Estate Tax Review

Estate Tax Review

Technical Report posted in Compliance on 6 May 2003| comments
audience: National Publication | last updated: 13 September 2012
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Abstract

Reviews the estate tax charitable deduction, qualifying recipients, conditions and limitations, qualifying partial interests, and reformation rules.

Section 2055 of the Internal Revenue Code1 governs the charitable estate tax deduction. The requirements for the deduction and some of the issues that typically arise with charitable gifts at death are discussed here.

Estate Tax Charitable Deduction

It is important to note that the requirements for the estate tax charitable deduction under Code Section 2055 differ slightly from the requirements for the income tax charitable deduction under Code Section 170. If the decedent was a United States citizen or resident, the charitable estate tax deduction is not limited to gifts to trustees or domestic corporations or associations for use within the United States.2 In addition, the charitable estate tax deduction is not subject to the percentage limitations that apply with respect to the charitable income tax deduction.3

Charitable Recipients

A deduction from the gross estate is allowed for "the value of all bequests, legacies, devises, or transfers" to several types of recipients:

Gifts at death may be made to or for the use of the United States, any State, Washington, D.C., or any political subdivision of these governmental entities. To qualify for the deduction, gifts to governmental entities must be solely for public purposes.4

Gifts may also be made to or for the use of any corporation provided that the corporation is organized and operated exclusively for "religious, charitable, scientific, literary, or educational purposes, including the encouragement of art or to foster national or international amateur sports competition (but only if no part of its activities involve the provision of athletic facilities or equipment), and the prevention of cruelty to children or animals." There must be no private inurement and the corporation must not fail qualification for tax exemption under Code Section 501(c)(3) because of attempts to influence legislation. In addition, the corporation must "not participate in, or intervene in (including the publishing or distributing of statements), any political campaign on behalf of (or in opposition to) any candidate for public office."5

The next type of gift that qualifies for the estate tax charitable deduction are gifts "to a trustee or trustees, or a fraternal society, order, or association operating under the lodge system, but only if such contributions or gifts are to be used by such trustee or trustees, or by such fraternal society, order, or association, exclusively for religious, charitable, scientific, literary, or educational purposes, or for the prevention of cruelty to children or animals." As in the case of corporate gifts, the trust, association, order or society cannot be disqualified under Code Section 501(c)(3) because of attempts to influence legislation and these entities may "not participate in, or intervene in (including the publishing or distributing of statements), any political campaign on behalf of (or in opposition to) any candidate for public office." Unlike the references to gifts "to or for the use of" governmental entities and corporations, the rule here covers only gifts "to" trusts or fraternal lodge societies, orders and associations.6

Gifts to or for the use of a veterans' organization or its departments, local chapters or posts, will qualify for deduction if the organization was incorporated by an act of Congress. No part of the organization's net earnings can inure to the benefit of any private shareholder or individual.7

Finally, gifts at death to an employee stock ownership plan will qualify for a deduction under Code Section 2055 as long as the gift is a "qualified gratuitous transfer of qualified employer securities" as explained in the rules of Code Section 664(g).8

The termination of a power of invasion, consumption or appropriation over property for the benefit of an individual prior to the due date for the filing of a federal estate tax return (Form 706) and prior to an exercise of the power is treated as a disclaimer of property for purposes of Code Section 2055(a).9 For purposes of gifts to or for the use of corporations, Section 501(j) provides rules which apply to this provision in a similar fashion.10 Regulation Section 20.2055-2(c)(1)(i) notes that a charitable deduction is allowable for a gift resulting from a qualified disclaimer under Code Section 2518.11

Property which passes to one of the qualified charitable donees and which is includible in a decedent's estate because the decedent held a Code Section 2041 power of appointment over it will be treated as a bequest by the decedent for purposes of the estate tax charitable deduction.12 The property may pass to charity as a result of the exercise, non-exercise, lapse or release of the power.13

