Jeffrey Harold Neher v. Commissioner of Internal Revenue

Citations: 852 F.2d 848; 62 A.F.T.R.2d (RIA) 5196; 1988 U.S. App. LEXIS 9804; 1988 WL 73450Docket: 86-1275

Court: Court of Appeals for the Sixth Circuit; July 19, 1988; Federal Appellate Court

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Jeffrey Harold Neher appealed the denial of federal tax deductions for payments made to the Church of Scientology in 1978 and 1979, totaling $9,103. The Commissioner of Internal Revenue disallowed these deductions, resulting in tax deficiencies of $450 and $1,029 for those years. Neher contested the ruling in Tax Court, which upheld the Commissioner's decision on March 6, 1986. Neher filed an appeal on March 17, 1986.

The case is part of a larger group of over 1,000 Tax Court petitioners who contributed to the Church and were bound by the outcome of a test case (Graham v. Commissioner) that favored the Commissioner. Following the Tax Court's ruling in Graham, similar judgments against other petitioners were issued, leading to multiple appeals across several circuit courts.

The Sixth Circuit Court, along with the Eighth and Second Circuits, determined that Neher's payments constituted "contributions" under 26 U.S.C. § 170(c)(2)(B) and concluded that the deductions were wrongfully denied. The court's decision reversed the Tax Court's ruling, favoring Neher.

Jeffrey Neher, the appellant, identifies as a Scientologist during the relevant tax years. The Tax Court's factual findings regarding Scientology’s religious practices, adopted from the decisions in Graham, detail that Scientology teaches individuals are spiritual beings comprising a mind and body, with the reactive mind being unconscious and a source of irrational behavior. Auditing, one of Scientology's two central practices, aims to help individuals, referred to as preclears, clear their reactive minds and achieve spiritual competence. This process is facilitated by trained auditors using an E-meter to identify spiritual difficulties through measuring skin responses during sessions, which are standardized and ritualized according to Scientology scriptures.

Training, the second central practice, involves courses structured from basic introductions to advanced auditor qualifications. Scientologists believe in progressing through various levels, categorized as 'Grades' and 'OT sections,' with a specific chart detailing these levels.

The doctrine of exchange necessitates that members pay for services rendered, with fixed donations required for auditing and training, which constitute the majority of Church revenue. Auditing fees range from $625 for a 12.5-hour session to $4,250 for a 100-hour session, with additional charges for specialized services. Members can receive discounts for advance payments, which are credited to their accounts, and refunds are available upon request before service commencement. The Church employs various promotional strategies, including free lectures and advertisements, to attract new members, focusing on community engagement through surveys.

The Tax Court in Graham determined that the Church operates commercially in providing religious services, with a primary goal of profit reflected in its activities and policies. However, this finding was deemed irrelevant in the current context. The government has conceded that the Church of Scientology qualifies as a 'religion' and 'church' under section 170 of the Internal Revenue Code of 1954, thus eligible to receive deductible charitable contributions. This concession occurred despite the Commissioner initially disallowing deductions based on the Church's revoked tax-exempt status, a revocation upheld by the Tax Court in a previous case. The Ninth Circuit later affirmed the Tax Court's decision but the government opted to expedite the appeals process without awaiting that case's final outcome. As a result, the current case must accept the stipulations that the Church is a 'church' and its practices are 'religious.' The court's function is limited to determining whether payments made to the Church qualify as 'gifts' or 'contributions' under the relevant statute for tax deduction purposes. Jurisdiction for this review is provided by Internal Revenue Code section 7482(a), which states that findings of fact by the Tax Court are reviewed under a 'clearly erroneous' standard, while legal questions are assessed de novo. This standard is met if the court, despite evidence supporting the findings, is convinced that an error occurred.

A taxpayer can deduct contributions made to qualified religious organizations under Section 170 of the Internal Revenue Code. To qualify as a deductible 'charitable contribution,' a payment must be a voluntary gift made without expectation of a return benefit. The burden is on the taxpayer to demonstrate that the payment qualifies as a gift under the statute, as established in case law, including Staples v. Commissioner and Estate of Wood v. Commissioner. Courts have shifted from the subjective 'detached and disinterested generosity' test from Commissioner v. Duberstein to a more objective 'quid pro quo' standard, which assesses whether the payment was offset by services rendered. This objective approach is favored in determining charitable contributions, as indicated by the legislative history of the Internal Revenue Code. The Haak v. United States case supports this standard, emphasizing that contributions lacking an expectation of financial return are essential for deductibility. The Tax Court referenced the Haak decision in evaluating the deductibility of payments made by Neher, ultimately ruling them as non-deductible.

