IRS To Contest Charitable Estate Tax Deduction

IRS To Contest Charitable Estate Tax Deduction

News story posted in Field Service Advice on 28 June 1999| comments
audience: National Publication | last updated: 18 May 2011
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Summary

In FSA 1999-1174, the National Office of the Service held that an estate tax charitable deduction should be denied because (i) the decedent did not have a primarily charitable intent, but rather intended the estate's residue to pass to a particular entity in all events, (ii) no assurance could be made that the trustee would not divert the assets to the particular entity given his relationship with the decedent, (iii) the statute and regulations contemplate that a qualifying charity actually receive the bequest, and (iv) a deduction is permitted only for the value of that portion of the residue of the estate, determined as of the date of death, which the trustee actually distributes to charity.

FSA 1999-1174

PGDC SUMMARY:

The day before his date of death, Testator executed a will and pour-over trust through which the residue of his estate would pass to a nonprofit corporation ("Charity"). Testator knew that Charity's tax-exempt status was being challenged. In addition, Testator strongly requested that the executor of his will and trustee of the related pour-over trust be chosen from a list which specified the names of preferred individuals. B was the executor and is the current trustee of the trust. The bequest to Charity was subject to the condition that it must have been determined to be tax exempt as of the date of death. If Charity's tax-exempt status remained under challenge, the trustee was to withhold distribution until it's status was confirmed or denied. If Charity's tax-exempt status was denied, then the residue of the estate would be distributed to such qualifying organizations as the trustee in its sole discretion chooses. However, B distributed a substantial portion of the charitable bequest to Charity while it's tax exempt status remained under challenge. A court subsequently concluded that Charity was not a charitable organization.

The Service concluded that the government should contest the estate tax charitable deduction because (i) Testator did not have a primarily charitable intent, but rather intended the estate's residue to pass to Charity in all events, (ii) no assurance could be made that B would not divert the assets to Charity given his relationship with Testator, (iii) the statute and regulations contemplate that a qualifying charity actually receive the bequest, and (iv) a deduction is permitted only for the value of that portion of the residue of the estate, determined as of the date of death, which the trustee actually distributes to charity.

FULL TEXT:

INTERNAL REVENUE SERVICE
MEMORANDUM

* * *
CC:DOM:FS:P&SI

date: * * *
to: District Counsel, * * *
Attn: * * *
from: Assistant Chief Counsel (Field Service) CC:DOM:FS
subject: * * *

I.R.C. section 2055

This memorandum clarifies our memorandum of * * * To the extent any aspect of this advice conflicts with our prior advice, this advice supersedes the prior advice.

ISSUE

Whether a charitable deduction is allowable to decedent's estate under the circumstances of this case?

CONCLUSION

Unless it is subsequently determined that * * * is a qualifying entity, we suggest that the government contest the deduction on the following basis. First, decedent did not have a primarily charitable intent, but rather intended the residuary to pass to * * * in all events. Evidence of this intent includes decedent's purpose in forming * * * as the new * * * decedent's testamentary documents, and the relationship between decedent's estate and * * * Secondly, even if decedent had a primarily charitable intent, no assurance exists that the trustee will not divert the assets to * * * given his relationship with * * * and no party will likely challenge the diversion. Third, the statute and the regulations contemplate that a qualifying charity actually receive the bequest. Fourth, even if the trustee ultimately distributes what remains of decedent's bequest to a qualifying charity, the Code and the regulations permit a deduction only for the value of that portion, determined as of the date of death, which the trustee actually distributes to charity. Given the foregoing, we do not suggest that you rely on the split interest rules of I.R.C. section 2055(e).

FACTS

* * * (decedent) died * * * Decedent's will, executed * * * provides, in part,

FIFTH: I have this day previously established the * * * by Agreement bearing the same date as this WILL, of which I am the Trustor and * * * is the Trustee. In that Trust Agreement I have provided for the payment of all of my debts, expenses of last illness, succession and transfer taxes, and administration expenses arising from my estate. I have also provided therein for certain benefits for my wife. I hereby direct the Trustee of the * * * to pay such debts and expenses from the assets of the trust, as such assets may be augmented by assets from my probate estate.

