Taxation of Private Religious Schools

By Richard R. Hammar, J.D., LL.M., CPA

© Copyright 1991, 1998 by Church Law & Tax Report.  All rights reserved.  This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is provided with the understanding that the publisher is not engaged in rendering legal, accounting, or other professional service.  If legal advice or other expert assistance is required, the services of a competent professional person should be sought. Church Law & Tax Report, PO Box 1098, Matthews, NC 28106. Reference Code: m65 m22 m70

Most church--operated schools share the federal income tax exemption of their parent church. Schools that are not controlled by a church ordinarily must apply for tax--exempt status. This procedure is discussed in Federal Income Taxation.

Many taxpayers have attempted to claim charitable contribution deductions for payments made to a private school or to a church operating a private school in which the taxpayer's child is enrolled. The IRS has emphasized that “a charitable contribution is a voluntary transfer of money or property that is made with no expectation of procuring a financial benefit commensurate with the amount of the transfer.”¹ Therefore, payments made by a taxpayer on behalf of a child attending a church--sponsored school are not deductible as contributions either to the school or to the church operating the school if the payments are earmarked for the child.²

The fact that payments are not earmarked for a particular child does not necessarily mean that they are deductible. The IRS has held that the deductibility of undesignated payments by a taxpayer to a private school in which his child is enrolled depends upon

whether a reasonable person, taking all the facts and circumstances of the case in due account, would conclude that enrollment in the school was in no manner contingent upon making the payment, that the payment was not made pursuant to a plan (whether express or implied) to convert nondeductible tuition into charitable contributions, and that receipt of the benefit was not otherwise dependent upon the making of the payment.³

In resolving this question, the IRS has stated that the presence of one or more of the following factors creates a presumption that the payment is not a charitable contribution: (1) the existence of a contract under which a taxpayer agrees to make a “contribution” and which contains provisions ensuring the admission of the taxpayer's child; (2) a plan allowing taxpayers either to pay tuition or to make “contributions” in exchange for schooling; (3) the earmarking of a contribution for the direct benefit of a particular individual; or (4) the otherwise unexplained denial of admission or readmission to a school of children of taxpayers who are financially able, but who do not contribute.¹ The IRS has observed that if none of these factors is determinative, a combination of several additional factors may indicate that a payment is not a charitable contribution. Such additional factors include but are not limited to the following: (1) the absence of a significant tuition charge; (2) substantial or unusual pressure to contribute applied to parents of children attending a school; (3) contribution appeals made as part of the admissions or enrollment process; (4) the absence of significant potential sources of revenue for operating the school other than contributions by parents of children attending the school; (5) other factors suggesting that a contribution policy has been created as a means of avoiding the characterization of payments as tuition.² If a combination of such factors is not present, payments by a parent will normally constitute deductible contributions, even if the actual cost of educating the child exceeds the amount of any tuition charged for the child's education.

The IRS has illustrated the application of these principles in the following examples:

Situation 1. A school requests parents to contribute a designated amount (e.g. $400) for each child enrolled in the school. Parents who do not make the $400 contribution are required to pay tuition of $400 for each child. Parents who neither make the contribution nor pay the tuition cannot enroll their children in the school. A parent who pays $400 to the school is not entitled to a charitable contribution deduction because the parent must either make the contribution or pay the tuition in order for his child to attend the school. Therefore, admission to the school is contingent upon making a payment of $400. Such a payment is not voluntary.

Situation 2. A school solicits contributions from parents of applicants for admission during the school's solicitation for enrollment of students or while applications are pending. The solicitation materials are part of the application materials or are presented in a form indicating that parents of applicants have been singled out as a class for solicitation. Most parents who are financially able make a contribution or pledge to the school. No tuition is charged. The school suggests that parents make a payment of $400. A parent making a payment of $400 to the school is not entitled to a charitable contribution deduction. Because of the time and manner of the solicitation of contributions by the school, and the fact that no tuition is charged, it is not reasonable to expect that a parent can obtain the admission of his child to the school without making the suggested payments. Such payments are in the nature of tuition, not voluntary contributions.

Situation 3. A school admits a significantly larger percentage of applicants whose parents have made contributions to the school than applicants whose parents have not made contributions. Parents who make payments to the school are not entitled to a charitable contribution deduction. The IRS ordinarily will conclude that the parents of applicants are aware of the preference given to applicants whose parents have made contributions. The IRS therefore ordinarily will conclude that a parent could not reasonably expect to obtain the admission of his child to the school without making the payment.

