Scientology and The IRS: A War of Attrition

July 17, 2012 — Leave a comment

The divorce between Katie Holmes and Tom Cruise has garnered a significant amount of discussion on the internet. An additional driving force is the fact that Tom Cruise is a Scientologist and Holmes feared for her daughter’s safety because of their close ties with the religion and its practices. So what exactly is Scientology and what is its relationship with the IRS?

Scientology was instituted in 1953 by L Ron Hubbard with the belief that all people are immortal beings who have forgotten their true nature. Through spiritual rehabilitation known as “auditing,” followers must re-experience traumatic events in their past to free themselves of the emotional weight. Auditing is only available for a specific amount of “donations” as well. Some countries like the United States recognize it as a religion, others like the U.K. and Canada do not.

The practice of scientology seems odd and culturally irrelevant, however, it gained tax exempt 501(c)(3) status. The war between the IRS and Scientology began when members were paying Hubbard for “auditing,” however, were not getting any tax exemptions. The IRS considers a religion to be exempt if the beliefs are truly and sincerely held and the practices associated are not illegal or contrary to clearly defined public policy.

Hubbard realized the advantages of Scientology becoming a religion when he unsuccessfully tried to transfer assets from one non-exempt organization to an exempt but inactive one in 1966. Scientology was then transformed from psychotherapy to a religion. This offered protection against government regulation (due to Hubbard’s quasi-medical claims), immunity from claims of fraud, and tax-exempt benefits. While the tax structure of the United States was built after most religions were formed, Scientology structured its religion based on the U.S.’s tax structure.

The IRS was reluctant to identify Scientology as a legitimate religion because the net earnings of the organization were directly benefitting L Ron Hubbard. However, many parishioners organized to sue the IRS for disallowing deductions for payments they made to Scientology in light of Section 170 of the tax code (allows individuals to claim deductions for charitable contributions). Many different cases began to rise and the Supreme Court consolidated all of the cases in 1989. The Supreme Court found that the payment for Scientology’s auditing services was considered quid pro quo because a true donation does not warrant an expected return.

After losing in the Supreme Court, Scientologists were still adamant about creating the religion in the eyes of the tax gods. In 1991, they argued that the quid pro argument lost in 1989 is inconsistent with the IRS allowing rental fees paid by Protestants in order to sit in a specific pew during religious services. The IRS caved in 1993 and allowed for deductions of “auditing” and granted Scientology its tax-exempt 501(c)(3) status.

Scientologists have received a tremendous amount of criticism from people across all faiths and ideologies. Perhaps the biggest criticisms are the astronomical fees and controversial methods of protecting the interests of the organization. What we do know is that Scientology is a religion according to the IRS and therefore is entitled to the same benefits other religions have obtained.

JDKatz, P.C. is a full-service law firm focused on tax law and estate planning. We are dedicated to minimizing your existing liability and risks while providing valuable tax planning to streamline your tax issues in the future. Please call us at 301-913-2948 to schedule an appointment to meet with one of our trusted attorneys.

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