Conditional Gifts and Other Limitations to the Deduction

Conditions precedent and conditions subsequent may impact the estate tax charitable deduction. If the gift does not become effective unless some event happens or some act is performed, the deduction is allowed only if "the possibility that the charitable transfer will not become effective is so remote as to be negligible."14 In addition, if the gift takes place but could be defeated by a subsequent act or event, then the deduction is allowed only if the possibility that the act or event will occur is "so remote as to be negligible" at the time of the decedent's death.15

Ascertainable Value

A basic tenet of the deduction is that the value of the gift must be ascertainable as of the date of death.16 For example, if the amount of the charitable gift is subject to anyone's discretion, then the deduction will be limited to the minimum amount that must pass to charity even if a much greater amount actually passes to charity.17

If a charitable estate tax deduction is claimed for property included in a decedent's estate but which was transferred during life, the Regulations provide that the executor should submit a certified or verified copy of the written instrument of transfer along with the decedent's federal estate tax return (Form 706).18 The executor should also include a written penalties of perjury statement with the Form 706 specifying whether an action to construe or contest the decedent's will or any provision of it affecting the charitable deduction has been instituted or the executor believes such an action is contemplated or designed.19

Interrelated Estate Tax Computation

If federal estate taxes or other estate, inheritance, succession or legacy taxes are partly or entirely payable out of property for which a charitable estate tax deduction would otherwise be allowed, then the amount of the deduction must be reduced for the amount of the taxes so payable.20 In other words, the deduction cannot be greater than the amount that actually passes to charity. This often results in a circular, or interrelated, computation because the reduction in the charitable deduction in turn increases the taxes payable that again reduces the charitable deduction and so forth.21 The calculation must be run until the additional taxes zero out. The Regulations specify that the federal estate tax return should make full disclosure of the computation of the deduction.22 If the deduction is dependent upon a tax not paid by the time of filing the return, the executor should submit a computation of that tax with the Form 706.23

Other Factors Affecting Charitable Deduction

It should be noted that Code Section 2053 allows a federal estate tax deduction for certain state death taxes imposed on charitable gifts.24

The payment of administration expenses from a charitable gift may also impact the deduction allowed. The executor of an estate has the option of deducting administration expenses on the federal estate tax return or on the fiduciary income tax return for the estate.25 A series of cases distinguished between administration expenses paid from the income generated by property included in the estate and administration expenses paid from the principal of the property with respect to the deduction.26 After a split among the United States Courts of Appeal, the United States Supreme Court reviewed the issue and, in a plurality opinion, ruled that administration expenses payable from income generated by property reduce the charitable or marital deduction only if the payment constitutes a "marital limitation" on the charity or surviving spouse's right to income from the property.27 As a result of the Supreme Court's holding, the Internal Revenue Service announced that it is currently studying the administration expense issue.28

Effect of Settlements and Compromise Agreements

Any part of a testamentary charitable gift that is surrendered or assigned by a charity pursuant to a "compromise agreement in settlement of a controversy" will not be deductible as a gift to such charity.29 If a charity receives property as a result of a compromise agreement, the allowance of the deduction generally depends on whether the amount passing to charity is a transfer from the decedent or from the decedent's heirs or by purchase under the particular facts involved. 30 To be deductible, there must be a transfer from the decedent.31 The general rule for deductions arising from settlements and compromises applies only to bona fide will contests.32 Similarly, no charitable estate tax deduction is allowed where amounts are given to charity by a beneficiary or fiduciary of an estate rather than by the decedent.33

Other Limitations on Deduction

Another important limit on the estate tax charitable deduction for a gift of property at death is that the value of the deduction cannot exceed the value of the gifted property that is required to be included in the estate.34 Nor may an estate tax charitable deduction be taken for property for which a qualified terminable interest property marital deduction is allowed under Code Section 2056(b)(7).35

Code Section 2055(e)(1) disallows a charitable estate tax deduction for gifts to or for the use of trusts or organizations described in Section 508(d) or Section 4948(c)(4) "subject to the conditions specified in such sections."36

