On Church Myths, Deductions and Elections ...

I have been involved in an interesting discussion with my fellow Christian civil rights attorneys about the tax exempt status of so-called “sovereign” and/or "unorganized" or "unincorporated" churches that choose not to apply for 501(c)(3) tax exempt status.

It is absolutely true that there is no legal requirement that a body of believers acquire any government license or legal recognition to meet and associate. Christians are free to meet, associate and speak as they choose without any special approval by a government agency. But, tax exempt status is another matter.

While the IRS does not require churches to apply for tax exempt aka 501(c)(3) status, it does not follow that the church is not obliged to follow the tax code, especially concerning tax exempt status and charitable deductions. 501(c)(3) applications to the IRS simply authorize the IRS to issue a letter recognizing and clarifying an already existing state of existence for churches who choose to be tax exempt. However, the fact that a church has not applied for 501(c)(3) exemption does not mean that it has “opted out” of compliance with the tax code. Rather, 501(c)(3) status is automatically imputed to churches who accept tax exempt status without application.

The Internal Revenue Code, including § 501(c)(3), is part of the United States Code and is a generally applicable law of the land. The constitutional rights to free speech, free association and the free exercise of religion do not exempt churches or individual citizens from obedience to the generally applicable law of the land. Employment Div. v. Smith, 494 U. S. 872, 881. While Smith specifically addresses obedience of the tax code in the text of that decision, a subsequent decision, U.S. v. Indianapolis Baptist Temple, 224 F.3d 627 (7th Cir. 2000, cert denied. US 2001) made it abundantly clear that churches are not exempt from the tax code, holding:

… there is no basis under either the Free Exercise Clause or the Establishment Clause for the argument that neutral, generally applicable, minimally intrusive tax laws (like the ones at issue here) cannot be applied to religious organizations.

This decision also made it abundantly clear that the courts and the IRS are free to treat a church as the legal entity that closest describes its operation regardless of the church’s organizational statements to the contrary:

… IBT takes issue with the district court's characterization of it as an unincorporated religious society under Indiana law. IBT contends that it is a "New Testament Church," not an unincorporated religious society, and that by characterizing it as such an entity, the district court "established" a state church and imposed on IBT a form of worship contrary to its beliefs. The district court did neither of these things. It simply described the legal (not religious) nature of an already existing church

So, to clear up a couple of popular myths about church organizations, churches are not exempt from generally applicable laws of the land and those churches which accept federal tax exempt status are 501(c)(3) exempt organizations in the eyes of the law whether they have formally applied for that status or not. Further, the courts are free to treat them as 501(c)(3) organizations for the purposes of determining their eligibility for tax exempt status and may also treat them as the legal business entity (usually an unincorporated association) that most closely describes their method of operation regardless of their organizational statements to the contrary.

While generally, a donor's receipt provided by the church that includes the church name, address, the donor's name, amount donated and a statement that it was an exchange for intangible religious benefits is sufficient to meet the legal standard for a religious charitable donation, it is also true that:

… deductions are a matter of legislative grace, and that taxpayers must satisfy the specific statutory requirements for the deductions they claim. Davis v. Commissioner [Dec. 40,564], 81 T.C. 806, 815 (1983), affd. without published opinion 767 F.2d 931 (9th Cir. 1985). Taxpayers bear the burden of proving their entitlement to the deductions they claim. Welch v. Helvering [3 USTC ¶ 1164], 290 U.S. 111 (1933); Rule 142(a). A deduction is allowable under the provisions of section 170 when a contribution or gift is made to a qualified organization …

Bullock v.Commissioner, 56 T.C.M. (CCH) 636, T.C. Memo. 1988-526.

In order to be entitled to a deduction under section 170(a), petitioner must prove that the Church qualified under section 170(c)(2).

Beall v. Commissioner, 46 T.C.M. (CCH) 74., T.C. Memo. 1983-252. In short, for the deduction to be allowable by the donor, the church must conform to the Internal Revenue Code provisions for 501(c)(3) organizations. Disallowed deductions in turn create a second level of scrutiny and accountability for the church by the both the donor and the IRS. While there is usually no penalty for the disallowed deduction to the church, only to the donor, other considerations do come into play. The following is a text book example of actual fraud taken from a pastor education program taught by the Christian Law Association:

A pastor declares that “all contributions are tax deductible because the church meets the qualifications (for tax exempt status) of IRC § 501 (c)(3) even though the pastor has no idea if the church qualifies for federal tax exempt status. The donor is audited, the church is deficient in its § 501(c)(3) qualifications and the donors (deductions for) contributions are denied resulting in additional taxes and penalties to the donor.

