Tag: church finances

FAIRWELL HOUSING ALLOWANCE TAX EXEMPTION

There may not be any housing tax exemption for pastors.  Such an exemption has existed since 1954.  Most pastors lived at the “parsonage” owned and provided by the church.  As churches became more affluent, the involuntary vow of poverty became less appealing.  Pastors wanted to build up equity and own their own home.  The parsonage began to slip into history.  To aid pastors in acquiring a home churches turned to the “housing allowance.”  The “housing allowance” began to form a significant part of the compensation of pastors.  The allowance allowed the minister to buy a home near enough to the church to allow rapid access to the church but not owned by the church.  The “housing allowance” was not included in taxable income.  The “housing allowance” will remain a viable tax exemption for anyone, including pastors, that are required to live at a certain place by their employer just like any other secular employee.  But, the “housing allowance” may not continue in the absence of the employer’s mandate if this decision stands.

In Gaylor v Mnuchin, Opinion and Order (WD Wis. 2017), 26 USC §107(2) has again by the same federal court been held to be in violation of the Establishment Clause.  The Court held that the statute discriminates against secular employees because they cannot qualify for the exemption.  The Court held the exemption does not have a secular purpose.  The argument that the statute was enacted to implement the constitutional entanglements clause was rejected.  The Court held the legislative history indicated the motive behind the statute was a preference for ministers over secular employees.  The Court noted that taxes have been held to be neutral and not a burden on free exercise of religion, otherwise every tax would have to be inapplicable to employees of religious organizations.  Housing allowances for pastors required to live on church grounds will not be effected because that is governed by a different section of the statute.  The opinion of the Court runs to 47 pages.

Tax preparers that try to apply this decision should be cautioned that the Court expressly omitted from its ruling the other sections of the statute.  Only 26 USC §107(2) is the subject of the decision.  The practical loss of the housing allowance will only occur in those situations in which the housing allowance is used to shelter part of the income of the pastor.  It will not be lost under this decision if the religious organization requires its pastor to live in a certain location or in a church owned parsonage.  Any housing allowance that would be permitted to a secular employer’s employee will still be allowed for a religious organization employee.

No doubt this decision will be appealed as it has been in the past.  Ultimately, the issue will be decided by a federal appellate court and possibly someday by the US Supreme Court.  Several if not many tax years will come and go before then.  Technically, the reach of this decision is not outside of the Western District of Wisconsin.  But, the IRS could chose to insist it be followed nationally.

REMOVAL AND THE ECCLESIASTICAL ABSTENTION DOCTRINE

Generally, federal courts can only hear cases in which the Plaintiff is from a state other than the state from which the Defendant hails or if the case involves a federal law.  Generally, assuming the parties are from the same state, a federal court will review the state court Petition or Complaint that was removed by the Defendant to federal court to determine if the Petition or Complaint raises a question under federal law.  If none is found, the case will be remanded to the state trial court from which it came.  The Ecclesiastical Abstention Doctrine and the Ministerial Exception are federal constitutional law doctrines but typically they are raised in a case as defenses by the Defendant.  If the state trial court Petition or Complaint only mentions state law, unless there is a federal law lurking in the Petition or Complaint, the federal court will not have jurisdiction and will remand the case to state trial court.

In Savoy v Savoy, Slip Op., 2017 WL 1536158 (D. Nev. 2017), the Plaintiff demanded an accounting from the church corporation under the state law governing corporations.  The Plaintiff also alleged that the corporate officers breached their fiduciary duty of loyalty to the corporation as defined by state law.  The Defendant removed the case from state court to federal court based on the Defendants’ defensive assertion of the Ministerial Exception and the Ecclesiastical Abstention Doctrine.  But, following normal federal policy, the case was remanded to state court because the Plaintiff and Defendant were residents of the same state and because the Plaintiff did not assert a right under federal law.  That the Defendant asserted a right under federal constitutional law was not enough.

The facts of the case are not explicated in the Court’s opinion with sufficient detail to make a guess why removal to federal court was considered by the Defendant a good idea.  But, the Ecclesiastical Abstention Doctrine and the Ministerial Exception may be raised in a state court proceeding probably to the same or similar effect.  Indeed, state courts sometimes are more reluctant to delve into church splits than federal courts.

DONOR DO OVERS

In the typical church, fund raising to achieve an objective is not always successful.  To raise enough money to build a fellowship hall, or a youth facility, or some other adjunct facility is often started and not finished.  If insufficient money is collected to achieve a stated purpose what happens to the money that is collected can be a source of angst.  Returning the money may present administrative problems like identifying exactly who gave what because many donations are “anonymous.”  Most churches have a church treasurer sworn to secrecy but donations that have to be documented for tax purposes may make anonymity sometimes illusory.  Also, most churches do not have clear policies regarding whether donative intent is binding and if it is, for how long.  Also, if the money is returned to identified givers, must the money be returned with an IRS form 1099 requiring the church to have or obtain the donor’s social security number?

