On March 15, 2019, the U.S. Court of Appeals for the Seventh Circuit held in Gaylor v. Mnuchin that the tax exemption for “ministers of the gospel” (defined below) under Section 107(2) of the Internal Revenue Code (the “Code”) does not violate the Establishment Clause[1] of the First Amendment and, therefore, is constitutional, overruling the district court decision.[2]

In Gaylor, the Freedom From Religion Foundation (the “FFRF”)[3] sued the Treasury Department after the Internal Revenue Service (the “IRS”) denied the refund claims of FFRF’s co-presidents who sought to exclude the portion of their salaries paid in the form of a housing allowance. The central issue in the case on appeal was whether the district court was correct in holding that the exclusion for housing allowances under Section 107(2) is a law “respecting an establishment of religion.”

Overview of Section 107

Section 107, commonly referred to as the “parsonage exclusion,” excludes from gross income housing furnished to a “minister of the gospel” (or, “minister”) as part of his or her compensation. For the purposes of this Code section, a “minister of the gospel” is “a duly ordained, commissioned, or licensed minister of a church or a member of a religious order”[4] and applies to religious leaders of any denomination.[5] The housing may be provided in kind under Section 107(1), in which case the rental value of the home including utilities are excluded,[6] or in the form of an allowance under Section 107(2), in which case the allowance is excluded to the extent it is considered “reasonable compensation” for the minister’s services[7] and is actually used in the taxable year in which it is received to pay for rent, the purchase of a home or expenses directly related to providing a home.[8] A cap on the exclusion under Section 107(2) equal to the fair rental value of a home, including furnishings, appurtenances and utilities, was added by Congress in response to constitutional concerns over the holding in Warren v. Commissioner, where the Tax Court determined that the language of the statute did not impose any such restriction.[9]

Consistent with exemptions under the “convenience-of-the-employer” doctrine for secular employees whose jobs have housing requirements, Congress enacted Section 107 to provide a housing exemption for ministers whose homes are often used as part of, or located in a certain area for, their ministry. While Section 107(1) was generally accepted by the FFRF to put ministers on equal footing as other employees who may exclude certain employer provided in kind housing under Section 119(a)(2),[10] the FFRF argued that the exemption under Section 107(2) for housing allowances is “different” and “better” than those for secular employees under the Code. Section 107(2) differs primarily from Section 119(a)(2) in that it excludes housing allowances as well as in kind housing and it does not require ministers to use their homes as a part of their ministry or to live in certain proximity to their “work” (i.e., their congregation).

Exclusion under Section 107(2) Found Constitutional

The court found that Section 107(2) does not violate the Establishment Clause as it has a secular legislative purpose, its principal effect is neither to endorse nor to inhibit religion and it does not cause excessive government entanglement.[11] The court additionally analyzed whether Section 107(2) is consistent with the “historical practices and understandings” of the Establishment Clause, following the mandate of Town of Greece v. Galloway.[12]

Although the primary housing exclusion provided under Section 119(a)(2) only excludes in kind housing, the court noted that there are “myriad” provisions in the Code that provide in cash and in kind housing exemptions for various categories of employees[13] and that limiting the parsonage exclusion to in kind housing tended to discriminate against ministers of smaller or poorer denominations.[14] Furthermore, Section 107(2) was found to avoid “excessive entanglement” with religion that would result if the IRS needed to inquire into the use of a minister’s home and what activities constitute “worship.” Although the IRS nonetheless must determine who qualifies as a “minister of the gospel” under Section 107,[15] the court reasoned that it involves less entanglement than the alternative of applying the requirements of Section 119(a)(2), which would force the IRS to determine what the “business” of a church is and how far the “premises” of the church extend.

Notably in determining whether Section 107(2) has the primary effect of advancing or inhibiting religion, the court declined to apply Justice Brennan’s plurality opinion in Texas Monthly that a tax exemption for religious publications violated the Establishment Clause because “[e]very tax exemption constitutes a subsidy that affects nonqualifying taxpayers,”[16] concluding that the Brennan plurality opinion was not binding under the Marks test.[17] As the Texas Monthly plurality was not binding, the court felt bound by Walz and Amos to conclude that tax exemptions do not constitute sponsorship of a religion.[18]

Turning to the historical significance test of Town of Greece, the court also found that Section 107(2) is constitutional because of the tradition throughout American history to provide tax exemptions for religion, particularly for church-owned properties. In other words, a tax exemption for parsonage is not what has been historically understood as constituting an “establishment of religion” and therefore is not a violation of the Establishment Clause.[19] The court dismissed both the district court’s finding that Section 107(2) is distinguishable from historical tax exemptions for religion since it is an income and not a property tax exemption, and the position of FFRF that a historical analysis of the Establishment Clause is only applicable when determining the constitutionality of legislative prayer.

Future of Section 107(2)

The ruling by the Seventh Circuit in Gaylor v. Mnuchin does not necessarily settle the constitutionality of Section 107(2). Whether the FFRF will appeal the case or whether the Supreme Court will review it is uncertain.