On October 24, 2018, a three-judge panel of the federal Seventh Circuit Court of Appeals heard oral arguments in Gaylor v. Mnuchin, a tax case brought by the Freedom From Religion Foundation (FFRF) and its individual leaders challenging the constitutionality of tax exemption for the venerable clergy housing allowance. Attorneys from the U.S. Department of Justice (DOJ) for U.S. Treasury Secretary and the IRS Commissioner, as well as a group of religious intervenors, urged the court to uphold the exemption and defended its basis in the Constitution and related religious liberty jurisprudence. Attorneys for FFRF and a group of opposing tax professors contended that the allowance favors religion in violation of the First Amendment.
Interest in this case has been both broad and intense, causing consternation among clergy of all religions, scrutiny and commentary by tax professors on both sides of the aisle, and a plethora of voices chiming in on this tax issue. Ten amici curiae (“friends of the court”) briefs have been filed, including a brief on behalf of eighteen states, another on behalf of representatives of Congress, and several others by religious organizations representing tens of thousands of worshipping bodies and millions of adherents.
The oral arguments made clear the two sides’ vastly differing perspectives: Opponents of the exemption argued that the statute at issue plainly and unconstitutionally endorses religion on its face. Supporters of upholding the statute and continuing the exemption argued that abolishing the statute would unconstitutionally and excessively entangle the government in religious concerns. Four attorneys spoke:
- Jesse Panuccio, the U.S. Associate Attorney General (and third highest ranking official at the DOJ) appeared on behalf of the U.S. Government, who argued against any Establishment Clause violation, emphasizing both the housing allowance’s secular purpose as one part of generally available tax benefits provided for employment-related housing and its effect of avoiding government entanglement with religion;
- Luke Goodrich, on behalf of several religious groups and individuals, who relied on historical support for the allowance’s constitutionality, the importance of equally treating parsonage and clergy housing allowances, consistent with convenience-of-the-employer and similar neutral tax concepts, the importance of avoiding government entanglement with religion, and the absence of any alleged “tax subsidy”;
- Adam Chodorow, on behalf of several tax law professors opposing the housing allowance, who objected to the housing allowance’s special treatment for clergy, asserted that it effectively amounts to a tax subsidy, and advocated excluding clergy from any categorical housing allowances as a matter of broader tax policy; and
- FFRF attorney Richard Bolton, who focused on statute’s narrow language applying only to clergy, railed against the housing allowance’s allegedly unfair economic benefit for clergy, and dismissed excessive entanglement arguments as overblown.
What will the judges rule, and what should be the outcome – either at the Seventh Circuit level or perhaps ultimately by the U.S. Supreme Court? The following summarizes the procedural background, the key tax provision at issue, and the oral arguments for and against the clergy housing allowance.
This case repackages an earlier 2013 case and appeal, in which the Seventh Circuit held that the plaintiffs challenging the housing allowance’s constitutionality did not have standing to bring suit. The constitutional doctrine of standing requires that plaintiffs must have a particularized grievance to sue. In other words, just being a taxpayer does not give an individual the right to sue. In the 2013 case, the plaintiffs never claimed a housing allowance exemption, and therefore there was no IRS denial thereof, thus there was no resulting harm to give the plaintiffs the requisite legal standing. Consequently, the Seventh Circuit rejected the claim on the lack of standing basis. For additional background, see our blogs here, here, and here.
The plaintiffs addressed the issue of standing by claiming a housing allowance, which the IRS then rejected because they were not clergy members. The plaintiffs then filed a new lawsuit, arguing that the IRS’s denial of granting housing allowance to them was unconstitutional, as it favors religion. Judge Barbara Crabb, a federal district court judge in Wisconsin, agreed with the plaintiff (as she did in the prior case), and held the tax provision unconstitutional. The government appealed her adverse ruling. For additional procedural history, see our previous blog here.
Tax Provision at Issue: Section 107(2)
At issue is Section 107(2) of the Internal Revenue Code. Its companion provision, Section 107(1) of the Internal Revenue Code, excludes the value of a church-provided parsonage from a clergy member’s taxable income. Section 107(2) continues a long line of jurisprudence affirming clergy-related tax exemptions, and its predecessor version was enacted in 1921 on the heels of the Sixteenth Amendment.
Section 107(2) states as follows:
In the case of a minister of the gospel, gross income does not include . . . (2) the rental allowance paid to him as part of his compensation, to the extent used by him to rent or provide a home and to the extent such allowance does not exceed the fair rental value of the home . . .
Section 107(2) has been interpreted to extend to all clergy, not just Christian ministers. In effect, Section 107(2) equalizes tax treatment for clergy members: whether they receive housing from their religious institution or obtain it themselves (via rental or ownership), the economic value of such housing is excluded from their compensation for purposes of income taxation. These provisions are thus similar to Section 119 of the Tax Code, which excludes from taxable income the value of housing provided “for the convenience of the employer” on “business premises” (whether owned by the employer or otherwise provided).
