Gaylor v. Mnuchin—A Step Toward Greater Clarity on Clergy Tax Exemptions?

Vol. 37 No. 1 | November 2017

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On October 6, 2017, the U.S. District Court for the Western District of Wisconsin declared section 107(2) of the Internal Revenue Code unconstitutional. The provision permits “ministers of the gospel” to exclude from income compensation designated as a housing allowance, thus giving churches and other religious organizations the ability to provide tax-free housing to their ordained ministers. The provision applies not only to parish priests living in modest housing, but also to televangelists like Joel Osteen, who currently lives tax-free in his $10.3 million mansion. It also applies to ministers who work in church-affiliated schools as teachers and administrators. This affords a significant benefit for certain schools whose religious tenets include the ministry of all believers. In one case, a basketball coach was entitled to exclude his housing allowance from income. The government foregoes around $800 million in revenue per year as a result of this provision, and, if the decision stands, it could have a significant impact on churches and other religious institutions.

Clergy and laypeople have long been able to exclude in-kind employer-provided housing from income, where the housing was provided so that the employees could perform their jobs. In 1954, Congress tightened up rules for laypeople, codified in section 119, while expanding the provision for clergy. Lay employees were only allowed to exclude 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. In addition, Congress added section 107(2), exempting cash allowances designated for clergy housing from tax. In 2002, the Ninth Circuit raised the question of the cash allowance provision’s constitutionality sua sponte in Warren v. Commissioner,1 recruiting Erwin Chemerinsky to file a brief on the question. Chemerinsky concluded that the provision was unconstitutional and filed a brief to that effect.2 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.

The Freedom From Religion Foundation, Inc., soon took up the challenge. In 2013, the U.S. District Court for the Western District of Wisconsin held section 107(2) to be unconstitutional. On appeal, the Seventh Circuit vacated the judgment and remanded with orders that the case be dismissed for lack of standing.3 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 6 months, they filed suit in federal district court. The court’s October 6, 2017 opinion in this second case reaffirms its earlier opinion and addresses additional arguments the parties made.

The court methodically addressed each of these claims, using the longstanding Lemon three-part test as a framework. [It concluded] that the law did not have a secular purpose.… [The] sponsors viewed the provision as a tool in the fight against godless communists and a way to support poorly paid ministers, undermining the claim that it is part of a broad web of similar housing provisions.

Proponents again raised standing challenges and made a number of claims in support of the exemption. First, they argued that the exemption, which singles out “ministers of the gospel” for a benefit, 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 argued that exemption from tax does not pose the same constitutional issues as direct subsidies. Third, they argued that, even if the provision does single out religion, it is appropriate as an accommodation to religion under the First Amendment’s Free Exercise Clause. One claim was that the provision is necessary to avoid the church-state entanglement that would arise were the general rules applied to churches and clergy. Another was that the provision is necessary to ensure that all clergy receive the same benefit, regardless of a church’s housing policy. Supporters also pointed to other exemptions in the Code as support for the propriety of this one.

The court methodically addressed each of these claims, using the longstanding Lemon three-part test as a framework.4 For instance, it examined the legislative history to conclude that the law did not have a secular purpose. The court noted that the sponsors viewed the provision as a tool in the fight against godless communists and a way to support poorly paid ministers, undermining the claim that it is part of a broad web of similar housing provisions. The court also rejected the claim that tax exemptions did not raise First Amendment concerns in the same way as direct support. The court further noted that requiring clergy to pay tax on all their income does not infringe on the free exercise of religion, thus undermining the claim that the exemption serves as an accommodation. Finally, the court asked the parties to file briefs regarding the appropriate remedy. Plaintiff’s goal in the lawsuit is not to get the refund for which they sued, but rather to have the provision deemed unconstitutional so that the benefit is no longer available. Those briefs were due at the end of October.

This case is certain to be appealed to the Seventh Circuit and eventually to the Supreme Court. It presents a complex mix of First Amendment law and tax policy. If the decision stands, many will view it as appropriately resolving a problem of preferential taxation of religious workers. Clergy will have to pay tax on all their compensation, and churches and clergy may decide to renegotiate their compensation packages. If the higher courts reverse this decision, the consequences will depend on the reasons given. Either way, we may get some clarity in this often murky area of the law.


2 Erwin Chemerinsky, The Parsonage Exemption Violates the Establishment Clause and Should Be Declared Unconstitutional, 24 Whittier Law Rev. 707 (2003).

4 Lemon v. Kurtzman, 403 U.S. 602 (1971) (finding that a statute concerning religion (i) must have a “secular legislative purpose,” (ii) must not have a “principal or primary effect” that  advances or inhibits religion, and (iii) must not result in “excessive government entanglement” with religion.

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ABA Tax Times, June 2017
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