Year End Review For Charitable Gift Planners - 1999

Year End Review For Charitable Gift Planners - 1999

Article posted in Treasury on 5 May 2003| comments
audience: National Publication | last updated: 18 May 2011


The following is a summary of the rulings, cases and other items we found to be particularly interesting for charitable planning in 1999, including the new legislation on charitable split dollar insurance. Since many News Alerts are delivered from PGDC in any one year, we thought it may prove helpful to cull out the 1999 highlights for your ease of review. It is always a good idea to take a few moments to review the past year as a new year begins.


Emanuel J. Kallina, II, Esquire
Jonathan D. Ackerman, Esquire
Kathy Hanson, Esquire
Michael P. Panebianco, Esquire

The following is a summary of the rulings, cases and other items we found to be particularly interesting for charitable planning in 1999, including the new legislation on charitable split dollar insurance. Since many News Alerts are delivered from PGDC in any one year, we thought it may prove helpful to cull out the 1999 highlights for your ease of review. It is always a good idea to take a few moments to review the past year as a new year begins.

Legislative Developments

One of the "hot topics" for charitable gift planners in 1999 was the proposal, and ultimate passing of, legislation denying charitable contribution deductions for transfers associated with split-dollar insurance arrangements. It began in early February 1999, when Gerald D. Kleczka, D-WI proposed a Bill to deny such deductions. Several days later, Bill Archer, R-Texas and Charles B. Rangle, D-NY proposed H.R. 630, which contained greater detail than the Bill by Kleczka and which proved to be the framework for the legislation signed into law by President Clinton on December 17, 1999. Prior to its ultimate passage, this proposal, in virtually identical language, was attached to several other Bills as a revenue offset provision. A brief summary of each of the Bills follows:

Proposed Legislation

Charitable Life Insurance

Charitable Integrity Restoration Act

Mr. Kleczka introduced a Bill which, if passed, would prohibit charitable split-dollar insurance. The charitable tax deductions will be disallowed on a retroactive basis and the exempt status of a charity engaging in a split-dollar arrangement in life insurance with a private individual after 2/4/99 will jeopardize its tax-exempt status.

H.R. 630

H.R. 630 was introduced by House Ways and Means Committee Chair Bill Archer, R-Texas and ranking Democrat, Charles B. Rangel of New York. This Bill, if passed, will amend section 170 of the Internal Revenue Code of 1986 to specifically prohibit charitable split-dollar insurance. Specifically, this Bill will disallow a charitable income tax deduction for a contribution to charity, when the charity pays any premium on a life insurance, annuity or endowment contract, in which the donor, any family member of the donor or any other person designated by the donor receives any direct or indirect benefit. This provision shall apply to transfers made after February 8, 1999.

H.R. 630 will also impose an excise tax on the charity for making such premium payment in the amount of the premium payment and is effective on the date of enactment of this Bill. For premiums paid after February 8, 1999, the charity must file an annual return indicating, with respect to any premiums subject to the excise tax, the amount of such premiums, the name and taxpayer identification number of each beneficiary and such other information as the Secretary may require.

S. 1134

The Senate Finance Committee released S. 1134 which includes the denial of charitable contribution deductions for transfers associated with charitable split-dollar insurance arrangements.

Amendment to H.R. 434

The Joint Committee on Taxation released its description of a substitute amendment for H.R. 434 to include the denial of charitable contribution deductions for transfers associated with charitable split-dollar insurance arrangements.

Taxpayer Refund and Relief Act of 1999

On August 5, 1999, the House and the Senate passed the Taxpayer Refund and Relief Act of 1999, a $792 billion tax cut package. Title XV -- Revenue Offsets, deals, in part, with charitable life insurance. On September 23, 1999, President Clinton vetoed this Bill.

Tax Relief Extension Act of 1999

The Senate Finance Committee has approved S. 1792, "Tax Relief Extension Act of 1999" which includes a revenue offset provision dealing with charitable split-dollar life insurance identical to the provision included in "The Taxpayer Refund and Relief Act of 1999."

Final Legislation

Charitable Life Insurance

H.R. 1180

On December 17, 1999, President Clinton signed into law H.R. 1180, the "Ticket to Work and Work Incentives Improvement Act of 1999," which includes the denial of charitable contribution deductions for transfers associated with split-dollar insurance arrangements. There are several differences in this final legislation from what was included in earlier proposals, namely, H.R. 1180 (i) provides an exemption for certain annuity contracts purchased to fulfill the obligation under a charitable gift annuity, (ii) permits charitable remainder trusts, under certain circumstances, to hold a life insurance, annuity, or endowment contract, and (iii) states that, in the case of a charitable remainder trust which holds a "personal benefit contract," the excise taxes will apply to the trust rather than the benefitting charity.

Treasury Regulations

Final Regulations

Regulations Revising Actuarial Tables

The IRS has issued temporary and proposed regulations (T.D. 8819; REG-103851-99) which revise the actuarial tables in valuing annuities, interests for life or terms of years, and remainder or reversionary interests. The temporary regulations effect the valuation of inter vivos and testamentary transfers of interests dependent on one or more measuring lives and are effective as of May 1, 1999. The regulations also provide transitional rules intended to alleviate any adverse consequences resulting from the proposed regulatory change.

Proposed Regulations Son of Accelerated CRT

According to the Service, the proposed Regulations are intended to "prevent taxpayers from using charitable remainder trusts to achieve inappropriate tax avoidance." The proposed Regulations provide that a charitable remainder trust shall be treated as having sold, in the year for which a distribution of an annuity or unitrust amount from the trust is due, a pro rata portion of the trust assets to the extent that the distribution of the annuity or unitrust amount (i) is not characterized in the hands of the recipient as income under Sections 664(b)(1), (2), or (3) of the Code and (ii) was made from an amount received by the trust that was not (a) a return of basis in any asset sold by the trust, or (b) attributable to cash contributed to the trust with respect to which a deduction was allowable under Sections 170, 2055, 2106, or 2522 of the Code.

Any transaction that has the purpose or effect of circumventing these rules will be disregarded. If enacted, the proposed Regulations will apply to distributions made by a charitable remainder trust after October 18, 1999.

To the extent that a charitable remainder trust financed a distribution to a beneficiary by borrowing funds or entering into a forward sale or other similar transaction prior to the effective date of these Regulations, the Service may recast the entire transaction to characterize the distribution as gross income rather than corpus or challenge the qualification of the trust under Section 664 of the Code. In addition, the Service may (i) impose the self-dealing tax under Section 4941 of the Code, (ii) treat the trust as having unrelated business taxable income under Section 512 of the Code from the transaction, and (iii) apply any applicable penalties to the participants in the transaction.