Rogers v St. John United Methodist Church, Slip Op., (unpublished) (Mich. App. 2017) was the reversal of a trial court’s grant of a Motion to Dismiss.  In most jurisdictions, obtaining a dismissal by motion based on the pleadings is problematic at best.  Also, at that stage, without discovery or a trial, the factual evidence is often not complete or cannot be considered.  However, it seems the donation for a new fellowship hall was probably not enough to build and additional fund raising was apparently not successful or for some other reason leadership decided not to build.  After a passage of time, the donors sought a refund.  Apparently the donors were sufficiently well identified and the money sufficiently segregated that it was identifiable as to amount.

The opinion of the court, again based on and reversing a trial court’s dismissal founded only on pleadings, was that “resolution of plaintiffs’ claims does not require a court to analyze questions of religious doctrine or ecclesiastical polity” and for that reason the trial court received the case back on remand for further proceedings.  In other words, the court was holding donative intent could be determined without considering religious considerations.

The opinion was silent about the law of donations in general, i.e., whether once donated the donor retains any authority over the use of proceeds.  The opinion was silent about the bylaws of the church.  Often well drafted bylaws clearly state a policy that donative intent is not binding on leadership and that no return of donated funds can occur even if a donative intent cannot be fulfilled.  Bylaws often also make donations religious by reciting Scriptural edicts regarding donations.

Thus, the opinion of the appellate court in Rogers should be viewed as provisional and not viewed as a general statement of law.  That intent could be determined may have been a projection based on the what the court had before it.  As the case proceeds, if it does, that intent may not be so easily determined.

UNINCORPORATED ASSOCIATIONS AND CHURCH CORPORATIONS

In the beginning, all churches were unincorporated associations.  The demands of modern accounting and property ownership, including liability risk management, pressed the unincorporated association to incorporate.  However, in order to successfully incorporate, the unincorporated association has to follow steps outlined in the law of the state of residence.  Even done amicably, such a transition can be challenging to volunteer led churches and pastors that do not also happen to be lawyers.  In the middle of a church split, the transaction cannot be completed in most states.

An example of this is Church of the First Born of Tennessee, Inc. v Slagle, Slip Op. (Tenn. App. 2017).  Church of the First Born outlived two generations of founders and desperately needed a new organizational structure that would ensure smooth leadership transitions going forward.  This was especially true after the church grew into a multi-campus church and established a church school sited on what probably was millions of dollars of real estate.

Before such an amicable restructuring took place, a church split arose.  The Court was unsure whether the split arose due to the financial pressures of supporting the church school or whether it was a doctrinal issue that arose because after the founders passed away, new leadership did not command the unanimity that the founders earned but surrendered upon their passing.  While the dispute roared around those issues, indeed, those issues were not terribly critical to the resolution.

The Plaintiff was a newly minted church corporation that tried to step into ownership of some of the church assets on behalf of one side of the split.  But, because asset ownership transfers are impossible unless all of the members of the unincorporated association have notice and vote to approve the transaction, the mere incorporation by one group in the split did not have the effect of transferring assets.  The Plaintiff was, therefore, without standing to bring any claim at all and the case was dismissed.

Church leaders have a duty to recognize their own mortality and plan for leadership succession in a fair process.  While many church leaders bristle at the idea of church bylaws or other written policies adopted as the governing rule of the church by a vote of the members, every church that does not have them and does not periodically review and update them increases the risk that a rift in the membership will shatter the peace of the church or in fact doom the church.  A church that can own millions of dollars of property should be able to hire a competent lawyer to lead the church to adopt bylaws or written rules.  Incorporation is a low cost and relatively well understood first step and makes asset management much easier.

YOU CAN’T FIGHT CITY HALL – OR THE BANK

A church split of “longstanding” resulted at the end in an interpleader action brought by a bank.  The bank paid the proceeds of the church accounts into the registry of the court.  For the interpleader action, the bank sought attorney fees, expenses, and a reservation of some of the proceeds (and maybe all of the remainder to be reserved) for future legal expenses.  One of the parties objected and alleged the bank was not an impartial stakeholder, and counterclaimed against the bank.  However, the court awarded legal fees and expenses to the bank.  Bank of America, NA v Jericho Baptist Church Ministries, Inc., Memorandum Opinion, (D. Maryland 2017).

A short Memorandum Opinion of this type does not usually contain detailed recitations of facts.  Thus, the actual fury of the church split was not detailed.  Resolution of the church split by the court, if the court did so, is not detailed in this opinion.