SIXTH: I give, devise and bequeath all of the rest, residue and remainder of my estate, whether real, personal or mixed, and wheresoever situated, including all lapsed and failed gifts, . . . to the then-acting Trustee, or Trustee, under the * * * earlier established this day by written agreement bearing the date of this WILL. I direct that the residue of my said estate shall be added to and shall be held, administered and distributed as a part of said trust, according to the terms of said trust and any amendments thereto made prior to my death.

Decedent's trust, also dated * * * provides, in part,

G. Residue. All principal and accumulated income remaining after the distribution provided for in paragraphs A, B, C, D, E, and F, above, including any lapsed gifts, shall, as soon as is convenient, be distributed to * * * a nonprofit * * * corporation, of Los Angeles, * * * provided that * * * is then an organization described in Section 501(c)(3) of the Code.

If at the time of Trustor's death the status of * * * as an organization described in Section 501(c)(3) of the Code is under challenge or question by the Commissioner of Internal Revenue in any administrative or judicial proceeding, then the Trustee shall withhold the remaining Trust Estate from distribution until either the status of * * * as an organization described in Section 501(c)(3) of the Code has been confirmed in an administrative or judicial proceeding, or * * * has exhausted all administrative and judicial remedies in pursuit of confirming its status as an organization described in Section 501(c)(3) of the Code. If the status of * * * as an organization described in Section 501(c)(3) of the Code is confirmed, then the Trustees shall distribute the entire remaining Trust Estate to * * *. If * * * has exhausted all administrative and judicial remedies available to it and its status as an organization described in Section 501(c)(3) of the Code is not confirmed, or is denied, then the Trustee shall distribute the entire remaining Trust Estate to or among such other organization or organizations, whether domestic or foreign, which are organized exclusively for the purposes of * * * as founded and further developed by Trustor and which is an organization or are organizations described in Section 501(c)(3) of the Code, as the Trustee may in his sole discretion determine. During any period in which the Trust Estate is withheld from distribution pending the outcome of proceedings respecting the status of * * * as an organization described in Section 501(c)(3) of the Code, the Trustee shall, not less frequently than annually, distribute all of the Trust's income to such organization, or among such organizations, as are organized exclusively for the purposes of * * * as founded and further developed by Trustor and which is an organization or are organizations described in Section 501(c)(3) of the Code as the Trustee may in his sole discretion determine.

To insure that decedent's underlying objectives were carried out, he required as "an absolute condition" that the executor of the will and trustee of the related pour-over trust be an * * * in good standing, and specified the names of the preferred individuals. Decedent named * * * as his first choice. * * * was the executor and is currently the trustee of the trust.

In * * * the court found that * * * was not an organization described in section 501(c)(3) of the Code. Nonetheless, as of this writing at least * * * other * * * of * * * currently qualify as charitable organizations. The qualifying * * * are all nonmanagement divisions of * * * On * * * upon the completion of probate, the trustee paid approximately $* * * of income to * * * despite the fact that its charitable status was then under challenge.

BACKGROUND

In * * *, supra, the * * * examined decedent's intent in forming * * * and in seeking to leave his income producing assets (primarily copyrights and trademarks relating to * * * to * * * The court concluded that decedent and other * * * leaders formed * * * in * * * as part of decedent's estate plan. * * * was designed to control the commercial aspects of * * * to control * * * as a whole, and to be a tax exempt organization. Id. at * * * The court found that * * * was necessary because * * * had lost its tax exempt status and decedent needed another tax exempt entity to control the financial resources and income producing property of * * * Id. at * * * Archiving the * * * was incidental to this primary purpose. Id. The court found that * * * was only the latest incarnation of the on- going effort of * * * as a whole to shelter income from taxation. Id. at * * * The court found that, in conjunction with * * * existing options to take over the trademarks and patents of * * * (earlier transferred by inter vivos gift), the bequest would complete * * * control over all publishing, copyright, trademark and patent materials relating to * * * Id. at * * * It noted that under decedent's property distribution scheme, * * * would have absolute control of the bulk of the income producing property of * * * because it stood at the peak of the * * * Id. at * * *

