Why Are Churches Tax Exempt? Federal Rules and Property Tax

Churches are tax exempt for two reasons that reinforce each other. Federal law treats them as charitable organizations under Section 501(c)(3) of the Internal Revenue Code, which exempts religious organizations from federal income tax. And the First Amendment prevents the government from using its taxing power to burden religious practice or to entangle itself in how religious organizations operate. Every state and the District of Columbia layer a property tax exemption on top of that federal treatment, a practice that dates back to the founding era.

The Constitutional Reason

The First Amendment contains two clauses that together support tax exemptions for religious organizations. The Free Exercise Clause prevents the government from burdening religious practice through taxation. The Establishment Clause bars the government from becoming too deeply involved in how religious organizations operate. Taxing churches would require government auditors to evaluate religious properties, review religious spending decisions, and judge what counts as a legitimate religious activity. That is the kind of entanglement the First Amendment is designed to prevent.

The Supreme Court addressed this directly in Walz v. Tax Commission of the City of New York (1970). A property owner challenged New York’s tax exemption for religious properties as a violation of the Establishment Clause. In a 7-to-1 decision, the Court upheld the exemption. It held that the purpose was neither to advance nor inhibit religion and that no particular church had been singled out for favorable treatment. The Court explained that tax exemptions create only “minimal and remote involvement between church and state and far less than taxation of churches,” and that “benevolent neutrality” toward religious organizations is “deeply embedded in the fabric of our national life.”¹ The exemption, in the Court’s view, is not a government subsidy of religion. It simply keeps the taxing power from being used in ways that could favor or suppress specific faiths.

The Statutory Reason

Section 501(c)(3) of the Internal Revenue Code exempts from federal income tax any organization operated exclusively for religious, charitable, or educational purposes, so long as no part of its net earnings benefits any private individual and it does not participate in political campaigns.² Churches fall squarely within that category, which means their donations and offerings are not federal taxable income, and donors can deduct their contributions.

What sets churches apart from other nonprofits is that they receive this exemption automatically. Most 501(c)(3) organizations must file Form 1023 with the IRS to apply for recognition of their tax-exempt status. Churches, their integrated auxiliaries, and conventions or associations of churches are specifically excused from this requirement under Section 508(c)(1)(A).³ The IRS confirms that a church meeting the Section 501(c)(3) requirements is automatically treated as tax exempt without needing to apply, and donors can claim charitable deductions for contributions even if the church has never sought a formal determination letter.⁴ Many churches still apply voluntarily because a formal IRS letter makes it easier to open bank accounts, receive grants, and reassure donors that their contributions are deductible.

Churches are also excused from filing the annual Form 990 information return that nearly all other tax-exempt organizations must file. The same exemption extends to interchurch organizations, integrated auxiliaries, church-affiliated schools below college level, and exclusively religious activities of religious orders.⁵ The trade-off is that churches operate with less public financial transparency than other nonprofits.

For tax purposes, the IRS interprets “church” broadly to include houses of worship of all faiths, including synagogues, mosques, and temples.⁶

What Churches Have to Do to Keep the Exemption

The exemption is not unconditional. A church has to pass an organizational test, meaning its governing documents limit its purposes to religious or charitable activities. And it has to pass an operational test, meaning it actually devotes its time and resources to those purposes in practice.²

Two rules do the heavy lifting on the operational side.

No Private Inurement

None of a church’s net earnings may benefit any private individual.⁷ If a pastor or church officer receives compensation or perks that significantly exceed fair market value, the IRS treats the excess as an “excess benefit transaction.” Under Section 4958, the person who received it owes an initial excise tax of 25 percent of the excess.⁸ If the transaction is not corrected within the taxable period, a second-tier tax of 200 percent applies.⁹ In the most serious cases, the IRS can revoke the church’s tax-exempt status altogether.

No Political Campaign Activity

In 1954, Congress added a provision to Section 501(c)(3), commonly called the Johnson Amendment, that prohibits all tax-exempt organizations, including churches, from participating in political campaigns for or against any candidate for public office.¹⁰ The statute bars organizations from participating in, or intervening in, any political campaign, including by publishing or distributing statements on behalf of or in opposition to any candidate.²

A church cannot endorse candidates, contribute money to campaigns, or use its platform to favor one candidate over another. Even oral or written statements that show a preference for a particular candidate can be treated as a violation. The penalty is loss of tax-exempt status.

