No Charitable Set Aside Deduction for Estate Due to Litigation

Under Code Section 642(c)(2) an estate may claim a current charitable contribution deduction for income tax purposes, notwithstanding that the income earned will not be paid or used for a charitable purpose until sometime in the future. That is, the estate need not actually pay income over to the charity in the year it is earned to obtain a charitable deduction – it is enough if the funds are set aside for later payment to the charity.

In a recent Tax Court case, the remainderman of the estate was a church. However, at the time the income tax return for the year at issue was filed (albeit filed late), there was ongoing litigation regarding who was entitled to what from the estate. Income earned during the year that appeared to be otherwise due to the church was now at risk of being diverted to pay other claimant beneficiaries and litigation costs.

Under Regulations, no charitable set-aside deduction deduction will be available if there is a risk that the set aside income may not find its way to charity. They require the estate to prove that the possibility that the amount set aside for the charitable beneficiaries would go to noncharitable beneficiaries be so remote as to be negligible. Treas. Regs. Sec. 1.642(c)- 2(d). In the case at issue, the IRS sought to disallow the deduction due to the risk that the set aside income could be diverted to noncharitable beneficiaries and expenses.

The Tax Court sided with the IRS and disallowed the deduction. The estate argued that due to the advanced state of settlement negotiations, there was little risk that the income would not go to two churches (at some point, another church was added as a beneficiary) at the time the return was filed. The court noted that at the time of the return filing, even if the pending settlement was finalized, the shares of the churches were still uncertain since the issues of legal fees and coexecutors’ commissions remained unsettled. Also, until that issue was resolved, the will was not validated. Based on these facts, the risk of loss of funds was not “so remote as to be negligible.”

This is the second case in 2015 with similar facts and a similar result. The first case was Estate of Eileen S. Belmont, et al.v. Commissioner, 144 T.C. No. 6, which I wrote about here. Estates and trusts seeking a set-aside deduction that are engaged in litigation should consider themselves warned that the IRS will scrutinize such deductions and contest them when appropriate, and that the Tax Court is apt to side with the IRS on these issues.

Estate of John D. DiMarco, TC Memo 2015-184.