Scope of tax exemption for religious entities: The Catholic Charities case

States have long grappled with the question of whether certain functions connected to religious organizations, such as schools, hospitals, etc. should be eligible for unemployment tax exemptions, so this is not the first time the Supreme Court has considered a similar question. In St. Martin Evangelical Lutheran Church v. South Dakota, 451 US 772 (1981), the Court held that the church directly conducted the activity, the religious body did not have to pay unemployment taxes. However, if the exemption is claimed by a legal entity that is not a church, it must be operated primarily for religious purposes, among other requirements.

Background

The Federal Unemployment Tax Act (FUTA) is a federal law requiring employers to pay taxes on wages of employees to help fund unemployment benefits for individuals. The FUTA tax is collected by the federal government, but there is a credit to the employer for tax paid to qualifying state unemployment compensation programs. Wisconsin operates an unemployment compensation program, which has been certified as compliant with FUTA by the Secretary of Labor. Under Wisconsin law, employers are exempt from the state’s unemployment taxes if services are provided by “an organization operated primarily for religious purposes and operated, supervised, controlled, or principally supported by a church or convention or association of churches.” This language mirrors the exemption language found in Internal Revenue Code Section 3309(b)(1)(B).

Catholic Charities Bureau was organized by the Catholic Church with the mission of meeting the critical needs of individuals and sponsoring service programs in northwestern Wisconsin. It has participated in Wisconsin’s unemployment program since 1972. This dispute started in 2016, when Catholic Charities Bureau sought an exemption from the state unemployment tax. Wisconsin denied Catholic Charities Bureau’s exemption and the ensuing litigation worked its way through the Wisconsin courts. In March 2024, the Wisconsin Supreme Court ruled that Catholic Charities Bureau was not entitled to an exemption, despite being “operated, supervised, controlled or principally supported” by the Catholic Church, because it was not operated for primarily religious purposes. The Wisconsin Supreme Court stated that, because nonreligious organizations could and do engage in the same types of charitable activities, the provision of services to the needy was not inherently religious and noted that Catholic Charities Bureau did not limit its services to Catholics or engage in proselytizing (i.e., in spreading a Catholic message). Cath. Charities Bureau, Inc. v. State Lab. & Indus. Review Comm’n, 3 N.W.3d 666 (Wis. 2024).

In other words, the Wisconsin Supreme Court argued from activities to purposes. Because the activities of the organization were activities that secular or nonreligious organizations also engage in, the Wisconsin Supreme Court found Catholic Charities to have nonreligious purposes.¹

The US Deputy Solicitor General filed an amicus brief supporting the taxpayer and had ten minutes of argument time to support Catholic Charities before the Supreme Court. He argued that the Wisconsin Supreme Court erred in its interpretation of FUTA and the Wisconsin statute.²

In oral argument, the Justices seemed sympathetic to Catholic Charities Bureau. The Justices pushed back on Wisconsin’s argument that Catholic Charities Bureau could not receive the exemption because it did not engage in proselytization. Justice Kagan stated that it was “pretty fundamental that we don’t treat some religions better than others.” Her point was that, because not every religion engages in proselytization, it would not be appropriate to make this a requirement.

Supreme Court Decision

Certiorari was granted by the US Supreme Court to determine whether Wisconsin violated the First Amendment’s Religion Clauses by denying a religious organization an otherwise available tax exemption because the organization does not meet the state’s criteria for religious behavior. The issue before the US Supreme Court was whether the reasoning employed by the Wisconsin Supreme Court passed Constitutional muster. The Wisconsin Supreme Court’s argument that, because charitable services can be offered by nonreligious organizations having secular motivations, Catholic Charities Bureau was not operated for primarily religious purposes was not directly before the Supreme Court.

The Court held that the Wisconsin statute does violate the First Amendment, because the First Amendment mandates government neutrality between religions. “Decisions about whether to ‘express and inculcate religious doctrine’ through worship, proselytization, or religious education when performing charitable work are . . . fundamentally theological choices driven by the content of different doctrines.” By penalizing Catholic Charities for offering charitable services to non-Catholics and not proselytizing service recipients, Wisconsin was showing preference for some religions over other religions.

It also subjects any state-sponsored difference in treatment between religions to strict scrutiny, meaning the state action must be based on a “compelling” state interest and be “narrowly tailored” to address such interest. Wisconsin argued that it had a compelling state interest in ensuring its citizens had unemployment coverage, and that the Wisconsin statute was narrowly tailored to avoid entanglement with employment decisions related to religion. However, Catholic Charities Bureau provides its own unemployment compensation for employees, with essentially “equivalent” benefits to the state system. Additionally, Wisconsin conceded that this statute contains “an element of over-inclusivity,” thus making it difficult to successfully argue the measure is narrowly tailored. Because Wisconsin failed to carry this burden under strict scrutiny, the Supreme Court held that the Wisconsin statute denying Catholic Charities Bureau’s exemption from state unemployment was unconstitutional. The case was remanded to state court for additional proceedings.

Justice Thomas and Justice Jackson both agreed in full with the majority’s Constitutional principle of nondiscrimination but filed separate concurrences. Justice Thomas wrote that the Church’s own view as to whether Catholic Charities was an arm of the Church should carry the day, without regard to the fact that as a legal matter Catholic Charities was a separate entity. Justice Jackson stated that the exemption should only be available to entities that “prepare[e] individuals for religious life” while agreeing that Wisconsin, which apparently had a much broader understanding of the purposes that qualify for the exemption, had made an unconstitutional distinction based on whether a charity engages in proselytization or not.

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1. Note that the Mayo Clinic litigation in the 8th Circuit, in which the Government is also arguing from activities to purposes, has reached the Court of Appeals for a second time and may eventually have to be decided by the US Supreme Court. The Mayo Clinic case does not involve First Amendment issues. Mayo Clinic v. United States, 997 F.3d 789 (8th Cir. 2021); 642 F. Supp 3d 831 (D. Minn. 2022); File No. 16-cv-03113, 2023 US Dist. LEXIS 48184 (D. Minn. Mar. 2, 2023).
2. The Deputy Solicitor General stated that the relevant inquiry was whether the principal objects or aims of the organization are religious and that it is irrelevant whether a secular organization could have engaged in the same kinds of activities. The brief argues that the approach taken by the Wisconsin Supreme Court “wrongly invites government officials to question whether a particular expression of faith is sufficiently ‘religious’ and to discriminate among certain faiths.” Brief for the United States as Amicus Curiae Supporting Petitioners at 27.