Minister’s housing tax break raises fairness issue
The District Court for the Western District of Wisconsin has tossed a firecracker in the direction of the Congress and the IRS.
Some might consider the tossed object to be a high explosive. Either way, the outcome of the court’s action is yet to be resolved.
First some context. Section 107 of the tax law allows a minister of the Gospel to exclude from income a rental allowance paid as part of the minister’s compensation, provided the allowance is used to provide a house. The allowance cannot exceed the fair rental value of the house, including utilities.
Section 119 allows any employee to exclude from income employerprovided lodging if the lodging is provided for the convenience of the employer and use of the lodging is a condition of employment.
The problem then is this: A minister of the Gospel is entitled to an exclusion that others are not, or is entitled to an exclusion on terms that are different than apply to other employees. Does this then violate the establishment clause of the Constitution?
Whether it passes constitutional muster or not, Section 107 is quite a benefit. Let’s say a house is available for a monthly payment, including principal, interest, taxes and insurance of $1,500. The utilities are an additional $300 per month. The monthly payment breaks down to include $1,200 of mortgage interest and property taxes.
If a non-minister owns this home, he or she is entitled to deduct the $14,400 annual interest and taxes as an itemized deduction on schedule A The tax benefit will likely be less than $14,400 because the taxpayer can only deduct the total itemized deductions in excess of the “standard deduction.”
However, let’s assume the taxpayer gets the full benefit of the $14,400, and that the taxpayer’s federal and state tax rate is 25 percent. The tax deduction for interest and taxes then saves $3,600 (25 percent of $14,400).
The non-minister pays total housing (principal, interest, taxes, insurance and utilities) of $21,600 (see the breakdown above), and with the government’s tax “rebate” of $3,600, the net cost of housing for the year is $18,000.
The minister conforms to the tax law requirements to designate $21,600 as a housing allowance excludable under Section 107. This does not exceed the fair rental value of the house. The minister may also deduct $14,400 of interest and taxes on schedule A.
The minister’s gross income is then reduced by $36,000. The interest and taxes are essentially deducted twice (once through the exclusion, once through the deduction), and the mortgage principal insurance and utilities once (through the exclusion). The minister, if in the same 25 percent tax bracket, saves $9,000 in taxes, and the net cost of housing for the year is $12,600.
So The Wisconsin-based Freedom from Religion Foundation brought a suit against the government contending that the Section 107 exclusion violated the establishment clause of the Constitution. It provided a benefit for religious people not justified by the need to alleviate a special burden on religious exercise.
The Wisconsin District Court held in 2013 that the exclusion did violate the establishment clause. The 7th Circuit Court of Appeals vacated this decision because the plaintiffs lacked standing to sue.
Freedom from Religion responded by providing a housing allowance to two of its employees, who then filed refund suits to take advantage of the exclusion. The refund claims stated they were not ministers but wanted to take advantage of Section 107.
Last month, the Wisconsin District Court again held the exclusion to be unconstitutional, finding the plaintiffs to have standing. The exclusion was held to be a special benefit that could not be justified on secular grounds. The government made various arguments attempting to justify the
exclusion on secular grounds. However, the court found that there were logical defects in each of these arguments.
The court noted that an exclusion could be acceptable if it were available to all taxpayers, or perhaps all taxpayers below a certain income threshold, or even to all taxpayers working for not-forprofit organizations.
This decision will probably be appealed and it will be interesting to see what the 7th Circuit, or perhaps even the Supreme Court, ultimately decides.