IRS Pronouncements and Court Cases

Charitable Remainder Trusts

LTR 9903001 - CRAT Payments to Special Needs Trust

In this Ruling, the IRS holds that an outright gift of one-half of the decedent's personal residence to a charity founded by the decedent and a gift of a remainder interest in the other half of the residence to that charity will qualify for estate tax charitable deductions. A special needs trust established for the decedent's disabled child was the holder of the life estate in the latter one-half of the residence. The IRS states that the decedent's request that the charity and the special needs trust enter into a "use agreement" providing which portion of the property the life estate beneficiary may use does not disqualify the remainder interest for the charitable deduction because the use agreement would be entirely voluntary. Therefore, the decedent's request does not make the charitable gift of the remainder interest subject to a condition or power. Finally, the IRS holds that the payment of the annuity interest from a testamentary charitable remainder annuity trust established by the decedent to the special needs trust for the disabled child's lifetime will not disqualify the charitable remainder annuity trust under Code Section 664. The trustee of the special needs trust has sole discretion to distribute income and principal to the child. Citing Revenue Ruling 76-270, the IRS observes that the trustee of the special needs trust will hold and administer the annuity payments for the child and the special needs trust will be includible in the child's estate because the child has a general power of appointment over the trust assets.

POINTS TO PONDER: This Ruling highlights how charitable planning may be combined with planning for disabled family members. The donor in this Ruling funded at her death a charity (created by the donor) with an outright gift of a one-half undivided interest in her personal residence, a remainder interest in the other one-half undivided interest in the personal residence and a remainder interest in a testamentary charitable remainder annuity trust. Thus, the donor provided a disabled child with a residence and an income stream for the child's life by combining planned giving vehicles.

LTR 199907013 - Discretionary Allocation of Post-Gift Gain

A established a net income with make-up charitable remainder trust ("Trust") for the benefit of B for B's life. A intends to contribute appreciated securities to the Trust, which provides that the trustee may reasonably allocate to the income of the Trust some or all of the post-contribution capital gains realized by the Trust on the sale of any stock, bond, or other security that produced limited or no income during the period owned by the Trust.

Under local law, if the Trust gives the trustee discretion in crediting a receipt or charging an expenditure to income or principal or partly to each, no inference will be made that the trustee has acted improperly because he or she has made an allocation contrary to a provision of local law. Accordingly, the Service held that trust income may include the appreciation in certain Trust assets that occurred since the Trust held those assets, and that the Trust's provision giving the trustee discretion over the allocation of some or all of the post-contribution gain to fiduciary income will not prevent the Trust from qualifying as a charitable remainder trust under section 664.

POINTS TO PONDER: This is a great Ruling. Since December 10, 1998 and the issuance of the Final Regulations, an allocation of post-contribution gain to fiduciary income was clearly permissible. Practitioners have wondered whether providing the trustee with discretion in allocating gain to income may create administrative inconsistencies or provide too much control to the donor or income beneficiary.

The IRS has determined that the flexibility to allocate some or all of the post-contribution gains to fiduciary income is valid. Of course, this determination will provide trustees with greater control over the timing of trust income and the distribution to the income beneficiary. Is the next step permitting the spigot trust with any investment? In answering this question, a cloud has been placed on this Ruling. Frances Shafer, IRS representative, was unaware of this Ruling when questioned at the National Committee on Planned Giving's 12th Annual Conference.

LTR 199915045 - CRT Owns Life Insurance Policy

Grantor proposed to create a charitable remainder unitrust with a bank being the trustee ("Trust"). Under the governing instrument of the Trust, the trustee is to pay quarterly installments to the grantor's stepdaughter, who is the sole income beneficiary of the Trust. The grantor intends to purchase an insurance policy on her spouse's life, fund the policy with enough cash so that no additional premiums are expected to be due, and then assign ownership of the policy to the Trust. Upon the death of the stepdaughter, the trustee will distribute all of the then principal and income of the Trust to charities that qualify as organizations described in sections 170(b)(1)(a), 170(c), 2055(a), and 2522(a) of the Code.

Taking note that the insurance policy is irrevocably payable for a charitable purpose, the Service held that neither the existence or exercise of the trustee's power to pay the annual premiums on the insurance policy will disqualify the Trust as a charitable remainder trust. Additionally, the Service held that (i) the grantor will be entitled to an income tax charitable contribution deduction for the present fair market value of the remainder interest in the insurance policy, (ii) the grantor will be allowed a gift tax charitable deduction under 2522(a) of the Code for the present value of the remainder interest in the Trust, and (iii) the Trust will not be included in the gross estate of either the grantor or his wife because neither retained any interest in or power over any of the property transferred to the Trust and that under the terms of the Trust neither will possess any interest or power with respect to the Trust corpus.

POINTS TO PONDER: Could the donors have contributed appreciated securities with the policy to the CRT to fund the premium payments, with the same tax consequences?

Notice 99-17 - Capital Gain Distributions

Notice 99-17 modifies in two respects Notice 98-20, which the IRS issued to provide guidance on the ordering of capital gain distributions made on or after January 1, 1998, from a charitable remainder trust under Code Section 664(b)(2). First, for taxable years ending after December 31, 1997, the section of Notice 98-20 dealing with pre-effective date capital gains should be ignored. Second, in Notice 98-20's example illustrating the ordering and character rules, the 28% group is changed to gains on collectibles (such as art and coins). These modifications put the IRS's guidance in sync with Code Section 1(h)(13)(D) as added by the Tax and Trade Relief Extension Act of 1998.

POINTS TO PONDER: Does this Notice constitute the guidance planned for 1999 on the treatment of capital gains taken into account by charitable remainder trusts mentioned in the IRS and Treasury's 1999 Business Plan Guidance.

LTR 199919039 - IRA to CRUT

Taxpayer was the President and CEO of Corporation A which merged into Corporation B in 1997. At the time of the merger each corporation had only one class of stock in its authorized capital. On January 2, 1998, Corporation A merged its Plan X, a qualified plan under the Code, with Corporation B's Plan Y, a profit-sharing plan with a cash or deferred arrangement, which is also a qualified plan under the Code. One hundred percent of Taxpayer's account balance in Plan X was in the form of Corporation A's stock, which upon the merger was exchanged for stock of Corporation B. Taxpayer proposes to rollover a portion of his plan to his IRA and to distribute the balance as a lump sum. Taxpayer will then contribute a portion of such stock to a CRUT.

The Service concluded that the distribution from Plan Y which was not rolled-over to the Taxpayer's IRA qualifies as a taxable "lump sum distribution" under the Code. However, because the distribution consisted of securities of the employer corporation (B), it qualifies as an exception to the general taxation rule under section 402(a)(1) of the Code and the built-in gain of the stock is therefore excluded from Taxpayer's gross income (See, section 402(e)(4)(b)). In addition, with respect to the CRUT, the Service held that: (i) Taxpayer will not recognize any gain or loss from contributing the stock received from the qualified plan to the CRUT; (ii) Taxpayer will receive an income and gift tax charitable deduction for the contribution of the non-rollover shares to the CRUT; (iii) the stock transferred to the CRUT will retain Taxpayer's cost basis and holding period for purposes of any subsequent sale by the CRUT; (iv) the four-tier system for characterizing the tax consequences to the income beneficiaries will apply; and (v) the gain from any subsequent sale by the CRUT of the non-rollover stock will be exempt from taxation to either the CRUT, the Taxpayer or Taxpayer's spouse.

POINTS TO PONDER: This Ruling highlights the fact-sensitive and highly technical nature of tax law conclusions. Generally, a taxable event occurs upon the distribution of assets from a retirement plan. However, in this Ruling, a unique set of circumstances provides an exception to the general rule of taxability on the distribution of retirement plan assets. Such circumstances provide an increased benefit to the donor, which promotes the consummation of a significant gift to charity.

