After a multi-year hiatus during which the Internal Revenue Service suspended all audits of churches, it appears that the Service is again auditing churches.
Under the Church Audit Procedures Act (CAPA), the IRS can audit a church only if (1) an “appropriate high-level Treasury official” has a reasonable belief that the church may not be exempt as a church or has unrelated business taxable income; and (2) the IRS provides written notice explaining the concerns giving rise to the audit and the general subject matter of the audit. After the IRS was reorganized in 1998, there was confusion over who constituted an “appropriate high-level Treasury official” for purposes of initiating church audits.
In 2007, the IRS initiated an audit of Living Word Christian Center, a Minnesota church, after it was reported that Living Word’s pastor had endorsed Representative Michele Bachmann during a sermon, an act that could have resulted in a revocation of the church’s tax exemption. The IRS also investigated financial transactions between the church and the pastor that may have constituted improper private inurement to the pastor. The audit was approved by the IRS director of exempt organizations, examinations, an official that Living Word alleged in a lawsuit was not “an appropriate high-level Treasury official.” After the U.S. District Court for the District of Minnesota agreed with the church in a 2009 decision, the IRS effectively suspended all examinations of churches pending the designation of “an appropriate high-level Treasury official” for approving such audits, but the Service failed to name such an individual.
All organizations that are exempt from taxation under section 501(c)(3) of the Internal Revenue Code – not just churches – are prohibited from participating or intervening in a political campaign on behalf of any candidate for public office. Although some churches have alleged that this restriction muzzles churches and amounts to a violation of their freedom of speech, churches are not restricted any more than other tax-exempt organizations, and a church is free to disregard the prohibition on “electioneering” as long as it is willing to forfeit its tax exemption. The restriction on electioneering is part of a broad policy enacted by Congress regarding what types of organizations should be entitled to the privilege of tax exemption.
In 2012, the Freedom From Religion Foundation (FFRF) filed suit against the IRS alleging that the IRS violated the Establishment Clause of the First Amendment by failing to enforce the electioneering prohibition against churches while simultaneously enforcing that prohibition against other nonprofits, including FFRF. FFRF sought to enjoin the IRS from its policy of non-enforcement of electioneering restrictions against churches and to force the IRS to designate a high-ranking official to initiate church audits.
FFRF and the IRS recently settled the lawsuit after the IRS informed FFRF that it had resolved which official would have signature authority to authorize church audits and that it had resumed examinations of churches. The IRS has designated the Commissioner of the Tax Exempt & Government Entities Division as the high-ranking official to approve church audits. The press release and court documents relating to the settlement provide few details on the new examination procedures, but they do state that the IRS has identified 99 churches that merit examination because of information relating to alleged electioneering activities. According to the FFRF press release, the IRS is in the process of reviewing its procedures to ensure fair enforcement of the electioneering prohibition across all tax-exempt organizations.
The enactment of CAPA may or may not have been good for churches, but it is certain that the recent multi-year suspension of church audits has been bad for churches as a whole. Setting aside concerns regarding electioneering, the failure to audit churches has allowed financial miscreants to operate with greater impunity. For instance, the Living Word case revealed troubling financial dealings between the church and its pastor, but the IRS was powerless to enforce the tax laws prohibiting private inurement or private benefit. Although it remains difficult for the IRS to initiate a church audit and such audits will no doubt be rare, the knowledge that it is again possible for the IRS to enforce tax laws against churches should deter some from violating the tax law with quite as much impunity.