Sklar v. Commissioner

Michael and Marla Sklar (“the Sklars”) appeal from a decision of the Tax Court affirming the disallowance of deductions they claimed for tuition and fees paid to their children’s Orthodox Jewish day schools. See Sklar v. Comm’r, 125 T.C. 281, 2005 WL 3497885 (2005). We have jurisdiction pursuant to 26 U.S.C. § 7482(a)(1), and we affirm.

I. FACTUAL AND PROCEDURAL BACKGROUND

A. Taxpayers

The Sklars are Orthodox Jews who in 1995 had five school-aged children. Rather than send their children to public school to meet California State educational requirements, the Sklars enrolled each of their children in one of two Orthodox Jewish day schools, Emek Hebrew Academy *1254 (“Emek”) and Yeshiva Rav Isacsohn To-rath Emeth Academy (“Yeshiva Rav”). They did so “because of their sincerely and deeply held religious belief that as Jews they have a religious obligation to provide their children with an Orthodox Jewish education in an Orthodox Jewish environment.” In 1995, the Sklars paid a total of $27,283 to Emek and Yeshiva Rav which included $24,093 for tuition, $1300 for registration fees, $1715 for other mandatory fees, and $175 for an after school Mishna program at Emek. 1 During 1995, Emek and Yeshiva Rav each were exempt from federal income tax under I.R.C. § 501(c)(3), which provides tax exempt status for certain institutions “organized and operated exclusively for religious, charitable, ... or educational purposes,” among others. Both schools also qualified as organizations described in I.R.C. § 170(b)(1)(A), which allows donors to deduct charitable donations to qualifying institutions.

Both schools provided daily exposure to Jewish heritage and values. Their goals included educating their students in Jewish heritage and values, as well as the tenets of the Jewish faith. To this end, time was allocated in the school day for prayers and religious studies, students were required to adhere to Orthodox Jewish dress codes, and boys and girls attended classes separately.

A child’s day at each school included specified hours devoted to courses in religious studies and specified hours devoted to secular studies. The length of time that each student participated in secular classes, as opposed to religious studies, and the length of the total school day varied with the gender and grade level of the particular student.

Quality secular education that fulfilled the mandatory education requirements of the State of California also was a goal of both schools. Emek sought to provide a thorough and well-balanced curriculum in both religious and secular studies so that every student could succeed “in the most rigorous yeshiva [ (Jewish)] high schools and other institutions of higher learning.” Yeshiva Rav sought to prepare its students for matriculation to yeshiva high schools and to attend a college or seminary.

During the school years in issue, the Sklars paid tuition and mandatory fees to Emek and Yeshiva Rav for their children’s education. To ensure payment, the Sklars, like other parents, were required to contract with each school to pay, and to give to each school postdated checks covering, the tuition for the upcoming school year. Both schools provided tuition discounts to families based on financial need, if documented by detailed financial information submitted to the schools’ scholarship committees, but the Sklars did not seek or receive such assistance. Although an Orthodox Rabbinic ruling precluded either school from expelling students from the Jewish studies program during the school year, nonpayment of tuition could result in expulsion from secular studies and the schools’ refusal to allow the children to register for classes in the subsequent school year.

B. The Prior Litigation

In 1993, the Sklars learned of a confidential closing agreement 2 the Internal *1255 Revenue Service (“IRS”) had executed with the Church of Scientology that purportedly allowed deductions for certain religious educational services such as auditing and training. The Sklars subsequently amended their tax returns for 1991 and 1992, and filed a return for 1993, including new deductions for a portion of the tuition they had paid to their children’s schools. See Sklar, 125 T.C. at 288. The IRS allowed these deductions, apparently under the impression that the Sklars were Scien-tologists. See id. The Sklars claimed similar deductions in 1994, but these were disallowed. Id. at 288-89. The IRS Notice of Deficiency explained that because the costs were for personal tuition expenses, they were not deductible. The Sklars pursued an unsuccessful petition for redetermination before the Tax Court regarding their 1994 deductions, which subsequently came before us. Judge Reinhardt, writing for our Court in an opinion joined by Judge Pregerson, upheld the Tax Court’s denial of the deduction. See Sklar v. Comm’r (Sklar I), 282 F.3d 610 (9th Cir.2002), amending and superseding Sklar v. Comm’r, 279 F.3d 697 (9th Cir.2002).

