Challenging the IRS’ (Non) Filing Requirements for Churches

It was recently reported by Giving USA that, in 2011, individuals and corporations donated almost $100 billion dollars to religious organizations. In a single year. Such amount is beyond  comprehension for most anyone. Even more amazing is the two tiers of tax benefits surrounding donations to religious organizations; donors are able to take a charitable contribution deduction when contributing to religious organizations, and secondly, religious organizations do not have to pay income tax on any contributions revenue they receive.

Churches, as being directly referenced in §501(c)(3) of the Internal Revenue Code, are exempt from payment of income taxes because they generally operate in a charitable manner. Additionally, on top of tax-exemption, churches unlike other exempt organizations, have been graced with several additional benefits.

For instance, churches are not required to:

  • file a Tax Exemption Application with the IRS upon formation,
  • prepare and file an annual information return with the IRS (Form 990), and
  • report the identities of their significant donors to the IRS.

Churches also have the benefit of:

  • not being as susceptible to IRS audits as compared to other exempt organizations as a result of Sec. 7611 of the Internal Revenue Code, and
  • the parsonage allowance which permits church ministers to essentially receive tax-free housing.

Since churches are not required to file a Tax Exemption Application or a Form 990, the government as well as the general public has limited visibility into a church’s finances. This is very concerning to many; Including Senator Chuck Grassley (R-Iowa), who has always been a vocal proponent of stringent transparency requirements for exempt organizations, with much of his focus on church reporting (or the lack thereof). In 2011, he issued a report on the financial practices of mega-churches, pressing for greater accountability for churches. However, there has not been much progress on the legislative front since the issuance of the Grassley report.

Times might be a changing. In recent months, three separate lawsuits have been filed against the IRS, challenging the IRS’ “preferential treatment” of churches and some religious organizations. Each lawsuit focuses on the significant advantages bestowed on churches which are not generally available to secular exempt organizations.

It was previously noted that churches are not required to complete a federal Tax Exemption Application to be recognized as tax-exempt by the IRS. As long as a church satisfies a preponderance of factors set forth by the IRS to qualify as a church, such church will be considered tax-exempt without the burden of having to file a Tax Exemption Application or Form 990. Preparation of a Tax Exemption Application is time consuming and costly. Additionally, the annual preparation and filing of a Form 990 is also a burdensome and costly process for most exempt organizations.  As such, being able to avoid the preparation and filing of a Tax Exemption Application and an annual Form 990 is a significant benefit for churches.

In such regard, two exempt organizations, the American Atheists Inc. and the Freedom from Religion Foundation filed lawsuits in December 2012 against the IRS directly related to the Tax Exemption Application and Form 990 filing exclusions available to churches. The lawsuits are each very similar; each argues that since churches are receiving the filing exclusions from the IRS, this violates both the Establishment Clause of the First Amendment of the Constitution as well as equal protection rights mandated by the Due Process Clause of the Fifth Amendment. Additionally, these suits argue that churches also receive additional benefits in addition to the aforementioned benefits, including the parsonage allowance and the reduced susceptibility to IRS audits.

Furthermore, while churches are subject to the same rules and requirements regarding “red flag” exempt organization issues like lobbying, political activities and unrelated business income, churches are less likely to fall below the radar screen because they are not required to file the Form 990. Another lawsuit recently filed relates directly to this “special” treatment. In November 2012, the Freedom from Religion Foundation filed a lawsuit against the IRS (Freedom from Religion Foundation vs. Shulman) over the IRS’s alleged failure to enforce electioneering restrictions against churches and other religious organizations.

The genesis of this lawsuit could have been sparked by numerous news outlets reporting that the IRS has not conducted any audits of churches for a good number of years, despite many reports of clergy and churches engaging in political activities and electioneering. Per the Freedom for Religion Foundation’s press release, the lawsuit that was filed requests that the court orders the IRS “to authorize a high-ranking official within the IRS to approve and initiate enforcement of the restrictions of §501(c)(3) against churches and religious organizations, including the electioneering restrictions, as required by law.”

While these lawsuits have only simply been filed at this juncture, they bring up important questions regarding the perceived and real “preferential” treatment granted to churches by the Internal Revenue Service. Many believe that the IRS is wary to heavily monitor the activities of churches because doing so may be a perceived as a violation of religious civil liberties under the First Amendment. But these lawsuits have flipped this concept, alleging that because the IRS does not require an annual Form 990 to be filed by churches, that this violates the religious civil liberties of non-church exempt entities. “Having tax-exempt status is a great privilege, and in exchange for that privilege, all other groups must file a detailed report annually to the IRS and the public on how we spend donations,” said Annie Laurie Gaylor, FFRF Co-President, “Why should churches be exempt from basic financial reporting requirements? Equally important, why would churches not wish to be accountable?”

Please do not hesitate to contact Lauren Havelock at 310-982-2804 or at lhaverlock@yhadvisors.com if you have any questions regarding churches and religious organizations or the exempt organization services that YH Advisors provides.