In determining decedent's intent in forming * * * the court found it necessary to examine * * * in the context of * * * as a whole, and rejected * * * assertion that it must be viewed by itself. Id. at * * * The court found that: * * * was inextricably linked to * * * as a whole. Id. at * * * Even though * * * was nominally a separate entity, in fact there was no meaningful separation between it and other * * * entities for purposes of the merits of a tax exemption. Id. at * * * refused to explain or respond to the allegations that decedent and * * * leaders devised * * * as part of a new structure which would mask decedent's actual control of * * * and make it appear that decedent no longer took an active role in running * * * Id. at * * *

The * * * took judicial notice of other * * * litigation and cited a * * * case which, in particular, found that * * * revealed that the purpose of the reorganization which created * * * was to "confuse and defraud the government," and the IRS in particular. Id. at * * *. It took judicial notice of other court decisions regarding the commerciality and tax evasion purposes of the management * * * Id. at * * *. The court noted a pattern of tax evasion.

THE LAW

FEDERAL LAW

Section 2055(a) allows a deduction from a decedent's gross estate in the amount of all bequests, legacies, devises, or transfers to or for the use of any corporation organized and operated exclusively for religious, charitable, scientific, literary or educational purposes. That section carries out the public policy favoring charitable giving. Estate of Burdick v. Commissioner, 96 T.C. 168 (1991).

The deductibility of a charitable contribution hinges upon whether the amount that charity will, in fact, receive is ascertainable at the decedent's date of death. Congress did not intend "that a deduction should be made for a contingency the actual value of which cannot be determined from any known data." Humes v. United States, 276 U.S. 487, 494 (1928). Instead, the amount of the transfer to charity must be "fixed in fact and capable of being stated in definite terms of money." Ithaca Trust Co. v. United States, 279 U.S. 151, 154 (1929); Henslee v. United Planters Bank, 335 U.S. 595 (1949). The time when the charitable bequest must be definitely ascertainable is the date of the testator's death.

The estate so far as may be is settled as of the date of the testator's death. The tax is on the act of the testator [and] not on the receipt of property by the legatees. Therefore the value of the thing to be taxed must be estimated as of the time when the act is done.

Ithaca Trust Co. v. United States, 279 U.S. at 155. The Supreme Court also stated in Commissioner v. Estate of Sternberger, 348 U.S. 187, 199 (1955):

This Court finds no statutory authority for the deduction from a gross estate of any percentage of a conditional bequest to charity where there is no assurance that charity will receive the bequest or some determinable part of it. Where the amount of a bequest to charity has not been determinable, the deduction has properly been denied. Henslee v. Union Planters Bank, 335 U.S. 595, 598-600; Merchants Bank v. Commissioner, 320 U.S. 256, 259-63; and see Robinette v. Helvering, 318 U.S. 184, 198. [Emphasis supplied.]

The executor must prove that the bequest will actually be received by a qualified charity. Treas. Reg. section 20.2055-1(c) provides that in establishing the right of the estate to the deduction authorized by section 2055, the executor should submit the following with the return:

(1) A copy of any instrument in writing by which the decedent made a transfer of property in his lifetime the value of which is required by statute to be included in his gross estate; for which a deduction under section 2055 is claimed. If the instrument is of record the copy should be certified, and if not of record, the copy should be verified. (2) A written statement by the executor containing a declaration that it is made under penalties of perjury and stating whether any action has been instituted to construe or to contest the decedent's will or any provision thereof affecting the charitable deduction claimed and whether, according to his information and belief, any such action is designed or contemplated. The executor shall also submit such other documents or evidence as may be requested by the district director.

A bequest that will never be paid is simply not deductible. See Estate of Bob, 4 T.C.M. 592 (1945).

STATE LAW

* * * follows the cy pres doctrine. Under the cy pres doctrine, the equitable power of a court makes it possible for the court to carry out a testamentary charitable purpose if the testator has expressed a general charitable intent, and for some reason his purpose cannot be accomplished in the manner specified in the will. See * * *. The Service agrees that, where it is applicable under state law, the cy pres doctrine applies to bequests under section 2055. See Rev. Rul. 72-442, C.B. 1972-2. Thus, where a will expresses a general charitable intent, but that intent cannot be carried out in the manner called for in the will, the courts will generally interpret the will in such a manner that charity will ultimately receive the bequest.