Key Points Raised at Oral Argument
What did the arguing attorneys emphasize, and what was important to the judges (at least based on their questions)? Not surprisingly, they focused on the proper test for Section 107(2)’s constitutionality, judicial constraint versus judicial activism, tax policy, the relevance of history, and how courts should handle legal matters involving clergy members and religious institutions.
1. The Government’s Key Points
Mr. Panuccio, the U.S. government attorney, opened by observing that the Tax Code contains many special rules for work-related housing, with Section 107(2) as one of them. Military personnel receive a similar housing tax benefit, as do many others – all as per the Tax Code, as decided by Congress as a matter of tax policy.
He then explained that Section 107(2) is constitutional under the U.S. Supreme Court’s 1971 Lemon v. Krutzman three-part test for determining whether or not the First Amendment Establishment Clause has been violated. Under Lemon, a court is to evaluate a law according to whether it (1) has any secular purpose, (2) has the primary effect of advancing religion, and (3) fosters an excessive entanglement with religion. Arguing that Section 107(2) meets all three factors, Panuccio emphasized that “when a secular purpose can be reasonably inferred,” judicial deference must be given. Even if the statute is an “imperfect fit,” the court must reasonably defer to Congress’ legislative pronouncement as a basic concept of tax law interpretation.
With respect to the second prong, he asserted that there is no improper or advancement of religion here. Rather, as the U.S. Supreme Court recognized in the Walz property tax exemption case, the clergy housing allowance is part of a broader, neutral general tax scheme allowing favorable tax treatment for many kinds of work-related housing. The area of clergy housing is thus not to be singled out for tax punishment, but rather accorded its categorical status like other housing provisions of the Code.
Mr. Panuccio further advocated that Section 107(2) actually avoids excessive entanglement with religion, as set forth in the third prong of the Lemon test, by allowing a categorical exclusion for clergy housing rather than requiring Section 119’s more fact-specific evaluation of specific housing uses (e.g., prayer time, worship, leadership meetings, Bible studies, other engagement with parishioners). Such government avoidance is consistent with the U.S. Supreme Court cases in Trinity Lutheran (holding that a religious preschool is entitled to government grant funds just like other nonprofit applicants) and Hosanna-Tabor (recognizing the “ministerial exception” as a bar to discrimination claims filed by ministry employees). By upholding Section 107(2)’s constitutionality, the court thus will promote separation between church and state.
2. The Becket Fund’s Key Points
Appearing on behalf of several intervening religious organizations and religious leaders, attorney Luke Goodrich asserted that in addition to applying the Lemon test, the court should apply the U.S. Supreme Court’s 2014 Town of Greece v. Galloway decision. Per Town of Greece, a court must evaluate First Amendment Establishment Clause issues in light of historical practices. In this case, history is quite relevant: there has been a long tradition of special tax treatment toward church parsonages since America’s founding.
Such treatment is not a tax subsidy because the government is not transferring funds from other taxpayers to religious institutions. Rather, it is analogous to the Section 119 “convenience of employer” housing provision. Under such approach, courts can allow for the equalizing effect of both Section 107(1) (for parsonages) and Section 107(2) (for other housing). In other words, Section 107(2) exists in part to keep the government from having to distinguish between religious sects – those offering the benefit of church-owned housing to clergy, and those without such church-owned properties to provide for clergy. In response to Judge Manion’s question about whether there is any “secular benefit,” Mr. Goodrich responded that clergy housing is essentially an extension of the church. Without Section 107(2)’s categorical exclusion, there would be too many “fact-specific, deeply entangling” questions about whether Section 119’s requirements would be met, as well as significant pressure on religious institutions to use parsonages instead of allowing greater flexibility for their clergy.
In response to Judge Brennan’s questions about the IRS’s involvement with religious institutions, Mr. Goodrich clarified that they face much lower tax burdens – and rightly so in light of applicable First Amendment considerations. For example, churches are automatically deemed to be Section 501(c)(3) tax-exempt organizations, with no requirement to affirmatively apply for such status per Section 508 of the Code. In addition, they are not legally obligated to file annual IRS Form 990 returns. Thus, while the IRS and other government entities must engage with religious institutions to a certain extent, it ought to be as minimally as possible. Intrusive inquiries into whether an individual is truly a clergy member, or whether an organization is truly a church, overstep the government’s constitutional role as a neutral arbiter that does not narrowly determine what constitutes religion.
In essence, Section 107(2) thus reflects an “IRS trade-off”: to apply Section 119 instead of Section 107(2) would be deeply entangling for the government, but Section 107(2) allows for an appropriate “hand-off” approach that is “consistent with current IRS practices.” Mr. Goodrich amplified this distinction with the following example. When it comes to the question of employee versus independent contractor status, the IRS avoids such very fact-specific issues by designating all clergy employees under Section 414(e) of the Code (for retirement/ERISA) and designating them all self-employed under other Code provision for social security and Medicare tax purposes.