Notice 99-31 - FLIPCRUT Reformation Deadline

The Service has announced that it has extended the deadline for special reformations of charitable remainder unitrusts provided in section 1.664-3(a)(1)(i)(f)(3) of the Regulations from June 8, 1999 until June 30, 2000. Additionally, the Service will clarify that the term "legal proceedings" in section 1.664-3(a)(1)(i)(f)(3) includes non-judicial reformations if state law permits them. The Service notes that state law may require the consent of all beneficiaries, including potential beneficiaries, and/or the notification of or consent to a reformation by the state's Attorney General on behalf of the named or unnamed charitable beneficiaries. Non-judicial reformations must be completed by June 30, 2000.

LTR 199936010 - Qualified CRUT Reformation and Bequest

Decedent's Will provides that A percent of the residuary of his estate was to be distributed outright to certain named individuals and that the remaining B percent of the residuary estate is to be held in Trust for period of ten years. During the ten year term, the income of the Trust is to be distributed to named charities in such amounts as the trustee shall determine in the trustees sole discretion. At the end of the ten year term, one-half of the Trust's assets is to be distributed equally among the named charities and the remaining one-half is to be distributed to certain named individuals. In addition, the Will provides that one of the named charities ("Charity") shall receive a fixed amount per year for a period of four years for the purpose of establishing a scholarship in the memory of a certain named individual.

The Service noted that, (i) as it is currently written, the Trust does not qualify for the estate tax charitable deduction under section 2055(a) of the Code because the charitable lead interest is not in the form of a guaranteed annuity or a fixed percentage, distributed annually, of the fair market value of the property, and (ii) the provision in the Will regarding the four yearly payments to Charity is ambiguous because it could be interpreted to commence either in the first year of the Trust of after the ten year period.

The trustee proposes to petition the court to reform the Trust pursuant to section 2055(e)(3) of the Code such that the Trust will be divided into two trusts, Trust A and Trust B, each of which will be funded equally with one-half of the B percent share of the residuary estate. The petition will also request that the provision for the payments to Charity for the scholarship will commence immediately, as of the date of death, and that the trustee of the Trust will serve as trustee of Trusts A and B. As proposed, the trustee of Trust A will pay a unitrust amount equal to six percent of the net fair market value of the assets in Trust A, as determined on the first day of each year, to the charitable beneficiaries, for a period of ten years, at which point the trustee will distribute the remaining principal in Trust A to the named individual beneficiaries. The trustee of Trust B will pay all trust income to the charitable beneficiaries for the ten year period, at which point the trustee will distribute the remaining trust principal to the charitable beneficiaries. In addition, the petition seeks an order authorizing the trustee of (i) Trust A to pay one-half of the amount to be paid to Charity each year for four years out of the unitrust amount and (ii) of Trust B to pay one-half of the amount to be paid to Charity each year for four years out of the trust income and out of trust principal to the extent income is not sufficient.

The Service ruled that (i) the proposed reformation of the Trust, as amended, into a charitable trust and a charitable lead unitrust will be a qualified reformation pursuant to section 2055(e)(3), (ii) based on the facts submitted and representations made, the charitable interest in Trust A will constitute a unitrust interest within the meaning of section 2055(e)(2)(B) of the Code and Regulation section 20.2055-2(e)(2)(vii), provided that it will be a valid trust under local law, (iii) an estate tax charitable deduction will be allowed under section 2055(a) of the Code for the present value of the unitrust interest of Trust A, and (iv) an estate tax charitable deduction will be allowed under section 2055(a) of the Code for the bequest to Trust B provided that Trust B is a valid trust under local law and that such construction is consistent with State law.

POINTS TO PONDER: The specification of the payments one-half from the CLUT and one-half from the charitable trust to meet the scholarship requirements highlights a unique way to meet the philanthropic desires of the donor.

LTR 199952071 - Mortgaged Property in CRT Solution

A limited liability company, which is treated as a partnership for federal tax purposes ("Company"), proposes to contribute appreciated real property encumbered by debt to a limited partnership ("Partnership") for units in the Partnership ("Units"). The general partner of the Partnership is a non-public real estate investment trust which is intended to qualify as a real estate investment trust under Section 856 of the Code ("REIT"). The Partnership uses an interim-closing-of-the-books allocation method with a semi-monthly convention for allocating partners' varying shares in partnership items. It is anticipated that when debt-encumbered property is contributed to the Partnership, the Partnership will almost immediately pay the debt, and close its books on the 15th day of each month. Pursuant to the Partnership's agreement, debt-encumbered property can only be contributed during the first half of each month and charitable donations of the interests in the Partnership can be made only during the second half of each month.

The Partnership agreement provides that limited partners of the Partnership may not convert its Units to shares of common stock in the REIT for a period of two years from the date the limited partner acquires its Units. If the limited partner is a non-profit or charitable remainder trust and had received the Units for less than full consideration, the two-year period will be calculated from the date that the donor of the Units acquired the Units.

Company anticipates holding the Units for two years and then transferring them to a charitable remainder trust ("Trust"), which may in turn exchange the Units for common stock in the REIT to hold as an investment or for future sale. The Trust will pay a unitrust amount to Company for 20 years and the remainder to a charitable organization described in Sections 170(b)(1)(A), 170(c), 2055(a), and 2522(a) of the Code. The unitrust amount will initially be the lesser of trust income or six percent of the net fair market value of the Trust's assets, and will flip to a fixed percentage payout of six percent upon the sale or exchange of interests in the Partnership, or REIT stock, for marketable assets.

The IRS held that, (i) the Company is a permissible grantor of the Trust, (ii) the Trust will qualify as a charitable remainder unitrust, (iii) the Trust will receive no debt-financed property transferred to it by Company, therefore the satisfaction of the debt by the Partnership or its general partner during a semi-monthly period for allocating partners' varying shares in partnership items in which the Trust does not hold any Units, will prevent the Trust from holding the Units subject to acquisition indebtedness under Section 514 of the Code, (iv) the conversion of Units to shares of common stock in the REIT will not result in unrelated business taxable income to the Trust, (v) the Trust will not recognize unrelated business taxable income from activities of the Partnership, (vi) ownership of shares of common stock in the REIT resulting in payment out of the earnings and profits of the REIT which constitute dividends within the meaning of Section 316 of the Code will not result in unrelated business taxable income to the Trust by virtue of Section 512(b)(1) of the Code, and (vii) the sale of the common stock of the REIT by the Trust will not result in unrelated business taxable income by the Trust by virtue of Section 512(b)(5) of the Code. The IRS deferred ruling on whether the transfer of Units to the Trust by the Company, and the subsequent exchange of the Units for common stock of the REIT, should be recharacterized for federal income tax purposes as the conversion of the Units into REIT stock by the Company followed by the subsequent contribution of the REIT stock to the Trust by the Company, based on all facts and circumstances surrounding the transfer.

POINTS TO PONDER: The IRS should always be applauded when its representatives assist donors in placing a charitable gift. This Ruling represents a significant planning opportunity for a vexing donor problem - avoidance of all the problems associated with a gift of encumbered property to a CRT, including grantor trusts, self-dealing, and UBIT issues.

Favorable CRT Reformation Rulings

The IRS continues to issue favorable CRT reformation rulings, especially when scrivenor's error is involved, See, LTRs 199923013, 199924029, 199927040, and 199903015.