Payments made by the taxpayer were not classified as voluntary contributions because they were made with the expectation of receiving equivalent benefits in return, thus constituting quid pro quo transactions rather than charitable contributions. The objective standard set forth in the Supreme Court case United States v. American Bar Endowment establishes that a payment cannot be deemed a charitable contribution if the contributor anticipates a substantial return benefit. For a contribution to qualify as charitable, it must be made without adequate consideration, requiring the taxpayer to show that contributions exceeded any received benefits.

The Tax Court's denial of the taxpayer's deduction for payments to the Church was found to be in error, as these payments were made with the expectation of specific benefits, which disqualifies them under section 170. Courts must differentiate between genuine charitable contributions and transactions where cash is exchanged for specific services. While some personal satisfaction may be derived from contributions, such as public acclaim or internal satisfaction, these do not negate the need for a clear distinction between charitable gifts and quid pro quo transactions.

Additionally, Congress's intent behind section 170 was to avoid giving charitable organizations an unfair competitive advantage over noncharitable entities. The Revenue Act of 1950 aimed to treat charitable organizations engaging in unrelated business activities similarly to their noncharitable competitors. Contributions that merely compensate for services do not promote the charitable purposes of the organization and could lead to unfair competition with private businesses providing similar services. Thus, only contributions that genuinely further the organization’s charitable objectives should be exempt from taxation.

The decision to grant the appellant a tax deduction for payments to the Church of Scientology aligns with congressional intent as outlined in section 170, recognizing the Church as a charitable organization that provides auditing and training as part of its charitable activities. The appellant's payments are deemed essential for supporting these activities, functioning similarly to outright gifts under the Church's doctrine of exchange. There is no general market for these services outside the Church, mitigating concerns of unfair competition with private businesses, including psychiatric services.

The Tax Court previously denied the appellant's deduction, asserting that he received a religious or spiritual benefit equivalent to his payment. It noted that the market value of such religious services is typically not established outside the relevant religious community, and that no evidence exists for a general market for Scientologist services. The Tax Court and circuit courts relied on precedents indicating that benefits from contributions can be spiritual rather than financial, countering the appellant's argument that such benefits should automatically qualify as charitable contributions due to their non-economic nature.

The appellant referenced other cases that support the notion that fixed donations to various churches seeking spiritual gain qualify as charitable contributions. However, the circuit courts distinguished these cases, asserting that they involve minimal benefits to the donor, unlike the direct counseling sessions provided by the Church. The appellant contests this distinction, prompting further examination of these arguments.

Case law supports the argument that for a taxpayer's deduction to be denied, the return benefit must be financial or economic. Relevant cases and legislative history indicate that nondeductible payments occur when the payor receives a material, tangible, financial, or economic benefit. For instance, in *Winters v. Commissioner* and *DeJong v. Commissioner*, the courts highlighted the necessity of a financial return for deductions to be disallowed. In the *American Bar* case, taxpayers received a tangible benefit with measurable market value, leading to a dual character analysis, allowing deductions only for the difference between the payment and the benefit's fair market value. 

In contrast, Neher did not receive any tangible benefit from his contributions; instead, he gained the right to participate in religious worship, which lacks a marketable financial value. The majority of cases imply that an economic return is necessary for nondeductibility, though the *American Bar* decision does not strictly require an economic benefit. The court emphasizes that a purely spiritual return does not suffice to classify a contribution as a non-gift. 

Valuing intangible returns, such as religious benefits, poses significant challenges. Although the government claims that the Church has already assigned value to these services, this assertion is misleading. The First Circuit, affirming the Tax Court's decision, noted that courts can assign value to intangible benefits, as demonstrated in *Hernandez v. Commissioner*. The government has recognized economic value in secular services despite their intrinsic valuation challenges, relying on prices set by service providers or similar services rather than intrinsic worth.

The court finds the suggestions from the Hernandez case impractical in a religious context. First, the Eighth Circuit's decision in Staples indicates that the stipulations and concessions preclude using the appellant's donations to value the services offered, as the Church operates as a bona fide institution with fixed donations not intended for profit. Second, there are no comparable service providers to assess the value of the Church's services, and attempting to do so could raise significant constitutional issues. Third, determining the Church's costs for auditing and training would unjustly involve the court in the Church's financial matters, risking government entanglement in religious operations. The court highlights concerns that such an approach could lead to government oversight of church records, which would be problematic. Unlike commercial events with clear market values, the benefits derived from religious worship are inherently personal and difficult to quantify, making it unfeasible to assign a monetary value. The court emphasizes that individual experiences of worship vary significantly, complicating any valuation attempt. Thus, the court declines to follow the Hernandez reasoning and refrains from assigning a value to the religious services received by the appellant.

