Pastors’ Housing Revisited (Again)

(Note: this is the fourth installment of a series (Part 1: Money for Nothing and the Housing for Free; Part 2: Pastors’ Housing, Take 2; Part 3: Pastors’ Housing Revisited) that spans four years and isn’t over yet.)

Today, a district court in the Western District of Wisconsin ruled that section 107(2) of the Internal Revenue Code is unconstitutional. Again.

So what’s section 107(2)? And what relevance could it possibly have for a Mormon blogging audience? I’m so glad you asked.

Background

Generally speaking, if your employer provides or pays for your housing, you have to include the value of that housing or the amount you receive as a housing allowance in your gross income.

There are a handful of exceptions to this general rule, though. And the one we care about is this: a “minister of the gospel” doesn’t have to include the value of housing provided as compensation in her gross income. If her employing church doesn’t provide housing, but instead provides a “rental allowance” as part of her income, she can exclude that to the extent the amount doesn’t exceed the fair rental value of her housing.

Several years ago, the Freedom From Religion Foundation challenged the constitutionality of the provision. Several of its executives argued that it unfairly benefited religion, because they couldn’t exclude the rental allowance that their employer, the Freedom From Religion Foundation, provided them.

The district court found in their favor, even though, it turned out, they hadn’t bothered to claim the allowance on their tax returns. The Seventh Circuit reversed, holding that the plaintiffs lacked standing (because they hadn’t suffered an injury). In a footnote, it suggested that, if they claimed the exemption on their tax returns and their claim was rejected, they may well have standing.

So they did, and the government didn’t challenge their standing.

So What Just Happened

When I posted on this a year ago, I predicted that the district court would find section 107(2) unconstitutional. And I was right! (Btw, this is relatively important. Because the Freedom From Religion Foundation doesn’t own the housing where its executives live, they didn’t have standing to challenge the exemption for in-kind housing provided to “ministers of the gospel”; the court only ruled that the exemption for rental allowances was unconstitutional.)

I also predicted that, getting to the merits, the Seventh Circuit would probably find the same thing. After reading the new opinion, I’m more convinced of that than I was before. The court sets out an airtight case (or, at least, as airtight a case as an Establishment Clause decision can possibly be) for the unconstitutionality of the parsonage allowance. The case is evenhanded and thorough, and even if the Seventh Circuit wanted to reverse it (and I don’t know whether or not the judges on the Seventh Circuit do), they would have to work to find a way to reverse it.

Interestingly, the court didn’t order any particular remedy. It requested briefing from the parties about what the appropriate remedy would be. Which means that there will be more to this story, and more to this series.

The court also provided a framework for Congress for how they could amend section 107(2) in a manner that would comply both with the reasons given for the allowance (specifically, to help poor ministers and poor congregations) and the Constitution.

How Does This Affect the Church?

Some Mormon leaders get a tax-free rental allowance. So if today’s decision stands, what happens to them?

In the first instance, their after-tax income goes down. Suppose we have a flat tax at a 25% rate. Further suppose that the relevant Mormon leader is paid $100,000.[fn1] If the church designates $10,000 of his pay as a rental allowance, that means he pays $22,500 in taxes (that is, $90,000 x 0.25). After taxes, then, he has $77,500.

If the parsonage allowance goes away, he has to pay taxes of 25% on his full $100,000, leaving him with $75,000 after taxes. In other words, he has $2,500 less in after-tax dollars.

So are church leaders out of luck? Not necessarily. The church can do two things to ensure they have the same after-tax income as before, though both cost money. On the one hand, the church could gross them up. A pre-tax salary of $103,333.33 will leave him with an after-tax income of $77,500.

Alternatively, the church can buy housing for the those church leaders who get a rental allowance. (Remember, the decision only finds the rental allowance unconstitutional; it doesn’t address the in-kind provision of housing.) Then the church could provide the housing and would only have to pay $90,000 (which would leave $77,500 after taxes).

Which is to say, this wouldn’t be cataclysmic for the church. It would either represent additional cost, or a haircut for church leaders, but there are ways to adjust.

[fn1] Note that I’m not suggesting that Mormon leaders earn $100,000, any more than I’m suggesting that we have an income tax with a flat 25% rate. Those two numbers just make the math easier.