As I sat down to write about a potential future in which churches and religious nonprofits lose their tax-exempt status, Time magazine was already on the beat. The calls to tax nonprofits that do not concur with the ruling in Obergefell v. Hodges have already begun. If you will allow me to indulge in a little speculation, I’d like to consider some of the possibilities that may lie ahead, raising issues that religious leaders and nonprofit executives need to be thinking about immediately in order to brace for a turbulent future. It goes without saying that many institutions will cave in to pressure to conform to the demands of the IRS, but for those that do not, the future is suddenly a lot more uncertain.
I suspect that the tax exemption for churches (as the government defines them) will last a bit longer and that there’s a decent shot that they will be allowed to maintain their exemptions over the long term. The constitutional and legal issues with taxing churches directly are thornier and harder to surmount, though the sweeping nature of Justice Kennedy’s rhetoric of ever-expanding, ever-progressing freedoms in his majority opinion in Obergefell should remind us not to get our hopes up. However, nonprofits such as religious hospitals, colleges, charities, and even secular policy nonprofits that take a stand on marriage issues might not have long before their tax-exempt status is revoked. When asked by Justice Alito during the Obergefell oral arguments whether this would be a logical outcome of the administration’s position, Solicitor General Donald Verrilli answered ominously: “It’s certainly going to be an issue. I don’t deny that. I don’t deny that, Justice Alito. It is it is going to be an issue.”
Efforts to introduce legislation to prevent this outcome may meet with some success on the state level in a handful of places, but the odds of such provisions taking hold on the federal level seem extremely dim. Few Democratic congressmen could be expected to support such laws, as their constituents increasingly view any protection of religious institutions as tantamount to discrimination. And it’s likely that many Republicans will shy away from becoming the next Governor Pence, who was slammed by the combined might of corporate America and the media establishment for advocating legislation that stated little more than that religious liberty is still a real thing. In this scenario states like Oklahoma or Utah might create their own definition of a non-profit separate from that used by the IRS in order to exempt religious nonprofits from some taxes. So BYU might owe a large chunk of money to the IRS, but escape state taxes and—crucially—property taxes that are owed to local, not federal, bodies.
Property taxes are an interesting case for churches, hospitals, and schools in particular, since such taxes are owed to local bodies which would have the authority to refrain from taxing such entities even if it became legal to do so. Even under the worst case scenario, the courts would likely be ruling that governmental bodies can tax churches and religious organizations, not that they must tax them. In more liberal states, you could imagine certain more conservative and religious municipalities, like Wheaton, IL, or parts of Orange County, CA, becoming tax-free havens for religion, consciously pursuing a strategy of welcoming religious communities both from conviction and in the hopes that churchgoers will move in or patronize local businesses as a result. If towns can give huge tax subsidies to big box stores on the theory that they will benefit the area, why not give one to the big Catholic hospital across the county line that’s looking for greener pastures?
This is all very abstract and speculative. So if you are in nonprofit leadership or donate substantial sums to religious nonprofits, what should you be thinking about in the coming months as the debate continues to unfold?
- Have a basic financial and organizational plan that could be implemented in the event that you or the charities you support suddenly lose nonprofit status. You won’t be able to plan for every detail, and you won’t know the exact nature of the new rules that might take effect. But you can think out some of the problems and the options that might be available to you to solve them.
- Do not panic, at least not for financial reasons. Donors to nonprofits do not give solely because they want money back from the IRS. Think about how much money political campaigns and PACs manage to raise without any charitable deduction. Remember that the charitable deduction is only beneficial to those who itemize, which means that two-thirds of taxpayers don’t care about the charitable deduction anyway. True, those that do itemize are likely to include your wealthier major donors, but if you’ve built good relationships with them, they are unlikely to disappear simply because of the tax consequences of further gifts.
- Private foundations may suddenly find their hands tied. If you are a donor or board member for a foundation, consider the possibility that some of your current grantees will lose 501c3 status in the near- to medium-term future, in which case any grants to them will no longer be qualified distributions from the foundation. Donors might consider holding more of their funds earmarked for charitable purposes outside of the foundation’s assets, or ratcheting up giving to churches and religious organizations while the current tax rules are still in place.
- Most donor-advised funds will look like a terrible idea. In these increasingly popular structures, donors can get all the tax breaks of charitable contributions up front by making an irrevocable transfer of funds to a donor-advised fund (DAF). The funds are no longer in the donor’s control; the donor merely advises the fund on which nonprofits to direct donations to. In current practice it is understood that the DAF will do exactly as the donor says. The problem is that the DAF is under no legal obligation to comply with the donor’s wishes, and that the largest DAFs are currently run by large public brokerage firms. Fidelity Charitable, for example, had $3.8 billion in contributions in 2014 alone, which makes it almost as large as the United Way. What if activists pressure Fidelity, Schwab, and Vanguard’s billion-dollar donor-advised funds to stop “funding hate”? For those who have already paid into the funds, nothing could be done. This could happen well before religious nonprofits actually lose 501c3 status, which would of course make DAF distributions to them formally impossible.
- The planned giving landscape will change. Donors with accumulated assets will no longer be able to use donations to religious groups to avoid estate taxes. Particular planned giving vehicles such as charitable remainder trusts and charitable gift annuities will obviously be affected. As beneficiary organizations lose nonprofit status, these legal arrangements may be dissolved entirely, causing unforeseen tax and legal consequences. The potential for turmoil is heightened because these instruments intricately tie up the financial interests of the donors themselves with the interests of beneficiary organizations.
We can’t predict exactly how the political situation will turn out, or the extent to which religious nonprofits need to be concerned. There may even be silver linings. Not worrying about 501c3 status may mean that the mission of an organization can operate more freely and that it spends less time and fewer resources on regulatory compliance once the dust has settled. The only thing we can be sure of is that if in fact religious nonprofits start to lose tax exempt status, the biggest immediate winners will be lawyers and accounting firms.