Members of Religious §501(d) Organization Were Employees Even Though No Wage Was Paid, Employee Benefits Deductible to Entity

The Ninth Circuit in Stahl. v. United States ruled that an members of a §501(d) organization were actually employees of the organization, and that the income reported by the members should be reduced by the amounts paid by the organization for medical and meals that would be properly deductible as excludable fringe benefits.

A §501(d) organization is a bit of a unique entity, being a religious and apostolic organization.  These organizations, in the words of the court, “maintain a common treasury and do not pay income tax” but rather the individual members pay personal income tax on their share of the entity’s income, making them a flow through style tax entity.  If the payments of medical and meals are allowed at the entity level, then the individual’s tax burden is lessened.

Under the tenets of the group’s Hutterite tradition, the members do not own individual property, such property being held by the organization.  As such, the entity did not pay wages to the members, as they would be required to contribute them immediately back to the organization.  The IRS argued that such individuals were clearly not employees of the organization and, therefore, no employee benefits should be allowed as a deduction.

While the District Court that originally heard the case agreed, the Ninth Circuit did not.  The Court of Appeals applied the Supreme Court’s definition of an employee as found in the 1992 case of Nationwide Mutual Ins. Co. v. Darden.  The Court disagreed with the trial court’s view that no business was conducted, noting the mere existence of other, social reasons for organizing did not detract from the fact that the group ran a large, and fairly successful, farming operation.  The Court also found the District Court had erroneously found no right to discharge individuals, noting that the organization provided for expulsion and the appellate panel did not find that such an option could not be use for poor performance of a job.

The Court noted the lack of payment of actual salaries was a factor in favor of the government’s position, but found valid reasons for such nonpayment of salaries (the fact that the amount would simply be repaid).  The failure to pay payroll taxes on the net earnings was noted by the Court, but it pointed out that the mere fact such tax might have been due and wasn’t paid would be a matter for the IRS to raise a payroll tax claim, and does not impact the finding of whether these individuals were employees.  Overall, the panel concluded, these individuals appear to be employees of the organization.

The Court remanded the case back to the District Court to deal with the factual issue of exactly which expenses would qualify for deduction since other requirements are imposed by the law before a deduction would be allowed.

The decision leaves open the question of whether the nonpayment of wages would have been fatal outside of the unique nature of a §501(d) organization, as well as whether members of other passthroughs (such as partnerships) might end up in an employment relationship—simply put, those issues were not before the Court.  Rather, the case illustrates that sometimes things aren’t quite as simple as they might appear (or as the IRS wishes them to appear).

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