In Sklar I, the Sklars made virtually identical arguments to those they assert here, based predominantly on their theories that a portion of their tuition payments are tax deductible because they received in exchange only intangible religious benefits and the Scientology Closing Agreement is an unconstitutional establishment of religion from which they should also benefit.

The Sklar I panel soundly rejected the Sklars’ argument that certain 1993 amendments to the Tax Code rendered their tuition payments deductible as payments to exclusively religious organizations for which the Sklars received only intangible religious benefits. 282 F.3d at 612-14. Specifically, the panel noted that the amendments addressed “clearly procedural provisions” and that the deduction the Sklars alleged would be “of doubtful constitutional validity.” Id. at 613.

Next, the Sklar I panel held that the IRS was compelled to disclose the contents of its Closing Agreement with the Church of Scientology, at least to the extent it fell under I.R.C. § 6104(a)(1)(A), see 282 F.3d at 614-18, and that such disclosure was necessary as a practical matter because the agreement affects “not just one taxpayer or a discrete group of taxpayers, but a broad and indeterminate class of taxpayers with a large and constantly changing membership.” Id. at 617. Further, the panel held “where a closing agreement sets out a new policy and contains rules of general applicability to a class of taxpayers, disclosure of at least the relevant part of that agreement is required in the interest of public policy.” Id. In Sklar I, the panel therefore rejected

the argument that the closing agreement made with the Church of Scientology, or at least the portion establishing rules or policies that are applicable to Scientology members generally, is not subject to public disclosure. The IRS is simply not free to enter into closing agreements with religious or other tax-exempt organizations governing the deductions that will be available to their members and to keep such provisions secret from the courts, the Congress, and the public.

Id. at 618. The Sklar I panel nevertheless opined, without resolving the issue, that *1256 the Tax Court’s ruling that the Closing Agreement was irrelevant to the deducti-bility of the Sklars’ tuition payments was “in all likelihood correct.” Id. It continued:

The Tax Court concluded that the Sklars were not similarly situated to the members of the Church of Scientology who benefitted from the closing agreement. While we have no doubt that certain taxpayers who belong to religions other than the Church of Scientology would be similarly situated to such members, we think it unlikely that the Sklars are. Religious education for elementary or secondary school children does not appear to be similar to the “auditing” and “training” conducted by the Church of Scientology.

Id. at 618 n. 13; see also Hernandez v. Comm’r, 490 U.S. 680, 684-85, 109 S.Ct. 2136, 104 L.Ed.2d 766 (1989) (describing “auditing” and “training”).

The Sklar I panel then turned to the Sklars’ Establishment Clause and administrative consistency arguments. Although it was not required to decide those issues because the Sklars had “failed to show that their tuition payments constitute a partially deductible ‘dual payment’ under the Tax Code,” Sklar I, 282 F.3d at 620, the panel noted that had it been required to do so, it would have first concluded that the IRS policy constitutes an unconstitutional denominational preference under Larson v. Valente, 456 U.S. 228, 102 S.Ct. 1673, 72 L.Ed.2d 33 (1982). 3 See Sklar I, 282 F.3d at 618-19. The panel reasoned that the denominational preference embodied in the Closing Agreement was unconstitutional because it “cannot be justified by a compelling governmental interest.” Id. However, the panel indicated it would not be willing to extend that preference to other religious organizations for three reasons: First, an extension of the preference would amount to state sponsorship of all religions, which the panel doubted “Congress or any agency of the government would intend.” Id. at 619-20. Second, an extension of the preference would be “of questionable constitutional validity under Lemon,” 4 because administering the policy “could require excessive government entanglement with religion.” 5 Id. at 620, 91 *1257 S.Ct. 2105. Third, the requested policy-appeared to violate I.R.C. § 170. Id.

