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From: 

https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3103906

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VIEWPOINT

TaxNotes

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The Parsonage Exemption Subsidizes Religion
by Adam Chodorow and Ellen P. Aprill

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Adam Chodorow is the Willard H. Pedrick Distinguished Research Scholar and associate dean for academic affairs at the Sandra Day O’Connor College of Law at Arizona State University.

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Ellen P. Aprill is a professor of law and the John E. Anderson Chair in Tax Law at
Loyola Law School Los Angeles.

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The authors would like to thank Marcy Strauss, Aaron Caplan, and Sanford Holo for their assistance.

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In this article, Chodorow and Aprill discuss section 107(2), which permits churches and other religious organizations to provide tax-free housing to their ordained ministers. They argue that the exemption provides special benefits unavailable to laypeople and thus raises serious establishment clause concerns.

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On October 6 the U.S. District Court for the Western District of Wisconsin declared section 107(2) unconstitutional. (1) The provision permits “ministers of the gospel” to exclude from income compensation designated as a housing allowance.

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It thus gives churches and other religious organizations the ability to provide tax-free
housing to their ordained ministers. Both clergy who rent and those who own their homes are eligible for this exclusion. Those who own their own homes may also take mortgage interest and property tax deductions, as well as build equity. These benefits apply equally to those who live on a modest scale and those who live in multi-million dollar homes. (2)

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Clergy save about $700 million each year in taxes as a result of this provision. The court found it to be a clear subsidy for religion. One of us, who does significant pro bono work for religious congregations, has often been told that clergy would be unable to make ends meet without this tax benefit, an argument that demonstrates how the housing allowance operates as a subsidy. Moreover, both clergy and religious congregations often underestimate the value of the housing allowance. A member of the clergy who pays $2,000 per month in rent and receives a $24,000 tax-free housing allowance likely sees the tax savings as $6,000, assuming a 25 percent marginal rate. However, the minister would have to be paid $32,000 in taxable income to yield $24,000 in after-tax income. In other words, the parsonage exemption yields a benefit of $8,000, not $6,000. Insofar as clergy and religious institutions do not fully understand the full value of the tax-free benefit, it seems unlikely that they adjust the taxable portion of the compensation to take the full benefit into account when setting total clergy compensation.

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The Beckett Fund for Religious Liberty intends to appeal the decision. The fund’s senior counsel stated in a press release, “It’s not unconstitutional for the federal government to treat faith leaders the same as other secular employees in their housing allowances. In fact, treating them differently would be discrimination against religion, pure and simple.” When the parsonage exemption is viewed in its proper tax context, it becomes clear that the Beckett Fund has it exactly backwards. The exemption provides special benefits unavailable to laypeople, even those who work under similar constraints and do similar jobs. Eliminating that benefit would not discriminate against religion. To the contrary, it would treat clergy just like everyone else, which is precisely the goal that the Beckett Fund purportedly desires.

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Background

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Clergy and laypeople have long been able to exclude in-kind employer-provided housing from income when it appeared that the housing was provided so that they could perform their jobs. In 1954 Congress tightened up the rules for lay people, which were codified in section 119, and expanded the provision for clergy. Lay employees were allowed to exclude only the value of in-kind housing provided on-site, required by the employer, and for the employer’s convenience. In contrast, ministers could exempt the value of all in-kind housing, regardless of location or the purpose for which it was provided. Further, Congress added section 107(2), exempting cash allowances designated for housing from tax. In 2002 the Ninth Circuit sua sponte questioned whether the cash allowance provision was constitutional in Warren (3), recruiting Erwin Chemerinsky to weigh in on the question.  Chemerinsky concluded that the provision was unconstitutional and filed a brief to that effect. (4) However, the parties quickly settled the case, and the court dismissed it over Chemerinsky’s objections, inviting him to file his own lawsuit if he wished to pursue the matter.

