UPDATE: Oral Arguments Completed in Clergy Housing Allowance Challenge

Attorneys representing both sides of the clergy housing allowance challenge currently under appeal made oral arguments on Wednesday to a three-judge panel with the US Court of Appeals for the Seventh Circuit in Chicago.

Now the waiting begins. An immediate decision is not anticipated, but observers expect one by early 2019.

At stake in the case is a 64-year-old tax benefit worth nearly $1 billion for clergy. In late 2017, a federal district judge in Wisconsin ruled the benefit to be an unconstitutional preference for religion after the coleaders of the Freedom From Religion Foundation (FFRF), a 501(c)(3) atheist organization, challenged it.

The 2017 decision technically would affect ministers only in Illinois, Indiana, and Wisconsin, however, there are possible ways it could apply nationwide if it stands. That prompted the current appeal by the federal government, which is responsible for defending the Internal Revenue Code, as well as a group of clergy members who asked to intervene because of the case’s potential ramifications beyond the district court where the case originated.

Section 107(2) of the Tax Code allows ministers who rent or own their own homes to receive an annual housing allowance from their employing church—and not pay federal income taxes on the designated amounts. The provision was adopted by Congress in 1954 after clergy from a variety of faith traditions indicated there was unequal tax treatment for those who were not provided a parsonage from their employing house of worship. Since 1921, clergy who live in parsonages receive federal income tax exemptions for housing-related expenses through Section 107(1) of the Tax Code.

In 2015, FFRF’s coleaders attempted to claim housing allowances and exempt them from federal income taxes by amending previous federal tax returns. The Internal Revenue Service denied at least one. The coleaders then filed suit, arguing they suffered a direct injury caused by Section 107(2)’s exclusive focus on clergy. That focus violated the Establishment Clause of the First Amendment, the FFRF coleaders said.

In Wednesday’s hearing, the Seventh Circuit justices focused their questions on which legal test should apply to the facts involving Section 107(2) based on prior precedent set by the Supreme Court of the United States. Those tests are designed to determine whether statutes like Section 107(2) are properly constructed for constitutional purposes.

Both sides contend they can prevail, regardless of whether the Seventh Circuit follows the approach used by the Supreme Court in a 2014 case, Town of Greece v. Galloway, or whether it follows a three-prong test the Supreme Court set for Establishment Clause challenges in 1971 through Lemon v. Kurtzman.

In Town of Greece, the Supreme Court said the “Establishment Clause must be interpreted by reference to historical practices and understandings.” In Lemon, the Court held a statute could survive an Establishment Clause challenge if it demonstrated (1) “a secular legislative purpose,” (2) “its principal or primary effect” is “one that neither advances nor inhibits religion,” and (3) it does not “foster an excessive government entanglement with religion.”

Attorneys Jesse Panuccio and Luke Goodrich, arguing on behalf of the government and intervening clergy, said history supports the constitutionality of Section 107(2) under both the Town of Greece and Lemon standards.

Tax exemptions for parsonages predated the country’s founding, Goodrich noted, and states kept those exemptions in place even after the founding, providing a “strong indicator that exemptions for parsonages were not viewed as an element of establishment.” Such historical practices and understandings would make Section 107(2) valid for Establishment Clause purposes under Town of Greece, he said.

Panuccio said Section 107(2) also satisfies all three prongs of Lemon.

“Since the ratification of the Sixteenth Amendment, Congress and the IRS have implemented the income tax with special rules for employment-related housing,” Panuccio said. “The Tax Code has numerous such provisions, each with slightly different requirements, but all united by a general theme of exempting the value of housing that is highly associated with work.”

Panuccio added that Section 107(2) “is but one example of the larger scheme,” satisfying the first prong under Lemon.

Section 107(2) also meets the second prong of Lemon because it operates as an accommodation “to deal with the realities of clergy life,” he added. With tax law accommodations available to housing for military personnel, overseas government employees, or university and hospital employees in certain instances, Panuccio said the accommodation for clergy does not turn into an improper advancement of religion.

And the third prong of Lemon is met, Panuccio concluded, because Section 107(2) creates less entanglement between the government and churches. Absent Section 107(2), the IRS likely would apply Section 119 or Section 280A of the Tax Code to determine whether tax-free lodging is appropriate. In the case of Section 119, for instance, the tax exemption is available when it is (1) furnished by an employer for an employee, (2) furnished in kind, (3) on the business premises of the employer, (4) for the convenience of the employer, and (5) a condition of employment. Determining those elements would prompt IRS inquiries into matters of ministerial employment, the nature and use of the minister’s home for religious purposes, and other questions that would be “very intrusive for clergy,” Panuccio said.

Opponents of the allowance challenged the idea that Section 107(2) is part of a larger secular scheme.

“Section 107(2) is unconstitutional because on its face it singles out ministers for a tax benefit that is unavailable to any other taxpayer,” said Adam Chodorow, a law professor from Arizona State University. When employers provide housing to an employee, it must be included as income unless “very limited circumstances” are involved, he said, which are not evidence of a broader scheme.

Chodorow also pointed out the tax-free parsonages at the time of the country’s founding involved property taxes, not income taxes—a significant distinction for interpreting historical relevance under the Supreme Court’s Town of Greece standard. The United States implemented income taxes in 1913.

The entanglement concerns raised by the government and intervenors are also inflated, Chodorow added. Were Section 107(2) to be struck down, clergy would pay tax on the cash allowances received by their churches in the same way they pay taxes on all of their income. “We don’t go down the parade of horribles that the other side claims,” he said. “We simply tax them on their full income.”

Answering questions to meet the qualifications of tax-free housing under Section 119, Chodorow said, also would not create excessive entanglement, probing only to determine whether the minister must live “on site,” receive the cash allowance “in kind,” and for the “convenience of the employer.” Such questions are not any more intrusive than questions churches answer to receive their nonprofit, tax-exempt status, or clergy answer to demonstrate they are ordained ministers for tax-filing purposes.

If the Seventh Circuit affirms the lower court’s holding, churches and ministers in Illinois, Indiana, and Wisconsin would lose their ability to use housing allowances. Alternatively, the Seventh Circuit could reverse the lower court’s decision, leaving the benefit intact for churches and ministers in the three states.

Though the Seventh Circuit comprises only Illinois, Indiana, and Wisconsin, clergy nationwide could still feel the effects were the Seventh Circuit to affirm. The IRS could decide at some point to apply that decision nationwide to promote consistency among taxpayers. Furthermore, an appeal could be made to the Supreme Court, and a decision—regardless of the outcome—would automatically become precedent nationwide. Commentators, including Church Law & Tax senior editor and attorney Richard Hammar, believe it’s very unlikely the Supreme Court would take the case.

Lastly, even if the Seventh Circuit reverses the district court’s decision, future challenges to the benefit could be brought in other parts of the country and eventually make their way through the other federal circuit court systems. Those courts are not bound to a Seventh Circuit decision, though they would consider the decision and could possibly find it persuasive.

It’s important to note that the parsonage allowance pertaining to church-owned housing remains unaffected by this case, regardless of how the Seventh Circuit decides, though parsonages are less common and do not allow clergy the flexibility and equity creation that housing allowances do.