Watch Dr. Richard Hammar's response to yesterday's reversal of the minister's housing allowance ruling.
UPDATE: For an update on the housing allowance ruling click here.
On November 13, 2014, a federal appeals court reversed a ruling by a federal district court in Wisconsin striking down the housing allowance as an unconstitutional preference for religion. The court concluded that the Freedom from Religion Foundation, and two of its officers, lacked standing to challenge the housing allowance. Standing is a constitutional requirement for anyone bringing a lawsuit in federal court, and generally means that a plaintiff must experience a direct injury. The Wisconsin court concluded that the plaintiffs had standing due to their “injury” of being denied a housing allowance exclusion should they claim one on their tax returns. But the appeals court refused to base standing on theoretical injury.
The court noted that to have standing to challenge the housing allowance, the Freedom from Religion Foundation’s officers would have to file tax returns claiming a housing allowance, and then have their tax returns audited by the IRS and the housing allowance denied. Only then would their injury be sufficiently tangible to satisfy the standing requirement.
The Freedom from Religion Foundation and its two officers face two challenges. First, housing allowances cannot be designated retroactively, so it will not be possible for the officers to file amended tax returns for prior years, or claim a housing allowance for 2014. The Foundation will need to designate a housing allowance by the end of 2014 for 2015, and then, when filing their 2015 tax returns that are due in April of 2016, the officers would claim a housing allowance exclusion. Second, the IRS would then need to select one of these returns for audit. The audit rate is currently one percent, so it is unlikely that this would happen, even if the officers claimed housing allowances for several years.
Even if these hurdles are overcome, and the officers meet the standing requirement, this simply gets them back into federal court. The appeals court did not address the constitutionality of the housing allowance in its ruling. It simply said that the plaintiffs lacked standing to challenge the constitutionality of the allowance. The appeals court ultimately may rule that the housing allowance is constitutional. Or it may decide that it is not. Either way, the ruling likely will be appealed to the United States Supreme Court, which will take even more time. Clearly, these steps will take considerable time, and, pursuant to Wisconsin court’s original order, its ruling “will take effect at the conclusion of any appeals . . . or the expiration of the deadline for filing an appeal, whichever is later.”
Should the Freedom from Religion Foundation and its two officers ultimately prevail in their quest to strike down the housing allowance as an unconstitutional preference for religion, what would be the impact? A ruling by the Seventh Circuit Court of Appeals would apply to ministers in that circuit, which includes the states of Illinois, Indiana, and Wisconsin. It would become a national precedent binding on ministers in all states if affirmed by the United States Supreme Court--an unlikely outcome because the Supreme Court accepts less than 1% of all appeals. Note, however, that the IRS would have the discretion to follow or not follow such a ruling in other circuits and might be inclined to follow it to promote consistency in tax administration. In conclusion, ministers and churches should be aware that the housing allowance remains under attack, and one day may be invalidated. Should that occur, there are two actions that will need to be implemented quickly. First, ministers will experience an immediate increase in income taxes. As a result, they should be prepared to increase their quarterly estimated tax payments to reflect the increase in income taxes in order to avoid an underpayment penalty. Note that there will be no effect on self-employment taxes for which the housing allowance is not tax-exempt. And second, many churches will want to increase ministers’ compensation to offset the financial impact. Such an increase could be phased out over a period of years to minimize the impact on the church.
I will be monitoring all future developments, and will keep you posted as they occur.
Richard Hammar, J.D., LL.M., CPA
This article was excerpted with permission from Church Law & Tax Report, © 2014 Christianity Today International.