The panel also indicated it would reject the Sklars’ administrative consistency claim because it “seriously doubted” that the Sklars were similarly situated to the Scientologists. 6 The panel further stated that even if the Sklars were similarly situated, “because the treatment they seek is of questionable statutory and constitutional validity under § 170 of the IRC, under Lemon, and under Hernandez, we would not hold that the unlawful policy set forth in the closing agreement must be extended to all religious organizations.” Id. at 620, 91 S.Ct. 2105.

Finally, relying on United States v. American Bar Endowment, 477 U.S. 105, 106 S.Ct. 2426, 91 L.Ed.2d 89 (1986), the Sklar I panel rejected the argument that the Sklars’ tuition payments were deductible as a “dual payment” or “quid pro quo payment,” a payment made in part as consideration for goods and services and in part for charitable purposes. In American Bar Endowment, the Supreme Court held that the taxpayer must satisfy a two-part test to be entitled to the § 170 deduction for a quid pro quo payment:

First, the payment is deductible only if and to the extent it exceeds the market value of the benefit received. Second, the excess payment must be made with the intention of making a gift.

477 U.S. at 117, 106 S.Ct. 2426 (internal citation and quotation marks omitted). The Sklar I panel held that the Sklars failed to introduce evidence demonstrating both “that any dual tuition payments they may have made exceeded the market value of the secular education their children received,” 282 F.3d at 621, or “that they intended to make a gift by contributing such ‘excess payment.’ ” Id. The panel also suggested that for the purpose of demonstrating the first part of the American Bar Endowment test, the “market value” for the tuition payments would be the cost of a comparable secular education offered by private schools, evidence the Sklars had failed to introduce, perhaps, because of the “practical realities of the high cost of education.” Id.

C. The Current Litigation

On their 1995 tax return, the Sklars claimed $15,000 in deductions for purported charitable contributions that comprised a portion of their five children’s tuition at Emek and Yeshiva Rav. The deduction was based on their estimate that 55% of the tuition payments were for purely religious education, an estimate supported by letters submitted two years later (in 1997) that were drafted by each of the schools at the Sklars’ request. Sklar, 125 T.C. at 288-89.

The IRS disallowed the $15,000 deduction. The IRS also determined the Sklars had “failed to meet the substantiation requirements of Internal Revenue Code Section 170(f)(8) with respect to the disallowed $15,000.00 of claimed charitable contributions.” The Sklars petitioned the Tax Court for a redetermination of deficiency, asserting that (1) the tuition and fee payments to exclusively religious schools are deductible under a dual payment analysis to the extent the payments exceeded the value of the secular education their children received (a question left somewhat *1258 open in Sklar I); (2) Sections 170(f)(8) and 6115 of the Internal Revenue Code, as enacted in 1993, authorized the deduction of tuition payments for religious education made to exclusively religious schools (an issue all but foreclosed by Sklar I); and (3) that the 1993 Closing Agreement between the Commissioner and the Church of Scientology constitutionally and administratively requires the IRS to allow other taxpayers to take the same charitable deductions for tuition payments to their religious schools (a question the panel discussed at length but declined to decide in Sklar I). Before the Tax Court, the Sklars and the IRS stipulated that in 1993 the IRS had executed a confidential closing agreement with the Church of Scientology, settling several outstanding issues between the IRS and the Church of Scientology. See id. at 298. Under this agreement, members of the Church of Scientology were authorized to deduct as charitable contributions at least 80% of the fees for qualified religious services provided by the Church of Scientology. See id. at 298-99.

The Tax Court again rejected the Sklars’ arguments, holding that the tuition and fee payments to the Jewish Day Schools were not deductible under any of the Sklars’ theories. 7 First, the Tax Court rejected the Sklars’ effort to prove that the tuition and fee payments so exceeded the market value of the secular education their children received that they took on a “dual character,” i.e. that the payments had the character of both a purchase of education and a charitable contribution. Id. at 291-94; see also American Bar Endowment, 477 U.S. at 117, 106 S.Ct. 2426. It found that the Sklars’ expert report regarding tuition at various Los Angeles area schools demonstrated only that

(1) Some schools charge more tuition than Emek and Yeshiva Rav Isacsohn, and some charge less; and (2) the amount of tuition petitioners paid is unremarkable and is not excessive for the substantial benefit they received in exchange; i.e., an education for their children.

