Myths About Religious Organizations and Tax Exemption

Reading the comments on the various articles to which I linked in this post, I was struck by the number of people who seemed completely unaware of the laws and regulations surrounding religious organizations and tax exemption. In response to that ignorance, I thought I would compile a list of – and responses to – the various myths that I see arise in conversations around this topic. I will continue to add myths and responses to this post as I encounter them.

A good reference for those who are interested in tax exemption rules covering churches and other religious organizations is the Internal Revenue Service’s Tax Guide for Churches and Religious Organizations.

Myth #1: Only Charitable Organizations Are Tax Exempt

Many people seem to believe that only ‘charitable’ organizations qualify for tax exemption, and this seems to lead to the idea that churches – if they are going to have tax exempt status at all – should only be exempt on those parts of the budget that go directly to serving the poor. Unfortunately for those advocating such a position, however, ‘charitable’ and ‘non-profit’ aren’t  identical categories under the law.

Tax exempt organizations include any organization that fits in a category listed under 26 USC 501. The most famous category of these organizations is 501(c)(3). This section states that any organization that is “organized and operated” for any of these purposes is tax exempt: “charitable, religious, educational, scientific, literary, testing for public safety, fostering national or international amateur sports competition, and preventing cruelty to children or animals.” However, other kinds of organizations are covered under other sections of the law and include certain civic leagues, business leagues, fraternal societies, teacher’s retirement fund associations, cemetery companies, organizations of past or present members of the armed forces and so on.

Under 501(c)(3), both charitable and religious purposes allow an organization to be tax exempt, but these are purposes among other purposes. Moreover, we can see a wide array of purposes under the idea of ‘charity’:

The term charitable is used in its generally accepted legal sense and includes relief of the poor, the distressed, or the underprivileged; advancement of religion; advancement of education or science; erecting or maintaining public buildings, monuments, or works; lessening the burdens of government; lessening neighborhood tensions; eliminating prejudice and discrimination; defending human and civil rights secured by law; and combating community deterioration and juvenile delinquency.

There are two points here for those who think that religious organizations shouldn’t be tax exempt because they are inadequately charitable. First, a lot of non-charitable organizations are tax exempt by virtue of the same law that grants religious organizations their tax-exempt status. Second, religious purposes are among those purposes that grant tax-exempt status regardless of whether we would consider the organization charitable. This situation is, importantly, very similar to the situation that allows other organizations that we might not consider charitable – like universities and hospitals – to be operated as non-profit organizations.

Myth #2: Religious Organizations Receive Special Status as Non-Profit Organizations

There is some truth to this, which will come to in a moment. First, however, it’s important to say that religious organizations are generally held to the same rules as any other 501(c)(3):

  • Their net earnings may not inure to any to any private individual or shareholder
  • They must not provide a substantial benefit to private interests
  • They must not devote a substantial part of their activities to attempting to influence legislation
  • They must not participate in, or intervene in, any political campaign on behalf of (or in opposition to) any candidate for public office
  • Their purposes and activities may not be illegal or violate fundamental public policy
  • They may not engage in substantial income producing activities that are unrelated to their tax exempt purpose
  • They must maintain books of accounting and other records to justify their tax exempt status in the event of an audit

There is some complexity in all of these areas. However, the complaints I generally read regarding tax exempt status for religious organizations are all complaints that could easily be addressed through these rules. For example, a church that appears to be operated primarily for the financial benefit of its minister can – and should – lose its tax exempt status. Similarly, a church that engages in partisan political activity can lose its tax exempt status. The critical point is that these are exactly the same rules that apply to all non-profit organizations.

There is, however, some truth to this myth: there are three major areas where churches – a term that for our purposes includes all worshipping communities regardless of religion – but not other non-profit organizations receive special treatment. First, churches that meet the requirements to be a 501(c)(3) do not need to apply for that status. They are automatically considered 501(c)(3) organizations. Some churches, however, choose to seek official recognition in order to gain certainty. Second, churches and some other religious organizations do not need to file IRS Form 990. Certain other organizations are also exempt from filing Form 990; some of those organizations must file different forms and some need not. Third, there are specific restrictions on when and how the IRS may audit churches.

