Irs Rank and Church Tax Inquiries: an Analysis of Proposed Treasury Regulations Under Internal Revenue Code Section 7611

• Jurisdiction: United States,Federal
• Author: By Alexandra Eaker and Ashley Kerins
• Citation: Vol. 23 No. 4
• Publication year: 2015

IRS Rank and Church Tax Inquiries: An Analysis of Proposed Treasury Regulations Under Internal Revenue Code Section 76111

By Alexandra Eaker and Ashley Kerins²

EXECUTIVE SUMMARY

In order to protect First Amendment rights and guard against unnecessary government interference with churches, section 7611 ofthe Internal Revenue Code of 1986, as amended ("IRC"), requires an appropriate high-level Department of Treasury ("Treasury") official to reasonably believe that a church may be carrying on an unrelated trade or business or may be otherwise engaged in activities subject to tax.³ The appropriate high-level Treasury official must document in writing the basis of his reasonable belief before the Internal Revenue Service ("IRS") can initiate a church tax inquiry.⁴

Section 7611 of the IRC defines an "appropriate high-level Treasury official" as "the Secretary of the Treasury or any delegate of the Secretary whose rank is no lower than that of a principal Internal Revenue Officer for an internal revenue region."⁵ The current Treasury Regulations further define the appropriate high-level Treasury official as the Regional Commissioner. The Treasury Regulations were passed when the IRS was organized in a multi-layered structure based on geography: national, regional, and district. In 1998, Congress adopted the IRS Restructuring and Reform Act, which replaced the tiered geographical structure with an issue-based structure. The IRS is now organized by taxpayer type rather than the taxpayer's location. The IRS Restructuring and Reform Act eliminated the position of Regional Commissioner, which leaves open for debate who qualifies as the appropriate high-level Treasury official capable of making a reasonable belief determination.

The IRS issued new proposed regulations interpreting IRC section 7611 on August 5, 2009.⁶ The proposed regulations update the Treasury Regulations to conform to the IRS structural changes and, simultaneously, lower the position charged with issuing the reasonable belief determination. The proposed regulations suggest that the Director of Exempt Organizations is the appropriate high-level Treasury official.⁷ The Director is four ranks removed from the previous position charged with issuing reasonable belief determination, the Regional Commissioner.

This paper proposes that the IRS position responsible for the reasonable belief determination should be elevated to the Commissioner of Tax Exempt Organizations and Government Entities ("TE/GE") so that the proposed regulations pass muster under the judicial standard for deference, generate revenue, avoid public criticism and promote voluntary compliance.

The IRS has suspended all IRS audits of religious organizations pending an update to the definition of the appropriate high-level Treasury official.⁸ According to the National Center for Charitable Statistics, religious organizations received over $95 billion in charitable contributions by individuals, foundations, bequests, and corporations in 2011.⁹ The large number of churches and donations creates potential for abuse. The IRS must pass final regulations that conform to the accurate IRS structure in order to resume monitoring churches.

I. DISCUSSIONA. Churches Receive Favorable Substantive and Procedural Tax Treatment

While tax-exempt entities receive favorable tax treatment, churches receive the most favorable tax treatment among tax-exempt entities. Churches are not burdened with onerous filing requirements. For example, churches are easily established because they do not have to initially file Form 1023,¹⁰ they are exempt from mandatory annual Form 990 filings,¹¹ and from filing returns upon dissolution or liquidation.¹² Those who administer sacraments, direct worship, and lead the spiritual life of religious institutions¹³ are given favorable tax treatment with respect to housing,¹⁴ retirement plans,¹⁵ and payroll tax withholdings.¹⁶ Additionally, and of particular importance to this paper, there are a series of safeguards the IRS must adhere to before it can audit a church.¹⁷

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Section 7611 of the IRC outlines audit safeguards. It requires "an appropriate high-level Treasury official" to reasonably believe that the church may be carrying on an unrelated trade or business or may be otherwise engaged in activities subject to tax.¹⁸ Pursuant to IRC section 7611, an appropriate high-level Treasury official means any delegate of the Secretary whose rank is no lower than that of a principal Internal Revenue officer for an Internal Revenue Region. The Treasury Regulations further clarify that the appropriate high-level Treasury official was the Regional Commissioner, formerly the head of an internal revenue region.¹⁹

B. The IRS Reorganization Eliminated the Appropriate High-Level Treasury Official

In 1998, the IRS underwent a reorganization.²⁰ Under the old structure, the IRS was organized geographically: the Northwest, the Southeast, the Midstates and the Western region. Each regional office was headed by a Regional Commissioner and administered the entire tax law for every type of taxpayer within its designated geographic area.

