Is the Charitable Deduction for Trusts Limited to Adjusted Basis?

No, says a U.S District Court.

An irrevocable trust received distributions from a partnership in one year and purchased property. In a later year it contributed the property to a qualified charity, after the property had appreciated in value. It took an income tax charitable deduction for the fair market value of the property.

Code Section 642(c)(1) allows for an income tax charitable for trusts. It reads:

[T]here  shall  be  allowed  as  a  deduction  in  computing  its  taxable
income  (in  lieu  of  the  deduction  allowed  by  section  170(a),  relating  to
deduction for charitable, etc., contributions and gifts) any amount of the gross
income,  without  limitation,  which  pursuant  to  the  terms  of  the  governing
instrument is, during the taxable year, paid for a purpose specified in section
170(c)  (determined  without  regard  to  section  170(c)(2)(A))… (emphasis added)

The IRS argued that the “gross income” language (1) limits a trust’s deduction to the amount of gross income it contributed to charity; (2) gross income does not include unrealized appreciation; and (3) a liberal construction of the  statute  allowing  fair  market  valuation  would  negate  the  gross  income  derivative requirement. Thus, it sought to limit the deduction to the trust’s adjusted basis in the contributed property.

The District Court began its analysis by noting that the policy behind the charitable contribution is to encourage charitable deductions. This was not a good start for the IRS.

Another policy issue was that the IRS sought to apply the rule that an income tax deduction is a
matter of legislative grace and that the burden of clearly showing the right to the claimed deduction is on the taxpayer. While there is such a rule, the court noted statutes regarding charitable deductions are not matters of legislative grace, but rather “expression[s] of public policy.” As such, provisions regarding charitable deductions should be liberally construed in favor of the taxpayer.

The Court also noted a distinction between Section 642, and Section 170 (relating to charitable deductions for individuals). Unlike Section 170, Section 642 has no limiting language on the amount of the deduction, including limits relating to appreciation in contributed property. The Court perceived the IRS as seeking to impose limitations where Congress clearly declined to do so.

One of the IRS’ arguments was that the contribution had to be traced to gross income. While this is true, there is no requirement that the payment had to be traced to income from the same tax year as the contribution. So the fact that the property was purchased in a prior tax year with income from that year was not a problem. That the contribution was paid out of trust principal and not income was also not an issue – the Court found that such an argument conflated fiduciary accounting principles with the federal tax concept of gross income.

Since the case is not an appellate court case but only an interpretation of a District Court, the precedential value of the decision is limited. Given the substantial amounts at issue, the IRS may appeal.

Green v. U.S., U.S. District Court for the Western District of Oklahoma, Case No. CIV-13-1237-D (11-4-2015)