United States: District Court Strikes Down Rental Allowance Tax Exemption For Ministers

A federal court recently declared unconstitutional Internal Revenue Code Section 107(2), which excludes from gross income a rental allowance paid to a "minister of the gospel" as part of his or her compensation, on the grounds that it violates the Establishment Clause of the U.S. Constitution.  Religious institutions offering such allowances should closely monitor further developments in this area of the law and consider alternative compensation strategies if federal courts in their jurisdiction adopt similar holdings.

The U.S. District Court for the Western District of Wisconsin recently declared unconstitutional Section 107(2) of the Internal Revenue Code ("Code"), which excludes from gross income rental allowances paid to ministers as part of their compensation, on the grounds that it violates the Establishment Clause of the First Amendment to the Constitution of the United States.  Although the decision is only binding in the Western District of Wisconsin, similar challenges to Code Section 107(2) are likely in the aftermath of this decision.  Religious institutions that provide rental allowances to their ministers should closely monitor any appellate review of this decision, as well as developments with respect to Code Section 107(2) in other jurisdictions, to ensure that they remain legally compliant and that their compensation strategies reflect the current state of the law.  Religious institutions with clergy in the Western District of Wisconsin, which includes Madison, La Crosse and Eau Claire, who benefit from Code Section 107(2)'s exclusion should be aware of this decision and should discuss its implications with their legal counsel and tax advisors. 


Code Section 107(2) excludes from gross income a rental allowance paid to a "minister of the gospel" as part of his or her compensation.  Its companion provision, Code Section 107(1), exempts from gross income the rental value of a home directly provided to a minister as part of his or her compensation.  Taken together, these provisions permit religious institutions to include tax-free housing as part of the aggregate compensation offered to their ministers.

District Court Holds Section 107(2) Unconstitutional

On November 22, 2013, the U.S. District Court for the Western District of Wisconsin held in Freedom from Religion Foundation, Inc. v. Lew that Code Section 107(2) violates the Establishment Clause of the First Amendment to the U.S. Constitution. 

The plaintiffs in the case consisted of the Freedom from Religion Foundation (the Foundation), an organization devoted to educating the public regarding nontheistic beliefs, and its two co-presidents.  The defendants were Jacob Lew (Secretary of the Treasury) and Daniel Werfel (Acting Commissioner of the Internal Revenue Service) in their official capacities.

The district court first ruled that, despite the government's objections, the plaintiffs had standing to bring the suit.  The co-presidents of the Foundation receive rental allowances as part of their compensation from the Foundation, but are ineligible for the Code Section 107(2) tax exemption because they are not "ministers of the gospel," as Code Section 107(2) requires.  To qualify as a minister of the gospel, an individual must meet specific criteria set out in U.S. Department of the Treasury Regulations §§ 1.107-1(a) and 1.1402(c)-5.  As a result, the district court ruled that they suffered an injury caused by the denial of the tax exemption available only to ministers of the gospel.

Next, the district court assessed the merits of the plaintiffs' claim that Code Section 107(2) is unconstitutional.  In reviewing Code Section 107(2), the district court relied heavily on the Supreme Court of the United States' decision in Texas Monthly, Inc. v. Bullock, 489 U.S. 1 (1989), which it identified as the only case in which the Supreme Court has addressed the constitutionality of a tax exemption granted solely to religious persons.  In Texas Monthly, the Supreme Court held that a statute exempting religious periodicals from state sales tax violated the Establishment Clause on the grounds that it did not have a secular purpose or effect and was not necessary to alleviate a significant burden on the free exercise of religion.  The district court reasoned that the Supreme Court's holding in Texas Monthly compelled its holding that Code Section 107(2) is unconstitutional, finding that Code Section 107(2) violated the Establishment Clause for similar reasons. 

The district court rejected the government's argument that Code Section 107(2) should be upheld because the Supreme Court has upheld a statute that provides tax exemptions to property used for "religious, educational or charitable purposes."  The district court stated that that holding was inapplicable because the property tax exemption that the Supreme Court upheld benefited not merely religious persons, like Code Section 107(2), but benefitted a wide variety of nonprofit enterprises, some of which happened to be religious organizations.

The district court also rejected the government's argument that Code Section 107(2) should not be viewed as solely benefiting religious entities because nothing in the statute would preclude an atheist from receiving the rental allowance exemption if the atheist qualified as a "minister of the [atheist] gospel."  The district court noted that no reasonable interpretation of Code Section 107 would include atheists in its purview and, even assuming for the sake of argument that atheist ministers were eligible for the rental allowance exemption under Code Section 107(2), the statute would still discriminate against secular individuals who espouse neither the tenets of atheism nor those of any other religious sect.

Notably, the district court did not assess the constitutionality of Code Section 107(1), which is the companion provision to Code Section 107(2) and grants a tax exemption on the rental value of a home directly provided to a minister as part of his or her compensation.  Thus, religious institutions that rely on Code Section 107(1) to provide tax-exempt housing to their ministers are not directly affected by the district court's decision. 

Additional challenges to the constitutionality of both Code Sections 107(1) and 107(2) are likely in the wake of the district court's decision, especially given the Foundation's ongoing challenges to what it claims are violations of the Establishment Clause.  Religious institutions that currently provide tax-exempt housing to their ministers under either provision should closely monitor developments in this area of the law and act now to assess alternative compensation strategies that may be implemented if courts in their jurisdiction adopt similar holdings.  At a minimum, religious organizations should use this Western Wisconsin development to consider adjusting their compensation packages to the extent possible, perhaps shifting to Section 107(1)-type benefits.  Religious institutions should consult with their legal and tax advisors to confirm that their ministers meet the definition of a minister of the gospel and to adequately document the housing allowance benefits provided.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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