In 2002, the Internal Revenue Service (IRS) was involved in a lawsuit over the "parsonage exemption," a provision in the federal tax code that allows "Ministers of the Gospel" to exclude from their taxable income the value of a parsonage or other congregation-provided housing allowance. On its own initiative, the federal appellate court hearing the lawsuit appointed an attorney to argue one question that the parties - the minister and the IRS - did not want to raise. The court wanted to know whether the parsonage exemption violated the Establishment Clause, by providing an improper benefit to religion. This question was reasonable. With very few exceptions, employees must include employer-provided housing in their taxable income. The appeals court's decision to address the constitutionality of the parsonage exemption sparked an immediate response in Congress. Within weeks of the court's action, Congress passed and the President signed a new law, the Clergy Housing Allowance Clarification Act of 2002. The Act answered the legal question at issue in the IRS lawsuit, and thus stripped the court of its authority to rule on the constitutionality of the parsonage exemption.
 This political episode is telling. It suggests that at least some aspects of the tax status of religious entities are open to question, but it also reveals the powerful political support for the tax exemption of religious entities. Even if Congress is highly unlikely to alter religious entities' tax status, however, that status does raise interesting and important legal and ethical issues. In this article I'll describe the existing exceptions that religious organizations enjoy. I'll also address the main constitutional questions: whether religious tax exemptions violate the Establishment Clause or are required by the Free Exercise Clause. Finally, I will identify a few of the ethical issues for churches to address in deciding whether to avail themselves of the exemptions.
A. Taxation of religious entities: a brief overview
 Religious institutions are subject to - but frequently exempted from - a variety of types of taxation. I'll focus here on four types: income, payroll, property, and sales. These taxes may be imposed by one or more governmental entities, whether federal, state, or local. The specific exemption applicable to religious institutions may differ substantially depending on the character of the religious entity. Congregations and other places of worship may be treated differently from religious schools, social service agencies, or other faith entities.
1. Income tax
 When they consider the tax exemption of religious entities, most people focus on the institutions' status under federal and state income tax rules, and rightly so. The Internal Revenue Code classifies religious institutions as "exempt organizations," as provided and defined in section 501(c)(3) of the Code. Churches and other religious communities are treated as exempt under this provision even if they have not formally applied to the IRS for determination of their exempt status. That benefit - status without IRS determination - is enjoyed only by religious congregations and does not even apply to other religious entities (e.g., social welfare agencies or schools). Many religious bodies, including the ELCA, have obtained a formal determination of their status, whether individually or through a "group exemption letter" (such as the ELCA's).
 Status as a 501(c)(3) entity means that an organization does not have to pay corporate income tax on revenue generated by the entity's ordinary activities. Thus, the Code exempts income generated by the investment of a religious entity's endowment funds, or (generally speaking) the fees charged by a congregation for the use of the worship space for a wedding, or the tuition for a child enrolled in the church pre-school.
 Notwithstanding their status under 501(c)(3), exempt organizations may be required to pay tax on "unrelated business income." Such taxation, known as UBIT, applies to revenue generated by certain commercial activities of an exempt entity. The rules essentially impose taxes when the income is derived from commercial activity that is "regularly carried on," performed by paid employees, and is not performed "primarily for the convenience of [the entity's] members." Thus, an occasional car wash or bake sale used as a fundraiser by the congregation's youth group would not be subject to UBIT. But if the congregation opened a bakery or a permanent car wash facility, UBIT would almost certainly apply. Indeed, engaging in excess commercial activity may jeopardize the congregation's tax exempt status altogether.
 There is one very important difference between 501(c)(3) entities and other organizations exempt from taxation under the Code. Those who donate to the religious, charitable, and educational institutions covered in 501(c)(3) are entitled to deduct such contributions from their own income taxes. This added benefit of deductibility comes with several strings attached. First, 501(c)(3) entities must account for such donations, and provide donors with specific statements of charitable contributions - attesting that the donor did not receive "tangible" benefits in return.
