Ministers are allowed to exclude the portion of their compensation designated as a housing allowance from their taxable income. Quite a few people question the constitutionality of this provision and it looks like it may be finally put to the test. A federal district court has ruled that the Freedom From Religion Foundation has standing to proceed with its suit against the exclusion (Code Section 107). There are arguments that the provision is constitutional, though. I have invited Frank Sommerville to make the case for Section 107’s constitutionality. Mr. Sommerville is a lawyer and a CPA from Dallas Texas. He has written and lectured extensively on issues affecting not-for-profits.
HISTORICAL CONTEXT OF SECTION 107
Section 107 is best analyzed by reviewing the historical context surrounding the development of Section 107 of the Internal Revenue Code, the clergy housing allowance. Section 107 is only one part of the larger statutory framework of exclusions for employees who receive employer-assisted housing due the requirements of the job and for the convenience of their employers. See Joint Committee on Taxation, General Explanation of the Tax Reform Act of 1986, (JCS-10-87) May 4, 1987, at {54} (in amending I.R.C. 265(a) “Congress concluded that it was appropriate to continue the long-standing tax treatment…claimed by ministers and military personnel who receive tax-free housing allowances”).
Current tax policy lightens the tax burden of the taxpayers who receive qualifying employer-assisted housing. See Sections 107 (clergy housing), 119 (general housing), 134 (military housing), and 911(a)(2) (foreign housing). Congress created these tax-free housing allowances within its discretion and to demonstrate a willingness to give tax breaks to classes of taxpayers who have little choice about their personal living space. Whether the employer provides a cash allowance or a home, each benefit serves the same purpose; that is, often the employer’s needs affect the living space needs of its employees. Many times, these classes of employees frequently relocate, thus preventing them from settling down and hindering long term close friendships. Further, the employers frequently require them to use their homes to conduct employer business. Additionally, the employee’s place of service may not be desirable. These employees must reside where their employer requires and must frequently use their residence for employer business. Some employees sacrifice amenities that most citizens take for granted, such as long term stability in one locale and privacy.
Tax favored employer-assisted housing existed in both the statutory and common law of taxation prior to the enactment of the Internal Revenue Code of 1954. In fact, all the Internal Revenue Code references to taxation of employee assisted housing began with “convenience of the employee” doctrine. As discussed below, the convenience of the employer doctrine was recognized by the Bureau of Internal Revenue in 1919, before it was ever codified. Section 107 traces its origin to the convenience of the employer doctrine beginning in 1921; Section 134 traces its origins to the convenience of the employer doctrine beginning in 1919; while Section 911 traces its origins to the convenience of the employer doctrine beginning in 1926. Together these code sections create a logical framework that Congress created for addressing the taxation of employer assisted housing. Due to their common origin, they have many elements in common and should be analyzed together.
The Bureau of Internal Revenue addressed employer-provided housing and meals very early. O.D. 265, 1 C.B. 71 (1919) (providing that the value of the meals and lodging furnished a seaman was not taxable compensation). Dubbed the “convenience of the employer” doctrine, the concept looks at employees who had very little say in the place of their residence or where they ate meals. The basic premise: taxable compensation does not include housing and meals provided for the convenience of the employer. Other governments have typically excluded this type of benefit from taxation for thousands of years. Seaman, ranchers, innkeepers, ministers, military officers and the President of the United States all have benefited from this doctrine since at least 1919.
In 1920, the year after the original pronouncement, the Treasury Department amended its income tax regulations to formalize this doctrine. T.D. 2992, 2 C.B. 76 (1920), amending Treas. Reg. 45, Art. 33. Later that same year, the Bureau of Internal Revenue also expanded the concept to include cash payments in lieu of in-kind meals. O.D. 514, 2 C.B. 90 (1920) (the value of supper money given employees who worked late was not compensation).