Churches may still discuss social and moral issues connected to their faith, run non-partisan voter registration drives, and host candidate forums where all candidates receive equal access. The line is between advocating on policy issues, which is permitted, and endorsing or opposing specific candidates, which is not.

Separately, Section 501(c)(3) provides that “no substantial part” of a tax-exempt organization’s activities may consist of attempting to influence legislation. Unlike other charities, churches cannot elect the alternative expenditure test under Section 501(h), which provides clearer dollar thresholds for permissible lobbying.¹¹ Churches remain subject to the vaguer “substantial part” test, which the IRS evaluates on the facts and circumstances of each case.

What Churches Still Pay Tax On

The exemption does not cover every dollar a church earns. If a church regularly runs a business that is not substantially related to its religious mission, the profits are subject to the Unrelated Business Income Tax under Sections 511 through 513.¹² Common examples include operating a commercial parking lot open to the general public or running a retail store selling goods unrelated to the church’s religious purpose. This income is taxed at the standard corporate rate of 21 percent. The purpose is to prevent tax-exempt organizations from gaining an unfair advantage over private businesses competing in the same market.

Some categories of income are excluded from UBIT even when the activity is unrelated to the church’s mission:

Income from a trade or business in which substantially all the work is performed by unpaid volunteers.
Income from selling merchandise that was donated to the church.
Rents from real property, though this exclusion does not apply if the rent is calculated based on the tenant’s income or profits, or if the property is debt-financed.

A church with $1,000 or more in gross income from an unrelated business must file Form 990-T to report and pay the tax, even though it is otherwise exempt from filing Form 990.¹³ The rental exclusion is detailed in Section 512(b)(3), which excludes rents from real property unless more than 50 percent of the total rent under the lease is for personal property, or the rent depends on the tenant’s income or profits.¹⁴

State and Local Property Tax

The federal income tax exemption is only part of what people usually mean when they say churches are “tax exempt.” Every state provides some form of property tax exemption for religious property, and the Supreme Court upheld that practice in Walz as constitutionally permissible.¹ Because property tax can represent a significant annual expense, this is often one of the most financially valuable tax benefits a church receives.

To qualify, the property generally must be used primarily or exclusively for religious activities: worship services, religious education, or administrative offices necessary for the church’s mission. If part of a property is used for a purpose unrelated to the church’s religious mission, tax assessors in many jurisdictions will tax that portion separately. State laws typically require the church to hold title and demonstrate the use serves a public benefit.

Specific requirements and renewal procedures vary widely by state. Some require only an initial application that remains valid until the property changes hands or use. Others require periodic re-certification. Churches that fail to meet local requirements can face substantial annual property tax bills based on the assessed value of the real estate.

1
Oyez. Walz v. Tax Comm’n of the City of New York
2
Office of the Law Revision Counsel. 26 USC 501 – Exemption From Tax on Corporations, Certain Trusts, Etc.
3
Office of the Law Revision Counsel. 26 U.S. Code 508 – Special Rules With Respect to Section 501(c) Organizations
4
Internal Revenue Service. Churches, Integrated Auxiliaries and Conventions or Associations of Churches
5
Internal Revenue Service. Annual Exempt Organization Return: Who Must File
6
University of Notre Dame. Definitions of ‘Church’ and ‘Association of Churches’ Must Be Updated to Prevent Abuse of Special Legal Protections, Study Argues
7
Internal Revenue Service. Inurement/Private Benefit: Charitable Organizations
8
Office of the Law Revision Counsel. 26 U.S. Code 4958 – Taxes on Excess Benefit Transactions
9
eCFR. 26 CFR 53.4958-1 – Taxes on Excess Benefit Transactions
10
Internal Revenue Service. Charities, Churches and Politics
11
Internal Revenue Service. Measuring Lobbying Activity: Expenditure Test
12
Office of the Law Revision Counsel. 26 USC 511 – Imposition of Tax on Unrelated Business Income of Charitable, Etc., Organizations
13
Internal Revenue Service. Unrelated Business Income Tax
14
Office of the Law Revision Counsel. 26 U.S. Code 512 – Unrelated Business Taxable Income