Tax-exempt bonds for religious institution don't violate Constitution.

Under IRC section 103 taxpayers may exclude from gross income interest on so-called private activity bonds that also qualify under IRC section 141, which includes the private loan financing test. To meet this test a government unit must issue the bonds. The availability of tax-exempt financing to religious institutions depends on whether the government unit--by issuing the bonds--violates the establishment clause of the First Amendment to the U.S. Constitution: "Congress shall make no law respecting an establishment of religion...."

In 1991 the Industrial Development Board of Nashville (IDB) and the Metropolitan Government of Nashville (Metro) approved a $15 million tax-exempt bond issue for David Lipscomb University, a liberal-arts institution affiliated with the Churches of Christ. The school used the bond proceeds to build new facilities and renovate existing ones. Lipscomb is an IRC section 501(c)(3) organization, and the bonds met all the requirements to be considered tax-exempt private activity bonds.

Five Nashville-area taxpayers sued the IDB and Metro on the grounds that, by issuing the bonds, the government advanced religion in violation of the First Amendment. The taxpayers argued Lipscomb was so intensely religious that any type of aid to the school would have this effect as there was no way to separate the university from religion. The district court found for the taxpayers and issued a permanent injunction prohibiting the IDB and Metro from selling the bonds. The IDB and Metro appealed to the Sixth Circuit Court of Appeals.

Result. For IDB and Metro. The Sixth Circuit reversed the district court's orders and found in favor of the two government entities. The court held that, since they were in no way responsible for repaying the bonds (even in the case of default) and issued them for many other profit and nonprofit entities, their issuing the bonds was at most an indirect benefit. The court said the only impact on taxpayers was the potential loss of tax revenue--an indirect benefit to the university too small to consider.

Courts have decided similar cases based on how much an educational institution promotes religion to its faculty and students. The Sixth Circuit agreed Lipscomb was intensely religious but decided that issuing bonds was a general benefit religious entities should be allowed, much as they receive police and fire department protection and are exempt from tax. Further, the court felt the IDB and Metro "no more endorsed Lipscomb University than it did Wal-Mart in issuing industrial revenue bonds."

CPAs with clients that are religious education institutions could advise them to seek out tax-exempt bonds to finance only expenditures that would give some type of economic benefit to the community, such as construction expenditures. Lipscomb did sign a statement that it would not use the bond proceeds to directly benefit religious endeavors. Thus, building a new chapel probably would not be acceptable, but constructing a new gynmasium would. Accountants should recommend some caution since of the three judges deciding this case, one strongly dissented.

* Steele v. Nashville Industrial Development Board, 6th Cir., 8/14/02.

Prepared by Sharon Burnett, CPA, PhD, assistant professor of accounting and Darlene Pulliam Smith, CPA, PhiD, professor of accounting, both of the T. Boone Pickens College of Business, West Texas A & M University, Canyon.