125 T.C. at 293-94. The Tax Court concluded that the Sklars failed to demonstrate that any part of their tuition payments was intended as a charitable contribution and that the well-established law precluding deduction of tuition payments to schools providing both secular and religious education controlled. Second, the Tax Court held that the 1993 amendments to the Code “did not change what is deductible under section 170.” Id. at 296-97. In keeping with our reasoning in Sklar I, the Tax Court concluded that neither § 170(f)(8), nor § 6115, as amended in 1993, nor the accompanying legislative history suggested that Congress intended to make a substantive change to the Code or to overrule the “long line of cases” precluding deductibility of tuition payments to religious schools. Id. at 296. Third, the Tax Court held that the Closing Agreement between the IRS and the Church of Scientology is irrelevant to the question of whether the Sklars are entitled to the § 170 deductions. Id. at 299. Finally, the Tax Court concluded that the Sklars’ separate payments for Mish-na classes, which were held apart from other classes at Emek, should not be treated any differently than the tuition and fee payments. The Sklars timely appeal.

II. DISCUSSION

A. Standard of Review

“We review the Tax Court’s conclusions of law and its construction of the tax code *1259 de novo, and no deference is owed that court on its application of the law.” Sklar I, 282 F.3d at 612. We review the Tax Court’s factual determinations for clear error and its evidentiary rulings for abuse of discretion. See Sparkman v. Comm’r, 509 F.3d 1149, 1155-56 (9th Cir.2007).

B. The Sklars’ 1995 Tuition Payments Are Not Deductible as Charitable Contributions Under the Internal Revenue Code

Section 170 of the Internal Revenue Code allows taxpayers to deduct “any charitable contribution,” defined as “a contribution or gift to or for the use of’ certain eligible entities enumerated in § 170(c), including those exclusively organized for religious purposes and educational purposes. I.R.C. § 170(a)(1), (c). “[T]o ensure that the payor’s primary purpose is to assist the charity and not to secure some benefit,” we require such contributions to be “made for detached and disinterested motives.” Graham v. Comm’r, 822 F.2d 844, 848 (9th Cir.1987). Therefore, “quid pro quo” payments, where the taxpayer receives a benefit in exchange for the payment, are generally not deductible as charitable contributions. See Hernandez v. Comm’r, 490 U.S. 680, 689-91, 109 S.Ct. 2136, 104 L.Ed.2d 766 (1989). In keeping with this framework, tuition payments to parochial schools, which are made with the expectation of a substantial benefit, or quid pro quo, “have long been held not to be charitable contributions under § 170.” Id. at 693, 109 S.Ct. 2136; see also DeJong v. Comm’r, 309 F.2d 373, 376 (9th Cir.1962) (“The law is well settled that tuition paid for the education of the children of a taxpayer is a family expense, not a charitable contribution to the educating institution.”).

In Hernandez, the Supreme Court considered “whether taxpayers may deduct as charitable contributions payments made to branch churches of the Church of Scientology” 8 in return for services known as “auditing” and “training.” 490 U.S. at 684, 109 S.Ct. 2136. Both are considered forms of religious education. “Auditing” involves a form of spiritual counseling whereby a person gains spiritual awareness in one-on-one sessions with an auditor. By participating in “training,” a person studies the tenets of Scientology, gains spiritually, and may seek to become an auditor. Members of the Church of Scientology sought to deduct payments for auditing and training as charitable contributions for religious services. The Court held that such payments for religious educational services “do not qualify as ‘contribution^ or gift[s].’” Id. at 691, 109 S.Ct. 2136. Rather, “[t]hese payments were part of a quintessential quid pro quo exchange: in return for their money, petitioners received an identifiable benefit, namely, auditing and training sessions.” Id. The Court reasoned “ ‘[t]he sine qua non of a charitable contribution is a transfer of money or property without adequate consideration.’ ” Id. (quoting American Bar Endowment, 477 U.S. at 118, 106 S.Ct. 2426).

