Trust Granted Deduction for Full Fair Value of Donated Property, Not Limited to Basis in Property

In the case of Green v. United States, 116 AFTR 2d ¶ 2015-5394, US District Court, Western District of Oklahoma, Case No. CIV-13-1237-D the court was asked to decide the application of the charitable contribution provisions applicable to trusts and estates under IRC §642 and a donation of appreciated property.

IRC §642(c)(1) provides:

(1) General rule

In the case of an estate or trust (other then 1 a trust meeting the specifications of subpart B), there shall be allowed as a deduction in computing its taxable income (in lieu of the deduction allowed by section 170(a), relating to deduction for charitable, etc., contributions and gifts) any amount of the gross income, without limitation, which pursuant to the terms of the governing instrument is, during the taxable year, paid for a purpose specified in section 170(c) (determined without regard to section 170(c)(2)(A)). If a charitable contribution is paid after the close of such taxable year and on or before the last day of the year following the close of such taxable year, then the trustee or administrator may elect to treat such contribution as paid during such taxable year. The election shall be made at such time and in such manner as the Secretary prescribes by regulations.

The Court notes that the provision refers to IRC §170 which provides general charitable contribution rules and find that §642 must be read “read in light of the basic definitions and principles set forth in § 170, except where expressly contradictory.”

The Court notes that under the general rules of §170 that a charitable contribution of property that be treated as capital gain property would generally be deductible at the fair market value of such property.

However the IRS objects that this would not be allowed for a trust for property with an inherent gain due to the “income” requirement of §642.  As the Court noted, the IRS argued:

…(1) that 26 U.S.C. § 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 Court did not agree with this view that the IRS held. 

The Court begins by noting that, unlike §170, §642(c) has no percentage limitation language in it.

Despite the absence of any limiting language in § 642(c)(1), Defendant argues for a strained construction, and holds tight to the "familiar rule that an income tax deduction is a matter of legislative grace and that the burden of clearly showing the right to the claimed deduction is on the taxpayer." INDOPCO Inc. v. Comm'r, 503 U.S. 79, 84 (1992) (quoting Interstate Transit Lines v. Comm'r, 319 U.S. 590, 593 (1943) (internal quotations omitted)).

However, the District Court finds that the unique nature of the charitable deduction provisions serve to offset this rule, noting:

The Sixth Circuit addressed this distinction in Weingarden v. Comm'r, 825 F.2d 1027 (6th Cir. 1987), acknowledging that generally statutes imposing a tax are construed liberally, in favor of the taxpayer, while statutes allowing deductions and exemptions are strictly interpreted, being "matters of legislative grace." Id. at 1029 (citing Porter v. Comm'r, 288 U.S. 436, 442 (1933) and I. R. Mertens, Law of Federal Income Taxation §§ 3.05, 3.07 (1986) (internal quotations omitted)). However, and of particular importance here, Weingarden went further to distinguish statutes regarding charitable deductions, stating they are not matters of legislative grace, but rather "expression[s] of public policy." Weingarden, 825 F.2d at 1029 (citing Helvering v. Bliss, 293 U.S. 144, 150-51 (1934) (further citations omitted, internal quotations omitted)). As such,"[p]rovisions regarding charitable deductions should . . . be liberally construed in favor of the taxpayer." Id. (citingHartwick Coll. v. United States, 801 F.2d 608, 615 (2d Cir. 1986)). Thus, even if the language of the statute were unclear, a liberal construction in favor of the taxpayer would be appropriate.

A key issue here is the gross income requirement found in §642(c).  The Court looked to this by looking at the source of funds used to purchase the property in this case as the test.  It holds:

However, Defendant also contends that for the Donated Properties to qualify as charitable deductions under§ 642(c)(1), they must be "sourced from[14] and traceable to[15] a trust's gross income." See Defendant's Motion [Doc. No. 38] at 13 (citing 26 U.S.C. § 642(c)(1) and Crestar Bank v. I.R.S., 47 F. Supp. 2d 670 (E.D. Va. 1999) (emphasis added)). The parties agree that the requirements necessary to qualify as a deduction under § 642(c)(1) include that the donation be traceable to gross income. See infra note 16. The Court concurs, and finds there is no real question here regarding the type of income used to purchase the Donated Properties. The properties were all purchased with distributions from Hob-Lob to the Trust. Each distribution was part of GDT's gross income for the year in which it was distributed. Therefore, the Donated Properties were purchased with an amount of the Trust's gross income.

The IRS claims, however, that after the properties were purchased they become part of trust principal and thus the contribution was not made out of income.  The Court, agreeing with the trust, found that the issue is not whether the contribution came from state law income, but rather whether it came from federal tax law gross income.

The IRS next argues that, in any event, the trust should not be able to claim a deduction in excess of basis since the unrealized appreciation was not reflected in the trust’s income.  The Court did not accept that view, noting:

Defendant contends that any capital appreciation must not be considered in the Donated Properties' valuation because such constitutes unrealized gains. SeeDefendant's Motion [Doc. No. 38] at 16-19 (citing W.K. Frank Tr. of 1931 v. Comm'r, 145 F.2d 411 (1944), U.S. v. Benedict, 338 U.S. 692 (1950), and Comm'r v. Cent. Hanover Bank & Tr. Co., 163 F.2d 208 (2d Cir. 1947)). In support of this position, Defendant likens the Donated Properties either to (1) cash gifts not fully derived from gross income, or (2) donations made out of a trust's corpus. However, those analogies are inapposite because, as the Court has found, each of the Donated Properties derives from the Trust's gross income. Under the facts of this case, using adjusted basis as the valuation standard would allow no consideration for the appreciation of real property donated in kind, regardless of whether such property was donated in the year of acquisition or in subsequent tax years. Defendant asks the Court to read a limitation into the statute where none expressly exists.

The result in this case is contrary to the position the IRS had outlined in Chief Counsel Advice 201042023 where the IRS made the argument for the deduction for a trust or estate would be limited to basis.  Given the case is a U.S. District Court case it seems likely the IRS will continue to assert that position in other matters, at least outside of western Oklahoma.

As well, given other charitable trust deduction cases recently it seems that the IRS has begun to take a closer look at claims for charitable contributions on Forms 1041.  Thus advisers should be sure to understand the special rules applicable to charitable deductions on the income tax returns of trusts and estates.