Tax Law Blog

Seventh Circuit Reverses District Court; Turns Away Constitutional Challenge to Minister's Housing Allowance

The principle that individuals have the right to worship as they see fit has been fundamental in the United States since the country's founding. However, while the government may be prohibited from establishing a religion or interfering with the free exercise thereof, that does not mean that government has no role in religion. Throughout history, organized religions have enjoyed special legal status, including in the Internal Revenue Code (the "Code").

The parsonage allowance, codified in Section 107 of the Code, has two parts.  Section 107(1) grants a tax exemption on the rental value of a home directly provided to a minister as part of his or her compensation. Section 107(2) excludes from gross income rental allowances paid to a minister as part of his or her compensation.

In November 2013, the U.S. District Court for the Western District of Wisconsin declared Section 107(2) of the Code unconstitutional because it violates the Establishment Clause of the First Amendment. The decision was appealed to the U.S. Court of Appeals for the Seventh Circuit. 

In a win for churches and other religious organizations, a three-judge panel of the Seventh Circuit, in Freedom From Religion Foundation Inc. v. Lew, concluded that the Freedom From Religion Foundation (FFRF) lacked standing to challenge the constitutionality of Section 107(2). 

The plaintiffs-appellees included FFRF, which is an organization devoted to educating the public about nontheistic beliefs and is recognized by the IRS as a charitable educational organization. FFRF’s co-presidents receive a housing allowance as part of their compensation package, but because they are not “ministers of the gospel” in accordance with Section 107(2) they must pay income tax on their housing allowances.

The Seventh Circuit reversed the lower court decision and ordered the case to be dismissed. It did so without considering whether Section 107(2) violates the Constitution, but rather on the grounds that the FFRF lacked standing to bring the suit and challenge the law.

Citing various U.S. Supreme Court decisions, the Seventh Circuit stated that for a party to have standing he or she must show “(1) a concrete and particularized ‘injury in fact’ (2) that is fairly traceable to the challenged action of the defendant, and that is (3) likely to be redressed by a favorable judicial decision.”  Standing, the court explained, “cannot be based on a plaintiff’s mere status as a taxpayer.” 

In this case, the court made clear that the plaintiffs could not establish standing without first claiming a parsonage exemption from the IRS and being denied. "[T]he plaintiffs were never denied the parsonage exemption because they never asked for it. Without a request, there can be no denial. And absent any personal denial of a benefit, the plaintiffs’ claim amounts to nothing more than a generalized grievance…”

It is unlikely that this issue will go away, and we expect to see additional challenges to the constitutionality of Section 107. A great deal of money is at stake - more than $700 million a year. If Section 107 is declared unconstitutional, this money will shift from church and ministry budgets to the payment of taxes that are now saved through the housing allowance.

We will continue to monitor this issue and any additional constitutional challenges. If you have any questions about these issues, or tax issues in general, please contact a Foster Swift attorney.

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