Charitable Lead Trusts

LTR 199908002 - S Corp Stock to CLAT and CLUT

The Service has ruled that two irrevocable trusts, funded with the stock of an S corporation, will qualify as charitable lead trusts and that the grantor will be entitled to gift and income tax charitable deductions. Additionally, upon the grantor's death, no portion of the principal will be included in his gross estate. The sole grantor proposed to create two irrevocable trusts: a charitable lead unitrust and a charitable lead annuity trust, both trusts being funded with the stock of a subchapter S corporation. The beneficiary of the charitable lead interests of both trusts is a tax-exempt private foundation of which the grantor is a director and officer. The by-laws of the foundation will be amended prior to the execution of the trusts so that the grantor will not have control over the disbursement of any funds received by either of the trusts. Both trusts will terminate in six years with the remaining principal and any accrued or undistributed trust income either distributed or held in further trust for the benefit of the grantor's descendants.

The Service held that the funding of the two trusts will result in completed gifts and that a gift tax charitable deduction and an income tax charitable deduction will be allowed in an amount equal to the present value of the unitrust interest and the present value of the guaranteed annuity payments.

Noting that as to whether the power of administration of the trusts is exercisable in a fiduciary or nonfiduciary capacity is dependant on the circumstances surrounding the administration of the trusts, the Service held that this question of fact cannot be determined until the federal income tax returns of the parties involved have been examined. Accordingly, the Service reserved the determination as to whether the grantor will be treated as the owner of the trusts under section 675(4) until such time.

POINTS TO PONDER: In light of the fact that the Service did not rule on whether the grantor will be treated as the owner of the trusts, to what extent is the donor risking his charitable and income tax deductions? Is there some other way to accomplish ownership status? Also see LTR 199922007 and 199927010 for other Section 675(4) caveats to establishing grantor trust status.

LTR 199927031 - Testamentary CLAT and CLUT (GST Issues)

The IRS rules that a taxpayer's estate will be entitled to charitable estate tax deductions for the present value of the unitrust and annuity interests in various charitable lead annuity trusts ("CLATs") and charitable lead unitrusts ("CLUTs") to be created and funded pursuant to pecuniary formulas specified in the taxpayer's proposed will and revocable trust because all the necessary variables for the formulas will be fixed and determinable as of the taxpayer's death. The IRS finds that the CLUTs and CLATs will be entitled to charitable income tax deductions for the amounts actually paid to charity in any year. With respect to the generation-skipping transfer tax rulings requested, the IRS holds that (i) the pecuniary bequests to fund the CLUTs and CLATs will not constitute direct-skips for generation-skipping transfer tax purposes because the charitable beneficiaries will be assigned to the same generation as the taxpayer; (ii) taxable terminations for generation-skipping transfer tax purposes will occur upon the expiration of the unitrust term of the CLUTs because all of the remainder beneficiaries of those trusts are skip persons; (iii) the taxpayer's generation-skipping transfer tax exemption may be allocated separately to each CLUT because the pecuniary amounts to be paid to each CLUT and CLAT will be separate and independent shares for generation-skipping transfer tax purposes; and (iv) the denominator of the application fraction for purposes of applying the generation-skipping transfer tax to each CLUT will be equal to the pecuniary amount passing to each CLUT under the taxpayer's will minus the amount allowed as a charitable deduction. Therefore, if generation-skipping transfer tax exemption equal to such denominator is allocated to each CLUT, the CLUTs will have generation-skipping transfer tax inclusion ratios of zero.

LTR 199927010 - Charitable Recipients of CLT Vary

Taxpayer proposes to establish a trust that will qualify as a charitable lead trust under section 2522 of the Code. The trustees are to select the charitable recipients of the lead interest from time to time. In the alternative, the trustees may irrevocably designate one or more charitable recipients in advance of the payment or the year of payment and evidence the commitment by promissory note or otherwise. The remainder beneficiaries are the taxpayer's daughters. The taxpayer retains no power to designate the persons who will receive income or property from the trust. According to the Service, the trust also contained a provision specifying that if "for any year, no applicable federal tax law contains a provision for reduction of tax on account of a charitable gift, no annuity payment is to be made for that year."

Based on the representations made, the Service rules (i) the annuity payable under the terms of the proposed trust will be a guaranteed annuity; (ii) the taxpayer will be entitled to a gift tax deduction based on the actuarial value of the guaranteed annuity payable to the charities from the trust; (iii) except to the extent that the trust has unrelated business income, the trust will be allowed deductions under section 642(c)(1) for amounts of gross income paid out to charitable beneficiaries described in section 170(c) during a taxable year or by the close of the following taxable year if the trustees so elect; and (iv) whether Taxpayer will be treated as the owner of the trust under section 675 will depend on the circumstances attendant upon the operation of the trust, which is a question of fact and will be determined when federal income tax returns of the parties involved have been filed and examined.

LTR 199947022 - Qualified Disclaimer Creates Testamentary CLAT

Taxpayer's Will provides that, upon death, assets with a specified fair market value on the date of distribution are to be placed into Trust 1. Taxpayer's Son will be the trustee of Trust 1. For a period of twenty years commencing on Taxpayer's death, Trust 1 will annually pay Foundation an annuity. The annuity amount is determined by a formula stated in the Will. Foundation is a private foundation organized by the Taxpayer and currently qualifies as a tax-exempt charitable organization under Section 501(c)(3) of the Code. The current Directors and officers of the Foundation include the Taxpayer's Son and Grandson. Upon termination of Trust 1, the remaining principal and undistributed income shall be distributed outright to Son if he is then living, or to his estate if he is not then living.

The Taxpayer's Will also provides that the residuary of the Taxpayer's estate go to Son or to Son's surviving issue per stirpes. If Son or a grandchild is a beneficiary under the Will and makes a qualified disclaimer under Section 2518 of the Code of any or all of their interest, then that portion will be devised to Trust 2. Son intends to disclaim a portion of his interest in Taxpayer's residuary estate.

The terms of Trust 2 are substantially the same as those of Trust 1, except (i) upon expiration of the charitable lead term, the remaining principal and undistributed income shall be distributed outright to Daughter-in-law, if then living, or if not, to her estate; and (ii) the terms include specific provisions regarding distributions to the Foundation, namely, (a) that the distributions are to be set aside in a separate fund and are not to be commingled with other Foundation assets and (b) that any beneficiary who made the qualified disclaimer with respect to the residuary estate will not have any power or authority over the separate funds and will not participate in any manner in the redistribution or allocation of benefits of the separate funds or the direction or selection of charitable beneficiaries. Grandson will be trustee of Trust 2. In addition, the by-laws of the Foundation provide for the segregation of disclaimed property and that such property be managed in all aspects by Directors who have not made disclaimers with respect to such property.

The Service held that, although the annuity amount is not expressly stated, it is determinable as of the date of Taxpayer's death based on the formula as set forth in the Will, and therefore satisfies the "guaranteed annuity" requirements of Section 2055 of the Code and the Regulations thereunder. Accordingly, Trust 1 and Trust 2 qualify as charitable lead annuity trusts and an estate tax charitable deduction is allowed under Section 2055(a) of the Code. In addition, the Service ruled (i) Son's disclaimer with respect to Taxpayer's residuary estate will satisfy the requirements of Section 2518(b)(4) of the Code in light of the Will's terms with respect to Trust 2 and the Foundation's by-laws requiring segregation of the disclaimed funds; and (ii) Trust 1 and Trust 2 will be allowed a deduction under Section 642(c) of the Code for each taxable year in an amount equal to the annuity amount paid by each trust during the taxable year, except to the extent that said Trust has unrelated business income under Section 681(a) of the Code and to the extent that contributions are nondeductiable under Sections 508(d) or 4948(c)(4) of the Code.