DISCUSSION

At the time the will and trust were executed, one day before decedent's death, decedent was aware that the tax exempt status of * * * was being challenged. Thus, the dispositive provisions of the trust leave the residue of the estate to * * * subject to the condition that * * * must have been determined to be a tax exempt organization as of the date of death. If the status of * * * remains under challenge as of the date of death, the trustee is to withhold distribution until * * * tax exempt status is either confirmed or denied. If * * * status is confirmed, the residue is to be then distributed to * * * If * * * tax exempt status is denied, the residue is to be distributed to such qualifying * * * organizations, as the trustee in his sole discretion, chooses. The income earned during any period during which the trustee must withhold distribution is to be distributed annually to such qualifying * * * organizations as the trustee in its sole discretion chooses. As noted above, as of the date of death, at least * * * other * * * organizations enjoyed tax exempt status. Thus, in the absence of reason to believe that the bequest would be directed to noncharitable purposes or entities, a bequest such as decedent's would normally qualify for the estate tax charitable deduction.

In * * * of * * * despite the fact that * * * exempt status remained under challenge, a substantial portion of the charitable bequest was paid by the trustee to * * * This payment is in obvious contravention of the terms of the trust. In * * * the * * * definitively determined that * * * was a nonqualifying entity. In light of the foregoing, a question arises as to decedent's true intent, and in the alternative, as to the likelihood of the trustee's compliance with the terms of the trust. Accordingly, unless it is subsequently determined that * * * is a qualifying entity, we suggest that the government contest the deduction on the following basis. First, decedent did not have a primarily charitable intent, but rather intended the residuary to pass to * * * in all events. Evidence of this intent includes decedent's purpose in forming * * * as the new * * * decedent's ambiguous testamentary documents, and the relationship between decedent's estate and * * *.

Second, even if decedent had a primarily charitable intent, there is no assurance that the trustee will not divert the assets to * * * due to his relationship with * * * and no party will likely challenge such a diversion. Third, the statute and the regulations contemplate that a qualifying charity actually receive the bequest. Fourth, even if the trustee ultimately distributes what remains of decedent's bequest to a qualifying charity, the Code and the regulations permit a deduction only for the value of that portion, determined as of the date of death, which the trustee actually distributes to charity.

A. Decedent intended to transfer the residue of his estate to * * * in all events. The terms of the will and trust, when viewed in conjunction with the surrounding facts, indicate that decedent intended primarily to benefit * * * in all events. Decedent intended to leave his estate to a tax exempt * * * if possible, but if not, to * * * in any event. We believe this is the case because the * * * decedent had created could function according to plan only if the decedent's assets passed to * * * The following facts evidence decedent's intent: (1) * * * was formed for the specific purpose of receiving the bequest in order to commercially manage the properties for the support of * * * (2) the language of the will suggests decedent's primary intent to benefit * * * regardless of its tax exempt status, and; (3) the trustee/executor's relation to * * * insured that he would, in fact, transfer the assets to * * * in all events.

1. PURPOSE FOR FORMING * * *

The decedent and the other * * * leaders formed * * * a "management" division of * * * to receive the bulk of decedent's estate. See * * * supra, at * * * They designed * * * to manage the commercial aspects of * * * to have ultimate * * * authority, and to archive and control decedent's * * * Decedent knew that no management * * * would qualify for tax exempt status since the commercial management of * * * properties had previously resulted in the disqualification of management * * * Id. at * * * Nevertheless, the decedent and the other leaders continued to seek the "holy grail" of having the revenue producing assets of * * * in a tax exempt entity. Id. at * * * This strategy has been characterized by the * * * as "fraudulent." Nonmanagement * * * cannot use the assets as decedent intended, i.e., to make money for * * * as a whole. See id. at * * * (financial structure of * * *. To the extent that an existing tax exempt * * * was reorganized to fulfill decedent's intent, it too would lose its tax exempt status because of the commercial and management focus. See id. at * * * et seq. (commercial purpose is inconsistent with * * * purpose). Thus, decedent did not intend that these assets pass to a nonmanagement division. Only * * * a management * * * could carry out decedent's plan.

