Joint Committee on Taxation, Overview of
Tax Rules Application to Exempt
Organizations Engaged in Television
Ministries (JCS-21-87), October 5, 1987

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church. The IRS position is that, in order to qualify as a church for Federal income tax purposes, an organization must satisfy at least some of the following criteria: (1) a distinct legal existence; (2) a recognized creed and form of worship; (3) a definite and distinct ecclesiastical government; (4) a formal code of doctrine or discipline; (5) a distinct religious history; (6) a membership not associated with any other church or denomination; (7) a complete organization of ordained ministers ministering to their congregations and selected after completing prescribed courses of study; (8) a literature of its own; (9) established places of worship; (10) regular congregations; (11) regular religious services; (12) schools for the religious instruction of the young; (13) schools for the preparation of its ministers; and (14) any other facts and circumstances that may bear upon the organization's claim to church status.

The U.S. Tax Court has stated that these criteria developed by the IRS for administrative purposes are useful guidelines, but not controlling rules, in determining whether an otherwise tax-exempt religious organization qualifies for the narrower category of a church. In making this determination, the Tax Court has taken into account such factors as whether such an organization provides regular religious services, conducted by an organized ministry, for established congregations at established places of worship; whether the organization has a distinct religious history and beliefs that set it apart from other recognized religions; and whether the organization has more than merely incidental associational aspects."

For example, in a recent case, the Tax Court held that an organization (the Foundation of Human Understanding) that spread the teachings of its founder through radio broadcasts, books, pamphlets, and a magazine and also regularly conducted religious services constituted a church for Federal income tax purposes. The broadcasting and publishing activities accounted for a large percentage of the organization's total expenditures and receipts. Noting that "the call to evangelize or otherwise spread one's religious beliefs is, undeniably, an integral part of many faiths," the Court also found that the organization's substantial broadcasting tions constituted a church. The Court emphasized that the and publishing activities did not "overshadow the other indicaorganization, which employed nine ordained ministers, regularly conducted religious services several times a week at two locations where its followers congregated. Finding that the organization's as sociational aspects were 'much more than incidental" and that other criteria listed by the IRS had been met, the Court concluded that the organization constituted a church for Federal income tax purposes.

Courts have uniformly rejected claims of tax-exempt status for, or deductibility of contributions to, "mail-order ministries" and similar situations where individuals attempt to claim "church" status as part of tax-avoidance schemes. Mail-order ministries gen

• See IRS Manual 7(10)69 Exempt Organizations Examination Guidelines Handbook, sec. 821.3 (April 5, 1982) See, e.g., Foundation of Human Understanding v. Comm'r, 88 T.C. No. 75 (1987) (reviewed by the Court), Pusch v. Comm'r, 89 T.C.M. 838, affd. 628 F.2d 1353 (5th Cir. 1980).

• Foundation of Human Understanding v. Comm'r, supra, note 7.

See, eg. Miedaner v. Comm'r, 81 T.C. 272, 282 (1983), Basic Bible Church v. Commy, 74 Т.С. 846 (1980), Rev. Rul. 81-94, 1981-1 С.В. 330, Rev. Rul. 78-232, 1978-1 С.В. 69.

An organization cannot qualify for tax-exempt status as a church, or other religious or charitable organization, and is not eligible to receive tax-deductible contributions, if any part of its net earnings inures to the benefit of a private individual (secs. 501(c)(3), 170). This prohibition is intended to ensure that the organization fulfill the rationale for such tax benefits by devoting itself exclusively to the public good, and to prevent the organization from conferring financial benefits (other than reasonable compensation) on persons having a personal or private interest in its activities. 10

In applying the prohibition on inurement, court decisions have closely scrutinized churches or other entities that are controlled by one person because of the potential for abuse in such organizations, and have stated that such a closely controlled organization must make full disclosure to the court of all relevant facts bearing on its exemption application or claim of exempt status. 11

Forms of inurement

Private inurement can take a variety of forms, including the payment of dividends or excessive compensation to an individual with an interest in the organization. 12 In determining whether an employee or other recipient of payments from an exempt organization has received excessive compensation, all benefits received in exchange for services such as bonuses, deferred compensation, below-interest or unsecured loans, payments of personal expenses, the personal use of cars, airplanes, or residences, and other benefits-are taken into account, as well as salaries.

Reasonable compensation generally is defined as the amount that would ordinarily be paid for like services by like organizations under like circumstances (see Treas. Reg. sec. 1.162-7(b)(3)). Under this standard, reasonableness generally is determined by reference to comparable employment agreements. Relevant factors cited in assessing comparability have included the date on which the service contract was made, the size of the organization, the nature of the services provided, and the individual's qualifications, experience, and familiarity with the organization.

Private inurement can occur through means other than the payment of dividends or excessive compensation. In a recent decision, 13 the Ninth Circuit Court of Appeals upheld revocation of the

Joint Committee on Taxation, Overview of
Tax Rules Application to Exempt
Organizations Engaged in Television
Ministries (JCS-21-87), October 5, 1987

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exemption of the Church of Scientology (California) on a finding of inurement, through means other than salary payments, of net earnings to the benefit of L. Ron Hubbard, founder of the Church, and others. The facts cited by the Court included (1) the Church's aggressive marketing of Hubbard's works and its practice of copyrighting publications authored by Church employees in his name, in conjunction with payments of substantial royalties; (2) Hubbard's "unfettered control over millions of dollars in Church assets," in the absence of testimony and documentation to trace the source and use of these funds; and (3) payment of 10 percent of the gross income of Scientology congregations, franchises, and organizations to Hubbard. The exact dollar amount of these latter payments was deemed irrelevant, the Court held, inasmuch as the stat ute provides that "no part" of an exempt organization's net earnings may inure to a private individual.