The restructuring replaced the regional offices with major operating divisions: the Wage and Investment Income Division ("W&I"), the Small Business and Self-Employed Division ("SB/SE"), the Tax-Exempt Organizations and Government Entities Division ("TE/GE"), and the Large Business and Internal Operating Division ("LB&I"). The four operating divisions have Commissioners and are organized around populations of similar taxpayers. The restructuring was intended to improve customer service, encourage voluntary compliance and streamline collection efforts because the operating divisions understand the individualized needs of a particular type of taxpayer.²¹

The reorganization eliminated old positions and created new positions. The Commissioner of Internal Revenue continues to head the IRS; however, many of the principal positions that report to the Commissioner have changed. For example, prior to the restructuring, each regional office was headed by a Regional Commissioner, who reported directly to the Commissioner of Internal Revenue. After the restructuring, Regional Commissioners were eliminated because there were no regions. Newly created Deputy Commissioners now report directly to the Commissioner of Internal Revenue. The Deputy Commissioner for Services and Enforcement oversees all of the major operating divisions. Each operating division is also led by its own Commissioner, who is responsible for managing that particular operating division. The Commissioner of a particular division is assisted by a Director and, below the Director, a Field Operations Director. Each position has an increasing level of authority and responsibility.

As a result of the reorganization, many statutes refer to non-existent positions. At issue here is IRC section 7611 and the corresponding Treasury Regulation's requirement that the Regional Commissioner—a defunct position—form the reasonable basis necessary to initiate a church inquiry or examination. The definition of an appropriate high-level Treasury official was not amended in the Treasury Regulations. Accordingly, there is uncertainty as to who qualifies as an appropriate high-level Treasury official because the statutory definition refers to an obsolete post.

1. The Savings Clause Keeps IRC Section 7611 Alive

Congress recognized that certain positions would be eliminated as a result of the restructuring; therefore, it included a savings provision. Section 1001(b) of the Restructuring and Reform Act provides,

All orders, determinations, rules, regulations . . . and other administrative actions . . . which are in effect at the time this section takes effect . . . shall continue in effect according to their terms until modified, terminated, superseded, set aside or revoked in accordance with law by . . . the Secretary of the Treasury [or] the Commissioner of Internal Revenue . . . .

This provision allows regulations to remain in effect even if they refer to nonexistent positions, such as IRC section 7611.

2. The IRS Lowers the Rank of the Appropriate High-Level Treasury Official

After the reorganization, the IRS delegated the reasonable belief determination to the Director, Exempt Organization Examinations ("DEOE"). The DEOE is the Field Operations Director for the TE/GE Division. The DEOE reports directly to the Industry Director for TE/GE, who reports to the Commissioner of TE/GE, who reports to the Deputy Commissioner for Services and Enforcement, who, finally, reports to the Commissioner of Internal Revenue. See Exhibit A.

C. The IRS Was Overruled on the Definition of an Appropriate High-Level Treasury Official

The IRS's use of the DEOE as the appropriate high-level Treasury position was struck down in United States v. Living Word Christian Center.²²

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The IRS initiated a church tax inquiry against Living Word Christian Center ("LWCC"). The IRS determined that a reasonable belief existed to initiate a church tax inquiry on the basis that LWCC engaged in activities that jeopardized its status as a tax-exempt organization and in excess benefit transactions.²³ Specifically, the IRS believed LWCC's pastor, Rev. Hammond, made political comments at a church function, LWCC made eight loans to Rev. Hammond totaling $1.9 million at favorable rates and terms, and LWCC was paying for Rev. Hammond's stunt plane, among other accusations.²⁴ DEOE Marsha Ramirez signed a letter stating a reasonable belief existed, as required under the provisions of IRC section 7611.²⁵

LWCC refused to participate in the inquiry and to provide requested documentation.²⁶ LWCC asserted that the IRS had not followed the provisions of IRC section 7611 because an appropriate high-level Treasury official had not made a determination in writing necessary to begin a church tax inquiry.²⁷ Essentially, LWCC contested the DEOE as an appropriate high-level Treasury official.

The IRS was...