The Court further rejected the taxpayers’ argument that a quid pro quo analysis *1260 was not even appropriate, because the payments for auditing and training services resulted in receipt of a purely religious benefit. Id. at 692-93, 109 S.Ct. 2136. The Court first found no support in the language of § 170, which makes “no special preference for payments made in the expectation of gaining religious benefits or access to a religious service.” Id. at 693, 109 S.Ct. 2136. Second, the Court reasoned that accepting the taxpayers’ “de-ductibility proposal would expand the charitable contribution deduction far beyond what Congress has provided.” Id. at 693, 109 S.Ct. 2136. For example, “some taxpayers might regard their tuition payments to parochial schools as generating a religious benefit or as securing access to a religious service,” which would be incorrect because “such payments ... have long been held not to be charitable contributions under § 170.” Id. Finally, the Court noted that “the deduction petitioners seek might raise problems of entanglement between church and state” because it would “inexorably force the IRS and reviewing courts to differentiate ‘religious’ benefits from ‘secular’ ones.” Id. at 694, 109 S.Ct. 2136. While declining to pass on the constitutionality of such hypothetical inquiries, the Court noted that “ ‘pervasive monitoring’ for ‘the subtle or overt presence of religious matter’ is a central danger against which we have held the Establishment Clause guards.” Id. (quoting Aguilar v. Felton, 473 U.S. 402, 413, 105 S.Ct. 3232, 87 L.Ed.2d 290 (1985)). Thus, the Hernandez decision clearly forecloses the Sklars’ argument that there is an exception in the Code for payments for which one receives purely religious benefits.

1. The 1993 Amendments to the Tax Code Did Not Overrule Hernandez

To circumvent Hernandez’s clear holding, the Sklars resurrect their Sklar I argument that the 1993 amendments to IRS §§ 170(f)(8) and 6115 overruled the Court’s holding in Hernandez that only gifts or contributions may be deducted under § 170. According to the Sklars, the 1993 amendments provide for the deduction of tuition payments for which they receive only intangible religious benefits. We agree with the Tax Court that the Sklar’s interpretation of the 1993 amendments is misguided.

Amended § 170(f)(8) requires the taxpayer to “substantiate[ ] the contribution by a contemporaneous written acknowledgment of the contribution by the donee organization.” I.R.C. § 170(f)(8)(A). This acknowledgment must include an estimate of the value of any goods or services the donor received in exchange, “or, if such goods or services consist solely of intangible religious benefits, a statement to that effect.” I.R.C. § 170(f)(8)(B)(iii). The amendment also defines an “intangible religious benefit” as one “which is provided by an organization organized exclusively for religious purposes and which generally is not sold in a commercial transaction outside the donative context.” Id. As the Tax Court correctly held, Sklar, 125 T.C. at 296-97, and as we have previously suggested, Sklar I, 282 F.3d at 613, this amendment creates an exception only to the new substantiation requirement created by § 170(f)(8)(A). 9 Nothing in the *1261 amendment’s language suggests that Congress intended to expand the types of payments that are deductible contributions. As the Sklar I panel explained:

Given the clear holding of Hernandez and the absence of any direct evidence of Congressional intent to overrule the Supreme Court on this issue, we would be extremely reluctant to read an additional and significant substantive deduction into the statute based on what are clearly procedural provisions regarding the documentation of tax return information, particularly where the deduction would be of doubtful constitutional validity.

Id.

The second pertinent 1993 amendment requires donee organizations to disclose limitations on the deductibility of certain quid pro quo payments to the donors of such payments. See I.R.C. § 6115. Amended § 6115(a) requires any organization that “receives a quid pro quo contribution in excess of $75” to provide the donor with a written statement declaring that the deductible portion of the contribution cannot include “the value of the goods or services provided by the organization,” along with “a good faith estimate of the value of such goods or services.” However, § 6115(b) explains:

For purposes of this section, the term “quid pro quo contribution” means a payment made partly as a contribution and partly in consideration for goods or services provided to the payor by the donee organization. A quid pro quo contribution does not include any payment made to an organization, organized exclusively for religious purposes, in return for which the taxpayer receives solely an intangible religious benefit that generally is not sold in a commercial transaction outside the donative context.