Situation 4. A society for religious instruction has as its sole function the operation of a private school providing secular and religious education to the children of its members. No tuition is charged. The school is funded through the society's general account. Contributions to the account are solicited from all society members, as well as from local churches and nonmembers. Persons other than parents of children attending the school do not contribute a significant portion of the school's support. Funds normally come to the school from parents on a regular, established schedule. At times, parents are solicited by the school to contribute funds. No student is refused admittance because of the failure of his or her parents to contribute to the school. Under these circumstances, the IRS generally will conclude that payments to the society are nondeductible. Unless contributions from sources other than parents are of such magnitude that the school is not economically dependent upon parents' contributions, parents would ordinarily not be certain that the school could provide educational benefits without their payments. This conclusion is further evidenced by the fact that parents contribute on a regular, established schedule.

Situation 5. A private school charges a tuition of $300 per student. In addition, it solicits contributions from parents of students during periods other than the period of the school's solicitation for student enrollments. Solicitation materials indicate that parents of students have been singled out as a class for solicitation and the solicitation materials include a report of the school's cost per student. Suggested amounts of contributions based on an individual's ability to pay are provided. No unusual pressure to contribute is placed upon individuals who have children in the school, and many parents do not contribute. In addition, the school receives contributions from many former students, parents of former students, and other individuals. A parent pays $100 to the school in addition to the $300 tuition payment. Under these circumstances, the IRS generally will conclude that the parent is entitled to claim a charitable contribution deduction of $100. Because a charitable organization normally solicits contributions from those known to have the greatest interest in the organization, the fact that parents are singled out for a solicitation will not in itself create an inference that future admissions or any other benefits depend upon a contribution from the parent.

Situation 6. A church operates a school providing secular and religious education that is attended both by children of parents who are members of the church and by children of nonmembers. The church receives contributions from all of its members. These contributions are placed in the church's general operating fund and are expended when needed to support church activities. A substantial portion of the other activities is unrelated to the school. Most church members do not have children in the school, and a major portion of the church's expenses are attributable to its nonschool functions. The methods of soliciting contributions from church members with children in the school are the same as the methods of soliciting contributions from members without children in the school. The church has full control over the use of the contributions that it receives. Members who have children enrolled in the school are not required to pay tuition for their children, but tuition is charged for the children of nonmembers. A church member whose child attends the school contributes $200 to the church for its general purposes. The IRS ordinarily will conclude that the parent is allowed a charitable contribution deduction of $200 to the church. Because the facts indicate that the church school is supported by the church, that most contributors to the church are not parents of children enrolled in the school, and that contributions from parent members are solicited in the same manner as contributions from other members, a parent's contributions will be considered charitable contributions, and not payments of tuition, unless there is a showing that the contributions by members with children in the school are significantly larger than those of other members. The absence of a tuition charge is not determinative in view of these facts.

Similarly, the IRS has ruled that a parent who sent his child to a church school that charged no tuition but that solicited funds from parents and others was entitled to a charitable contribution deduction only to the extent that “contributions” made to the school exceeded the fair market value of the child's education.³ The IRS also has disallowed a deduction for amounts contributed to an education fund maintained by a church and used to help finance the education of children of church members who attended nonpublic schools.⁴

In addition, the IRS maintains that contributions to racially restricted private schools are not deductible by the donor in computing federal income taxes.⁵

In 1973, the United States Supreme Court struck down state laws allowing income tax benefits to parents of children attending private schools on the ground that such laws constitute an establishment of religion.⁶ In one case, after noting that the vast majority of students attending nonpublic schools attend church--related schools, the Court held:

Special tax benefits, however, cannot be squared with the principle of neutrality established by the decisions of this Court. To the contrary, insofar as such benefits render assistance to parents who send their children to sectarian schools, their purpose and inevitable effect are to aid and advance those religious institutions.⁷

This ruling was qualified by the Supreme Court in an important decision in 1983. In the Mueller case,⁸ the Court was asked to review the constitutionality of a Minnesota statute allowing taxpayers, in computing their state income tax, to deduct certain expenses incurred in providing for their children's education. Unlike state laws previously invalidated by the Court,⁹ the Minnesota law granted a deduction for educational expenses incurred by all parents, including those whose children attend public or nonsectarian private schools. The Court found this difference to be critical, noting that “a program . . . that neutrally provides state assistance to a broad spectrum of citizens is not readily subject to challenge under the establishment clause.”¹⁰ The Court rejected the argument that the Minnesota law, while neutral on its face, was in practice unconstitutional since most parents of public school children incur no “education expenses” and 96 percent of the children in the state's private schools attend church--affiliated institutions. The Mueller case is significant because it permits state legislatures to grant tax relief to parents who are compelled to subsidize a system of education that they conscientiously oppose.

