Parsonage Exclusion Found By Seventh Circuit To Be Constitutional

On March 15, 2019, the U.S. Court of Appeals for the Seventh Circuit held in Gaylor v. Mnuchin that the tax exemption for "ministers of the gospel" (defined below) under Section 107(2) of the Internal Revenue Code (the "Code") does not violate the Establishment Clause1 of the First Amendment and, therefore, is constitutional, overruling the district court decision.2

In Gaylor, the Freedom From Religion Foundation (the "FFRF")3 sued the Treasury Department after the Internal Revenue Service (the "IRS") denied the refund claims of FFRF's co-presidents who sought to exclude the portion of their salaries paid in the form of a housing allowance. The central issue in the case on appeal was whether the district court was correct in holding that the exclusion for housing allowances under Section 107(2) is a law "respecting an establishment of religion."

Overview of Section 107

Section 107, commonly referred to as the "parsonage exclusion," excludes from gross income housing furnished to a "minister of the gospel" (or, "minister") as part of his or her compensation. For the purposes of this Code section, a "minister of the gospel" is "a duly ordained, commissioned, or licensed minister of a church or a member of a religious order"4 and applies to religious leaders of any denomination.5 The housing may be provided in kind under Section 107(1), in which case the rental value of the home including utilities are excluded,6 or in the form of an allowance under Section 107(2), in which case the allowance is excluded to the extent it is considered "reasonable compensation" for the minister's services7 and is actually used in the taxable year in which it is received to pay for rent, the purchase of a home or expenses directly related to providing a home.8 A cap on the exclusion under Section 107(2) equal to the fair rental value of a home, including furnishings, appurtenances and utilities, was added by Congress in response to constitutional concerns over the holding in Warren v. Commissioner, where the Tax Court determined that the language of the statute did not impose any such restriction.9

Consistent with exemptions under the "convenience-of-the-employer" doctrine for secular employees whose jobs have housing requirements, Congress enacted Section 107 to provide a housing exemption for ministers whose homes are often used as part of, or located in a certain area for, their ministry. While Section 107(1) was generally accepted by the FFRF to put...