Will Sklar II crack open Scientology’s Secret Agreement with the IRS?

In the early 1990s, Michael and Marla Sklar deducted part of their children’s school tuition from their income tax in an amount equal to the proportion they viewed their tuition going toward religious instruction, as opposed to secular teaching (e.g., math, english). He listed his deductions under section 170 of the Tax Code, which permits deductions for charitable and religious contributions. The IRS denied the Sklars their deduction, noting that the Sklars had not provided receipts from the Church of Scientology. Scientologists are permitted to deduct (hefty) payments for auditing because Scientology and the IRS agreed to view payments for auditing as “donations.”

The IRS and Scientology didn’t always agree on this, however—in fact, a U.S. Supreme Court case, Hernandez v. Commissioner, 490 U.S. 680 (1989), explicitly held that payments made by Scientologists for auditing were not deductible charitable contributions under section 170, because they were, in essence and structure, quid pro quo transactions. Prices for auditing services were fixed by the organization, which refunded payments if the auditing services went unperformed, the court noted.

Despite the IRS’s win over Scientology in 1989, Hernandez was not the only lawsuit Scientology was bringing against the IRS, and the IRS eventually relented and “settled” with the Church of Scientology (see Chris Owen compendium for more), which ceased all ongoing litigation against the IRS, and made a payment of $12.5 million (there were other details to the settlement, which is best summarized in this WSJ article).

“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.”

Although the agreement was reached in 1993, it didn’t come to light until 1997, when someone within the IRS leaked it to the Wall Street Journal, which published it in its entirety. Since then, neither the IRS nor Scientology has ever confirmed its veracity, but the parties haven’t denied it, either. (As an aside, Alison Eaton asked a compelling, somewhat related question in a 1996 law review article—Can the IRS overrule the Supreme Court? See 45 Emory L.J. 987 (1996).)

In light of the above, the Sklars argued that the IRS’s disparate treatment of Scientology was an establishment clause violation—the First Amendment prohibits the government from preferring any one religion over another. The Ninth Circuit (the Sklars appealed after losing at the Tax Court level) agreed with the Sklars insofar as there was an establishment clause violation, but declined to grant them their desired remedy. The cure to the Constitutional problem, they said, was not to give everyone what the Scientologists were getting, but to rescind any such unconstitutional privilege.

“The remedy is not to require the IRS to let others claim the improper deduction, too,” Judge Barry G. Silverman wrote. But then he went on to say:

“If the IRS does, in fact, give preferential treatment to members of the Church of Scientology—allowing them a special right to claim deductions that are contrary to law and disallowed to everybody else—then the proper course of action is a lawsuit to put a stop to that policy.”

Unfortunately, this is nearly impossible, as few, if any, taxpayers have standing to bring such a suit, especially after the Supreme Court’s recent narrowing of the Flast (392 US 83) doctrine, in Hein (433 F.3d 989). I’ll refrain from dragging this post down with a discussion of standing, but there’s more here and here as to why it’s effectively impossible for any person to bring a lawsuit against the IRS to rescind its unconstitutional agreement with Scientology.

Despite losing their appeal, the Sklars weren’t finished—they attempted the same type of deduction in consecutive years, so a second lawsuit was triggered by the subsequent denial, and the Sklars were back before the Ninth Circuit on February 4 of this year (I’ll refer to this case as Sklar II). The lower court quashed the Sklars’ attempts to subpoena Scientology for the secret agreement and other materials, so the oral arguments (which can be heard here and which is nicely summarized by the NY Sun here), were mainly about the IRS-Scientology secret agreement, and there were some encouraging signs.

As noted above, because neither Scientology nor the IRS have admitted to the veracity of the secret agreement published by the Wall St. Journal, the Tax Court has not allowed the agreement into evidence. And because the secret agreement is necessary for the Sklars to be able to make their disparate treatment argument—i.e., the Sklars must be permitted to deduct religious school tuition to remedy the IRS’s preferential treatment of Scientology—the secret agreement, they argue, must be disclosed.

The IRS has a few responses to this argument. First, the type of religious training Scientologists are permitted to deduct (payments for auditing) is different than religious training that goes on in private schools. But as Ninth Circuit Judge Wardlaw asked IRS attorney Ellen Delsole, “How do we know that?” The IRS’s argument relies on interpreting an agreement they won’t acknowledge exists, but admits to having read in the Wall Street Journal. “You tell us you don’t know anything of it, but you read the Wall Street Journal,” Judge Pregerson incredulously ponders.

Second, the IRS argues, the secret agreement is a settlement document between the IRS and private individual Scientologists, and to disclose the agreement would violate the privacy of those individuals (specifically, section 6103 of the Tax Code). This is also preposterous, because—assuming the secret agreement published by the WSJ is accurate, and there’s no reason to think it’s not—the individual taxpayers at issue are barely even addressed in the secret agreement. The settlement agreement largely addresses the restructuring of the Scientology corporate maze, its front groups, and so on. Plus, as Judge Wardlaw pointed out, judges have an array of tools to cure any privacy issues related to individuals—the document could be partially redacted, held under seal, etc.

Third (and this is really their only marginally valid argument), the Ninth Circuit in Sklar I already recognized the unfairness of the preferential treatment Scientology is apparently receiving, but that fact—true or not—does not alter the outcome of the Sklars’ request, whose outcome is determined by prior case law, most notably United States v. American Bar Endowment, 477 U.S. 105 (1986), and Hernandez. (That’s right: The same Hernandez decision that categorically barred Scientologists from deducting auditing payments, if you can wrap your head around that irony.)

“That’s your best argument: two wrongs don’t make a right,” remarked Judge Ronald Leighton (Western District of Washington, sitting by designation). But Judge Wardlaw openly questioned how the tax court could possibly know the outcome without considering Sklars’ argument in light of disclosed secret agreement, and may have tipped her hand when she said, “I think that’s what we’re going to have to do [remand with instructions to disclose].”

The IRS also offered a weak administrative nightmare argument—the IRS would be forced to answer to other taxpayers who might want the same deal the Scientologists are getting. The Sklars’ lawyer, Jeffrey Zuckerman, ably dismissed this argument: “If the IRS were saying white people were entitled to a certain deduction and black people were not, why would it be such a parade of horrors for the courts to come in and say the government may not act that way?”

It’s usually not possible to determine how a case is going to go based on oral arguments and the questions that judges ask, but one moment in the February 4 oral argument stood out to me as a “very good indicator,” to borrow a Scientology term of art.

Judge Wardlaw: “The view of the IRS is it can unconstitutionally violate the Constitution by establishing religion, by treating one religion more favorably than other religions in terms of what is allowed as deductions, and there can never be any judicial review of that?”

IRS (Delsole): “That is not at all what I said.”

Judges Pregerson & Wardlaw (simultaneously): “That’s the bottom line!”

Judge Wardlaw: “This does intrude into the Establishment Clause.”

It’ll be four months since those arguments next week, and an opinion should be issued soon. It seems entirely possible that the Ninth Circuit will remand with instructions to force the IRS to disclose the secret agreement so that the Sklars can make their disparate treatment argument. I suspect it won’t do Sklar any good, as the type of deduction he seeks is the type instituted by Congress, not via some loophole left open by an IRS settlement with Scientology, as patently unfair as that settlement agreement is and might be. But what it would do is make the secret agreement “fair game,” to borrow another term all-too-familiar to Scientology. Disclosure of the agreement doesn’t solve the standing problem (see above), but it does brighten a dark and ugly secret that both the IRS and Scientology wish to keep dark.