Tax exemptions

Monday, September 16, 2002

(Author’s note: Throughout this section “church” is used to mean any place
of worship, such as a mosque, synagogue, temple, etc. It does not indicate a
preference for Christian houses of worship, but is the convention employed by
the IRS and therefore followed here for ease of use.)

Although using tax dollars for churches has a long and contentious past,
public sentiment seems far less concerned about the converse relationship
between churches and taxing authorities — namely the tax-exempt status of
churches and other religious institutions.

Tax exemptions of different types were common in the Colonial period. After the Revolution and the ratification of the Bill of Rights, most states retained these exemptions. State and local governments continue to exempt churches from local taxation. In 1913 the federal government embraced this trend by exempting churches and other religious organizations from federal taxation in the modern federal tax code.

Under the federal scheme, all nonprofits that abide by certain regulations
are exempt from federal taxes. Donations made to such groups are likewise
tax-deductible for the donor. Churches and religious organizations receive these and some other benefits. For example, churches are not required to file tax returns or apply for tax-exempt status. The Internal Revenue Service
automatically considers churches exempt (though many churches file anyway in an effort to assuage concerns of donors.)

The reasoning behind making churches tax-exempt and unburdened by IRS
procedures stems from a First Amendment-based concern to prevent government involvement with religion. By avoiding initial inquiries into churches’ validity as houses of worship, government avoids violating the churches’ free-exercise right to define and regulate themselves. Legislators have also responded to public sentiment that churches provide a valuable function in the community, and therefore should receive benefits that other charitable organizations enjoy.

Specific IRS interpretations and codes distinguish between churches and
religious organizations. There are additional rules for religious institutions
that engage in business dealings unrelated to their ministry. Such business
ventures may be taxed by the government.

Restrictions on religious groups
Though the IRS seeks to protect the religious-liberty rights of church members, it is also concerned that churches function within their designated sphere and not engage in prohibited activities.

In order to maintain tax-exempt status, churches, like other 501(c)(3)
charitable organizations, must forego certain activities. Specifically,
501(c)(3) organizations are prohibited from engaging in excessive political
lobbying and any political campaigning. According to the IRS, Sec. 501(c) of the IRS Code requires that a tax-exempt religious organization “may not attempt to influence legislation as a substantial part of its activities and it may not participate at all in campaign activity for or against political

Some critics have complained that restricting a church’s right to engage in
political campaigning infringes on its First Amendment rights to both free
speech and free exercise of religion. In 2001, these complaints were brought to
Congress. Rep. Walter B. Jones Jr., a Republican from North Carolina, introduced the “Houses of Worship Political Speech Protection Act,” which would amend the tax code to allow churches to engage in political campaigning for candidates as long as such actions “were not a substantial part” of the churches’ activities.

After failing to pass, the bill was reintroduced in 2003 and again in 2005. The
2005 bill was modified to focus on the actual content of presentations made
during worship time.

Proponents of this bill say it is needed so that churches may function in
their prophetic role by encouraging parishioners to vote according to the
dictates of their faith. They claim the church has a long history of political
activity, including campaigning, and that the restrictions on campaigning were
not introduced into the tax code until 1954.

Opponents say restricting churches’ ability to campaign from the pulpit
protects the integrity of both the church and the political process. They also
point out that most clergy do not support the bill (77% disapprove of it,
according to a 2001 Gallup/Interfaith Alliance Foundation poll) and that it is
based on a poor understanding of current law. Currently, churches may speak out on social issues, but they cannot mention or campaign for specific candidates by name.

Yet statutes and codes do not always settle controversies over the relationship between churches and taxes. Courts hear lawsuits on issues spanning from the constitutional validity of tax exemption to complaints about the loss of tax-exempt status to what counts as a church for tax purposes.

The leading Supreme Court decision on this issue is Walz v. Tax Commission of City of New York (1970), in which Frederick Walz, a taxpayer, sued to prevent New York City from giving religious groups an exemption from taxes on property that was used exclusively for religious purposes. His argument was that the exemption provided a material financial benefit to religious organizations, and that such a provision was not permitted under the First Amendment’s establishment clause.

The Court responded that, though the establishment clause prohibits
government from sponsoring, funding or actively involving itself in religious
activities, it is allowed to operate with “a benevolent neutrality which will
permit religious exercise to exist without sponsorship and without
interference.” The question that must be asked when the possibility of
“establishment of religion” arises, the Court said, is “whether particular acts
in question are intended to establish or interfere with religious beliefs and
practices or to have the effect of doing so.”