Charitable Deductions

Income Tax - TAM 199908039 - S Corp Contributions

The IRS ruled (i) that section 267 of the Code does not defer the deduction of a charitable contribution because section 501(c)(3) organizations do not have gross income with respect to charitable contributions, therefore the matching of deductions and income is not applicable, and (ii) that deductions for charitable contributions made by S corporations are properly passed through to its shareholders and taken in the year that the contribution is actually paid.

The corporation is an accrual-basis taxpayer with a fiscal year ending March 31st. Prior to March 31st, the board of directors authorized a charitable contribution to the related foundation and actually paid the contribution the following May. Under section 267, a person and/or an organization to which section 501 applies are related for purposes of section 267 if the person controls the foundation directly or indirectly. However, the Service ruled that section 267 does not apply to charitable contributions because section 501(c)(3) organizations do not have gross income with respect to charitable contributions.

Income Tax - LTR 199915037 - Pledge of Stock Option

A company, whose common stock is publicly held and listed on an established securities market, pledged a stock option to a foundation allowing the foundation to purchase a specified number of shares of the company's common stock on a specific date. The foundation subsequently sold the option to an unrelated public charity.

Relying on Revenue Rulings 75-348 and 82-197, the Service held that (i) the company is treated as having made a charitable contribution in the year the option is exercised by the unrelated public charity, (ii) the amount of the company's charitable contribution will equal the excess of the fair market value of the shares on the date of exercise over the exercise price, and (iii) the company will be entitled to a charitable contribution deduction.

The corporation elected under section 170(a)(2) to treat the charitable contribution as actually paid in its tax year ending March 31st. However, the Service stated that (i) charitable contributions by S corporations pass through to its shareholders and are subject to the individual limitations on deductibility and (ii) because an S corporation computes its taxable income in the same manner as an individual, the election under 170(a)(2) is not available. Therefore, a shareholder may deduct the charitable contribution only in the year in which payment is actually made to the charitable organization.

Estate Tax - Estate of Fagan, Jr. v. Commissioner, T.C. Memo 1999-46

In this Memorandum decision, the Tax Court rules that (1) the amount included in a decedent's gross estate as a bequest from his mother should be increased because administrative expenses were not payable from the bequest under the terms of his mother's will; and (2) the estate tax charitable deduction for gifts of a portion of the decedent's revocable trust to charity should be reduced because the decedent's will provided that federal estate and state inheritance taxes were payable from the residue of the decedent's estate. Relying on North Carolina law, the Tax Court found that the decedent's mother intended that the specific bequest to the decedent was not to be decreased by either the federal estate tax or the administrative expenses because her will provided that these items were to be paid from the residuary estate. Regarding the second issue, the Tax Court stated that the decedent clearly instructed in his will that all taxes payable by reason of his death should be paid from the residuary estate, without apportionment, prior to its distribution to the trust as residuary beneficiary.

POINTS TO PONDER: Were the decedent's will and revocable trust agreement inconsistent with respect to the payment of estate taxes? What might the decedent have said in his documents to prevent the charitable estate tax deductions from being reduced?

Estate Tax - Estate of Kenneth E. Starkey v. United States, 83 AFTR2d Par. 99-843

At the time of death in February 1990, Decedent had accumulated approximately four million dollars' worth of personal and real property, a portion of which Decedent attempted to bequeath to a church in Chicago and college in Tennessee. Under his will, Decedent bequeathed one-third of his estate to his wife and made specific devises to each of his four children and to a trust for the education of certain persons. The residue of his estate was to be held in a testamentary trust for the benefit of the church and college. At the center of the dispute was whether a reference in the trust provisions to "missionaries preaching the Gospel of Christ" created a third unspecified class of trust beneficiaries or was merely a description of the church.

The estate reported a gross estate of approximately $3.9 million on its federal estate tax return, which was not filed until 1993. The estate claimed approximately $3.7 million in charitable and marital deductions and, after applying the unified credit, reported no estate tax due. Decedent's son, an attorney, unsuccessfully attempted to obtain a determination of tax-exempt status under section 501(c)(3) of the Code for the charitable trust created under Decedent's will. In June of 1996, the IRS issued a "Notice of Deficiency" to the estate, which in part disallowed the entire charitable deduction claimed as a result of the charitable trust. In 1996, an Indiana probate court reformed the trust to include certain required statutory language and construed the reference to "missionaries preaching the Gospel of Christ" as a description of the church. The estate paid the tax deficiency, filed a refund claim which the IRS denied, and then filed suit.

The United States District Court did not give any weight to the state court's reformation of the trust, stating that such reformations can "have no retroactive effect on a completed transaction with an entity that is not a party to the trust agreement or the legal proceedings" and that to allow otherwise "would also cause federal tax liabilities to remain unsettled for years, and to be vulnerable to the after-the-fact actions of private persons to negate the tax consequences of completed transactions in completed tax years." Additionally, the Court noted that the issue before the state court was a matter of federal law and that the United States was not a party to the state court proceeding.

Holding that the trust provided for an unspecified class of beneficiaries ("missionaries preaching the Gospel of Christ"), the Court concluded that the trust did not comply with the requirements of section 2055 of the Code because the estate could not demonstrate that (i) the testator specifically ordered that the trust property be used or held exclusively for charitable, religious, or other exempt purposes and (ii) a failure by the trustees to adhere to such charitable purposes would constitute a breach of fiduciary duty under the trust instrument. Additionally, the Court stated that "merely describing a trust as charitable does not ensure its compliance with federal laws for tax exemptions."

POINTS TO PONDER: Could the estate have obtained a better result by treating the testamentary trust as a non-qualified split-interest trust and following the reformation procedures under Code section 2055(e)? See TAM 9531003.

Income Tax - Notice 99-36 - Charitable Split-Dollar

In Notice 99-36, the Service describes how the typical charitable split-dollar transaction works and provides promoters' arguments in favor of the transactions including the Service's response to those arguments.

The Service states that (i) no charitable income or gift tax deduction will be allowed to a taxpayer who participates in this type of transaction, based upon the partial interest rule, (ii) depending on the "facts and circumstances," it may challenge the tax-exempt status of a charity that participates in charitable split-dollar insurance transactions on the basis of private inurement or impermissible private benefit, and (iii) it may assess taxes on excess-benefit transactions, self-dealing, and taxable expenditures under sections 4958, 4941, and 4945 of the Code.

Other possible penalties the Service may impose on participants in charitable split-dollar insurance transactions include the accuracy-related penalty under section 6662, the return-preparer penalty under section 6694, the promoter penalty under section 6700, and the penalty for aiding and abetting the understatement of tax liability under section 6701. Additionally, a charity that provides written substantiation of a charitable contribution in connection with this type of transaction may be subject to section 6701.

