Are gifts to clergy from their parishioners taxable income for federal income tax purposes? The answer involves a careful consideration of the surrounding circumstances. In its recent opinion in Brown, T.C. Memo. 2019-69, the Tax Court considered whether amounts a clergyman and his wife received were nontaxable gifts or whether the payments crossed the line into taxable income. The court's decision in this case could be informative for CPAs with tax clients who are members of the clergy.
In an audit of the 2007,2008, and 2009 returns of Mikel A. Brown Sr., a church pastor, and his wife, Debra A. Brown, the IRS used the bank-deposit method to reconstruct their taxable income. The IRS revenue agent analyzed the taxpayers' bank statements and records to identify total deposits and asked the taxpayers where the deposits came from. Deposits for which the taxpayers could not identify the source (beyond the extent of their reported income) were classified as taxable by the revenue agent. Using this method, the IRS asserted unreported income in each of the three years under audit. The taxpayers asserted that the unreported amounts represented either the church's housing, or "parsonage," allowance excludable from income under Sec. 107(2) or nontaxable gifts from church members.
Citing cases including a Fifth Circuit opinion, Bass v. Hawley, 62 F.2d 721 (5th Cir. 1933), which found that gifts arise from "personal affection or regard or pity," the court focused on four criteria used in prior case law (see Felton, T.C. Memo. 2018168; see also Terrell, 754 F.2d 1139 (5th Cir. 1985)), to examine payments to clergy and differentiate between payments that are nontaxable and those that are taxable:
* Were the payments given in exchange for services? For example, did they compensate for a lower salary, or were they offered in an effort to retain the clergy member's services? The court cited the size of the gifts as an indication that the payments were made to encourage Brown to remain in his position.
* Were the payments requested by the clergy member or other officials of the religious group? In this case, the court noted the use of a single-envelope giving system, rather than an envelope for church contributions and a separate envelope for gifts to the pastor (as in Felton). In addition, church members gave more heavily on two specific days of the year chosen to honor the pastor, which the court found indicated that church members had been requested to...