The Walz Court determined that where religious organizations were not
the only groups exempted from taxation — even non-religious organizations that pursued “charitable, benevolent, hospital, infirmary, educational, scientific, literary, library, patriotic, historical, or cemetery purposes” were also exempted — the mere fact that religious groups did benefit from such a scheme did not demonstrate any government preference for religion.

The Supreme Court has made clear that a tax exemption is neither prohibited
nor required under the First Amendment’s free-exercise and establishment
clauses. The Walz Court said that the long history of tax exemption for
religious organizations in no way creates an entitlement to any such exemption.

Furthermore, the Court noted that even if a legislature should decide to grant
tax exemptions, the constitutionality of the system of exemptions at issue in
Walz could not establish a presumption of constitutionality for any system that
benefited religious organizations.

Indeed, when the Court was called upon in Texas Monthly, Inc. v. Bullock (1989) to consider a statute granting a tax exemption specifically to religious periodicals, it determined (in a 6-3 plurality decision) that, although governments may grant exemptions to religious organizations as part of a broader classification (such as “nonprofit organizations”), groups could not be singled out for benefit solely because of their religious nature.

Though the courts clarified the constitutional limits of exemptions for
churches in the 1970s and ’80s, more recent controversies focus on the
parameters of prohibited church actions.

In 2000, the Washington, D.C., district court decided a case involving the
loss of a church’s tax-exempt status. In Branch Ministries v. Rossotti,
the church (then acting under the name “The Church at Pierce Creek”) ran a
full-page ad in The Washington Times and USA Today. The ads warned
Christians against voting for then-Gov. Bill Clinton of Arkansas because of his
positions on a variety of issues. When the ads came to the attention of the IRS
office, an investigation ensued. The IRS concluded that the church had violated
the restrictions against campaigning and the church’s tax-exempt status was

The church contested the sanctions, claiming violations of a number of its
constitutional rights, including a free-exercise violation under the Religious
Freedom Restoration Act (RFRA). The court analyzed the claims and found that, even under the far more stringent requirements of the compelling-interest test RFRA requires, the church had violated the statutory restrictions on campaigning and thus the IRS removal of exempt status would stand.

In another case, a Florida court examined whether “The Holy Land
Experience,” a religious theme park in Orlando, counted as a church for tax
purposes. The park recreates scenes from ancient Jerusalem and Biblical stories.

Run by Zion’s Hope, the park is purportedly designed to tell people about the
Christian faith, with a special emphasis on converting Jews to Christianity. An
entry fee of $35 and various concessions caused critics to claim this was not a
church, but a money-making enterprise that should be taxed. When the local tax agency attempted to levy property taxes on the park, Zion’s Hope sued. On July 5, 2005, Judge Cynthia Mackinnon ruled that the theme park did indeed count as a church, and was entitled to tax-exempt status.

These cases highlight some of the more difficult questions still lingering in
this area. Where does a prophetic sermon end and political campaigning begin?
What counts as a church? What criteria are used to decide? Who should

The one clear area is that the IRS and the courts look to the principle of
neutrality when determining whether a particular tax scheme violates the
establishment clause or other constitutional protections.

Related issues
Another recent issue involves the issuance of tax-free bonds and securities by religious schools to raise funds for improvements and advancement.

Many local taxing agencies allow certain nonprofit and entrepreneurial
enterprises to offer tax-free bonds to generate capital for improvements of
facilities or for other pressing needs. The purpose behind these preferential
instruments is to support businesses and charities that help the community and provide a benefit to others. The controversy local governments now face is
whether religious institutions may take advantage of these tax-free bonds.

In February 2003, the Supreme Court refused to hear an appeal of a ruling by
the 6th U.S. Circuit Court of Appeals allowing David Lipscomb University, a
Church of Christ-affiliated school in Nashville, Tenn., to use tax-free bonds as
a means of expanding its campus. The 6th Circuit reasoned that the tax-free
industrial improvement bonds could be used by religious schools because the
program was religiously neutral, neither preferring nor discouraging religious
institutions from participating.

Nashville is not alone. Across the country religious schools are attempting
to avail themselves of tax-preferred financing options, not only for capital
improvements, but for refinancing and restructuring, as well.

Lower courts seem split on the constitutionality of religious institutions
using tax-free bonds, but the trend seems clear. Most courts are finding that if
the program is not designed specifically for religious groups, but is instead a
neutral benefit open to all who meet certain secular criteria, then religious
groups cannot be denied access to these opportunities.

Even if the Supreme Court further clarifies the appropriate relationship between taxation and religious organizations, the issue is likely to instigate debate among Americans.

Vanderbilt Law School graduate Dave Roland contributed to this article
while in law school.

Updated August 2008