 Second, the Code limits or bars the participation of 501(c)(3) organizations in a variety of political activities. Such organizations may devote no more than an "insubstantial" amount of their income to lobbying activity - defined as efforts to advance or thwart specific legislation. Moreover, 501(c)(3) entities may not use any resources for political campaigns - defined as efforts to elect or prevent the election of specific candidates for public office.
 These two limits, especially the one focused on "electioneering," have generated a great deal of controversy in recent years. Some religious advocates allege that the restriction "muzzles" the political activity of churches and religious leaders, preventing the full and equal political involvement of faith-based communities. While the concerns are serious, the restriction is frequently misunderstood. Under the Code, 501(c)(3) entities are prohibited from using, for political purposes, any funds that are raised by that entity - in other words, funds for which the donor was allowed to claim a deduction on their income taxes. Such religious communities are entirely free to set up a separate entity - equally tax exempt, but not able to offer deductible contributions - to participate actively in political campaigns, or engage in more intensive lobbying efforts. The entity would then only need to show that its political acts were wholly funded through the separate organization.
2. Payroll taxes
 Like other employers - both for-profit and exempt entities - religious organizations are generally required to withhold income tax payments from their employees' pay, along with employer and employee payments under the Federal Insurance Contributions Act (FICA), which covers Social Security and Medicare. Religious employers may be able to utilize two exceptions to this obligation: first, they are not required to withhold such payments from "ministerial" employees (ordained leaders). Second, religious entities that conscientiously object to the FICA withholding requirement (because, for example, they believe that their religious body is responsible for taking care of elderly members) may formally opt out of the obligation, though they may not do so with respect to the income tax withholding requirement. The religious employer's conscientious objection to withholding under FICA does not relieve employees of their duty to make such payments. Employees of objecting entities must make contributions under the Self-Employment Contributions Act.
 If a congregation fails in its duty to withhold and pay such taxes, liability may be imposed not only on the entity, but also on any individuals deemed responsible for that failure. Thus, a volunteer treasurer or council president may be held personally liable for the non-payment, because those individuals were permitted to sign checks or make personnel decisions on behalf of the congregation.
3. Property taxes
 While real property held by religious entities is frequently exempted from state and/or local property taxes, states have different rules on the breadth of the exemption, particularly the types of religious uses exempted. Some states limit the religious exemption to houses of worship, but these states typically also have broad exemptions for property devoted to charitable use, which will almost invariably encompass the full range of religious entities' noncommercial use of land - whether for schools, parsonages, social welfare agencies, or retreat centers.
 Disputes over church property taxes tend to arise in one of two contexts: First, a newer religious movement may claim an exemption, and the jurisdiction may question whether or not the religion is bona fide or merely a sham designed to avoid property taxation. These conflicts are a feature common to all religious exemptions, and courts or administrative agencies necessarily adopt limiting definitions - often an inelegant exercise of legal reasoning, but the lack of such limitations would threaten the existence of the religious exemption. Second, disputes may arise when a religious entity has not yet started - or has suspended - religious use of property. Most jurisdictions require active, ongoing, religious use; passive holding of property by religious entities is not usually sufficient to obtain the exemption.
4. Sales taxes
 Religious entities may enjoy two kinds of sales tax exemption. As consumers of goods and services, religious entities may be relieved of the obligation to pay sales tax on such goods or services. As producers of goods and services sold to others, religious entities may be exempt from the duty to collect (and convey) state or local sales taxes. As I'll explain below, sales tax exemptions of the first sort tend to be uncontroversial, because religious entities are included in a broader set of organizations exempted from sales taxes. The second type - exemption of religious goods or services - may raise serious constitutional questions if the exemption is extended only to religious goods or only to goods produced by religious entities. At one time, before the Supreme Court challenge to this practice described below, it was common for jurisdictions to exempt only religious publications - and sometimes only a limited set of religious publications - from the sales tax. Other publications (or the publications of non-religious entities) were subject to the sales tax.
B. Constitutional issues in the taxation of religious organizations.
 The US Supreme Court has decided three cases involving the taxation of religious entities: Walz v. Tax Commission (1970), Texas Monthly v. Bullock (1989), and Swaggart Ministries v. Board of Equalization (1990). Taken together, these decisions provide a rough guide to the constitutional issues raised in church tax disputes.