Section 508(d) denies a deduction if an unabated tax under Section 507(c) has been imposed on the recipient organization and the gift was made "by any person after notification is made under section 507(a)," or "by a substantial contributor (as defined in section 507(d)(2)) in his taxable year which includes the first day on which action is taken by such organization which culminates in the imposition of tax under section 507(c) and any subsequent taxable year."37 Section 507(c) imposes a tax on terminating private foundations in certain circumstances.38

In addition, Section 508(d) denies a deduction if the gift is to a recipient private foundation or Section 4947 trust if such recipient's governing instrument does not meet the requirements of Section 508(e) during the taxable year or if the gift is to a recipient not treated as a Section 501(c)(3) entity because it has not complied with the requirements to notify the Internal Revenue Service that it is applying for Section 501(c)(3) status.39 Regulation Section 20-2055-5(b)(2) provides exceptions to the denial of the deduction under this provision for certain situations where the governing will was executed or property was transferred to the governing trust before October 9, 1969.40

Section 4948(c)(4) disallows a charitable estate tax deduction if the gift is made to a foreign organization about which the Service has issued a notice regarding a prohibited transaction in a year in which the organization is not exempt from tax under Section 501(a).41

Partial Interests

No estate tax charitable deduction is allowed for gifts of partial interests as provided in Section 2055(e)(2). A partial interest would arise where a decedent passes an interest in the same property to both charitable and noncharitable recipients.42 The principles used for the marital deduction in Code Section 2056 and the Regulations thereunder should be used to determine "whether an interest in property passes or has passed from the decedent" for purposes of the charitable deduction.43 If the effectiveness of a transfer for a private purpose is dependent at the date of the decedent's death upon the happening of an event or the performing of an act, then no transfer for the private purpose will be considered to have occurred if the possibility of the event or act taking place is "so remote as to be negligible."44

Exceptions to Partial Interest Rule

The partial interest exceptions of Code Section 170(f)(3) apply for purposes of the estate tax charitable deduction. These exceptions include a gift of a remainder interest in a personal residence or farm,45 a gift of an undivided portion of the decedent's entire interest in property,46 and a gift constituting a qualified conservation contribution.47 A personal residence does not have to be the decedent's principal residence in order to qualify.48 In order to qualify as a gift of an undivided portion of the decedent's entire interest in property, the gift "must consist of a fraction or percentage of each and every substantial interest or right owned by the decedent in such property and must extend over the entire term of the decedent's interest in such property and in other property into which such property is converted."49

Exceptions for remainder interest gifts to charity include charitable remainder annuity trusts, charitable remainder unitrusts and pooled income funds.50 Exceptions for other partial interests are for those "in the form of a guaranteed annuity" or "a fixed percentage distributed yearly of the fair market value of the property (to be determined yearly)," such as the charitable lead annuity trust or charitable lead unitrust.51

The Regulations under Code Section 2055 provide rules for valuing qualifying partial interests, such as remainder or income interests, for purposes of the charitable deduction. The deduction is based on fair market value, which is defined as present value.52

Works of Art

Some special rules apply for "works of art." For purposes of Section 2055(e)(4), a work of art is "any tangible personal property with respect to which there is a copyright under Federal law." If the work of art is contributed to a charity that uses it in a manner relating to the purpose or function that is the basis for the charity's tax exempt status, then the work of art and the copyright on the work of art are treated as separate assets for purposes of the partial interest rules. The charity in question must be a public charity or private operating foundation.53

Real Property Easements

A charitable estate tax deduction is allowed for an irrevocable gift of a qualified real property easement as defined in Code Section 170(h)(2)(C) if the easement meets the requirements of Code Section 170(h) regardless of whether the rules of Section 170(h)(4)(A) are met.54

Reformations

Section 2055(e)(3) contains rules for qualified reformations whereby an estate tax charitable deduction may be obtained for a transfer that would not otherwise qualify. In general, an interest may be reformed if it would qualify for an estate tax charitable deduction but for the partial interest rules of Section 2055(e)(2).55 A qualified reformation is an amendment, construction or reformation in the governing instrument which changes an interest that would not qualify for the deduction into an interest which will qualify.56 The change must be effective as of the decedent's death.57 Any difference between the date of death actuarial value of the qualified interest (after reformation) and the actuarial value of the non-qualified interest (prior to reformation) must be five percent or less of the actuarial value of the non-qualified interest (prior to reformation).58