Announced by the Treasury Department in 1920, the convenience of the employer doctrine required inquiries into the duties required of the employee and how the employer-provided housing affected the employee’s performance of those duties. As applied to ministers, the 1920 regulation required the Bureau of Internal Revenue to delve deeply into a minister’s duties and responsibilities, entangling the Bureau with the inner workings of religion. By deciding the necessity of such housing, the Bureau was forced to judge how churches conducted their religion. Thus, the results could have very easily violated the Free Exercise Clause.
In 1921, Congress prevented such inquiries by codifying the convenience of the employer doctrine as it would apply to ministers. Section 213(b)(11) of the Revenue Act of 1921, Pub. L. No. 67-98, ch. 136, 213, 42 Stat. 227, 239 (1921). Section 213(b)(11) became the present Section 107(1), except for one change. The former statute referred to the minister’s “dwelling house and appurtenances thereof” instead of his “home.” Section 213(b)(11) prevented unconstitutional inquiries into the church’s housing arrangement with the ministers, thereby fostering the separation of church and state while still excluding from taxable compensation church provided housing.
The Court of Claims expanded the convenience of the employer doctrine by holding that a cash housing allowance paid to military officers also qualified under the doctrine. Jones v. United States, 60 Ct. Cl. 552 (1925). In describing this concept, the Court of Claims held that the furnishing of the housing was an “inseparable incident of the office itself.” Id. at 574. This holding is very similar to the minister housing allowance because the church provides the housing as an incident to the office of the minister. With this decision, the court expanded the convenience of the employer doctrine to include cash allowances for housing. Section 213(b)(11) of the Revenue Act of 1921 became Section 22(b)(6) of the Internal Revenue Code of 1939. Eventually, ministers successfully claimed they were entitled to the same tax-free cash housing allowance that was available to the military and to secular employees under the convenience of the employer doctrine. See MacColl v. United States, 91 F. Supp. 721 (E.D. Ill. 1950) (minister’s cash housing allowance excluded from taxable income under Section 22(b)(6) of Internal Revenue Code of 1939); Conning v. Busey, 127 F.Supp. 958 (E.D. Oh. 1954) (same result). In Williamson v. Commissioner, 224 F.2d 377 (8th Cir. 1955), the appellate court expressly relied on the convenience of the employer doctrine and Section 22(b)(6) of the Internal Revenue Code of 1939 to allow a minister to exclude from taxable income a cash housing allowance. The Internal Revenue Service eventually acquiesced to this decision. See Rev. Rul. 56-68, 1956-1 C.B. 604. In reality, Congress simply codified what some courts had believed to be the law when it enacted Section 107(2) in 1954.
The convenience of the employer doctrine existed essentially unchanged until 1954. By that time, many disputes had arisen under the common law doctrine. Thus, in the 1954 amendments that became the Internal Revenue Code of 1954, Congress modified the convenience of the employer doctrine by adding Sections 119 and 911 and amended Section 107. The result was that Section 119 added the condition that the employer-provided housing must be on the employer’s premises. Such premises were defined as the place where a majority of the employer’s activities occurred. Section 119 also prohibited cash housing allowances.
Noticeably, Congress excluded the minister and military housing allowances from the new, restricted Section 119. By enacting Section 107(2), Congress simply kept the existing tax treatment of all ministers by recognizing in the statute that their cash housing allowance was tax-free like the cash military housing allowance.
Before 1954, if a church owned a home (parsonage, rectory or manse), its ministers paid less in taxes than those ministers serving in churches that did not own a home. Section 107(1) dictated the form of compensation paid ministers and discriminated against churches that could not afford to own housing or that otherwise preferred minister-owned housing for reasons of polity.
Section 107(1) gave incentives for churches to own real estate and to exclude those residences from the local property tax rolls. Ministers in churches who did not own a home asked Congress for parity with their fellow ministers who lived in church-owned homes. We believe that the enactment of Section 107(2) added many ministers’ homes to the local property tax rolls.
If Section 107 is analyzed as part of the employer assisted housing tax exemption, it appears to be a reasonable accommodation to religious freedom and constitutional.
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Originally published on Forbes.com on September 6th, 2012