 In sharp contrast to the Walz decision, the Court in Texas Monthly held unconstitutional a Texas law that exempted religious publications from the state sales tax. The Court distinguished the Texas law from that upheld in Walz, finding that the Texas sales tax provision exempted only religious publications; all non-religious publications were subject to the tax. Over a strong dissent from Justice Scalia, the Court concluded that the sales tax exemption lacked a plausible secular purpose: in singling out religious materials for favored treatment, the state impermissibly signaled its support for religion over non-religion.
 Taken together, Walz and Texas Monthly provide a rough guide to the analysis of religious tax exemptions under the Establishment Clause. Exemptions that include religious institutions among a broad set of beneficiaries readily survive constitutional scrutiny. Exemptions that benefit solely religion or religious institutions, however, stand on much shakier ground. Such exemptions are not necessarily vulnerable to constitutional attack: The Court recently affirmed the constitutionality of the Religious Land Use and Institutionalized Persons Act (RLUIPA), which requires the state to accommodate religious practices that are "sincerely burdened" by public law or regulatory action. And courts have long enforced the exemption of religious entities from the prohibition on religion-based discrimination in employment. Nonetheless, tax exemptions that apply only to religious entities are more easily seen as a benefit conferred on religion, rather than relief from a burden that falls especially hard on religion - the principle that undergirds the RLUIPA and employment exemptions.
2. Does the Free Exercise Clause require the exemption of religious entities from taxation?
 One of the most frequently used aphorisms in tax law would seem to have direct bearing on our second question. In McCulloch v. Maryland (1819), Chief Justice John Marshall said that "the power to tax is the power to destroy." Marshall's statement highlights the risk that the government's taxing power may pose to any disfavored group, a category that certainly includes religious communities in particular places and times (including the present). So, does public exercise of the power to tax, when applied to religious entities, rise to the level of an unconstitutional threat? The answer, in general, is "No." In Swaggart Ministries v. California Board of Equalization, the Supreme Court rejected a claim that application of state sales tax to religious publications imposed an impermissible burden on the free exercise of religion. The Court said that payment of a tax that is imposed equally on religious and relevantly similar non-religious goods does not represent a constitutionally cognizable burden on religious liberty. The mere fact that religious conduct is made more costly cannot, in itself, trigger protection under the Free Exercise Clause - because the same argument could then be applied to virtually any tax, as well as to any regulation that requires a religious entity to spend money in order to comply.
 The Court would almost certainly take a different view of a tax that was exclusively imposed on religious entities or publications. The Court might use any (or any combination) of several constitutional paths in assessing such a religion-exclusive tax - through the Establishment Clause, Free Exercise Clause, or even the Speech Clause - but the analysis would focus on the government's reason for imposing the tax. The Court would demand that any such reason must involve government interests of the highest order, a standard that the government would be hard-pressed to meet.
C. Christian Ethics and Church Tax Exemptions
 The questions of whether churches should ethically take advantage of religious exemptions certainly implicates broader questions of tax policy - such as the extent to which public education depends on property tax revenue - but here I'll offer only a few questions, tied more narrowly to the exemptions discussed earlier. The questions arise from a rough, but handy measure for legal and policy practices: How does the tax structure affect the most vulnerable, particularly the poor and disfavored religious groups?
1. Religious exemptions and the poor
 In contemplating the effect of religious exemptions on the poor, we might want to distinguish between property and income taxes. With respect to property taxes, municipal officials, or at least those charged with "revenue enhancement," regularly complain about the extent to which exemptions withdraw valuable property from the tax rolls. Other property holders are thus saddled with a proportionally greater tax burden. Seen in that light, it's not hard to imagine contexts in which taking advantage of the religious exemption would be open to question - for example, an inner-city parish, with most members living outside the city. The burden of the exemption would then fall not on the members of the congregation who could afford to pay taxes, but on the neighborhood. Where the neighborhood is economically disadvantaged - and perhaps depends heavily on property taxes for education and other basic services - the exemption's burden seems even more troubling.