The only lesson that should starkly leap from the opinion is that a church split that results in litigation will not stay between the parties and will lead to legal expenses of substantial amounts in many instances.  Certainly, if the dispute forces a bank to choose sides, it will usually not do so and will usually ask a court to resolve its role.  If the parties resist, the bank will seek and typically obtain legal fees and expenses.  Although typically interpleader legal fee awards are modest, as such things go, but often they are not the only awards of legal fees possible.

THE LUCK OF THE DRAW

A church received $1,000,000 from its property insurer because of hurricane damage.  At about the time the money was received, the church was faced with a sexual harassment claim.  The church decided the money would be safer from the sexual harassment claimant if the money was held in the trust account of the church’s lawyer.  It is unknown how the church thought putting the money out of sight in their lawyer’s trust account would protect it.  As it turned out, the church feared the wrong person.

The lawyer for the church transferred the money from the lawyer’s trust account to another account which appeared to be owned by the lawyer.  The lawyer spent the money on himself.  The theft was discovered.  The lawyer fled but was captured in another state and extradited.  The lawyer was convicted and drew a prison sentence of fifteen years and disbarred.  Like all wrongdoers, it sometimes seems, the lawyer was gone, dead or insolvent, and in this case two of three.

However, a portion of the million dollars was used by the lawyer to make payroll in his law firm.  His non-partner associate was paid from the proceeds in his routine by-monthly paycheck.  The non-partner associate somehow discovered or was told about the theft, or part of it, after the fact and had no control over the trust account.  The non-partner associate did not immediately report it to the church but hoped another law firm engagement would domino and that money could be used to repay the church.

The court in First United Pentecostal Church v Parker, Slip. Op. (Tex. 2017) held that the these facts stated at least a claim for breach of fiduciary duty against the non-partner associate for failing to timely report the theft.  The remedy would be disgorgement of any part of the proceeds received by the non-partner associate.  At trial, the non-partner associate might have other defenses; it is likely the church will be accused of unclean hands in depositing the money in the lawyer’s trust account presumably to put it out of the reach of a possible victim of sexual harassment.

Also, while the church may have had sufficient property insurance, it seems likely the church believed it did not have coverage for a sexual harassment claim such that asset protection efforts, no matter how misplaced, to the church seemed justified.  In any event, if the scheme was to hide assets, which is not necessarily clear from the court opinion, hiding them in a law firm trust account is not typically going to work and most lawyers would not be a party to it.  It should also be noted that clients generally do not have the means to protect themselves from their own lawyer’s avarice.

EMBEZZLEMENT BY PASTOR

 

The United States Bankruptcy Court for the Southern District of Mississippi, as well as a Mississippi county court were not fooled by the machinations of a rogue Pastor.  In, Cross Point Church v Andrews (In Re Andrews), Slip Op. 2016, the Pastor tried to withdraw the church from the denomination.  The denomination removed him from the pastorate of the church.  A part of the church board tried to support the Pastor by entering into an Employment Agreement with him after he had removed, but the Employment Agreement was not submitted to the congregation for a vote and the agreement did not specify the amount of compensation.  Arguing that he was acting innocently under the Employment Agreement, the Pastor and a church treasurer withdrew a year’s salary from the church bank account and deposited the proceeds in the Pastor’s personal checking account.  The Pastor lived on that money for a year while he founded a new church.  The Pastor and the rump of the board locked out the other members from the church and it took them six weeks to regain control and to assist in the installation of the new pastor assigned by the denomination.

 

 The church sued the Pastor in a state trial court and took a judgment for the amount of money withdrawn from the church bank account.  The Pastor sought bankruptcy protection but the church initiated an adversary proceeding.  The bankruptcy court found it did not have authority to revisit the removal of the Pastor under the Ecclesiastical Abstention Doctrine.

 

 Also, the Pastor admitted that as pastor, church officer, and board member, he owed a fiduciary duty to the church to safeguard its funds.  As a corporate officer, that duty was also imposed by statute.  The Pastor was a signatory, two were required but his was often affixed by stamp, to the church bank accounts.  The bankruptcy court found that taking the money was a breach of fiduciary duty.  The Employment Agreement was ignored by the court because the Pastor had been defrocked by the denomination and could not perform as Pastor under the agreement.  Also, the putative church board did not have authority to override the denomination.  For those reasons, the Pastor’s claim that he believed he could scarf up the cash was deemed not reasonable.  The debt to the church for the funds taken was excepted from the bankruptcy.

 

 The lessons in this matter about denominational authority under the controlling foundational documents are routine.  An outright finding that a Pastor exercising control over church assets and funds has a fiduciary duty, the highest duty in the law, to safeguard them should nearly always be considered the norm.  Few Pastors will be sufficiently remote from control of the assets and funds to avoid such a finding.