Case of First Impression

Case of First Impression

Article posted in Compliance on 4 January 2016| 6 comments
audience: National Publication, Richard L. Fox, Esq. | last updated: 8 January 2016
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Summary

Richard Fox explores a recent case, Green vs. US, which opens up some interesting planning opportunities

By: Richard L. Fox, Esquire

In Case of First Impression, District Court Holds That Contribution of Appreciated Property by Trust Purchased Out of Gross Income Qualifies for Charitable Income Tax Deduction Under IRC § 642(c) at Full Fair Market Value

In a case of apparent first impression, in Green v. U.S.,1 the court held that a trust that was authorized to distribute any amount of its gross income to charity was entitled to an income tax deduction under IRC § 642(c) for the full fair market value of donated property that was purchased with gross income the trust had received in prior years, and was not limited to the trust’s adjusted basis in the property.2

Background: Charitable Income Tax Deduction for Estates and Trusts Governed by IRC § 642(c) Rather Than IRC § 170(c)

In lieu of the charitable income tax deduction under IRC § 170(a), a charitable income tax deduction is available under IRC § 642(c) for charitable contributions made by estates and trusts. Unless all of the requirements of IRC § 642(c) are satisfied, a transfer of cash or property by an estate or trust that would otherwise be deductible as a charitable contribution under IRC § 170(a) will not be deductible for federal income tax purposes. Specifically, IRC § 642(c)(1) allows an estate and trust an income tax deduction for “any amount of gross income, without limitation, which pursuant to the terms of the governing instrument is, during the taxable year, paid for a purpose specified in IRC § 170(c).” Thus, the key to the charitable income tax deduction for an estate and trust under IRC § 642(c)(1) is that the amount:

1. Is paid during the taxable year;

2. Is from gross income (not from corpus or principal);

                        3. Is pursuant to the terms of the governing instrument (i.e., the will or trust document); and

4. Is for a purpose specified in IRC § 170(c).

There are key differences in the availability of a charitable income tax deduction to an estate or trust under IRC § 642(c) and to an individual under IRC § 170(c), summarized as follows:

                        1.         An individual is entitled to a charitable income tax deduction under IRC § 170(a), regardless of the source of payment of the charitable contribution, such that a contribution from any source is deductible by an individual. For a contribution to be deductible by an estate or trust under IRC § 642(c), the source of the contribution must be gross income and the contribution of such gross income must be made pursuant to the terms of the will or trust. Thus, absent a contribution being made from gross income and pursuant to the terms of the governing instrument, an estate or trust will not be eligible for a charitable income tax deduction, notwithstanding that a deduction would otherwise be available under IRC § 170(a).

                        2.         Unlike individuals, whose charitable deductions are limited to a certain percentage of income, estates and trusts are entitled to claim an unlimited charitable income tax deduction against their gross income. Where, for example, an estate or trust pays 100 percent of its income to charity during a taxable year, it may deduct the entire amount as a charitable contribution, provided the requirements of IRC § 642(c) are otherwise met. Because of availability of this unlimited deduction, unlike in the case of individuals, there are no provisions under IRC § 642(c) dealing with the carryover of excess charitable contributions for contributions exceeding the applicable percentage limitations.

                        3.         While individuals may only deduct contributions made to domestic charities, estates and trusts are eligible for a charitable income tax deduction for contributions to foreign charities.

                        4.         A special election is available to estates and trusts, but not to individuals, to claim a charitable income tax deduction in a taxable year for charitable contributions made in the following taxable year, thereby accelerating the deduction into the earlier taxable year.

                        5. Estates, as well as certain trusts created on or after October 9, 1969, are eligible for a charitable contribution for amounts of gross income that are permanently set aside for charitable purposes, whereas no permanent set-aside deduction is allowable to individuals.

Facts and Holding of District Court in Green v. U.S.