In response to one judge’s question about the relevance of the housing allowance’s financial impact, Mr. Goodrich responded simply that such consideration is a policy matter for Congress – not for the courts. Consistent with the U.S. government’s position, he closed by stating that even if Section 107(2) may not reflect “perfect tax policy,” the court must still defer to Congress if the court finds a “reasonable justification” for providing such categorical exclusion. The case for Section 107(2) is thus both a constitutional and historical inquiry.
3. The Opposing Law Professors’ Key Points
Appearing on behalf of several tax law professors (and not to be confused with the group of law professors who filed an amicus brief in support of Section 107(2)’s constitutionality), Arizona State University professor Adam Chodorow argued that Section 107(2) is unconstitutional on its face because it singles out clergy with a special tax benefit. Professor Chodorow proceeded through an explication of the Tax Code, with the starting premises that all housing allowance are taxable unless a specific tax provision provides otherwise. Only very limited tax carve-outs exist, such as for lighthouse operators and other onsite workers where such housing is “mission critical.” Congress may – and has – provided other favorable tax treatment for certain workers (e.g., government employees and other expatriates working overseas, no tax on “combat pay”), but such considerations should not apply here – and cannot as a constitutional matter.
Professor Chodorow further distinguished Walz’s applicability, arguing that it is specific to property tax exemption and recognized the constitutional validity of a tax benefit applicable to religious and non-religious property owners alike. In response to Judge Brennan’s question about applicability of Lemon and Town of Greece, Professor Chodorow responded that Section 107(2) advances religion and therefore should be ruled unconstitutional and that the Town of Greece case does not speak to income tax issues.
He was not so concerned with entanglement issues as advanced by others in light of Section 119. Rather, he argued that ministers will have to pay tax on any cash housing allowance, if Section 107(2) is struck down, with Section 119 being inapplicable since it is only for employer-provided housing.
In response to a judge’s question about whether Section 107(2) is a public benefit or a subsidy, Professor Chodorow came down clearly on the side of subsidy, arguing that the government should not subsidize clergy. He conceded, though, that Congress may subsidize what is deemed “good for society” through classes of members. For example, Congress could provide favored tax treatment for psychologists as a tax class, on the basis of their perceived value to society, but not for clergy alone.
4. Plaintiffs/Freedom from Religion Foundation’s Key Points
Casting Section 107(2) as a “pocketbook issue,” FFRF attorney Richard Bolton first asserted that Section 107(2) should not be constitutionally allowed to favor only clergy – to the exclusion of atheists like his clients. In doing so, he distinguished Section 501(c)(3) tax-exempt status and property tax exemptions as applying to both religious and non-religious nonprofits. But the clergy housing allowance wrongly provides an economic benefit only to clergy, on a non-neutral basis, and therefore it violates the Establishment Clause of the First Amendment. With respect to the numerous entanglement issues raised by other legal counsel, he categorized such objections as “Alice in Wonderland” problems that do not actually exist.
One judge noted the U.S. Supreme Court decision in Texas Monthly, which concerned a state sales tax exemption that applied only to religious publications and was struck down, but with fractured decisions among the justices. The judge further observed that the Tax Code contains many references to clergy and religious institutions, with no apparent entanglement issues. In response, Mr. Bolton focused on Section 107(2) as an impermissible benefit only to clergy.
Wrapping up, Mr. Bolton noted FFRF is an atheist, non-religious organization that is educational and philanthropic, without any constituency that gathers together. Since the clergy housing allowance is only for clergy and not for FFRF’s leaders, it should be struck down as an unjustifiable preference for religion.
5. Brief Rebuttal
Mr. Panuccio was allowed brief rebuttal time for the U.S. government, in which he made the following points. First, in response to Professor Chodorow’s argument about the Tax Code scheme here, Section 119 and Section 280A allow for exclusion of otherwise taxable income used for business-related housing expenses, and the applicable case law here mandates judicial deference to the apparent secular purpose. Second, as a matter of Free Exercise constitutional protections, it is far better to allow Section 107(2) to stand than to risk the greater danger of excessive entanglement under the Establishment Clause if it is struck down. Third, with respect to the Texas Monthly decision, a very different type of tax was involved there that was enacted after a history of broader tax exemption. In any event, there is no tax subsidy provided through Section 107(2), but rather a legislatively defined category for worker-related housing, much like other tax classifications and aimed at equalizing the tax benefit of Section 107(1)’s parsonage exemption.
Gaylor v. Mnuchin has generated a wide scope of interest, from atheists to clergy to tax professors. In the coming months, the Seventh Circuit will issue a decision in due course, with an appeal to the U.S. Supreme Court expected, no matter the outcome. In the meantime, clergy across the nation will wait, many of whom still depend on housing allowances to serve the religious institutions that remain a steadfast part of our common civic life.
 Such distinction flies in the face of Trinity Lutheran, in which the Court directed that religion may not be disfavored. His position also concedes the point that Congress, not the courts, is the appropriate arbiter of tax policy.