Valuation - Daniel L. Herman, et ux. et al. v. United States, 84 AFTR2d Par. 99-5413

A hospital filed a voluntary petition under Chapter 11 of the Bankruptcy Code in April 1987. Two businessmen ("Plaintiffs") and their friend desired to reopen the hospital for the community and formed a limited liability company, recruited a hospital board, and worked with various federal, state, and local officials to accomplish this goal. They learned that the interim administrator of the hospital was planning to auction off all of its equipment and hoped to clear $37,000 after paying the costs of the auction. The bankruptcy court accepted the Plaintiffs offer to buy all of the hospital's equipment for $40,000 and each of the Plaintiffs contributed $20,000 for the purchase in October 1998. In December 1990 the Plaintiffs donated the equipment to Johnson County Hospital, Inc., the hospital-to-be. One of the Plaintiff's accountants suggested that they get the equipment appraised so that they could each take a charitable deduction for the gift. The Plaintiffs asked the hospital's administrator to find some people to do the appraisals, and in December 1990, the equipment's fair market value was estimated to be $1,037,348 by one appraiser while another appraiser estimated the resale value of the equipment at $1,002,380.00 in January 1991. The Plaintiffs each claimed a charitable contribution deduction in the amount of $501,190, one-half of the lower estimate, for tax year 1990, and carried the excess contribution deduction forward to tax years 1991, 1992, and 1993.

The IRS audited the Plaintiffs and allowed each a charitable contribution deduction for tax year 1990 in the amount of $20,000, representing each Plaintiff's share of the purchase price of the equipment, and imposed a gross valuation misstatement penalty.

The IRS initially argued that the Plaintiffs are not eligible for any charitable deduction. The U.S. District Court for the Eastern District of Tennessee found that the IRS had previously indicated that the Plaintiffs are, in fact, entitled to charitable deductions and may not suggest otherwise at this late stage of the proceedings. The Court stated that the only issue, therefore, is the determination of the fair market value of the donated property and the propriety of the gross misstatement of value penalties.

The Court did not agree with the IRS' position that the bankruptcy court was a willing seller not compelled to sell and that the price the Plaintiffs paid for the equipment is relevant to the determination of the fair market value of the donated property. The evidence suggests that the sale of the equipment was made in haste, without objection from the creditors, and without a hearing on valuation. Furthermore, the Court noted that while the Weitz case had used the bankruptcy sale price for valuation purposes, it is distinguishable on its facts and was therefore inapplicable in the present case.

Even though the Court recognized that the appraisal did not meet all of the technical requirements of a "qualified appraisal," it stated such failure actually bolsters the Plaintiffs' position. The Court found the appraiser fully qualified and noted that, when asked to survey and evaluate the equipment at the hospital, the appraiser had no idea that his report would be used for tax purposes. Furthermore, the Court took note that the appraiser was not paid for his services and had no reason to overvalue the donated equipment because there was a possibility his company would have to replace the equipment in the future.

Accordingly, the Court stated that it was justified in relying on the appraisal for deciding the issue of valuation and held that the fair market value of the equipment was $1,002,380. In addition, the Court found no basis for penalizing the Plaintiffs under Section 6662(a) of the Code for a gross valuation misstatement in light of accepting the appraised amount. Therefore, the Court granted the Plaintiffs motion for summary judgment and held that the Plaintiffs are entitled to a refund of the additional federal income tax, interest, and tax penalties assessed against them.

POINTS TO PONDER: There is a difference between perception and reality. We likely will never know what really happened in this case. With respect to perception, it is clear that the IRS made at least one fatal litigation flaw - it did not present its own independent appraisal of value of the equipment. In this case, good facts presented at trial make a good result for the donors. However the strength of this case as precedent is questionable.

Gift Annuities

Revised Rates

The American Council on Gift Annuities has revised the charitable gift annuity rates it suggests for transfers on or after July 1, 1999. It should be noted that not all charitable organizations issue charitable gift annuities and, of those that do, some may deviate from the ACGA suggested rates.

Ozee v. American Council on Gift Annuities, Inc. (No. 96-11439) (5th Cir. 1998)

The United States Court of Appeals for the Fifth Circuit ruled that antitrust claims alleging price fixing in setting charitable gift annuity rates against the American Council on Gift Annuities, various charities and other parties are dismissed because of the Charitable Donation Antitrust Immunity Act of 1997. However, the Court remanded the case to the lower court to determine if any state law claims survive. The Court sanctioned the American Council on Gift Annuities and the other defendants in the case for their earlier frivolous appeal (prior to the enactment of the 1997 Act) and ordered the defendants to remit $15,000 to the plaintiffs.

As background to the instant case, the guardian of an annuitant sued the American Council on Gift Annuities, a number of charities and various other parties for price fixing in setting charitable gift annuity rates. Congress then passed the Charitable Gift Annuity Antitrust Relief Act of 1995, which exempted Code Section 501(c)(3) charities' usage of the same charitable gift annuity rate from federal antitrust laws and from similar state laws. Texas passed similar legislation.

In reliance on the 1995 legislation, the American Council on Gift Annuities and the other defendants filed a motion to dismiss the plaintiffs' claims. The lower court denied the motion to dismiss because the 1995 Act only protected charities exempt under Code Section 501(c)(3) and some of the defendants were not exempt organizations. The defendants appealed the denial of their motion to dismiss to the Fifth Circuit. The Fifth Circuit dismissed the defendants' appeal in 1997 for lack of jurisdiction and imposed sanctions on the defendants for filing a frivolous appeal. The defendants then appealed to the United States Supreme Court and sought additional legislative assistance from Congress.

Congress stepped in again by passing the Charitable Donation Antitrust Immunity Act of 1997, which, among other things, broadened the relief provided in the 1995 Act so that the immunity applies to non-charities as well as to charities. As in the case of the 1995 Act, the 1997 Act covers both federal antitrust laws and similar state laws. The 1997 Act was given retroactive application to all cases pending on the date of its enactment. After the passage of the 1997 Act, the United States Supreme Court vacated the Fifth Circuit's earlier judgment with respect to the defendants' appeal of the denial of their motion to dismiss and remanded the case to the Fifth Circuit for further consideration in light of the 1997 Act.

In the instant case, the plaintiffs conceded that the 1997 Act applies but urged the Fifth Circuit to remand the case to the lower court for consideration. The Fifth Circuit denied this request because it said the 1997 Act clearly renders the antitrust issues moot and no additional fact finding is necessary. Instead, the Fifth Circuit dismissed the antitrust claims but remanded the case to the lower court for determination of whether any state law issues remain open.

Finally, as to the sanctions, the defendants argued that the earlier frivolous appeal no longer existed because the Supreme Court vacated the Fifth Circuit's prior judgment and that it would be improper for the Fifth Circuit to reimpose the sanctions given the defendants' successful outcome in the current appeal. They also asserted that the Fifth Circuit had not read the 1995 Act as broadly as Congress had intended. The defendants suggested that the case involved an issue of first impression and so was not frivolous. The Fifth Circuit disagreed and reimposed the sanctions against the defendants for the earlier frivolous appeal. The defendants were ordered to pay $15,000 to the plaintiffs. The Court noted that the issue of the frivolity of an appeal must be judged according to the law as it exists at the time of the appeal. The Court also observed that the "novelty" of an appeal does not preclude the imposition of sanctions.

