## Facts

- The Church of Scientology of California was recognized as tax-exempt under I.R.C. § 501(c)(3) in 1957.
- In 1967, the IRS revoked the exemption, asserting the Church operated for profit, allowed earnings to inure to private individuals, and served private rather than public interests.
- For 1970–1972, the Church filed Form 990 information returns but did not file corporate income tax returns.
- After audit, the IRS issued a notice of deficiency for 1970–1972, asserting roughly $1.15 million in income tax deficiencies and about $287,000 in late-filing penalties.
- The Tax Court upheld the deficiencies and concluded the Church (1) operated for a substantial commercial purpose, (2) permitted inurement to L. Ron Hubbard, his family, and a related private corporation (OTC), and (3) engaged in conduct contrary to established public policy by attempting to impede IRS functions.
- The Church’s operations included fixed charges for auditing and sales of books and lectures priced to yield substantial profit; an internal directive included a policy to “MAKE MONEY,” and price reductions were discouraged.
- The Church generated significant net income and cash reserves during 1970–1972.
- Evidence showed substantial funds were controlled or accessed by Hubbard and associates, including royalties, percentage-based payments tied to organizational income, and transactions involving OTC that resulted in funds being made available to Hubbard and his wife.

## Issues

1. Whether the Church qualified for exemption under I.R.C. § 501(c)(3) for tax years 1970–1972 given the prohibitions on private inurement and substantial nonexempt (commercial) purposes.
2. Whether denial of exemption and related tax deficiencies violated the First Amendment (including free exercise and excessive entanglement) as applied to a religious organization.
3. Whether the Church established selective enforcement sufficient to invalidate the IRS’s actions.

## Decision

- The Ninth Circuit affirmed the Tax Court’s judgment.
- The court held the Church did not qualify for § 501(c)(3) exemption because a portion of its net earnings inured to private individuals and because it was operated in part for substantial commercial purposes.
- The court rejected the Church’s First Amendment challenges, concluding the IRS and courts permissibly applied neutral statutory standards to financial and operational conduct.
- The court rejected the Church’s selective enforcement claim for failure to meet the required showing.
- The affirmance sustained the income tax deficiencies and late-filing penalties for 1970–1972.

## Legal Principles

- A § 501(c)(3) organization must be operated exclusively for exempt purposes; substantial nonexempt commercial purposes defeat exemption even if religious activities are present.
- The prohibition on private inurement is an absolute bar: diversion of net earnings to insiders (directly or through related entities) disqualifies an organization from exemption.
- Fixed, profit-oriented pricing and business-like marketing of services and materials may support a finding of substantial commercial purpose inconsistent with § 501(c)(3).
- Applying neutral tax standards (e.g., inurement and operational tests) to a religious organization generally does not violate the First Amendment where the inquiry focuses on financial arrangements and operations rather than doctrine.
- Selective enforcement challenges require a demanding showing and do not succeed absent proof satisfying the applicable standard.

## Conclusion

The Ninth Circuit upheld revocation of the Church’s § 501(c)(3) status and the resulting tax liabilities for 1970–1972 because the Church’s earnings inured to private beneficiaries and its operations reflected substantial commercial purposes; the court also held that applying these neutral statutory limits did not violate the First Amendment and that selective enforcement was not proved.


Church of Scientology of Cal. v. Comm’r, 823 F.2d 1310 (9th Cir. 1987)