I.R.C. § 6115(b) (emphasis added). The Sklars read the exemption from the disclosure requirement for organizations organized exclusively for religious purposes which provide solely an intangible religious benefit completely out of context. The Sklar I panel explained why the Sklars’ reading of the exemption is unsupportable:

[Section] 6115 requires that tax-exempt organizations inform taxpayer-donors that they will receive a tax deduction only for the amount of their donation above the value of any goods or services received in return for the donation and requires donee organizations to give donors an estimate of this value, exempting from this estimate requirement contributions for which solely intangible religious benefits are received.

282 F.3d at 613.

Nor does the legislative history of these amendments even mention Hernandez, and the House Report specifically states that, although the new requirements apply only to quid pro quo contributions for commercial benefits, “[n]o inference is intended ... [regarding] whether or not any contribution outside the scope of the bill’s substantiation or reporting requirements is deductible (in full or in part) under the present-law requirements of section 170.” H.R.Rep. No. 103-111, at 786 n. 170 (1993), reprinted in 1993 U.S.C.C.A.N. 378, 1017 n. 170. Thus, the House Report confirms that Congress intended to preserve the *1262 status quo ante, and hardly serves as support for the Sklars’ argument. 10

To put to rest the Sklars’ statutory claim, we now hold that neither the plain language of the 1993 amendments nor the accompanying legislative history indicates any substantive change to Hernandez’s holding that payment for religious education to religious organizations is not deductible. We agree with the observation of both the Tax Court and the Sklar I panel that had Congress intended to overrule judicial precedent and to provide charitable contributions for tuition and fee payments to religious organizations that provide religious education, it would have expressed its intention more clearly. See 282 F.3d at 613, 125 T.C. at 296-97.

2. The Tuition Payments Were Not “Dual Payment” Contributions

The Tax Court correctly concluded that no part of the Sklar’s tuition payments is deductible under a “dual payment” analysis. See Sklar, 125 T.C. at 290-94, 299-300. In American Bar Endowment, the Supreme Court considered the question of the extent to which payments to organizations that bear the “dual character” of a purchase and a contribution are deductible under § 170. 477 U.S. at 116-18, 106 S.Ct. 2426. IRS Revenue Ruling 67246 had set forth a two-part test for determining the extent to which such payments are deductible:

First, the payment is deductible only if and to the extent it exceeds the market value of the benefit received. Second, the excess payment must be “made with the intention of making a gift.”

Id. at 117, 106 S.Ct. 2426 (quoting Rev. Rul. 67-246, 1967-2 Cum. Bull. 104, 105 (1967)). The Court held that Revenue Ruling 67-246 embodied the proper standard, reasoning: “The sine qua non of a charitable contribution is a transfer of money or property without adequate consideration. The taxpayer, therefore, must at a minimum demonstrate that he purposely contributed money or property in excess of the value of any benefit he received in return.” Id. at 118, 106 S.Ct. 2426.

In American Bar Endowment, taxpayer members of a charitable organization sought to deduct under § 170 refunds from insurance policies negotiated and purchased on their behalf by the charitable organization, which they donated to the organization. See id. at 106-09, 116-18, 106 S.Ct. 2426. They claimed that the premiums paid for the insurance, part of which was subsequently refunded due to the “experience rating” of the policies, were dual payments. Id. The Supreme Court held that the taxpayer members met neither prong of the two-part test for de-ductibility of dual payments. Stating that the “most logical test of the value of the insurance [the benefit received in return for their payment] is the cost of similar policies,” the Court held that because three of the four taxpayers “failed to demonstrate that they could have purchased similar policies for a lower cost,” they failed to demonstrate that their payment exceeded the market value of the benefit received.