On remand from the United States Supreme Court, the Court of Appeals for the Fifth Circuit dismissed antitrust claims alleging price fixing in the setting of charitable gift annuity rates on the basis that these claims were rendered moot by the Charitable Donation Antitrust Immunity Act of 1997. The Fifth Circuit remanded the case to the lower court to determine if any state law issues remain unresolved. Despite the successful outcome for the defendants, the Fifth Circuit reimposed sanctions against the defendants. The sanctions stemmed from the defendants' earlier appeal of the lower court's denial of their motion to dismiss after the enactment of the Charitable Gift Annuity Antitrust Relief Act of 1995 but prior to the enactment of the 1997 Act.


Action on Decision -- Acquiescence - Potential Capital Gains Tax

The IRS has acquiesced to the Second Circuit's ruling in Eisenberg v. Commissioner, 155 F.3d 50 (1998) which held that when valuing closely held stock which is the subject of a gift, an adjustment for potential capital gains tax liabilities should be applied, regardless of whether a liquidation or sale of the Corporation's assets was planned at the time of the gift.

Step Transaction

Ferguson v. Commissioner , 83 AFTR2d Par. 99-648

In Ferguson v. Commissioner, three individuals donated appreciated stock to charitable organizations immediately before their corporation was sold to another corporation in a tender offer. The Tax Court had held that the taxpayers were taxable on the gain in the stock transferred under the anticipatory assignment of income doctrine.

Factually, the taxpayers and their children owned 18.8 percent of the stock of American Health Companies Inc. ("AHC"). In July of 1988, AHC entered into a merger agreement with two acquiring corporations ("X"). Under the agreement, X was to purchase AHC's stock in a tender offer and then merge into AHC.

On August 3rd, AHC's board voted on the tender offer made by X. The taxpayers abstained from voting, as board members, on the tender offer; nonetheless, the offer was approved.

Between August 15th and 21st, the taxpayers executed "donation-in-kind" records stating their collective intention to donate 61,111 shares of AHC stock to charities. The taxpayers' stockbroker ("Broker") helped the taxpayers create separate accounts for ALL of their respective stockholdings. On August 26, the charitable foundations were formed.

As of August 30th, more than 50% of AHC's outstanding shares had been tendered or guaranteed. On September 8th, the Broker transferred the shares to the newly formed charities, at which time over 95% of the outstanding shares of AHC stock had been tendered or guaranteed. On September 9, 1988, the merger took place, with AHC stock being traded for X stock.

The IRS determined that the taxpayers were taxable on the gain attributable to the AHC shares that were donated to the charities. The Taxpayers argued that (i) the gifts had been made on August 15th and 21st, (ii) the charities were not legally obligated to tender their AHC stock, (iii) the right to the tender offer's proceeds did not mature until October 12th when X's directors adopted a resolution stating the terms of the merger, (iv) and Broker acted as agent for the charities, so the gifts were completed when they delivered their stock certificates to the Broker on August 15th and 21st.

The Tax Court held that Broker was not an agent of the charities, but instead an agent of the taxpayers, and stated "[taxpayers] have failed to explain how the gifts to the charitable foundations occurred on August 15, 1988, and August 21, 1988, respectively, when the [charitable] foundations were formed on or about August 26, 1988."

The Ninth Circuit upheld the Tax Court's decision and adopted the "anticipatory assignment of income" doctrine, which states that "once a right to receive income has "ripened" for tax purposes, the taxpayer who earned or otherwise created that right, will be taxed on any gain realized from it, notwithstanding the fact that the taxpayer has transferred the right before actually receiving the income." The Ninth Circuit also stated that "to determine whether a right has "ripened" for tax purposes, a court must consider the realities and substance of events to determine whether the receipt of income was practically certain to occur."

POINTS TO PONDER: Does this Ninth Circuit Court of Appeals case blur the lines established by Palmer, Revenue Ruling 78-197 and its progeny?

Leonard Greene, et ux. v. United States , 84 AFTR2d Par. 99-5108, No. 98-6038 (July 23, 1999)

Leonard and Joyce Greene ("Greene") made gifts of the long-term capital gains portion of futures contracts to a charity. The United States Court of Appeals for the Second Circuit ("Second Circuit") held that the unrealized difference between the fair market value and tax basis of the contracts must be recognized as taxable income under section 1256 of the Code at the time of the gift to charity. The Second Circuit was facing yet another appeal by Greene in this ongoing saga of gifts of futures contracts. Earlier, the Second Circuit remanded the case back to the District Court with the instructions that it apply section 1256 in proceedings consistent with its opinion, i.e. that Greene must adjust the value of the futures contracts to reflect their fair market value at the time of the gift and to recognize any economic gain or loss.

On remand, Greene argued that the Second Circuit did not specify how to calculate the amount of economic gain realized at the time of the donation. Greene took the position that section 1256(a)(2) of the Code required a "proper the amount of any gain...subsequently realized...," i.e. they asserted that since they received no actual gains at the time of the donation nor at the time of the charity's subsequent liquidation of the contracts, the "proper adjustment" required by section 1256(a)(2) of the Code should have entailed a reduction of their taxable gains to zero. The District Court rejected Greene's argument and held that section 1256 of the Code required Greene to treat the charitable contribution as if they had donated cash and that they were required to recognize any gain or loss. Greene appealed this decision to the Second Circuit.

The Second Circuit affirmed the District Court's holding and rejected Greene's position that they did not realize gain or loss from the charitable donations and that all gains are realized by the charity when the contracts are eventually liquidated. Greene had argued that section 1256(a)(2) of the Code entitled them to a "proper adjustment" to zero "for gain or loss taken into account by" adjusting the valuation of the contracts to reflect current market values pursuant to section 1256(a)(1) of the Code. Referring to its earlier decision, the Second Circuit explained that when two statutes conflict, absent a contrary directive from Congress, the statute with the more specific provision controls. Accordingly, the Second Circuit applied the recognition rules of section 1256 of the Code rather then the general language of section 1001 of the Code, stating that "an amount may be "realized" within the meaning of 1256(a)(2) even if it would not constitute an "amount realized" under 1001(b)." In addition, the Court stated that Greene will not be subject to double taxation because once the transfer has taken place, Greene terminated their interest in the property and will not recognize any further tax consequences from the charity's subsequent disposition of the transferred property. The Second Circuit cited additional support for its conclusion from section 1256's legislative history, where Congress specifically adopted the accrual method of accounting. Accordingly, the Second Circuit held that the transfer to charity created an amount subsequently realized within the meaning of section 1256(a)(2) of the Code, even though Greene never received the sum, because it is "subsequent" to all previous adjustments to the valuation of the futures contracts as mandated by section 1256(a)(1) of the Code.

POINTS TO PONDER: (1) In the first proceeding before the District Court and the Second Circuit, the Step Transaction Doctrine was raised. Why did the Service fail to raise this argument during the second round? Is it because the IRS had lost in its attempt to broaden the applicability of this doctrine by the same court which decided Blake? (2) Is a section 170(f)(3) analysis relevant (because the gift of the capital gains portion of the contract was not an undivided interest in an asset or a valid split interest under one of the other exceptions)?


