By: Gregg R. Woodnick, Markus Risinger & Ian D. Haney 

Originally posted in the Maricopa County Bar Association: Family Law Section Newsletter, March 2019, at 10.

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It is not unfamiliar to those practicing family law to have a client or opposing party provide a tax-return that does not match their salary. Most of these discrepancies result from individuals who earn cash and fail to report it as income. Such “under the table” income is clearly illegal. However, a discrepancy between reported income and salary is not always illegal. In fact, federal law permits individuals to exclude certain sums from their reported income.

Federal law permits clergy to enjoy a substantial tax benefit which has led to inequitable support obligations in Arizona divorce and child support proceedings. The Federal law is known as the “parsonage exemption,” codified as 26 U.S.C. § 107, which enables ministers to exclude housing expenses from their taxable income. When first enacted, this Federal law was justified because at the time, minsters, especially traveling ministers, were underpaid and subject to arguably unpleasant living conditions—e.g. serving a community in a wild west mining town. Notwithstanding times changing, § 107 is still in effect.

The history of § 107 starts in the early 1900s. The United States was expanding and there was a surge in the founding of small towns throughout the new states. Particularly, the western states, like Arizona, had the greatest potential for development as they were largely unexplored. The few towns that did exist out west were those quintessential “Wild West” towns made famous by John Wayne – small and unassuming with a couple of modest hotels, saloons, and basic housing.

Along with the gunslingers and frontiersmen, missionaries also settled west and, like their secular counterparts, luxury and wealth were extraordinarily rare. Heeding the mantra, “if we build it, they will come,” churches focused nearly all  its resources on constructing chapels in these small towns. Any residual resources went to build basic shelter for their migrating ministers. These shelters, the parson’s home, were constructed on church grounds to make the minster readily available to the community.

Congress, believing that the expansion of religion into these new territories was helpful to shepherd these wild towns towards civilization, wished to subsidize the church’s mission by assisting the settling ministers. As such, Congress enacted § 107 to curtail the unique difficulties these ministers where facing, such as low salaries, moving and settling costs, and discrimination. Specifically, § 107 allows “a minister of the gospel” to exclude from their taxable gross income the rental value of their home and utilities, so long as it is part of their compensation from the church. Initially, § 107 alleviated some of the burden common to frontier ministers; however, today, those burdens no longer exist.

The history of § 107 makes clear that the statute is a conditioned employment benefit intended to compensate for a specific set of circumstances, which no longer exist. Clergy no longer live in small one-room parsonages. Instead, clergy today live in modern American homes. Also, many clergy members earn as much as the accountants preparing their tax returns. Some Rabbis have Union negotiated contracts and can earn over $200,000 annually. Ministers employed by large “mega-churches” are reporting similar incomes. Additionally, there is the extreme example of televangelists, who earn millions. Clearly, it is now impossible to justify § 107 based on the living conditions and limited earning capacity of ministers. However, § 107 remains in effect and in unduly benefits Ministers.

If you are skeptical, consider two men: one working as a carpenter and the as clergy. Both earn salaries of $100,000 per year and pay $20,000 per year in housing expenses. The Carpenter ends up paying $24,000 in income tax. The Minister, however, is armed with § 107 and subtracts the $20,000 in housing expenses from of his gross income, which results in him only paying $17,600 in taxes. Ultimately, despite the Minister and the Carpenter having identical income and identical living expenses, the Minster alone enjoys a $6,400 savings. This is not only unfair from an individual tax standpoint, but it can adversely affect support calculations.

Indeed, Arizona law regarding the calculation of child and spousal support seem to hedge against the effect of § 107. For example, the Arizona Child Support Guidelines invite attorneys to look at a party’s income before taxes, and § 25-319(B)(4) requires a holistic approach when considering a party’s “ability” to pay spousal support. However, these laws cannot hedge against § 107 if attorneys rely on a party’s tax returns as gospel.

Assume that the Minister and the Carpenter each have two young children, and both are divorcing their wives in Arizona. The wives both teach in public elementary schools and earn $50,000 per year. As such, ignoring § 107, both the Minister and Carpenter households each have a combined income of $150,000. However, if an attorney only looks at the party’s tax returns, they will be led to believe the Minister earns only $80,000 and his combined household income is $130,000. In other words, the Minister will appear to earn $20,000 less, and contribute 5% less to the household income. Consequently, the Minister will owe less in child and spousal support than the Carpenter even though both earn and contribute the same amount. Furthermore, even if § 107 is considered resulting in the Minister and the Carpenter owing identical support obligations, it arguably is still an unfair result because year after year the Minister alone enjoys $6,400 more in spendable income.

Accordingly, when a party may qualify for the parsonage exception, to protect your clients and ensure equitable and fair support orders are entered, a lawyer should look beyond the front page of a tax return. To start, attorneys should probe for any claimed parsonage exception during discovery. For example, an attorney can include a line item on a financial affidavit that requests the amount claimed under § 107. Additionally, attorneys can scrutinize a party’s paystubs to see if they coincide with the party’s tax returns. Finally, attorneys may also consult with accountants who are familiar with § 107 and see if there are any indicia that the party in question claims a parsonage exception.

[1] The IRS liberally construes who qualifies as a minister under § 107, which can include “ministers” of non-traditional religions, such as online religions like the Universal Life Church.

[2] Adam Chodorow, The Parsonage Exemption, 51 U.C. Davis L. Rev. 849, 858-859 (2018).

[3] 26 U.S.C.§ 107 provides:

“[i]n 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 and to the extent such allowance does not exceed the fair rental value of the home, including furnishings and appurtenances such as a garage, plus the cost of utilities.