This legal scenario is going to be very important in the weeks and months to follow in that both presidential candidates are firm advocates of much more restrictive enforcement of the Internal Revenue Code concerning religious organizations. We have already seen examples both nationally and here in Oklahoma of opposition political groups monitoring the activities of conservative churches for the purpose of challenging their tax exempt status. A maliciously donated twenty dollar check in the offering plate could cost tens of thousands of dollars in legal fees as well as cause great embarrassment to both the church and its staff. Recognizing this, several national Christian civil rights legal firms are gearing up for litigation on this issue.

In actuality, tax exempt churches possess much broader legal rights to expression on political, legislative and social issues than most pastors are comfortable exercising. Pastors and church people alike should make themselves familiar with these rights and exercise them. The Alliance Defense Fund issued a “Dear Pastor” letter in 2006 which clearly outlines these rights. A link to that letter is HERE. But, those constitutional rights have limits. Liberty Counsel has produced an excellent checklist of political activities tax exempt organizations may and may not do. A link to that list is found HERE and an excellent letter can be found HERE. But, be careful to read the fine print. Many activities are limited to the 5% "insubstantial part of the operation as a whole" ceiling under previous cases and rulings. And of course, there is substantial disagreement with these positions. The position of Americans United for Separation of Church and State can be found HERE. Notice that there is no substantial disagreement on what the law says about political activities by tax exempt organizations only broad differences in its application.

Reading all of this together, it is obvious that: (1) pastors and churches have far broader constitutional rights to political expression under the IRC than they have been led to believe; (2) good defenses can be offered in most cases where problems arise with the IRS; but (3) the surest way for a church to lose their case with the IRS is to deny that the tax code applies to them if they have accepted tax exempt status.

The Tenth Circuit Court of Appeals has made it very clear that there is only one way for a church to regularly and substantially participate in a broad range of social, political and legislative matters without IRC § 501(c)(3) regulation and that is to forego tax exempt status. This was pointedly driven home by an historic Tulsa case, Christian Echoes v. United States, 470 F.2d 849, 857 (10^th Cir. 1973) which holds:

In light of the fact that tax exemption is a privilege, a matter of grace rather than right, we hold that the limitations contained in Section 501(c)(3) withholding exemption from nonprofit corporations do not deprive Christian Echoes of its constitutionally guaranteed right of free speech. The taxpayer may engage in all such activities without restraint, subject, however, to withholding of the exemption or, in the alternative, the taxpayer may refrain from such activities and obtain the privilege of exemption.

This ruling places churches that teach that the government has no jurisdiction over their activities in a very difficult position both legally and doctrinally. This position, while constitutionally and theologically correct in my opinion, has nevertheless been eroded by subsequent court decisions to the point that it is probably indefensible in court. And, even if the government had no jurisdiction over the church itself, there can still be no argument that it has jurisdiction over the tax returns and deductions of the individual donors.

I believe the biblical answer to this dilemma is found in Matthew 17:24 et. seq. where Peter was asked if Jesus paid the temple tax. Jesus was the Son of God and a rabbi. He was doubly exempt from paying this tax. But, to assert his exemption would have presented a stumbling block to many who did not recognize his status. Consequently, he paid the tax to prevent it from compromising his message on other more important issues.

Peter and Jesus had no choice, in that situation they had to pay the tax or face the controversy. American taxpayers and churches do have a choice. They can comply with the tax code and operate within its limitations or they can refuse tax exempt status. And, the Alliance Defense Fund, Liberty Counsel and others are now offering a third practical option for some churches, litigation to clarify the allowable activities of tax exempt churches. I fully support this effort. But, to accept this third option, you have to admit that the tax code applies to tax exempt churches.

It may be time for some churches to forego tax exempt status in order to free themselves from the government scrutiny associated with §501(c)(3) compliance. Churches that are very active in political and social causes could save themselves a lot of grief by simply foregoing the deduction and speaking freely. Granted, they would be submitting themselves and their donors to an unfair and probably unconstitutional financial disadvantage. But, they would also be exercising the same loving deference that Jesus did in Matthew 17:24 et. seq. by not allowing their tax exempt status to get in the way of the larger mission.

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A very interesting article on this subject quoting several prominent Tulsa tax attorneys can be found HERE.