2. THE WILL AND TRUST LANGUAGE

The testamentary documents controlling disposition of the residuary evidence decedent's primary intent to benefit * * * in all events. * * * is the only recipient specifically identified in the trust, and is the taker under decedent's primary dispositive provision. Arguably though, and subsequent events support this proposition, decedent intended that the alternative disposition of the estate also benefit * * * Decedent's alternative disposition, to be effective in the event that * * * did not qualify as a charitable organization, provides that the trustee is to transfer the trust corpus to an organization or organizations:

which are organized exclusively for the purposes of * * * as founded and further developed by Trustor and which is an organization or are organizations described in Section 501(c)(3) of the Code, as the Trustee may in his sole discretion determine.

(emphasis supplied).

The placement of the phrase "as the trustee in his sole discretion may determine" at the end the paragraph, and set apart by a comma, arguably gives the trustee the discretion not only to select the alternative charitable recipients, but also to determine whether the organization satisfies section 501(c)(3).

The decedent utilized ambiguous language to afford the trustee an arguable basis for directing the residue to * * * despite the fact that a court might interpret the language differently. Decedent's * * * mandate obfuscating tax issues in this manner. Cf. * * * supra at * * * methods of dealing with IRS under decedent's directives) * * *

* * * Read in this light, the language of the will supports an argument that decedent's intent was to transfer the assets to * * * in all events.

This argument cannot be made based solely on the language of the testamentary documents, however. Only when the dispositive language is read in light of surrounding circumstances known to decedent, and in light of subsequent events, is it at least arguable that decedent contemplated benefitting * * * regardless of * * * lack of qualified status.

3. THE RELATIONSHIP OF THE TRUSTEE/EXECUTOR TO * * *

The relationship of the executor/trustee to * * * evidences the decedent's intent to transfer the assets to * * * in all events. To insure that the trustee/executor transferred the assets to * * * decedent required as "an absolute condition" that the executor of the estate and trustee of the trust be an * * * in good standing and specified the name of the preferred individuals. * * * was his first choice.

By requiring his executor and trustee to be an * * * in good standing, decedent ensured that the trustee would exercise his discretion in favor of * * * * * * had ultimate * * * authority over * * * and thus over the executor/trustee. In addition, only * * * could commercially exploit the assets (which are primarily copyrights and trademarks central to * * * on behalf of * * * in accordance with * * * See * * * supra. The trustee as an * * * has a sworn duty to follow * * * which make * * * the commercial head of * * * Thus, * * * require him to transfer the assets to * * *

B. Diversion of Assets

1. TRUSTEE'S RELATIONSHIP TO * * * Alternatively, the trustee, due to his position as an * * * in good standing, will transfer the assets to * * * regardless of the intent expressed by the will because of his obligation as a * * * to direct the assets to a management * * * We base this argument on the same facts discussed above concerning the executor/trustee's relationship to * * * The diversion of the assets results in a disallowance of the deduction since it was never Congress' intent to grant a deduction for amounts which, in fact, never find their way to a qualifying charity. See Estate of Bob, supra.

2. APPLICATION OF CY PRES DOCTRINE Arguably, under * * * law, a state court could require the trustee to transfer the bequest to a qualifying * * * of * * * under the cy pres doctrine. Decedent arguably expressed a general intent that his estate pass to a qualifying charity. Thus, under state law, a court could construe the will to require the trustee to distribute funds only to those * * * of * * * whose charitable status has not been revoked.

It does not appear that there is any party with standing to enforce the cy pres doctrine who is ready to do so. No * * * of * * * has objected to the transfer of the assets to * * * in the * * * years since decedent's death. * * * controls the other * * * of * * * In addition, * * * of * * * prohibit the assets from passing to a nonmanagement division of * * * Further, the * * * Attorney General has shown no interest in enforcing the bequest, despite the fact that a substantial portion of the bequest has already been diverted to a nonqualifying entity. Thus, it does not appear that anyone will challenge the diversion of the bequest.