Neher's request to differentiate between religious benefits and other benefits from monetary contributions to qualified entities suggests an impractical need for strict distinctions among various charitable organizations (religious, educational, scientific, artistic) under section 170. The Eighth Circuit's decision in Staples supports this view, highlighting the differences between religious and other benefits. Neher also raised concerns about the deductibility of fixed donations to other religions, such as tithing in Mormonism and fees for Jewish High Holy Day Services, which are crucial to their faiths. These fixed contributions, including collection plate offerings and mandatory dues, have been historically recognized as deductible charitable contributions, as established in various revenue rulings.

However, the ongoing validity of these rulings, particularly regarding pew rents and mandatory church dues, is uncertain. The Tax Court was able to differentiate the appellants' fixed donations from deductible contributions that are primarily charitable in nature. The Hernandez court tried to distinguish its ruling by suggesting that fixed dues provide rights for collective worship, unlike individualized services. This distinction is deemed irrelevant since donations to churches for worship do not yield specific private benefits to donors; instead, they primarily benefit the religion's members and society as a whole. The public benefit of religion persists regardless of the nature of worship or whether donations are voluntary or fixed. In this case, the appellant's payments were made with the understanding that they supported the Church's religious objectives, benefiting the Church's members and the public.

A disagreement with the Tax Court and four circuit courts is expressed regarding the distinction between Neher's payments to the Church and other deductible contributions. It is asserted that these payments for religious services qualify as charitable contributions, entitling Neher to a federal income tax deduction. The dissenting judge in Christiansen v. Commissioner is cited, warning that any contrary ruling could negatively affect religious institutions. The court finds Neher's payments for auditing and training, part of Scientology practices, to be charitable under section 170, thereby not addressing Neher's constitutional or selective prosecution claims. Consequently, the Tax Court's decision is reversed.

Judge Wellford concurs with the opinion, highlighting that the government has conceded the Church of Scientology's tax-exempt status for this case, despite previous challenges to it. He suggests that the government should contest the Church's tax exemption based on its commercial characteristics, notably its focus on 'auditing' and the doctrine of 'exchange.' Wellford supports the reversal based on prior case law emphasizing that recognized religious practices in bona fide churches should be deductible under section 170, while also acknowledging Neher's arguments regarding the deductibility of similar fixed donations made to other religions, which have historically been recognized as charitable contributions.

Fixed payments made by church members based on income from mandatory outside employment have been examined in relation to tax deductions for religious contributions. Previous rulings, including Rev. Rul. 70-47, which categorized pew rents and mandatory dues as tax-deductible, are scrutinized for consistency across circuit courts. The Hernandez case attempted to differentiate between types of contributions, asserting that fixed dues enable participation in collective worship, while the appellant's payments were for individualized services. However, this distinction is deemed insignificant, as donations to religious organizations traditionally benefit the broader community rather than the individual donor.

It is argued that the appellant's contributions were primarily for supporting the Church's religious objectives, thus providing a public benefit. The Tax Court's position is challenged, with the assertion that no meaningful distinction exists between the appellant's payments and those previously recognized as deductible contributions. Consequently, it is concluded that the appellant's payments for auditing and training within Scientology qualify as charitable contributions eligible for a federal income tax deduction under section 170.

The court's decision reverses the Tax Court's ruling, implying potential implications for religious institutions in general. The court does not address the constitutional and selective prosecution claims raised by the appellant, focusing solely on the classification of contributions as charitable.

Concurrence is expressed with Judge Jones' opinion, highlighting two critical factors: First, the government has conceded that the Church of Scientology is a "church" and a tax-exempt organization for this specific case, despite having previously challenged and successfully revoked its tax-exempt status in earlier proceedings. This concession limits the scope of the current decision to circumstances where the government has waived any challenge to the Church's tax-exempt status and its commercial activities. The author argues that the government's appropriate course of action should be to contest the tax exemption claimed by the Church, which exhibits more commercial characteristics than typical religious attributes. The emphasis on practices such as "auditing" and the doctrine of "exchange" supports this view. Additionally, the rationale from Staples and other related cases is endorsed, particularly regarding the absence of a "recognizable return benefit" under section 170, given the government's initial concession about the religious nature of the Church's practices. Consequently, there is support for reversing the Tax Court's decision. All references pertain to the Internal Revenue Code of 1954, as applicable during the relevant tax years.