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.

Background

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...

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