By: Sam Brunson
On Friday, Shu-Yi posted an overview of Puerto Rico’s financial problems, and described the centrality of the island’s tax regime to those problems. Today, I’m going to dig into one particular aspect of Puerto Rican taxation: tax-exempt churches.
Last year, the Puerto Rican Treasury department launched an ambitious pilot program[fn1] under which it planned on auditing more than 40 tax-exempt organizations. Juan Zaragoza, Puerto Rico’s Secretary of Treasury, announced that this month the program moves to Phase 3: auditing churches.
As in the U.S., the Puerto Rican tax law exempts some nonprofit organizations from tax. Puerto Rican tax law explicitly exempts
Churches, church conventions or associations, as well as religious and apostolic organizations, including corporations and any community chest, fund, or foundation, organized and operated exclusively for religious purposes, no part of the net earnings of which inures to the benefit of any private shareholder or individual.[fn2]
Some tax-exempt churches, Zaragoza asserted, aren’t really churches, but rather family businesses. They make annual profits, just like a shoe store (and yes, his example was a shoe store), but, because they claim to be tax-exempt churches, they don’t pay taxes on their profits.
(In the interest of full disclosure here: I don’t have any particular familiarity with the Puerto Rican income tax. Before I read this story and Shu-Yi’s post, I knew very few specifics. I mean, I knew that it had its roots in the U.S. federal income tax,[fn3] and I knew that Puerto Rican residents don’t own U.S. federal income tax on their Puerto Rican-source income,[fn4] but that was largely it.)
The interesting thing to me about Puerto Rico’s Phase 3 is how easily Zaragoza seems to be able to implement it. The IRS would face significant frictions if it tried to do the same thing. In 1984, Congress enacted section 7611, which makes it much harder for the IRS to audit churches. To audit a church, the IRS must jump through a number of hoops (including, essentially, getting written permission from “an appropriate high-level Treasury official” and providing notice of the audit in advance). If the IRS jumps through the hoops, it faces limitations on what it can investigate, and it must conclude its audit within two years. And, if that audit doesn’t result in revocation or a deficiency, the IRS cannot audit the church again for five years.
The IRS understands the purpose behind these hoops and limitations stemming from the Religion Clauses of the Constitution. Though the Constitution does not mandate the church audit procedures, the Internal Revenue Manual provides that
[e]ven in cases not subject to the specific restrictions of IRC § 7611, IRS personnel should be mindful of the rights granted by the First Amendment to the Constitution, which limits government interference with the free exercise of religion to cases of compelling government interest. The IRS’s legitimate interest of enforcing compliance with federal tax laws does not extend to the source and content of sincerely held religious beliefs.
So what can Puerto Rico’s pilot program tell us about constitutional constraints on the IRS’s ability to audit churches? It’s not entirely clear: per the Insular Cases, the Bill of Rights does not apply in its entirety to Puerto Rico. While the Supreme Court has incorporated the Free Speech Clause (among other things), it has not expressly applied the Religion Clauses to Puerto Rico.
It probably doesn’t matter, though, given that Puerto Rico’s constitution mimics ours in that respect. Under the Puerto Rican constitution, “No law shall be made respecting an establishment of religion or prohibiting the free exercise thereof. There shall be complete separation of church and state.”[fn5]
In the end, it will be interesting to see how Phase 3 goes, and especially whether the Puerto Rico Treasury faces any pushback against the audits and how the courts react to that pushback if it comes. Perhaps we will see that the constraints the IRS functions under when it comes to churches are too stringent. Or perhaps we’ll see that, in fact, the Religion Clauses of the Constitution require it to use the kid gloves Congress has slipped over its hands.
[fn1] I’m trying to take most of my news from Primera Hora, a Puerto Rican periodical. If you’d rather check my sources in English, ThinkProgress also has the story, though it seems to be based in large part on the Primera Hora story.
[fn2] 13 L.P.R.A. § 30471(a)(1). (Note that the Westlaw and Lexis have English translations of Puerto Rican law). Interestingly enough, Puerto Rico limits the amount of lobbying that tax-exempt organizations can do, but, unlike U.S. tax law, the prohibition does not apply to churches, and it does not entirely forbid other tax-exempt organizations from endorsing candidates for office. Id. § 30471(a)(2)(E).
[fn3] Puerto Rico’s income tax originally had its roots in the Internal Revenue Code of 1939. Even in its initial incarnations, though, it different in some significant ways. Joseph A. Novak, A New Appraisal of Puerto Rico in the Light of Recent Tax Legislation, 19 Tax L. Rev. 209, 211 (1964). Like our Internal Revenue Code, it has subsequently gone through a number of significant iterations. Puerto Rico’s current Internal Revenue Code (“Código de Rentas Internas de Puerto Rico“) dates to 2011, though significant changes have been made as recently as last year.
[fn4] I.R.C. § 933.
[fn5] L.P.R.A. Const. Art. II, § 3.