The Tom Cruise – Katie Holmes divorce has brought Scientology back into the news. It created a little puzzle for me. I constantly run into references to Scientology cases when reading tax decisions, but I could not recall actually reading any of them. I hate when that happens. The answer to the puzzle turned out to be pretty simple. There was a thirty years war between Scientology and the IRS. The war ended in 1993 with Scientology related organizations being recognized (or rerecognized ) as churches. The final resolution was not a model of transparency . Although not officially acknowledged by the Service, the confidential closing agreement between the Service and the Church was leaked. If this purported text of the agreement is a fabrication, it was masterfully done. The closing agreement appears to be similar in length to the Treaty of Westphalia, which ended the actual Thirty Years War (1618-1648).
The earliest Scientology cases were the ones where the church originally lost its exempt status. It turned on the issue of inurement. Rather than being a church, the Service contended, successfully, that it was acting more like L. Ron Hubbard, Inc. Those cases had some interesting stuff:
During the 1960’s, Scientology organizations around the world were required to pay directly to L. Ron Hubbard, ten percent of their income. These payments were termed “debt repayments” because they were designed to compensate Hubbard for his work in originating the Scientology religion. The Tax Court concluded that during 1971-1972 the Church continued to make debt repayments to Hubbard.
During the years in question, the new directors performed only one function. In the summer of 1972, they approved L. Ron Hubbard’s decision to transfer approximately two million dollars from an OTC bank account in Switzerland to the Apollo. The money was stored in a locked file cabinet to which Mary Sue Hubbard had the only set of keys.
The rest of the twenty odd decided cases, which may represent a small sample of thousands of lawsuits, were mainly skirmishes in the war between Scientology and the Service. Church entities were resisting summons and the IRS was resisting FOIA requests. Critics of the closing agreement seem to think that the Service crumbled, which was inexcusable, since the Service was mostly winning in court. There was one case, most critical to Scientology, to which it was not technically a party. The case of Robert Hernandez went all the way to the Supreme Court. In 1987, the Supreme Court ruled that “fixed donations” that Mr. Hernandez made in exchange for “auditing” sessions, while attached to the “E-meter”, were quid-pro-quo and hence not deductible.
There is criticism of the Service for giving away the store that it won in Hernandez, in the closing agreement:
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.
Presumably this would put the auditing session, which are the Scientology equivalent of a sacrament, in the same category as “pew rents” which Revenue Ruling 70-47 holds to be deductible as contributions.
The closing agreement came up in litigation in 2002. Michael Sklar was arguing that the Service should be bound to apply its principles more generally to allow the deduction of at least some of the tution to an Orthodox Jewish day school. The Ninth Circuit chided the Service for not releasing the closing agreement and punished it by assuming for purposes of the its decision that it said what Mr. Sklar said it did. That was not all that helpful to Mr. Sklar, though:
We seriously doubt that the Sklars are similarly situated to the persons who benefit from the Scientology closing agreement because the religious education of the Sklars’ children does not appear to be similar to the “auditing”, “training” or other “qualified religious services” conducted by the Church of Scientology. Second, even if they were so situated, because the treatment they seek is of questionable statutory and constitutional validity under 170 of the IRC, under Lemon, and under Hernandez, we would not hold that the unlawful policy set forth in the closing agreement must be extended to all religious organizations
Myself, I think the IRS “treaty” with Scientology seems to make a lot of sense. The churches were required to put controls in place that probably make them more compliant than most churches, unless they have eroded over time. To the credit of the Service and the courts, it was never about the specific beliefs, but always about the inurement issues, which tend to be applied pretty even handedly. I would love to hear what my friends from the Freedom From Religion Foundation think and also of course the thoughts of Robert Baty, bane of the basketball ministers. Watch the comments section.
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Originally published on Forbes.com on July 11th, 2012