United Cancer Council, Inc. v. Commissioner, 83 AFTR2d Par. 99-416

On appeal, the Seventh Circuit has reversed the Tax Court in United Cancer Council Inc. ("UCC"), holding that the now defunct charity's net earnings did not inure to the benefit of its outside fundraiser, Watson & Hughey Company ("W&H") and, therefore, did not violate the prohibition against private inurement.

The Tax Court had previously upheld the Service's second ground for revoking UCC's exemption, i.e., private inurement, but did not rule on its first ground, private benefit. The only issue before the Seventh Circuit was whether a part of UCC's net earnings inured to the benefit of a private shareholder or individual.

The facts were undisputed. When UCC was formed in 1984, a committee of the board picked W&H as the best prospect for raising funds to ensure its survival. Another committee negotiated the contract. Some of the terms of the contract which the Service found troubling, and based its classification of W&H as in insider of UCC, included: (1) that W&H would "front" the expenses of the fundraising campaign with UCC reimbursing it as soon as the campaign had generated sufficient donations, (2) that in return, (a) W&H would be UCC's exclusive fundraiser for the length of its five-year contract, (b) W&H would be given co-ownership of the list of prospective donors generated by its fundraising efforts and (c) UCC would be prohibited from selling or leasing the list both during the term of the contract and after it expired. W&H had no similar restriction.

During those five years, as a result of W&H's efforts, UCC raised $28.8 million. The associated expenses and reimbursements pursuant to the terms of the contract came to $26.5 million. The Service argued that, based on these facts, 90 percent of the contributions received by UCC during the five-year term were paid to W&H, making W&H the actual recipient of the contributions. It further argued that UCC was completely under the control of W&H during those five years because it was UCC's only fundraiser.

The Seventh Circuit held that these points bear no relation to the prohibition against private inurement, stating that the prohibition was "designed to prevent the siphoning of charitable receipts to insiders of the charity, not to empower the IRS to monitor the terms of arm's length contracts made by charitable organizations with the firms that supply them with essential inputs..." Since the Tax Court did not rule on the Service's argument that UCC had conferred a private benefit, the Seventh Circuit remanded the case to the Tax Court for decision on this issue.

POINTS TO PONDER: The result is surprising where 90% of the monies raised inured to the benefit of the private fundraiser. However, private inurement and benefit are increasingly raised as concerns for outright and planned gifts, a recent example of which is charitable split-dollar life insurance. The result in this case could generate some legislative interest, the breadth of which, whether intentional or unintentional, could adversely impact planned giving. The Seventh Circuit remanded the case to the Tax Court on the private benefit claim. The Tax Court's holding will be interesting in that regard.

The Fund for Anonymous Gifts v. IRS , 83 AFTR2d Par. 99-654

William Lehrfield established The Fund for Anonymous Gifts ("Fund") and named himself as trustee in 1993. Fund's purpose was to (i) allow donors to make charitable contributions on an anonymous basis and still be eligible for the charitable contribution deduction, and (ii) allow donors to make a donation to Fund with the condition that the donation be invested by the trustee as directed by the donor, and that the income from the investment be donated on an anonymous basis at a later time as specified by the donor to the ultimate charitable recipient. Under the trust agreement, the trustee was bound by any enforceable conditions subsequent which a donor placed on his donations, which included who the ultimate recipient of the donation is, when the donation is made, and how the donation is invested.

The District Court held that Fund failed to meet its burden of proving that it was formed to operate for an exempt purpose and did not address whether Fund qualified as a publicly supported charity under 170(b)(1)(A)(vi). On appeal, Fund agreed to amend its trust agreement to eliminate the provision which allowed conditions subsequent on the donations to Fund. The D.C. Circuit Court of Appeals ordered the IRS in March 1999 to show cause as to why its position denying tax-exempt status to Fund should not be reversed.

In its response to the Court of Appeals' motion to show cause as to why Fund should not prevail given that it enacted a retroactive amendment eliminating the control provision, "the government [offered] an incoherent response." Additionally, the Court stated that "the government was unable at oral argument, and is unable a year later, to offer any understandable reason why, apart from the control provision (now removed), [Fund] is not a section 501(c)(3) organization."

Accordingly, the Court (i) vacated the District Court's decision and ordered the District Court to enter a favorable summary judgment to Fund on the section 501(c)(3) determination, and (ii) remanded the issue as to whether the Fund should be classified as a publicly-supported charity rather than a private foundation.

POINTS TO PONDER: The IRS' concern regarding a donor directed fund is clear -- how does this decision affect the recently-popular and approved-by-LTR commercial charitable funds?

Oregon State University Alumni Ass'n, et al. v. Commissoner, 84 AFTR2d Par. 99-5400

Two alumni associations went to trial in the Tax Court on stipulated facts, which are substantially the same in both cases (each schools' alumni association conducted their affinity credit card programs together). Essentially, each alumni association raised money for their schools by letting a bank offer credit cards using their names. The agreement required the alumni associations to provide accurate mailing lists and materials, which the bank could reproduce and distribute to alumni, advertising the program at least once a year. The alumni associations spent approximately twelve hours a year of clerical staff time on matters relating to the cards, such as preparing the mailing lists on magnetic tapes for the bank. In addition, the alumni associations did a little more promotion than they were required to do, such as a few printings and mailings, for which the bank reimbursed most of their expense, meetings with the bank by each association's executive director once a year for an hour or two, and occasionally pass on information about an alumnus who called about some credit card problem. Combined, the two schools grossed approximately $1.1 million during the two tax years in question. The IRS argued that the money was unrelated business income but the Tax Court disagreed and held that it was royalty income.

On appeal, the IRS argued that the Tax Court misunderstood the statutory definition of royalties and that the alumni associations did too much work for the money to be royalties. The IRS also urged the Ninth Circuit to read Sierra Club, Inc. v. Commissioner to exclude from royalty income any money received from the performance of services, and to treat money as received from services if the recipient performed any services to get it. The IRS argued that all receipts from the affinity card program should be unrelated business income. However, the Court noted that the IRS did not argue for an allocation of the $1.1 million in revenue raised in a two-year period in proportion to the 50 or so hours of service provided by the two alumni associations, with the balance allocated to royalty income.

The Ninth Circuit analyzed statutory and case law and stated "the royalty exclusion cannot be an all-or-nothing proposition" and that "the question comes down to whether...the bank was paying the alumni associations for...the good will associated with the schools' names, seals, colors and logos, or whether it was paying them for mailing list management and promotional services." Based on the facts, the Ninth Circuit upheld the Tax Court's decision that the income constituted royalties and therefore not taxable as unrelated business income.

Multidisciplinary Practice

One of the most controversial issues facing the legal, financial and accounting professions this year was the consideration of a "Multidisciplinary Practice" (or MDP). The MDP would permit an arrangement in which lawyers partner and share fees with professionals from other disciplines. The House of Delegates of the American Bar Association (ABA) recently voted not to change the professional rules which prohibit the sharing of fees among lawyers and nonlawyers. Such vote was instigated by a Commission established by the ABA to consider the implications of an MDP. That Commission recommended the change in the professional rules eliminating the prohibition for sharing fees and partnering with nonlawyers. Considering the potential issues involved with MDPs, the rapidly changing environment in the financial services market, and the globalization of the marketplace, the consideration of MDPs will likely continue. Recently, the ABA sponsored an internet meeting on this issue with worldwide participation. If interested, go to

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