So there is some truth in the perception that churches receive special treatment. However, for the most part, churches and other religious organizations exist under the same restrictions as other 501(c)(3) organizations.

Myth #3: Churches Should Lose Their Tax Exempt Status For Their Political Activities

The political activity of churches appears to be a major concern for many people who advocate removing their tax exempt status. On the one hand, there is a legitimate concern here: some churches and religious organizations engage in inappropriate partisan political activity and there is a clear problem with engaging in those activities while at the same time being exempt from paying taxes. On the other hand, however, many people seem to believe that any political activity is grounds for removing an organization’s – and specifically a religious organization’s – tax exempt status.

501(c)(3) organizations, though, are allowed to participate in some political activities and it’s important for critics of religious – or other non-profit – political activity to understand the rules. Very briefly, no 501(c)(3) is allowed to devote a substantial part of its activity to attempting to influence legislation, public referenda, ballot initiatives, etc. The critical part of this rule is the phrase ‘substantial part’. Churches are evaluated by the case-by-case ‘substantial part’ test. Other religious organizations may elect to be evaluated on the ‘expenditure test’, where the question is what percentage of funds were spent on the activity. Similarly, 501(c)(3) organizations may not participate in political campaigns that support or oppose specific candidates for public office.

However, certain political activities are generally allowed. Organizations – including churches and other non-profit organizations – may participate in policy education, voter education, public forums, voter registration, get out the vote drives and so on. Moreover, a non-profit organization may educate on general issues that may be important to public policy without attempting to influence legislation (e.g.: an organization can educate people regarding hunger without taking a advocating for or against any particular legislation). Clergy and other leaders of religious organizations, of course, like leaders of all non-profits, retain their personal rights to speak and act on issues of public policy as individuals.

Again, there are two points here for people who think that religious organizations should not be tax exempt because of their political activity. First, political activity as a whole is not forbidden to non-profit organizations, including churches and other religious organizations. Second, religious organizations are again subject to the same rules as other 501(c)(3) organizations. Needless to say, the first amendment implications of changing these rules only for churches and other religious organizations would not be trivial.

Myth #4: Clergy Don’t Pay Taxes

I have to say that I was very surprised to see the number of people who seemed to believe that clergy don’t may taxes. Clergy do, in fact, pay taxes just like anyone else. There are, however, three things that make clergy taxes different from most people’s taxes. First, clergy are sometimes treated as employees of their church or other organization (e.g., when it comes to income taxes or retirement plans) and sometimes as self-employed contractors (e.g., when it comes to Social Security and Medicare taxes). Interestingly, churches are not permitted to pay the employer portion of Social Security and Medicare taxes for their clergy. Many churches do reimburse their clergy for that share, but that reimbursement qualifies as taxable income.

Second, clergy are permitted to take a housing allowance that does not count as income for tax purposes. This is usually in the form of parsonage or a cash housing allowance. In the case of a parsonage, the clergy person does not count the fair market rental value of the parsonage as income on their taxes and may also receive a parsonage allowance to cover utilities and other reasonable expenses. In the case of a housing allowance, the clergy person does not count the specified amount of the housing allowance as income on their taxes. The challenge for clergy is that the housing and parsonage allowances must be determined ahead of time (i.e., any additional money spent on housing remains taxable and any money from the housing allowance not spent on housing becomes taxable), must represent compensation of ministerial services (which would call into question the legitimacy of large mansions) and cannot exceed the fair market value of the home furnished and plus utilities.

Note that while this is a perk of being clergy, other organizations are able to get the same effect. College and university presidents, for example, do not need to pay taxes on housing provided to them by their employer. Similarly, other 501(c)(3) organizations are able to provide tax free housing if such housing is provided for the convenience of the employer and the employee is required to live there.

Third, and finally, some clergy may request an exemption from Social Security and Medicare taxes provided that they conscientiously object to public insurance. Of course, any clergy who do so are also unable to benefit from Social Security and Medicare. This exemption, however, only applies to compensation received in the course of ministerial duties. If the clergy person has another non-ministerial job for which they receive compensation, they must pay Social Security and Medicare taxes on that compensation.

So the idea that clergy simply do not pay taxes is simply wrong. It is true, however, that clergy taxes are different and often far more complex.

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