In addition, the nonremainder interest in a charitable remainder reformation situation must terminate at the same time before and after the reformation.59 In reformation situations that do not involve charitable remainder interests, the reformed interest (after the reformation) and the non-qualified interest (prior to the reformation) must be for the same period.60 However, if a non-qualifying nonremainder interest is for a term of more than twenty years and is reformed to a term of twenty years, it will be treated as if it were for the same term before and after reformation for purposes of this rule.61

Requirements for Noncharitable Beneficiaries

All payments to noncharitable beneficiaries before a remainder interest "vests in possession" must be expressed as "a fixed percentage of the fair market value of the property" or as a specified dollar amount.62 The Code specifies that "For purposes of determining whether all such payments are expressed as a fixed percentage of the fair market value of the property, section 664(d)(3) shall be taken into account."63 However, the rule that such interests must be so fixed does not apply if the judicial reformation is begun within ninety days of the last date (including extensions) for filing an estate tax return if one is required or the last date (including extensions) for filing the trust's first required income tax return if no estate tax return is required to be filed.64 In addition, if the gift in question is passing under a will executed or a trust created prior to January 1, 1979, then the rule that such interests must be so fixed does not apply.65

Limitation on Estate Tax Deduction on Reformed Interest

The charitable estate tax deduction allowed for the reformed interest cannot be greater than the deduction that would been allowed for the non-qualifying interest had it not been disallowed because of the partial interest rules.66

Wholly Charitable Trusts

If a reformable interest is in a trust that is wholly charitable or passes to a charity because an individual dies or a trust terminates or distributes property in accordance with the trust instrument because of an individual's death by the time the estate tax return is due (including extensions), then an estate tax charitable deduction will be allowed without reformation.67 A "wholly charitable trust" is a trust that is described in Code Section 4947(a)(1) upon the allowance of the charitable deduction.68

Reformations of Split-Interest Charitable Vehicles

The IRS is instructed in Code Section 2055 to issue regulations permitting reformations of pooled income funds and remainder interests in personal residences or farms and to issue regulations "to carry out the purposes of this paragraph, including regulations providing such adjustments in the application of the provisions of section 508 (relating to special rules relating to section 501(c)(3) organizations), subchapter J (relating to estates, trusts, beneficiaries, and decedents), and chapter 42 (relating to private foundations) as may be necessary by reason of the qualified reformation."69

Code Section 2055(e)(3)(J) provides that a charitable remainder trust that fails to satisfy the ten percent rule of Sections 664(d)(1)(D) and 664(d)(2)(D) may be either declared null and void from the outset or the noncharitable interest may be reformed so that it satisfies the ten percent rule if the reformation is commenced within the appropriate time frame under Section 2055.70

Statute of Limitations on Tax Deficiencies

If there is a reformation under Code Section 2055, the statute of limitations for the assessment of tax deficiencies related to estate tax charitable deductions will not expire until at least one year after the IRS receives notice that the reformation has occurred.71 This includes proceedings for purposes of satisfying the ten percent rule for charitable remainder trusts.72


  1. All references are to the Internal Revenue Code of 1986 as amended from time to time and the Treasury Regulations thereunder.back