Do teachers and administrators at church--operated schools qualify for a housing allowance exclusion? The subject of housing allowances is considered fully in chapter 6. To summarize, section 107 of the Internal Revenue Code specifies that “in the case of a minister of the gospel, gross income does not include (1) the rental value of a home furnished to him as part of his compensation, or (2) the rental allowance paid to him as part of his compensation, to the extent used by him to rent or provide a home.” The income tax regulations add that “[i]n order to qualify for the exclusion, the home or rental allowance must be provided as remuneration for services which are ordinarily the duties of a minister of the gospel.”¹¹ Accordingly, ministers may exclude from their gross income (for income tax reporting purposes) the fair rental value of housing provided to them on a rent--free basis, or that portion of their compensation that is designated as a housing or rental allowance by their employer (to the extent that it is used to pay housing--related expenses). In summary, the housing allowance exclusion is available so long as two conditions are satisfied: (1) the recipient is a minister, and (2) the parsonage or housing allowance is provided to the minister as compensation for services performed in the exercise of ministry. Both of these conditions are discussed below.

1. The recipient is a minister. Would teachers at a church--operated private school be considered “ministers” for federal tax purposes? This is a complex question. In 1989, the Tax Court announced a new test for determining whether or not a particular individual is a minister: “Five factors [must be] analyzed. Those factors are whether the individual (1) administers sacraments, (2) conducts worship services, (3) performs services in the `control, conduct, or maintenance of a religious organization,' (4) is `ordained, commissioned, or licensed,' and (5) is considered to be a spiritual leader by his religious body.”¹² The fourth consideration (the individual is ordained, commissioned, or licensed) must be present in each case. The Tax Court indicated in the Knight case that a minister must satisfy at least 2 of the remaining 4 considerations. However, the court warned that this is not a mathematical test, and that the facts of each case must be considered fully in reaching a decision.

The United States Tax Court ruled in 1968 that a Southern Baptist minister of education was not eligible for a housing allowance despite the fact that he was “commissioned” by his local church. The Court observed that the minutes of the meeting at which the “minister” had been “commissioned” indicated that he had been commissioned “as a minister of the gospel in religious education so that he may receive benefits of laws relative to social security and the Internal Revenue Service [sic].” The Court called this commissioning “nothing more than a paperwork procedure designed to help him get a tax benefit . . . without giving him any new status.” It noted that his duties were in no way changed by the commissioning. Such evidence convinced the Court that the individual was not “recognized by his church as a minister of the gospel,” and accordingly could not be considered a minister for tax purposes.¹³

This precedent suggests that persons who are licensed or ordained while employed as teachers would not be considered ministers by the IRS to the extent that they, like the minister in the Lawrence case: (1) received ministerial credentials  “so that [they] may receive benefits of laws relative to the Social Security Act and Internal Revenue Service,” (2) their “licensing” was “nothing more than a paperwork procedure designed to help [them] get a tax benefit . . . without giving [them] any new status,” (3) “[their] duties were in no way changed” by receipt of their ministerial credentials,   (4) they have never performed the sacraments or ordinances of the church—including communion, baptism, marriages, and funerals, and (5) they have little if any formal theological training. The IRS would doubtless conclude that such individuals would not even be considered “ministers” or spiritual leaders by their own church. This of course would mean that they also would fail the fifth of the five factors enunciated in the Knight case for determining whether or not an individual is a minister for tax purposes.

On the other hand, a minister who previously was ordained or licensed for legitimate ministerial purposes and in fact was employed in pastoral ministry, and who now feels called to a teaching ministry, would clearly qualify as a minister under the Knight test.

2. Services performed in the exercise of ministry. There is little doubt that teaching at a church--controlled school constitutes “service performed in the exercise of ministry,” and accordingly satisfies the second eligibility requirement for a housing allowance under Code section 107. In 1962, the IRS ruled that “ordained ministers of the gospel . . . who teach or have positions involving administration and over--all management duties in the parochial schools, colleges, or universities which are integral agencies of religious organizations under the authority of a religious body constituting a church or church denomination are in the performance of their duties as ministers of the gospel for purposes of section 107 of the Code, and they may, therefore, exclude from their gross income the rental value of a home furnished to them as part of their compensation, or rental allowances paid to them, as part of their compensation to the extent used by them to provide a home.”¹⁴

Whether or not private school property is exempt from state or local property taxes is considered in Tax Legislation.

Incorporation and Tax Exemption of Private Religious Schools

Proof of Nondiscrimination in Private Schools

Right to Attend Private Schools

The Distinction Between Public and Private Education

Discharge and Discipline of Students of Private Schools

Discharge and Discipline of Teachers

Application of Federal Labor and Discrimination Laws to Private Schools

Tuition Refunds

Government Regulation of Private Schools

Zoning Laws and Private Schools

Safety and Health Regulations for Private Schools

Child Abuse Reporting Requirements for Private Schools

Legal Liability for Student Injuries

Government Regulation of Child Care Facilities

“Homeschools”

Use of Public School Teachers in Private Schools