Charitable Giving Without Trusts Deduction Rules And Techniques

Transcription

1 Charitable Giving Without Trusts Deduction Rules And Techniques Martin Hall All references in this outline to IRC or Code mean the Internal Revenue Code of 1986, as amended. All specific section references are to the Internal Revenue Code of 1986, as amended, unless otherwise indicated. A. Introduction 1. As a general rule, a donor is entitled to an income tax charitable contribution deduction for the full amount of the donor s contribution to a qualified charitable organization In the case of a cash gift, the deduction amount is simply the amount of the cash contributed. In the case of a gift of property, the deduction is measured by the fair market value of the property contributed. 2. A deductible charitable gift reduces the taxable income of the donor and thereby reduces the donor s taxes by an amount equal to the amount of the deduction multiplied by the donor s marginal income tax rate. The true cost of the gift to the donor is the value of the gift less the tax saving. In addition, since a gift of appreciated property to charity is not considered a sale or ex- Martin Hall is a partner with Ropes & Gray LLP in Boston, Massachusetts, and a frequent speaker at ALI-ABA s estate planning courses of study. The author would like to express his thanks to Jerry J. McCoy, who has given this presentation in prior years and upon whose materials this outline is based. A complete set of the course materials from which this outline was drawn may be purchased from ALI-ABA by calling CLE-NEWS and asking for customer service. (Have the order code SJ087 handy). Or order online at 39

2 40 ALI-ABA Estate Planning Course Materials Journal April 2005 change, the donor does not recognize gain or loss at the time of the transfer. This can be viewed as a further benefit to the donor. 3. Similar deduction rules apply in the transfer tax arena, albeit that such rules prevent a tax from arising from the transfer as opposed to creating a tax benefit. Accordingly, in computing taxable gifts, a donor is allowed to deduct most charitable and similar gifts For transfers at death, section 2055 provides that all bequests, legacies, devises or transfers for public, charitable, and religious uses can be deducted in determining the decedent s taxable estate. 4. Exceptions to these rules abound. The exceptions are not uniform in their application, with the result that certain charitable gifts may not give rise to a transfer tax but do not provide an income tax deduction. The exceptions fall into three broad categories: those arising from the legal character of the recipient organization; those arising from the type of property transferred; and those arising from the property interest transferred. A discussion of these exceptions will be the focus of this outline. B. Legal Character Of The Charitable Organization 1. Foreign Charities a. Under section 170(c)(1) (5), a donor receives an income tax charitable contribution deduction only for gifts to: i. A State, a United States possession, the United States government or the District of Columbia, or any political subdivision, for public charitable purposes; ii. A corporation, trust, community chest, fund, or foundation created or organized in the United States, any State, the District of Columbia, or any U.S. possession, and operated exclusively for charitable, religious, scientific, educational, and other limited purposes; iii. iv. Domestic veterans organizations and lodges; and Non-profit cemetery companies. b. With the exception apparently of the last category above, no deduction is permitted for gifts to foreign governments or charities. It should be noted, however, that a deduction will be permitted for a gift to a domestic charity, even though all or some portion of the funds of the domestic organiza-

3 Charitable Giving Without Trusts 41 tion may be used in a foreign country. Treas. Reg A-8(a)(1). The domestic charity must, however, have control and discretion as to the use of grants it makes overseas and must review and approve overseas projects as being in furtherance of its own exempt purposes. See, e.g., Rev. Rul , C.B. 48; Rev. Rul , C.B The domestic charity cannot serve as a mere conduit. c. For gift and estate tax purposes, the geographic limitations are not as broad. The regulations state clearly that the deduction is not limited to domestic corporations or associations, or to trustees for use within the United States. Treas. Reg (a) and (a)-1(a). The foreign organization must, however, meet the general requirements of section 501(c)(3). The principal area of controversy concerns gifts to foreign governments, which are not deductible for transfer tax purposes if made for public purposes but which may be deductible if made for charitable purposes. Old Colony Trust Company v. United States, 438 F.2d 684 (1st Cir. 1971) (bequest to Canadian public hospital corporation deductible as gift for charitable purposes); Kaplun v. United States, 436 F.2d 799 (2d Cir. 1971) (gift of coin collection to State of Israel on condition that it be exhibited in museum deductible for estate tax purposes); but cf., Edwards v. Phillips, 373 F.2d 616 (10th Cir. 1967), cert. denied, 389 U.S. 834 (1967) (bequest to Danish school district for betterment of schools or aid to students not deductible). 2. Private Foundations a. For income tax purposes, a donor only receives a charitable contribution deduction for a gift of appreciated property to a private foundation measured by the lesser of the donor s cost basis and the fair market value of the property. 170(e)(1)(B)(ii). This rule does not apply, however, and a deduction for full fair market value is permitted, if the recipient foundation is: i. A private operating foundation as described in section 4942(j)(3); ii. A conduit foundation which distributes all contributions received for a particular year by the 15th day of the third month of the following year, as described in section 170(b)(1)(E)(ii); or iii. A pooled common fund foundation as described in section 170(b)- (1)(E)(iii).