The trust in Green v., U.S. expressly authorized the trustee to “distribute to charity such amounts from the gross income of the Trust as the [trustee] determines appropriate.” The trust also provided that “[a] distribution may be made from the Trust to charity only when both the purpose of the distribution and the charity are as described in Section 170(c) of the Code.”  The trust was a partner in a partnership from which it had a substantial allocation of gross income and received substantial distributions from the partnership.  The trust utilized some of that gross income received attributable to the partnership distributions to purchase interests in real estate.  After the real estate had substantially appreciated in value, the trust made contributions of the real estate to charitable organizations.  On its originally filed tax return, the trust claimed an income tax charitable deduction under IRC § 642(c), but only in an amount equal to its income tax basis, not the fair market value of the real estate.  Subsequently, the trust filed claims for refund claiming charitable deductions for the full fair market value of the real estate.  

The IRS disallowed the refund claim and the trust filed suit in the United States District Court.  The IRS argued that (1) IRC §642(c)(1) limits a trust's deduction to the amount of gross income it contributed to charity; (2) gross income does not include unrealized appreciation; and (3) a liberal construction of the statute allowing fair market valuation would negate the gross income derivative requirement. The IRS also asserted that the trust was not entitled to the IRC § 642(c)(1) deduction because, when the donations were made, the real estate had become part of the principal of the trust, and that trustee of the trust was not authorized to make charitable donations from principal, such that the donations were not “pursuant to the terms of the governing instrument.” The court determined that the donated properties were all purchased with distributions from a partnership in which the trust had an interest and that each distribution was part of the partnership’s gross income for the year in which it was distributed. Therefore, the court held that the “Donated Properties were purchased with an amount of the Trust's gross income” and stated that there can be no serious question that the donations were made “pursuant to the terms of the governing instrument.”

The court in Green considered whether the trust’s charitable deduction should be limited to the income tax basis of property that had been originally acquired with its gross income.  A key element in the court’s decision apparently was whether the deduction allowed under IRC § 642(c) should be strictly construed.  The court acknowledged that generally deductions are a “matter of legislative grace” and thus should be strictly construed.  The court held that charitable deductions are not a “matter of legislative grace,” but “rather expression[s] of public policy” that should be liberally construed. Thus, the court stated that even if the language of the statute were unclear, a liberal construction in favor of the taxpayer would be appropriate.”  The court further noted that the policy behind the charitable income tax deduction allowed under IRC § 170 is to encourage charitable activities and IRC § 642(c)(1) has a similar purpose and must be read in light of the basic definitions and principles set forth in §170, except where expressly contradictory.  In this regard, the court stated that Congress did not specify a different standard of valuation in § 642 and in light of IRC § 170’s general rule of fair market valuation regarding donations of property other than cash, a fair market valuation standard is consistent “does not do violence to the plain language of § 642(c)(1).”

Planning Possibilities

Under the Green case, an estate or trust that is authorized to make distributions of gross income to charity could purchase assets (out of gross income) that are likely to appreciate in value and, when assuming they have appreciated, contribute the appreciated property to charity and receive an enhanced deduction under IRC § 642(c) (over and above the tax cost basis) without having to recognize the inherent gain in those assets, just as in the case of an individual who contributes appreciated property.  Investments may, of course, decline in value so that if those depreciated assets are contributed to charity, the trust or estate would have a smaller deduction, so that a sale of the asset producing a taxable loss would be preferable to a charitable contribution. 

  • 1. 116 AFTR 2d 2015-6668 (W.D. Ok 2015).
  • 2. Before discussing the court’s decision in more detail, it is interesting to note CCA 201042023. The issue discussed in the CCA was whether a trust’s deduction under section 642(c) was limited to the trust’s tax basis in non-cash assets acquired with its gross income, notwithstanding that the fair market value of that property was much greater than tax basis. Although not as well detailed as the facts in Green, it seems that the CCA discusses the actual Green situation. The CCA acknowledged there were “no prior cases or other authority in which the Service has so limited” the charitable deduction under section 642(c) to the basis of the property contributed. Nevertheless, the CCA concluded that the charitable income tax deduction should be limited to income tax basis, not its higher fair market value.

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