Charitable contribution deductions for trusts and estates are subject to unique rules that are discussed in Private Letter Ruling 201611002. The conclusions of this ruling aren’t at all surprising, but it does provide a good review of the topic, including the differences between “accounting” and “tax” definitions for trusts.
The trust was the beneficiary of an IRA of a decedent who established the trust. The trust provided that the IRA is to be distributed to a charitable organization. That raises a tax concern since the trust is a taxable entity and the IRA, rather than being left directly to the tax exempt charity, had been left to the trust which was to distribute the IRA to that organization.
The trust, as successor beneficiary of the IRA, is not allowed to simply transfer the IRA itself to the charity without triggering a taxable distribution to the trust—interests in an IRA cannot be assigned in a tax free manner. As well, the IRA represents income in respect of a decedent under IRC §691(a), so a distribution will generate taxable income.
However, a trust can claim a charitable contribution deduction if certain requirements are met, requirements found in IRC §642(c)(1) which provides:
(1) General rule
In the case of an estate or trust (other then  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.
Or, to put it more simply, the contribution must be authorized by the trust governing documents and must be paid out of an amount of “gross income” in order to be deductible.
It is clear the trust allows (and in fact directs) the trustee to pay the amount to the charity. The real question is whether the payment comes out of gross income.
Under the Uniform Principal and Income Act (2008) (UPIA) Section 409(c), a payment from an IRA held by a trust or estate is allocated:
- 10% to income and 90% to principal to the extent it represents a minimum required payment from the account and
- 100% to principal to the extent it is in excess of the minimum or if there is no current minimum required distribution
Does this mean the trust is “out of luck” since, at best, 10% of the distribution if it takes only the minimum distribution each year and sends that to the charity. So in that case it would only be able to deduct 10% of the amount it sent to the charity. And if it takes the funds out faster than that, it would have no deduction on the excess. Is that how this works?
The ruling points out the answer is no. While it is true that only, at most, 10% of the distribution represents income under the UPIA (and thus most states’ own principal and income act), the limit is not on that income (most often referred to in tax law as “accounting income”) but rather on “gross income” which is a term defined in the Internal Revenue Code (see IRC §61 which is conveniently titled “Gross income defined”).
The law requires the payment come out of gross income which IRD is part of (IRC §691(a) in fact specifically refers to the inclusion of such items in gross income). Thus under IRC §691 the trust is allowed a deduction for the amounts paid—and, unlike an individual, there is no percentage of income limitation on the deduction.