C. Documentation of Transfer to a Qualified Charitable Organization

Under the Regulations As required by Treas. Reg. section 20.2055-1(c), the executor must submit such other evidence as the district director requests before the deduction may be allowed. As discussed above, the ambiguities of the trust, decedent's overriding intent, and * * * past record create more than a reasonable doubt that the trustee will distribute the residue to * * * Furthermore, in * * * supra, the * * * emphasized the long standing hostility of * * * toward the payment of taxes and the fact that * * * has been less than forthright in its dealings with the I.R.S. See id. at * * * * * * Given this past history, * * * judicially recognized animosity toward the tax system, and repeated problems regarding tax matters, Treas. Reg. section 20.2055-1(c) reasonably disallows the charitable deduction in the present case. Thus, until such time as the estate demonstrates to the Commissioner though appropriate documentation that the trustee has actually distributed the assets to an organization described in section 501(c)(3), no deduction is allowable.

D. Valuation of Deduction

The value of the residual interest passing to charity as of the date of death determines the amount of a charitable deduction. Cf. Rev. Rul. 73-98, 1973-1 C.B. 407 (residue of estate also reduced by all expenses paid from income). The current payment of income to a nonqualifying entity diminishes the value of the residual interest passing to charity since the charitable beneficiary is deprived of the interim income. Stated differently, a dollar received at the date of death is more valuable than that same dollar received ten years later. Thus, the later the transfer of a dollar of the corpus takes place, the less valuable it is, measured as of the time of death. The actuarial tables used to value a remainder interest following a life income interest base valuation on this premise.

Secondly, we note that the assets constituting the residue are "wasting assets." The assets which were purportedly to pass to charity were primarily copyrights worth about $* * * Since these have limited useful lives, they are wasting assets in much the same way as an oil well. The current "income" presently paid out from the use of this limited resource may deplete the remainder interest. Thus, a portion of the so called "income" may, in reality, be a distribution of the underlying corpus. If the trustee pays such an income interest to a noncharitable beneficiary for a long enough period, nothing will be left for the charitable remainderman. The subject trust, however, requires the trustee to "amortize" a "reasonable" portion of the income to principle. Presumably decedent meant to address the "wasting asset" problem by this language. See Fort Worth National Bank v. United States, 396 F. Supp. 337 (N.D. Tex 1975) for a discussion of this problem.

Accordingly, even if what remains of the residuary is ultimately transferred to a qualifying charity, a deduction will be allowable only for the present value of that portion, determined as of the date of death, (and after verifying that proper adjustments have been made to principal to compensate for the wasting nature of the corpus) which actually is transferred to charity.

EVIDENTIARY MATTERS

Finally, it is clear that the decedent's intent cannot be determined by looking solely to the will and trust instrument, since decedent drafted these instruments as part of a larger plan. See * * * supra at * * * In determining the intent of the decedent in forming * * * the * * * found it necessary to examine * * * in the context of * * * as a whole, and rejected * * * assertion that it must be viewed by itself. Id. at * * * The * * * could discern the true purpose of * * * only by examining the circumstances surrounding * * * formation, notwithstanding * * * attempts to limit the court's inquiry. Since decedent formed * * * to receive the bequest, and to commercially exploit the assets for * * * we must be prepared to establish these facts in this case, just as we did in the * * * including judicial notice of the related cases. It is only in the light of these facts that we can establish a record demonstrating the decedent's true intent in drafting his will and pour-over trust. This document may include confidential information subject to the attorney-client and deliberative process privileges, and may also have been prepared in anticipation of litigation. This document should not be disclosed to anyone outside the IRS, including the taxpayer(s) involved, and its use within the IRS should be limited to those with a need to review the document in relation to the subject matter or case discussed herein. This document also is tax information of the instant taxpayer which is subject to I.R.C. section 6103. Please refer any questions on the above matter to * * * at * * *

By: Daniel J. Wiles
Passthroughs & Special
Industries Branch

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