Scientologists and IRS settled for $12.5 million

The Wall Street Journal/December 30, 1997
By Elizabeth MacDonald

The Church of Scientology paid the federal government $12.5 million as part of a broad 1993 settlement with the Internal Revenue Service under which the church's main branch secured its tax-exempt status.

According to a copy of the settlement, details of which have never before been made public, the church also agreed to set up a special "church tax-compliance committee," composed of high-level church officials, to monitor its adherence to the pact and to laws governing nonprofit organizations.

Further, the church agreed to drop thousands of lawsuits filed against the IRS in courts around the country and to stop assisting people or groups suing the agency based upon claims prior to Oct. 1, 1993, the settlement date. Any Scientology member or organization that sues based on those claims could face IRS penalties.

The 1993 agreement was nearly unprecedented and brought an end to an extraordinary battle. Starting in 1967, the IRS had argued that the main Scientology church should lose its tax-exempt status because it was a for-profit business that enriched church officials. The church's response was an all-out attack: filing suits against the IRS, feeding negative stories about the agency to news organizations, and supporting IRS whistle-blowers.

The church's $12.5 million payment was intended to cover the church's payroll, income and estate-tax bills for an undisclosed number of years prior to 1993. It is unclear how much money the IRS originally sought.

Other major provisions of the settlement:

The IRS canceled the payroll taxes and penalties it had assessed against certain church entities and seven church officials, including church leader David Miscavige. (The pact doesn't specify the amount of these bills). It also dropped liens and levies it had filed against these entities and officials for these bills.

The church tax-compliance committee was required to give the IRS annual reports for 1993 through 1995 disclosing how much the church paid its 20 top-compensated officials, as well as the finances of 23 member churches, businesses and organizations. Failure to file the reports could result in penalties of as much as $75,000 for each committee member.

The IRS can impose as much as $50 million in penalties on certain church entities if the IRS finds that they repeatedly spend church funds on noncharitable purposes, including enriching themselves. The penalties would be in effect through 1999.

The IRS dropped its audits of 13 Scientology organizations, including the mother church, the Church of Scientology International, and agreed not to audit the church for any year prior to 1993. The IRS also dropped litigation to enforce summonses for church records.

Regulating the activities of churches has long been a prickly area for the IRS. The First Amendment generally prohibits the government from determining what is and isn't a valid church; yet the tax-collection agency is charged with making certain that churches don't abuse their taxexempt status, since taxpayers effectively subsidize their operations. The Scientology settlement shows just how difficult it is to walk that line.

IRS officials refused to discuss the settlement, citing confidentiality rules. Spokesman Frank Keith said the IRS granted Scientology tax-exempt status "because the church provided adequate documentation and information to us to enable us to make the determination that they met the legal standards under the law and that they were legally entitled to tax-exempt status."

Monique Yingling, a lawyer for the church, declined to comment on details of the agreement but said the church "does comply with the tax laws." She added that the church "received a more in-depth standard of scrutiny than other religions." Ms. Yingling also said that the church's $12.5 million payment was not a tax bill but was "meant to resolve all outstanding disputes" between the church and the IRS.

"At one time the IRS asserted [that the church owed] hundreds of millions of dollars, [and] it might have gone as high as a billion dollars," Ms. Yingling said. The IRS so far has not assessed any penalties against the church as spelled out in the agreement, she said.

Some tax experts worry the settlement may prove it pays to harass the tax agency. "The IRS normally settles on tax issues alone," said Robert Fink, a New York tax lawyer who reviewed the agreement. "What the IRS wanted was to buy peace from the Scientologists. You never see the IRS wanting to buy peace."

The Church of Scientology was established in Los Angeles in 1954 and was granted tax-exempt status in 1957. But 10 years later, the IRS pulled the tax exemption for the main church in California, although not for any other branches, according to church officials. The IRS claimed that founder L. Ron Hubbard and his family were enriching themselves with church funds. Subsequently, courts also noted that the church makes money from the sale of Scientology books and materials, as well as its "sacrament" of "auditing," in which members generally are required to pay church-trained "auditors" to hook them up to a device that is supposed to purge negative thoughts.

The settlement, which lets Scientologists deduct on their individual tax returns "auditing" fees as donations, supersedes the IRS's earlier rule denying such deductions -- a position that was backed by the U.S. Supreme Court.

The church owns an estimated $300 million in assets; between 1988 and 1992, according to church documents filed with the IRS, its revenues totaled about $1.1 billion. In a separate IRS filing, the church said it may spend an estimated $114 million for a variety of church-related activities, including designing titanium time capsules to hold Mr. Hubbard's "scriptures." Mr. Hubbard died in 1986.

A trust that oversees the church's 7,056 ton, 440-foot cruise ship, Freewinds, also got tax-exempt status. According to church filings with the IRS unrelated to the pact, the church uses the ship, which is docked in Curacao and "has sailed almost exclusively in the Caribbean," as a "seagoing religious retreat" for church parishioners. The church bought the ship with $5 million in donations in 1986.

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