  2. Reg. § 20.2055-1(a).back

  3. Id.back

  4. I.R.C. § 2055(a)(1) and Treas. Reg. § 20.2055-1(a)(1).back

  5. I.R.C. § 2055(a)(2) and Treas. Reg. § 20.2055-1(a)(2).back

  6. I.R.C. § 2055(a)(3) and Treas. Reg. § 20.2055-1(a)(3).back

  7. I.R.C. § 2055(a)(4) and Treas. Reg. § 20.2055-1(a)(4).back

  8. I.R.C. § 2055(a)(5) (for transfers after August 5, 1997).back

  9. I.R.C. § 2055(a) and Treas. Reg. § 20.2055-2(c)(1)(ii).back

  10. I.R.C. § 2055(a).back

  11. Treas. Reg. § 20.2055-2(c)(1)(i).back

  12. I.R.C. § 2055(b) and Treas. Reg. § 20.2055-1(b)(1).back

  13. Treas. Reg. § 20.2055-1(b)(1).back

  14. Treas. Reg. § 20.2055-2(b)(1).back

  15. Id.back

  16. See e.g., Estate of Marine v. Commissioner, 97 T.C. 368 (1991).back

  17. Id. (holding that no deduction was allowed for a gift of over two million dollars to charity via a residuary charitable bequest because the value of the charitable gift was not ascertainable at death given that the executors had the discretion to make certain pre-residuary payments to an unlimited number of persons of up to one percent each of the value of the gross probate estate).back

  18. Treas. Reg. § 20.2055-1(c)(1).back

  19. Treas. Reg. § 20.2055-1(c)(2).back

  20. I.R.C. § 2055(c) and Treas. Reg. § 20.2055-3(a).back

  21. Treas. Reg. § 20.2055-3(b).back

  22. Treas. Reg. § 20.2055-3(a).back

  23. Id.back

  24. I.R.C. § 2053(d) and Treas. Reg. §§ 20.2055-3(c) and 20.2053-9.back

  25. I.R.C. § 642(g).back

  26. See e.g., Estate of Hubert v. Commissioner, 63 F.3d 1083 (11th Cir. 1995) (involving charitable and marital deductions); Burke v. U.S., 994 F.2d 1576 (Fed. Cir. 1993) (involving charitable deduction); and Estate of Street v. Commissioner, 974 F.2d 723 (6th Cir. 1992) (involving marital deduction).back

  27. Estate of Hubert v. Commissioner, 117 S.Ct. 1124 (1997).back

  28. I.R.S. Notice 97-63, 1997-47 I.R.B. 6 (soliciting public comments on possible approaches to the issue for a proposed regulation revising Treas. Reg. § 20.2056(b)-4(a) with respect to the marital deduction).back

  29. Treas. Reg. § 20.2055-2(d).back

  30. See e.g., Estate of Gilbert v. Commissioner, 4 T.C. 1006 (1945).back

  31. Treas. Reg. § 20.2055-1(a) and see e.g., Estate of Dumont v. Commissioner, 150 F.2d 691 (3rd Cir. 1945) (charitable estate tax deduction allowed where amount charity received in settlement of a will contest was found to have passed by inheritance rather than by purchase).back

  32. See e.g., Rev. Rul. 89-31, 1989-1 C.B. 277 (1989) ("In situations involving settlements of bona fide will contests the Service will no longer challenge the deductibility of immediate payments to charities solely on the ground that they were made in lieu of a split interest that would not constitute an allowable deduction under section 2055(e)(2) of the Code. However, settlements of will contests will continue to be scrutinized in order to assure that the settlement in question is not an attempt to circumvent section 2055(e)(2) by instituting and settling a collusive contest."); and Tech. Adv. Mem. 89-45-004 (Aug. 4, 1989) ("The grandchildren's recourse was against the attorney who drafted the codicil and failed to have it signed prior to the decedent's death. If there was a claim that the codicil had been executed, the grandchildren's claim might have constituted a bona fide will contest, and the estate would have been entitled to a charitable deduction for the value of the payment made to the charities in satisfaction of the settlement agreement.").back

  33. See e.g., Estate of Lockett, 75 T.C.M. 1731 (1998) (in holding that no charitable estate tax deduction was allowed because gift was made by trustees of decedent's trust rather than by decedent, the Court noted, "A recurring problem is whether the decedent directed the transfer to a qualifying organization or whether the estate fiduciary made the transfer in the exercise of his discretion; only in the former case is a deduction generally allowed").back