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The Freedom From Religion Foundation soon took up the challenge. In 2013 the U.S. District Court for the Western District of Wisconsin held section 107(2) unconstitutional. On appeal, the Seventh Circuit vacated the judgment and remanded with orders that the case be dismissed for lack of standing. (5) The court held that the plaintiffs needed to ask for the benefit and be denied to establish injury, which is an important element for standing. In response, the plaintiffs arranged to receive a housing allowance from their employer, paid tax on it, and then sought a refund. When the IRS failed to respond within six months, the plaintiffs filed suit in federal district court. The court’s October 6 opinion in this second case reaffirms its earlier opinion and addresses additional arguments the parties made.

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In addition to standing issues, proponents make several claims in support of the exemption.  First, they argue that although the exemption singles out “ministers of the gospel” for a benefit, it should be seen as part of a broader policy of excluding housing that includes sections 119 (the general rule), 911 (expatriates), 134 (military personnel), and 912 (government employees working overseas). Second, they argue that exemption from tax does not pose the same constitutional issues as would direct subsidies. Third, they argue that even if the provision does single out religion for a benefit, it is appropriate as an accommodation to religion under the First Amendment’s free exercise clause. By way of  example, they point to other exemptions in the code as support for the propriety of this one.

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A Special Benefit for Clergy

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It is impossible in the space available to address all the arguments made in the case, and  indeed many focus on arcane and often befuddled First Amendment jurisprudence. However, the parsonage exemption is part of the tax code, and understanding how it functions within that code is at the heart of the Beckett Fund’s arguments described above and critical to the constitutional analysis.

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The Beckett Fund points to other housing provisions in the tax code to argue that the
parsonage exemption is simply part of a broader, neutral web of exemptions that happens to include clergy, much the way section 501(c)(3) includes charities, educational facilities, and churches. As a result, the argument goes, eliminating the exemption actually discriminates against clergy. The problem is that the provisions applicable to other employees differ markedly and in important ways from the housing allowance given to ministers. In other words, the argument works only if the listener ignores the requirements of the other tax provisions regarding housing and the policies underlying them. (6)

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The default rule is that employer-provided housing, whether in-kind or as an allowance, is considered income and subject to tax. However, Congress has carved out a very limited number of exceptions. Section 119 allows a taxpayer to exclude the value of in-kind on-site lodging furnished for the convenience of the taxpayer’s employer. Examples of those who qualify for an exemption under section 119 include hospital workers, hotel managers, and seamen, all of whom must be on-site overnight to perform their jobs. In those cases, the housing is not compensatory and is therefore properly excluded from income. As noted above, section 107(1) gives clergy far more favorable treatment by allowing in-kind housing to be off-site and compensatory in nature. It thus excludes actual income from the tax base in a manner that section 119 does not. (7)

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In some limited circumstances, Congress has allowed employers to provide tax-free housing allowances, as does section 107(2). However, those provisions can also be easily distinguished from the parsonage exemption. For instance, sections 134 and 912 permit military personnel and federal government employees living abroad to exclude housing allowances. The exemption in those cases should be understood as part of the employment contract between the government and its workers. Rather than tax those amounts and gross up salaries to account for the additional taxes, the government simply excludes the allowances from income. Section 911 permits those who have established a tax home overseas to exclude foreign earned income, including some housing costs. This provision eliminates double taxation for those subject to foreign taxes.  Alternately, it could be seen as a subsidy to encourage international trade. Extrapolating from these limited provisions, which cover a small subset of government and overseas workers, to a broad policy that naturally includes clergy — and only clergy — seems a stretch.

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Any notion that Congress considers those employees to be similarly situated and therefore equally worthy of tax-free housing, albeit in completely different statutes enacted and different times, is easily refuted by looking at section 107’s legislative history. When Congress expanded the parsonage exemption in 1954, it made clear that it was doing so to support clergy in their fight against the godless communists and in recognition of their historically low pay. Efforts to describe a broad, neutral policy are nothing more than a post-hoc rationalization, devoid of any support in the historical record.