4 42 ALI-ABA Estate Planning Course Materials Journal April 2005 b. In addition, if the property consists of qualified appreciated stock, a full fair market value deduction is permitted. Qualified appreciated stock is defined as stock of a corporation for which market quotations are readily available on an established securities market. 170(e)(5)(B); Todd v. Comm r, 118 T.C. 334 (2002) (nonlisted bank holding company stock was not qualified). Note that the definition does not include bonds or other debt instruments. Furthermore, stock loses its status as qualified appreciated stock if more than 10 percent of the stock by value of the particular corporation has been contributed by the donor or members of the donor s family. 170(e)(5)(C). c. Contributions to purely private foundations are also subject to different annual deduction limits for income tax purposes. In general, a donor can claim an income tax charitable contribution deduction in any year not to exceed 50 percent of the donor s contribution base (adjusted gross income computed without any net operating loss carryback) for that year. 170(b)- (1). If the property contributed would generate a long-term capital gain if sold, the annual deduction limit is reduced to 30 percent of the donor s contribution base. 170(b)(1)(C)(i). In the case of gifts to private foundations, these deduction limits are reduced to 30 percent and 20 percent of the contribution base respectively. 170(b)(1)(B) and 170(b)(1)(D). Any contribution amount that exceeds any of these limitations may be carried forward and deducted subject to the same limits in each of the five years succeeding the year of the contribution. Id. d. For gift and estate tax purposes, private foundations are treated no differently from public charities and full deductions are permitted, irrespective of the nature of the property transferred. In addition, the gift and estate tax deductions are without limit. C. Type Of Property Transferred 1. Appreciated Assets a. For purposes of computing the income tax charitable contribution deduction, a donor is required to reduce the value of property contributed by any gain that would not be taxed as long-term capital gain if the property were sold. 170(e)(1)(A) and This rule affects inter alia the following types of property gifts:

5 Charitable Giving Without Trusts 43 i. Short-term capital gain property. If the donor has not held the property for one year or more, the current long-term capital gain holding period, the donor s deduction for the appreciated asset will be limited to the donor s cost basis in the asset. ii. Business inventory. Subject to limited exceptions set forth in sections 170(e)(3) and (4) for inventory property gifts by corporations for the care of the ill, the needy or infants or which meet the definition of qualified research contributions, a gift of business inventory property will only generate a deduction measured by cost basis. See, e.g., Greer v. Comm r, 70 T.C. 294 (1978), aff d, 634 F.2d 1044 (6th Cir. 1980) (donation of race horses by dealer). iii. Creative works. Likewise, since works of art and manuscripts are ordinary income assets in the hands of their creators, a gift of such property by the artist or author results only in a cost basis deduction, or in no deduction at all if all costs attributable to the creative work have already been deducted by the donor as a business expense. Treas. Reg A-1(c)(4). This same rule applies to the donor of a work of art or manuscript who acquired the property by inter vivos gift from the creator and 1221(a)(3)(C). In contrast, due to the operation of the stepped-up basis rules at death that remove the ordinary income taint, a person who inherits a work of art from the artist may claim a full fair market value deduction for a later charitable gift of the work Furthermore, the treatment of artists and writers is not consistent with the treatment of inventors, whose patents are treated as capital gain property As a result, gifts of such inventions by an inventor (or a transferee) are treated like gifts of any other capital gain property and are generally deductible at full fair market value. iv. Property subject to depreciation recapture. When property that would trigger the recapture of depreciation on sale under sections 1245, 1250 or 1252 is donated to charity, the amount of the donor s deduction equals the fair market value of the property reduced by the amount of depreciation that would have been recaptured. This is because recapture produces ordinary income. v. Section 306 stock. If preferred stock is distributed to shareholders as a non-taxable stock dividend, section 306 taints the stock by providing that all or a portion of the gain on the stock s subsequent sale is taxable as ordinary income and not as capital gain. As a consequence, a charita-