Appeals court restores 'parsonage allowance' to save religious leaders millions on taxes

MILWAUKEE – Religious leaders don't owe income tax on free housing from their congregations, a federal appeals court ruled Friday.

The so-called "parsonage allowance" in IRS rules had been challenged by the Madison-based Freedom From Religion Foundation as a violation of the First Amendment.  A federal district judge in Madison agreed it was unconstitutional.

But the 7th U.S. Circuit Court of Appeals reversed, saving ministers of many stripes a possible $1 billion a year in income taxes, according to a religious freedom group.

In an opinion written by Milwaukee-based Judge Michael Brennan, the court held that excluding housing allowances from ministers' taxable income does not violate the First Amendment's directive that Congress shall make no law “respecting an establishment of religion” in violation of the First Amendment.

Annie Laurie Gaylor, co-founder and co-president of the Freedom From Religion Foundation, said the group was weighing whether to ask the full 7th Circuit to review the case or take it to the U.S. Supreme Court.

“It’s a blow,” Gaylor said.

U.S. Department of Justice spokeswoman Kelly Laco called the ruling “a win for the religious protections enshrined” in the Constitution. The Justice Department was defending Treasury Department Secretary Steve Mnuchin, who was named in the lawsuit.

Lawyers for affected religious leaders rejoiced at Friday's ruling.

“The tax code treats ministers the same as hundreds of thousands of nonreligious workers who receive tax-exempt housing for their jobs – that’s not special treatment, it’s equal treatment,” said Luke Goodrich, vice president and senior counsel at Becket Fund for Religious Liberty, a nonprofit law firm that intervened in the lawsuit on behalf of various ministers.

One of them is Father Patrick Malone of the Holy Cross Anglican Church in Waukesha.

“The court rightly recognized that striking down the parsonage allowance would devastate small, low-income houses of worship in our neediest neighborhoods and would cause needless conflict between church and state," Goodrich said.

 An earlier suit was dismissed in 2014 by the 7th Circuit, which found the Freedom From Religion Foundation had no standing to challenge IRS section 107.

In 2016, it filed a new lawsuit, this time claiming that its own staff had sought reimbursement of federal income tax paid on the portion of their salaries the group decided to call a housing allowance under section 107.

Brennan noted an "overarching arrangement" in the tax code to exempt employer-provided housing for certain employees in many contexts has a secular, not religious purpose.

Another secular purpose was to eliminate discrimination between ministers. Allowing the allowance only for in-kind housing, like a residence attached to a church – the original rule – was unfair to smaller, poorer denominations that might not have such facilities, and it was expanded in the 1950s to apply to money paid to cover ministers' rent elsewhere.

"Any financial interaction between religion and government – like taxing a church, or exempting it from tax – entails some degree of entanglement. But only excessive entanglement violates the Establishment Clause," Brennan wrote.

Nor does the allowance have the primary effect of advancing religion on behalf of the government, he wrote. Rather it allows churches to advance religion.

The churches that intervened in the case say that without the housing tax break, many religious groups and their clergy could not pursue their ministries.

In Malone's case, his $1,500 monthly housing allowance at Holy Cross Anglican Church was half of his total compensation in 2017 and let him live near his church and minister to its 65 active members.

Follow Bruce Vielmetti on Twitter: @ProofHearsay. Contributing: The Associated Press