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Eliminating the clergy’s ability to receive tax-free housing would not exclude them from benefits generally available to other workers or discriminate against them, as the Beckett Fund claims. Those who satisfy the general rule in section 119 would be eligible to exclude housing to the same extent as everyone else who qualified. To the contrary, it would put clergy on the same footing as all other domestic employees, save the military and a select few who live and work overseas. The notion that eliminating a provision that specifically benefits clergy would discriminate against them is breathtaking in its audacity. It is also wrong.

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Next Steps

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If the decision stands, clergy who take advantage of this provision will see their tax bills go up. Although this tax increase could cause some hardship, that consequence alone is insufficient to avoid the outcome. Courts routinely prohibit religion-specific subsidies if they violate the establishment clause, even though the prohibition may cause an economic loss for the recipient. (8)  Moreover, organizations that make use of the housing allowance can adjust the salaries of clergy who could not satisfy section 119, with the parties allocating between themselves the burden of the additional tax obligations.

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Alternately, Congress could actually create a broad class of similarly situated employees eligible to exclude their housing costs, of which clergy were a natural part. (9)  There would be no need to invent a legislative history or stitch together disparate provisions enacted at different times for different purposes to argue that failure to offer clergy special benefits unavailable to others was an act of discrimination against them. A congressional fix would permit distinctions and financial considerations that a court could not take into account.

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Conclusion

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In recent years, some religious adherents have argued that they should be exempt from generally applicable laws that require them to violate their religious beliefs. The argument has enjoyed some political success, producing, for example, the Religious Freedom Restoration Act. If, however, religious organizations and individuals are to be free from government interference, they should also embrace the First Amendment’s corollary — that they not receive government support. The parsonage exemption operates as a special subsidy to clergy, and no amount of special pleading can change that. That a select few government employees and expatriates receive tax-free allowances does not mean that failing to make similar arrangements available to clergy discriminates against them.

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Religious organizations hold themselves out as moral and ethical entities. They will live up to their own standards, and serve as a model for all Americans, when they accept constitutional principles, even those that create financial burdens.

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FOOTNOTES

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(1) Gaylor v. Mnuchin, No. 16-cv-215 (W.D. Wis. 2017).

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(2) Because of standing issues, the court did not address the
constitutionality of section 107(1), which allows clergy to receive tax-free
in-kind housing. Approximately 13 percent of clergy who receive
housing benefits do so under that provision.

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(3) Warren v. Commissioner, 302 F.3d 1012 (9th Cir. 2002).

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(4) Chemerinsky, “The Parsonage Exemption Violates the
Establishment Clause and Should Be Declared Unconstitutional,” 24
Whittier L. Rev. 707 (2003).

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(5) Freedom From Religion Foundation Inc. v. Lew, 773 F.3d 815 (7th Cir.
2014).

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(6) For a more in-depth discussion of this issue, see Adam Chodorow,
“The Parsonage Exemption,” 51 U.C. Davis L. Rev. (forthcoming 2018).

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(7) As part of the ongoing tax reform efforts, the House has proposed
curtailing section 119 by imposing a cap on the housing value that may
be provided tax-free. It is not clear at the time this piece went to press
whether this proposal will become law, but if it does, it would further
highlight the ways in which section 107 provides benefits to clergy above
and beyond those given to others.

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(8) See, e.g., Texas Monthly Inc. v. Bullock, 489 U.S. 1 (1989) (invalidating
sales tax exemption restricted to sacred texts and proselytizing
literature).

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(9) See, e.g., Ellen P. Aprill, “Parsonage and Tax Policy: Rethinking the
Exclusion,” Tax Notes, Aug. 26, 2002, p. 1243 (suggesting that Congress
create a limited exemption for employees of tax-exempt organizations
who are on call overnight).

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