 That said, it is equally possible that this imaginary context: a) is not as burdensome as one might suppose, because of offsetting benefits provided by that parish to its neighborhood through the social programs and community stabilization that churches sometimes provide; or b) is not representative of the jurisdiction's religious entities, which, taken as a whole, provide significant benefits to the community, even if not every entity provides such benefits. Partly from administrative need, and certainly from constitutional concerns, the tax code must work in generalities. Separating beneficial from the burdensome churches is not a task one should entrust to bureaucrats, or to anyone else for that matter.
 With respect to income taxes, the impact of religious exemptions is likely to be more diffuse, because the "cost" to the tax rolls of exempting religious entities is much less obvious than the withdrawal of an otherwise valuable parcel. The net corporate income generated by most churches (that which is not otherwise captured under UBIT) is likely to be modest at best. Instead, the most important aspect of a religious exemption comes through the deductibility of donors' contributions. The relevant questions, then, focus on the extent to which such donations to religious entities divert funds that otherwise would have been used for the benefit of those in need. Such diversion might come either through tax revenues lost to the government, on the (questionable) assumption that the government would use the funds for those in need, or through donations lost to other charitable entities that would have used the funds in care for the poor.
2. Religious exemptions and disfavored religious communities
 Although most discussions of religious tax exemptions tend (as mine has) to link religious entities with the broad range of other non-profit activities granted such exemptions, religious exemptions also play an important role in the protection of vulnerable religious communities. This protection requires, at the very least, even-handed treatment of such communities - which means that the same burden imposed on the most vulnerable religious communities must also be imposed on the most established.
 One point of vulnerability inevitably comes when a government official is called on to decide whether a particular entity should be deemed "religious" and thus entitled to tax exemption. Although IRS rules - and those used by state authorities - tend to take an expansive view of "religion," the law still requires an official determination of the religious applicant's sincerity, and measurement of such sincerity typically involves comparison of the applicant's religion with a set of characteristics found in recognized religious bodies. The inquiry is designed to sift out applicants that are attempting to manipulate the tax system, and the reported cases in which religious status is denied frequently involve patently self-interested - and sometimes quite frivolous - claims. (The most frequent involve so-called "mail order" churches, set up for the express - and advertised - purpose of allowing taxpayers to shelter income from taxation.)
 Nonetheless, the determination does involve the exercise of official power over communities that, although sincerely religious, might look quite different from traditional faiths. A similar problem arises with respect to property taxation, when officials are required to determine whether a proposed land use is religious - even if the government acknowledges that the entity that owns the property is religious. The only solution to such problems rests with the basic elements of due process, including the transparency of official decision-making, reasoned decision-making, and the right of appeal.
 Finally, the concern about vulnerable religious groups encompasses more traditional groups as well, though this concern arises primarily from the interaction between zoning rules and property taxation. Recognizing that religious uses do not generate tax revenue - either through sales or property tax - land use planners are increasingly trying to exclude religious uses from areas zoned for commercial use. The problem is that religious uses typically fit best within the infrastructure of commercial zones, which can sustain greater vehicle traffic and noise than areas zoned for residential use (and especially single-family residential zones). The result, as a practical matter, can be the effective exclusion of religious uses, or at least their banishment to the periphery of communities. Any analysis of the tax exemption of religious properties needs to take into account this - certainly unintended - effect of that status.
 In all, state and federal legislative bodies and the courts have exercisedsignificant protection for religious entities. Congress and statelegislatures have created religious exemptions from income, payroll,property, and sales taxes, and courts have upheld the propriety of thoseexemptions under the Establishment Clause. While religious entities do nothave an absolute right to such exemptions under the Free Exercise Clause,state and federal legislators have made no serious movement to revoke thepresent exemptions. The more difficult questions are ethical - should religious entities take advantage of those exemptions, particularly wherewithdrawal of church properties' taxation might significantly affect the taxbase of a low-income neighborhood, or where minority religions are being putat a significant disadvantage?
