On Fred Karger, Tax Exemptions, and the Mormon Church

@smbrnsn preferably “9 ways this is stupid. You won’t believe #6!”

— Andrew S (@GASpriggs) December 16, 2016

Today, Fred Karger asked a provocative question: should the Mormon church lose its tax exemption? To answer that question, he’s asking for certain (anonymous) tips about the church’s use of its money, though implicit in the way he frames the question is that yes, it should. In short, his argument the the church should lose its tax exemption seems to follow these contours:

• The church has, and earns, lots of money.
• The church engages in for-profit businesses and investments with that money, and doesn’t pay taxes on its for-profit earnings.
• The church uses tax-deductible tithing money for lobbying, in contravention of the tax law.

He wants to collect information to ultimately file “the biggest, loudest and most comprehensive IRS challenge to a Church’s tax-exempt status in history.” 

Unfortunately, his analysis evinces a significant lack of understanding of the tax exemption and of IRS procedure in general. As Andrew S (who brought Karger’s post to my attention) charitably explains what might have gone wrong with Karger’s analysis, “non-specialists often get details of a field very, very wrong.”

As a specialist, though, I feel some obligation to respond to his errors.[fn1]

The Church Has a Lot of Money. Also a Lot of Revenue

That’s almost certainly correct.[fn2]

But so what? I mean, sure, I get that in the popular imagination, do-gooding nonprofits aren’t multi-billion-dollar organizations. But that imagination has nothing to do with the actual world we live in. Some numbers:

• Yale’s endowment is in the $25.4 billion range. It expects net revenues of $3.5 billion in fiscal year 2017.
• In 2015, the American Red Cross had net assets of $1.6 billion, and net revenue of $2.7 billion.
• In 2015, the Bill & Melinda Gates Foundation had assets of $40.4 billion. It looks like it only had revenue of $6.7 million, though.

What am I saying, then? Just this: while Karger is almost certainly right that the church has a lot of assets (though I have no idea if it’s his asserted $1 trillion), just like for other tax-exempt organizations, the value of its assets has no relevance to its tax-exempt status.[fn3]

The Church Engages in For-Profit Business and Doesn’t Pay Taxes

Andrew has already addressed this assertion, thoroughly and in great detail. I don’t have a lot to add, so if you haven’t read his excellent post yet, I’d recommend it.

A tl;dr version (but I don’t do justice to it, so seriously, read his) is this: the church has put its for-profit businesses into separate corporations. Those corporations pay taxes. They may well dividend some of their after-tax earnings and profits to the church, and the church doesn’t pay taxes on those dividends, because that’s what tax exemption is. Also, to the extent the church engages in business directly, it should (and almost certainly does) pay the unrelated business income tax, a tax imposed on tax-exempt organizations that engage in business.

Even leaving those details aside, the church does pay taxes. I know, both from my own practice experience and from received knowledge in the tax community, that the IRS takes employer withholding taxes very seriously. And where an employer doesn’t pay those, the IRS both notices and acts. So the assertion that the church doesn’t pay any taxes, unless he has evidence that the church shirks its employee withholding responsibilities (and it doesn’t) is completely unfounded.

But also, as Andrew explained, one of the consequences of tax exemption is that tax-exempt organizations don’t pay taxes on passive income. And it’s passive income to the tax-exempt organization if it’s earned in a taxable subsidiary.

It’s also worth noting that, even if the church were a taxable entity, it would almost certainly not owe taxes on tithes and offerings it received; those would almost certainly qualify as gifts, and gifts are not taxable income (so you don’t have to pay taxes on your bounty from Santa!).

The Church Spends Money Lobbying and Otherwise Influencing Legislation

Yep. And, like the first point, so what?

Okay, maybe a little more explanation: section 501(c)(3) of the Internal Revenue Code contains two limitations on the ability of tax-exempt organizations to participate in politics. The first is an absolute prohibition on endorsing or opposing candidates for office.[fn4]

The second is a limitation on tax-exempt organizations’ ability to lobby and otherwise engage in political behavior. The language here is kind of vague and ambiguous; an organization doesn’t qualify as tax-exempt unless

no substantial part of the activities of which is carrying on propaganda, or otherwise attempting, to influence legislation …

What does “no substantial part” mean? There’s no bright line, though courts have laid out some contours. One court held that where less than 5% of a tax-exempt organization’s activities were influencing legislation, it did not violate the no-substantial-part rule. Another court held that an organization between 16 and 20% of its annual expenditures to influencing legislation failed the test.

