December 11, 2008 | Read Time: 4 minutes
In the latest skirmish over how much authority the government has in regulating houses of worship, a federal court in Minnesota may have given religious institutions across the nation a new defense against potential audits by the Internal Revenue Service.
United States Magistrate Judge Jeffrey J. Keyes last month rejected an effort by the IRS to force a church in the Minneapolis suburbs to turn over its records for an audit, ruling that the agency violated a 1984 law that was designed to protect religious congregations from unfair intrusions by government into their financial affairs.
The IRS had asked the court to force the Living Word Christian Center, in Brooklyn Park, Minn., to turn over financial records and notes from its board meetings.
The judge sided with the church, which argued that the tax agency’s investigation had been started by an official of insufficient rank. Under the Church Audit Procedures Act, decisions to breach church-state walls must be made by top leaders at the Treasury Department.
While the government is likely to challenge the decision, tax-law experts expect Mr. Keyes’s ruling to spur similar challenges to church audits and say it may even force the IRS to engage in a lengthy, formal rule-making process to determine who has the authority to order an investigation into a church’s finances.
Ann Thomas, a Washington lawyer who specializes in nonprofit law, said the federal court’s report is a “wake-up call” to the IRS. “I definitely think that a lot of churches could challenge current audits,” Ms. Thomas said.
Political Endorsement
The IRS began to investigate Living Word in April 2007, following reports that Rev. Mac Hammond had endorsed U.S. Rep. Michele Bachmann, a Minnesota Republican, from the pulpit — an act that would violate charity tax laws. In investigating that allegation, the IRS found that the church had engaged in financial transactions that may have improperly benefited Mr. Hammond, and possibly called into question the congregation’s tax-exempt status. Living Word leased planes owned by Mr. Hammond, and the pastor borrowed money from the church, which later forgave a portion of the debt, according to court documents.
In a letter to his congregation, written earlier this year, Mr. Hammond said that all of his compensation, including the loans and aircraft leases, had been approved by the church’s Board of Directors and had followed IRS guidelines.
In June 2007, the church did reply to some of the IRS’s requests for information, but refused to answer later questions about its operations and canceled a scheduled conference with tax agents. Living Word argued that an April 2007 letter alerting them about an inquiry into their finances, signed by Marsha A. Ramirez, then director for exempt organizations, violated the Church Audit Procedures Act.
After that law was passed in 1984, the Treasury Department issued formal regulations that the lowest-ranking IRS official who could approve a church audit was the regional commissioner, just one level of authority below the IRS commissioner.
But the IRS reorganized in 1998, eliminating the regional commissioner position along with a geographic structure that divided the nation into quadrants. The newly organized IRS was based on categories of taxpayers, such as small businesses or tax-exempt organizations.
Getting ‘Sloppy’
After the reorganization, the authority to order a church audit was given to the director of examinations for tax-exempt organizations — four management levels below the commissioner, according to the court’s analysis. And that authority was delegated not by a formal rule-making process, but by the IRS’s employee manual, which does not carry the force of law and does not have the same authority as formal regulations, Judge Keyes wrote.
“One of the factors that really counts against the IRS is that they didn’t do notice and rule making,” said Ellen P. Aprill, a professor who teaches about tax-exempt organizations at Loyola Law School, in Los Angeles, and a former U.S. Treasury official.
Beyond that, Judge Keyes’s opinion is the latest sign that the IRS is getting “sloppy” in applying the tax laws, said Marcus S. Owens, a tax lawyer in Washington and one of Living Word’s legal representatives in this case. Mr. Owens is also a former commissioner for tax-exempt organizations at the IRS.
Sally G. Blinken, a New York lawyer and former New York State assistant attorney general, echoed that sentiment, saying the IRS “got caught with their pants down.”
But she is also concerned that the court’s opinion will further hamper the service’s efforts to monitor religious organizations, which are already excluded from many regulations required of other nonprofit groups, such as the requirement to file Form 990 financial disclosures.
“What the heck does leasing a plane have to do with religious freedom?” she asked. “It’s just outrageous if the head of examinations can’t look into alleged self-dealing.”
Amy K. Rotenberg, a lawyer and spokeswoman for the church, said the issue is about whether the IRS has to follow the law. “Congress outlined special protections to prevent politically motivated investigations. All we’re saying is that the IRS did not follow the rules laid out, and if they do we will fully comply.”