 Congregations may want to address thesequestions in the context of the larger discussions they should be havingabout whether our overall tax system is consistent with Lutheran ethicalprinciples, a subject that is addressed elsewhere in this issue.
. The provision at issue is contained in Section 107 of the Internal Revenue Code. The IRS interprets the language of the exemption to provide the exemption for ordained ministers or their functional equivalents in any faith. The lawsuit was Warren v. Commissioner of Internal Revenue, 282 F.3d 1119 (9th Cir. 2002).
. The attorney appointed by the court was law professor Erwin Chemerinsky. He gives an account of the case - and his analysis of the parsonage exemption - in a law review article, The Parsonage Exemption Violates the Establishment Clause and Should Be Declared Unconstitutional, 24 Whittier L. Rev. 707 (2003).
. Chemerinsky cites congressional sources for his claim that the parsonage exemption saves clergy around $500 million a year.
. For very good overview of tax law as it applies to religious organizations, see ; ; C Law & Tax Report
. IRS , page 12.
. Pew Forum .
. Ministers may elect to have the church withhold income tax payments, but ministers are exempted altogether from FICA withholding. Instead, ministers must pay Social Security and Medicare taxes under the Self-Employment Contributions Act (SECA), unless the minister formally claims a conscientious objection to such contributions, in which case the minister is then ineligible for Social Security and Medicare benefits that otherwise would have accrued during his or her ministry.
. See Carter v. United States, 717 F.Supp. 188 (SDNY 1989).
. For a good overview of both history and practice of property exemptions for churches, see John Witte, Tax Exemption of Church Property: Historical Anomaly or Valid Constitutional Practice? 64 S. Cal. L. Rev. 363 (1991).
. See, for example, California's three distinct exemptions that may apply to religious property; the primary difference between the three seems to involve the process for obtaining and maintaining the exemption (uses other than houses of worship have slightly more burdensome administrative requirements). The extent of the tax exemption granted is the same across all three categories: www.boe.ca.gov/proptaxes/pdf/pub48.pdf
. The Court has also decided two cases that involve the tax treatment of particular religious expenses, Hernandez v. Commissioner (1989) (on the deductibility of Scientology's "auditing" fees); and Davis v. United States (1990) (on the deductibility of Mormon parents' payments to their sons while on church-sponsored missionary service).
. Cutter v. Wilkinson (2005). For more detail on RLUIPA, see www.rluipa.com (website maintained by the Becket Fund for Religious Liberty, which has been involved in many of the lawsuits involving RLUIPA).
. See Corporation of Presiding Bishop v. Amos (1987) (upholding constitutionality of Title VII's exemption of religious employers from the restriction on religion-based discrimination).
. In retrospect, it is easy to see in this argument the unraveling of the entire fabric of free exercise exemptions from the law of neutral applicability - a conclusion reached within months of the Swaggart Ministries decision, in Employment Division v. Smith (1990).
. The religion-only tax - which would be nearly impossible to justify - stands in contrast to religion-only exclusions from public aid, which is a staple of Establishment Clause law. Government regularly funds only secular activities - indeed is constitutionally forbidden to directly fund religious activities. In Locke v. Davey (2004), this distinction was challenged as a violation of the Free Exercise and Speech Clauses, but the Court upheld a state restriction on aid to religion, citing traditional Establishment Clause principles as constitutionally sufficient justification for the restriction. For more on Locke v. Davey, see Lupu & Tuttle analysis, online at: www.religionandsocialpolicy.org.
. I don't mean to minimize the independent significance of donations to religious entities for the support of worship, care for those in the religious community, proclamation of the gospel, and religious education. Whether the state endorse such activities as matters of public welfare is a much more difficult constitutional and theological question.
. See Larson v. Valente (1982), in which the Court struck down registration and reporting rules that applied only to religious entities that received less than 50% of their funds from members. The Court found that the rules had been written to restrict the activities of the Unification Church and perhaps other religious groups that engaged in public solicitation.
© September 2007
Journal of Lutheran Ethics
Volume 7, Issue 9