What does that mean for the Mormon church? Karger points out that the church spent $200,000 on fighting for Proposition 8. To clearly violate the no-substantial-part rule, that would mean that the church’s total expenditures for the year would have to have been less than $1.25 million. I mean, it fits comfortably in the less-than-5% safe harbor as long as it spent $4 million. Is it possible that the church only spent $1.25 million in 2008? I mean, yes, it’s possible.

But tremendously unlikely.

And what about the fact that the money it spends is tithing money that may have been deducted? For tax purposes, it’s totally irrelevant.

The Biggest, Best IRS Challenge Ever

Finally, Karger wants to collect information so that he can file an IRS complaint.

The thing is, there’s actually no such thing as an IRS complaint. I mean, you can complain about the IRS. Lot’s of people do. And you can probably complain to the IRS. But you can’t make the IRS do anything.

Why not? There’s something called the Tax Anti-Injunction Act. Basically, it says that you can’t sue the government about taxes unless you actually paid the taxes or the taxes were assessed against you (depending on whether you sue in district court or the Tax Court, respectively). Because Karger isn’t trying to challenge taxes that he pays, he lacks standing to sue.

Of course, that doesn’t preclude him from writing a letter. But I’m curious what he expects the letter to do. Let’s assume that he discovers some tax violation or fraud. What’s the IRS going to do about it?

Probably nothing. Look, auditing a church is a tough thing to do—Congress has enacted a whole bunch of hoops before the IRS can audit a church, and then significant limitations on how the audit can function after it starts.

And, after the Tea Party exemption debacle, the IRS is, in my understanding, gun-shy to go after tax-exempt organizations. Also, the IRS is underfunded and understaffed. And even if it ends up assessing tax, there’s unlikely to be a lot of additional federal revenue. Like I said, the vast majority of the church’s revenue is donations that wouldn’t be taxable anyway. Its business income is mostly in entities that already pay taxes.

What you’re left with, mostly, then, is investment income. But once the church is taxable, it can also take deductions, including for salaries and other costs of running the church and, presumably, depreciation on its extensive real property holdings, etc. In the end, the net benefit to the government is minimal, and weighing that against the pushback—both from Congress and the public—for going after a church, plus the cost of jumping through the hoops of actually doing a church audit make it unlikely that even a sternly-worded letter would cause the IRS to act.

An Apologist for the Tax Law

Why do I write this? Mostly because I love the tax law, and I hate to see it abused and weaponized. Like Andrew said, it’s clearly possible that the church isn’t fully compliant with the tax law. But I’ve not seen anything to suggest that it isn’t, other than Karger’s unsubstantiated assertions, pretty much all of which misunderstand the law as it is.

[fn1] Before I get started, though, one disclosure: to titular question of Karger’s post, I would answer with a qualified no. It’s totally outside the scope of this post, but my coauthor and I are currently working on an article where we address fundamental questions of tax exemption. It’s still in the early stages, but I’m sure we’ll post it somewhere when we have a draft written. Based on that analysis, though, I argue that, as a normative matter, nonprofits, including churches, should be exempt from taxes. (It’s qualified, though, because, as I’ll explain in a minute, tax-exempt organizations do pay some taxes.)

[fn2]And yes, I know that the church isn’t terribly transparent financially. In fact, I’ve written fairly extensively about 20th-century Mormon financial disclosure.

[fn3] Note that I’m going to mostly avoid addressing some of the really low-hanging fruit. For example, I sincerely doubt that church earns money from its law firm holdings, because the ABA Model Rules of Professional Conduct prohibit non-attorneys from owning law firms. I don’t teach Professional Responsibility (and it’s already taking plenty of time to write this without doing additional research into a tangential topic), so it’s possible that some states haven’t enacted this particular rule. But all of the states I’m familiar with have.

[fn4] Though for being an “absolute prohibition,” it’s pretty under-enforced, especially with respect to churches, but also non-church tax-exempt organizations.