develop different exemption frameworks based on their own legislatively determined tax policy.

Property Tax Exemptions

Property tax exemption provides another example of evident widespread state tax variety.  Some states include property tax exemption within their state constitutions, while other permit it by statute.  While all states provide some degree of exemption for religious property, their specific laws may focus narrowly (i.e., “churches”) or broadly (“religious”), and may provide contrasting treatment of parsonages and other religion-related housing.  Again, such diversity reflects the states’ relative flexibility to determine tax policy, affirmed in Walz, as constitutionally permissible – though particularities are not necessarily compelled.  These areas reflect Zelinsky’s continued themes: “the trade-off between enforcement entanglement and borderline entanglement, the diversity with which the states make this trade-off, and the virtue of our system of decentralized, federalist decision-making, which allows the individual states to make different assessments” of these trade-offs, while further serving the “nonsubsidizing purpose of minimizing enforcement entanglement between church and state.”

Other Federal Tax Exemptions

In contrast, Zelinsky examines the income tax-related complexities of parsonages and housing allowances for clergy, religious exemptions from social security taxes, and religious exemptions under the federal Affordable Care Act.  He observes that these areas can be controversial, particularly the housing allowance which is continually attacked on constitutional grounds by groups like the Freedom From Religion Foundation.  (See our prior blog article, Clergy Housing Allowance Redux and Reflections.)  But, as Zelinsky observes, these challenges may entail swapping entanglement-based religious exclusions (e.g., no housing allowance for clergy under Section 107(2) of the Tax Code), for just as troubling but different entanglement issues (e.g., clergy housing for the “convenience of the [religious] employer” under Section 119).  The answer may well lie in recognizing such religious exemptions, as a matter of constitutionally permissible tax policy.

On the other end of the tax exemption spectrum is the federal income tax exemption for churches under Section 501(c)(3).  This well known public charity exemption generously allows for religious, educational, charitable, and other categories of nonprofits to enjoy both exemption and tax-deductible contributions.  Such exemption thus illustrates Zelinsky’s point that a broadly applicable exemption status should involve little constitutional or tax policy controversy.  But controversy inevitably accompanies religion-based tax exemption areas, in a wide array of areas – e.g., automatic tax exemption for churches (under Section 508 of the Tax Code), church exemption from Form 990 filing requirements, Form 990-T filing requirements for “unrelated business taxable income,” political campaign activity prohibitions, lobbying restrictions, and various state unemployment insurance exemptions for church-relate ministries  Each of which entails various degrees of government scrutiny and IRS policing, such as to determine what is a “church” and whether a church is crossing any lines into restricted or taxable activities.

Conclusion 

Without question, churches are definitely subject to taxation.  But as Zelinsky observes throughout his book, religious tax exemptions are critically important and are generally to be protected – as a gift, a right, or a mix of both.  Lawmakers, judges, and scholars thus may differ on underlying rationales, applicable constitutional contours, and related tax policy aspects.  Such considerations involve additional complications given the overlay of federalism principles, new and complex areas of taxation, and evolving church practices.

Zelinsky’s fourfold approach is quite attractive in parsing through such matters, as an overarching rubric for thinking about religious tax exemption.  Tax exemptions may work best when broadly to religious and nonreligious organization alike, essentially as an obvious legal right.  A tax exemption applicable only to religious organizations may be more questionable legally, but on balance, allowing such exemptions may be best for avoiding unwanted government intervention (i.e., constitutionally questionable “entanglement”).  They therefore may rightly be viewed as a wonderful and cherished gift within our country’s deeply religious heritage and constitutional framework.