Many years ago, through a peculiar set of circumstances, I found myself sitting in the waiting room of an IRS Criminal Investigation office. When I finally went into the office it looked much like other IRS offices I had been in, except for the big trophy – from a pistol shooting competition, a subtle reminder that these were accountants who carried guns and had arrest powers. In the waiting room there had been a poster, I think it might have been a recruiting poster, that talked about how gangster Al Capone was finally convicted of income tax evasion. CI takes a great deal of pride in that achievement, even though it was accomplished by a predecessor organization , as this video shows
That particular conviction led to a classic remark. When someone got an audit notice, they would be ribbed by someone saying – “That’s how they got Al Capone.”
Some critics of Scientology have similar hopes. They believe that because of all Scientology’s wrongdoing, the IRS should investigate the various entities and revoke their exempt status, because it will be determined that they are not really churches.
How I Got On This
I thought a piece on the tax history of Scientology would make a nice little sidebar to the stories about Tom Cruise and Katie Holmes. I knew that Scientology must have had an interesting tax history, because I see so many references to Scientology decisions in other tax cases, but I found it puzzling that I did not recall any current cases. The answer was interesting. Nearly twenty years ago Scientology entities had entered into a closing agreement with the IRS to resolve a veritable thirty years war that had raged between the movement and the IRS. The closing agreement was confidential and has not been confirmed by the IRS, but its contents were leaked in 1997.
There were four main provisions. Scientology paid 12.5 million dollars to settle all outstanding audits. Scientology agreed to have a Church Tax Compliance Committee put into place for seven years, that would be reviewed by a national accounting firm. Scientology organizations were recognized as 501(c)(3) organizations, specifically churches (Churches, unlike other exempt organizations do not have to file annual reports (Form 990) that are available for public inspection.) Finally, members would be allowed to deduct “fixed donations” for “auditing” as charitable contributions. The deduction issue is the most surprising part of the agreement, because the Supreme Court had ruled that auditing payments were not charitable deductions.
As I quickly learned from my comments, this interesting little historical side note is still a live controversy at least in the court of public opinion, if not in the Tax Court. Scott Pilituk, who is recognized as a legal expert by the Village Voice, gave me a guest post explaining how wrong I was for thinking the agreement was benign. I indicated at the end of the piece, that he hadn’t convinced me, which prompted a commenter to speculate that I might be on Scientology’s payroll.
I still don’t agree with Scott on the exemption issue. This is not from a different view of Scientology. I am agnostic on the abuses of Scientology, but am willing to accept the criticisms as accurate for the sake of argument. I still come up with the entities behaving like churches.
Many of the critics claim that auditing is effective and the current administration has taken the organization in a direction different from that intended by the founder. That’s the type of thing people say about churches. Scott believes that exemptions for churches exist because they on net do more good than harm, so if we have a church that is on net harmful, its exemption should be yanked.
I believe that religion is a separate sphere that should have minimal intrusion and that we should not have the IRS evaluating churches to see if they are net positive. Regardless of which of us is right, if you look at entities that have had church status revoked, you will find it is because of formalistic issues or there being insubstantial organizations not on whether their teachings are making people better or worse. Unless the framework is changed I suspect a close examination of Scientology entities as they are now would leave them as churches. Keep in mind, that, in my view anyway, saying something is a church is not necessarily saying it is a good thing.
I find the deduction issue much more disturbing. Here is a copy of a Scientology brochure, where they explain what payments are deductible. Here is what the 1993 closing agreement says:
Until the earlier of (i) December 31, 1999, (ii) the issuance or adoption by the Service of audit policies or practices in the examination of tax returns utilizing uniform and consistent principles for determining the deductibility of fixed donations to all churches, or (iii) until legislation is enacted which affects the deductibility of such fixed donations, the Service agrees not to contest the deductibility of Church of Scientology fixed donations in connection with qualified religious services. The phrase “qualified religious services” means those appearing on the “Scientology Classification, Gradation and Awareness Chart.”
Like the Church Tax Compliance Committee, it looks like the Service’s commitment, in that regard, has expired. The agreement had indicated the spirit in which the IRS was going to proceed on the deductibility issue:
The Service acknowledges its obligation to interpret and apply the “gift or contribution” requirement of Code section 170(c) equally and consistently to the fundraising practices of all religious organizations that receive fixed donations from parishioners in connection with participation in worship and similar religious rituals or services.
The problem I have had is coming up with anything like the charges for auditing in Scientology in any other religion. It occurred to me that the Sklar’s who thought similar principles should allow the deduction of at least part of the tuition to Jewish elementary schools had a really good point. I don’t know to what extent the training in the school is focused on preparation for bar mitzvah, but to the extent that it is, it is hard to see how that is different in principle from the auditing sessions that allow you to advance in Scientology. Certainly Catholic elementary education as I remember it had a great deal to do with training you to access the actual grace produced from participating in the sacraments and other rituals such as saying the rosary. Catholicism has a very explicit rule about not charging for sacraments – to do so is called simony, but training is required.
When Congress amended the Code to require that donees inform donors of the value of any goods or services that they were given in exchange for donations, the concept of intangible religious benefits was carved out. Here is a discussion of that:
However, with respect to the substantiation provision, the conference agreement clarifies that in cases where, in consideration (in whole or in part) for a contribution of $250 or more, a religious organization furnishes to the contributor solely an intangible religious benefit generally not sold in a commercial transaction outside the donative context, the written substantiation must contain a statement to the effect that an intangible religious benefit was so furnished, but the substantiation need not further describe, nor provide a valuation for, such benefit.
For example, a donor who, for a payment, is granted admission to a religious ceremony for which there is no admission charge is provided an intangible religious benefit. A donor is not provided intangible religious benefits for payments made for tuition for education leading to a recognized degree, travel services, or consumer goods.
I don’t think it is real clear how the “fixed donations” for auditing fit in there. There is, however, nothing that has overturned the Supreme Court decision that found that they were not deductible.
Conclusion
To take another reference from the Untouchables, I think that critics of Scientology who are egging the IRS on to examine the exempt status of the various entities might be taking a knife to a gunfight. It is a strategy, that I don’t think should work, but more importantly for them, I think it is a strategy that will not work. On the other hand, I am very troubled by the deduction issue. The problem with anybody other than the IRS tackling it is how to get standing. Critics might want to challenge the administration on the issue though. The closing agreement is long expired and the Supreme Court decision still stands.
I hope to get some more guest posts on this issue, but I don’t know when I will pick it up again on my own. I have fallen way behind in other areas.
You can follow me on twitter @peterreillycpa.
Originally published on Forbes.com on July 22nd, 2012