  34. I.R.C. § 2055(d).back

  35. Treas. Reg. § 20.2055-6 (citing I.R.C. § 2056(b)(9) and Treas. Reg § 20.2056(b)-9, which deny double deductions by a decedent's estate for the same property interest).back

  36. I.R.C. § 2055(e)(1).back

  37. I.R.C. § 508(d)(1) and Treas. Reg. § 20.2055-5(a).back

  38. I.R.C. § 507(c).back

  39. I.R.C. § 508(d)(2) and Treas. Reg. § 20.2055-5(b) (referencing Treas. Reg. § 1.508-2(b)(1) for additional rules).back

  40. Treas. Reg. § 20.2055-5(b)(2).back

  41. I.R.C. §§ 2055(e)(1) and 4948(c)(4) and Treas. Reg. § 20.2055-5(c).back

  42. I.R.C. § 2055(e)(2) and Treas. Reg. § 20.2055-2(e)(1) (the Regulations provide a number of examples).back

  43. Treas. Reg. § 20.2055-2(e)(1).back

  44. Id.back

  45. I.R.C. §§ 2055(e)(2) and 170(f)(3)(B)(i) and Treas. Reg. §§ 20.2055-2(e)(2)(ii) and (iii).back

  46. I.R.C. §§ 2055(e)(2) and 170(f)(3)(B)(ii) and Treas. Reg. § 20.2055-2(e)(2)(i).back

  47. I.R.C. §§ 2055(e)(2) and 170(f)(3)(B)(iii) and Treas. Reg. 20.2055-2(e)(2)(iv) (referencing Treas. Reg. § 1.170A-14 for the definition of a qualified conservation easement).back

  48. Treas. Reg. § 20.2055-2(e)(2)(ii).back

  49. Treas. Reg. § 20.2055-2(e)(2)(i).back

  50. I.R.C. § 2055(e)(2)(A) and Treas. Reg. § 20.2055-2(e)(2)(v).back

  51. I.R.C. § 2055(e)(2)(B) and Treas. Reg. § 20.2055-2(e)(2)(vi) (for guaranteed annuity interests) and Treas. Reg. § 20.2055-2(e)(2)(vii) (for unitrust interests).back

  52. Treas. Reg. § 20.2055-2(f) (citing Treas. Reg. § 1.664-2(c) for valuation of a remainder interest in a charitable remainder annuity trust; citing Treas. Reg. § 1.664-4 for valuation of a remainder interest in a charitable remainder unitrust; citing Treas. Reg. § 1.642(c)-6 for valuation of a remainder interest in a pooled income fund; citing Treas. Reg. §§ 20.2031-7, 20.2031-7A and 20.2031-8 for valuation of a guaranteed annuity interest; and providing for valuation of a unitrust interest "by subtracting the present value of all interests in the transferred property other than the unitrust interest from the fair market value of the transferred property.")back

  53. I.R.C. § 2055(e)(4) and Treas. Reg. § 20.2055-2(e)(1)(ii).back

  54. I.R.C. § 2055(f).back

  55. I.R.C. § 2055(e)(3)(C)(i).back

  56. I.R.C. § 2055(e)(3)(B).back

  57. I.R.C. § 2055(e)(3)(B)(iii).back

  58. I.R.C. § 2055(e)(3)(B)(i).back

  59. I.R.C. § 2055(e)(3)(B)(ii)(I).back

  60. I.R.C. § 2055(e)(3)(B)(ii)(II).back

  61. I.R.C. § 2055(e)(3).back

  62. I.R.C. § 2055(e)(3)(C)(ii).back

  63. Id.back

  64. I.R.C. § 2055(e)(3)(C)(iii).back

  65. I.R.C. § 2055(e)(3)(C)(iv).back

  66. I.R.C. § 2055(e)(3)(E).back

  67. I.R.C. § 2055(e)(3)(F).back

  68. Id.back

  69. I.R.C. § 2055(e)(3)(H).back

  70. I.R.C. § 2055(e)(3)(J).back

  71. I.R.C. § 2055(e)(3)(G).back

  72. Id. (as amended for transfers in trust made after July 28, 1997).back

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