Nonabusive compensation arrangements

In some circumstances, payments based on a percentage of net profits have been held not to violate the prohibition on inurement. For instance, the IRS has permitted tax-exempt organizations to adopt percentage compensation arrangements if the following five circumstances are present:

(1) the arrangement derives from a completely arm's length contractual relationship, with the service-provider having no participation in the management or control of the organization;

(2) the contingent payments serve a real and discernible business purpose independent of any purpose to operate the organization for the benefit of the service-provider;

(3) the amount of the compensation is not dependent principally on revenue of the exempt organization but rather on the accomplishment of the objectives of the compensatory contract;

(4) review of the actual operating results reveals no evidence of abuse or unwarranted benefits; and

(5) there is a ceiling or reasonable maximum so as to avoid the possibility of a windfall benefit to the service-provider based on factors having no direct relationship to the level of service provided.14 In addition, the Internal Revenue Service has permitted a taxexempt organization to offer its employees a qualified profit-sharing plan, so long as the amount contributed to the plan constituted reasonable compensation and the plan met other requirements of Federal law. 18 In doing so, the IRS acknowledged that such plans further an exempt purpose by increasing employee productivity. Parsonage allowance

In general

The Code provides an exclusion from gross income for (1) the rental value of a home furnished to a minister as part of the minister's compensation, or (2) a rental allowance paid to a minister as part of compensation to the extent used to rent or provide a home (sec. 107). The rental allowance exclusion applies to amounts of

GCM 38905 (June 11, 1982).

"G.C.M 38283 (February 15, 1980),

Joint Committee on Taxation, Overview of
Tax Rules Application to Exempt
Organizations Engaged in Television
Ministries (JCS-21-87), October 5, 1987

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compensation used during the to rent or otherwise provide a dwelling, including directly related expenses. Thus, the exclusion applies to the value of a dwelling furnished to the minister, together with furniture, fixtures, and appliances; rent or mortgage payments for a residence; costs of improvements or remodeling; and expenditures for utilities, insurance, and maintenance and repair. 16

Under the present law, there is no limit on the amount of the exclusion for a parsonage allowance, provided that the amount does not exceed reasonable compensation for the minister's services, and any rental allowance is, in fact, used by the minister to rent or otherwise provide a home. 17

Deductibility of interest and tax

In 1983, the IRS ruled that a minister could not claim deductions for mortgage interest and real estate taxes on a residence to the extent such expenditures were allocable to tax-free housing allowances received by the minister. The IRS took the position that where a taxpayer incurred expenses for purposes for which taxexempt income was received, permitting a full deduction for such expenses would lead to a double benefit not allowed under section 265 (disallowing deductions for expenses allocable to tax-exempt income).

The Tax Reform Act of 1986 overruled the IRS position and provided that section 265 shall not disallow otherwise allowable deductions for interest paid on a mortgage on, or real property taxes paid on, the home of a minister, on account of an excludable parsonage allowance. Accordingly, a minister may exclude the amount of compensation received as a housing allowance, and (if the minister itemizes deductions) may offset other income with deductions for expenditures for residential mortgage interest and real estate

taxes.

C. Restrictions on Political and Lobbying Activities

In general

Charitable organizations for which deductions are allowed for Federal income tax purposes, including churches, cannot engage in any political activity and cannot engage in more than an insignificant amount of lobbying activity (secs. 501(c)(3) and 170(c)(2)).18 Thus, if a church intervenes in a political campaign or engages in substantial lobbying, including through the use of broadcast facilities, then its tax-exempt status may be jeopardized.19

Joint Committee on Taxation, Overview of
Tax Rules Application to Exempt
Organizations Engaged in Television
Ministries (JCS-21-87), October 5, 1987

7

Political activity

Because section 501(c)(3) organizations are subject to a ban on political activity, the principal issue presented by this rule is, simply, the definition of "political" activity. In general, prohibited political activity involves the participation or intervention, directly or indirectly, in any political campaign on behalf of or in opposition to any candidate for public office.20 The office involved can be national, state, or local; and it is not required that the election be contested or involve the participation of political parties. 31

The determination of what constitutes intervention in a political campaign requires weighing all relevant facts and circumstances. 22 Section 501(c)(3) specifically mentions "the publishing or distribut ing of statements" that support or oppose a candidate as examples of political intervention. Other clear examples would include making or soliciting campaign contributions, providing publicity or volunteer assistance, and paying expenses of a political campaign. In many cases, the critical issue in determining whether an activity constitutes intervention in a political campaign is whether it reflects or advances a preference between competing candidates.23

When members of an organization are involved in political activities, it is necessary to determine whether such activities are at tributable to the organization, or instead are undertaken independently by the individuals in their private capacities. In general, principles of agency are relevent to this determination. For example, acts undertaken by individuals under actual or purported authority to act for the organization, and acts planned or ratified by the organization, are considered activities of the organization.** Where an exempt organization uses a business subsidiary as a "guise" for carrying out particular activities without restriction, the subsidiary's activities are attributed to the parent.28

Lobbying activity

In contrast to the absolute ban on political activity, a church or other organization seeking exemption under section 501(c)(3) is permitted to engage in some lobbying activity provided that the activity is not "substantial." Thus, it is necessary for purposes of section 501(c)(3) not only to define "lobbying" activity, but also to determine the meaning of the term "substantial."

In general, a section 501(c)(3) organization is engaged in lobbying activity if it advocates the adoption or rejection of legislation. For