United States: Tax Court Refuses Charitable Deduction Where Estate Failed To Permanently Set Aside Charitable Funds

In its recent decision of Estate of Belmont, 144 T.C. No. 6 (02/19/2015), the Tax Court held that an estate failed to meet the requirements under Internal Revenue Code Section 642(c)(2), and disallowed the estate's charitable deduction on its income tax return.

Code Section 642(c)(2) provides that any part of the gross income of an estate, permanently set aside during the taxable year under the terms of the decedent's will for a charitable purpose, will be allowed as an income tax deduction for the estate.  The Regulations further clarify that no amount will be considered permanently set aside for purposes of Code Section 642(c)(2) "unless under the terms of the governing instrument and the circumstances of the particular case the possibility that the amount set aside...will not be devoted to such purpose or use is so remote as to be negligible."

In this case, the decedent, Eileen S. Belmont, died testate on April 1, 2007, with a last will and testament dated February 11, 1994.  Ms. Belmont's will provided that the first $50,000 of her residuary estate be distributed to her brother, David Belmont, and the residue to the Columbus Jewish Foundation, a Code Section 501(c)(3) charitable organization.

At the time of her death, Ms. Belmont owed two pieces of real property – a residence in Ohio and a condominium in California – and had a retirement account, which distributed a death benefit of approximately $243,000 to her estate.  The retirement benefit distribution represented income in respect of a decedent pursuant to Code Section 691, and was reported on the estate's income tax return for the taxable period ended March 31, 2008.  After federal withholding, approximately $219,000 was distributed from the retirement account into the estate's bank account.

In July 2008, the estate filed its income tax return for the period ended March 31, 2008, which reported the retirement benefit.  The estate claimed a charitable contribution deduction of nearly $220,000, relying on the fact that Ms. Belmont's will directed the residue of her estate to the Columbus Jewish Foundation, despite the fact that no distribution had yet been made to the Foundation.

At the time of Ms. Belmont's death, her brother, David, resided in her California condominium.  Following Ms. Belmont's death, David attempted to negotiate a life tenancy in the California condominium from the Foundation.  In February 2008, the Foundation declined his offer and David was requested to vacate the property.  David did not vacate the property and in April 2, 2008, filed a creditor's claim in California court, claiming an alleged breach of an oral contract between David and Ms. Belmont wherein he was promised a life tenancy in the property.  David ultimately prevailed when his case concluded in March 2012.

As a result of the litigation, the estate incurred expenses and costs, causing it to deplete some of the $220,000 it had ostensibly set aside for the Foundation.

The Tax Court noted that in order for an estate to properly claim a charitable contribution deduction under Code Section 642(c)(2) (distinguishable from a charitable contribution deduction under Code Section 642(c)(1) for amounts actually paid during the taxable year), three criteria must be met:  (1) the charitable contribution must be an amount from the estate's gross income; (2) the charitable contribution must be made pursuant to the terms of a governing instrument; and (3) the charitable contribution must be permanently set aside for purposes specified in Code Section 642(c)(2).

The estate argued that there was no reasonably foreseeable possibility that it would incur unanticipated costs associated with litigation, while the Internal Revenue Service argued that there was a substantial likelihood of prolonged litigation, and that the estate was clearly on notice that prolonged litigation was more than a remote possibility when it claimed the charitable deduction.

The Tax Court agreed with the Internal Revenue Service, noting that while it had not had a chance to examine the "so remote as to be negligible standard" in the context of Code Section 642(c)(2), it reviewed the same language in connection with the Regulations prescribed under Code Section 170, where it defined "so remote as to be negligible" as "a chance which persons generally would disregard as so highly improbable that it might be ignored with reasonable safety in undertaking a serious business transaction."  The court concluded that the information known or knowable to the estate when it filed its Form 1041 in July 2008 was sufficient to put the estate on notice of the possibility of prolonged litigation, and therefore the expenditure of estate funds for expenses and costs was certainly more than "so remote as to be negligible."  As such, it held that the $220,000 was not permanently set aside as required by Code Section 642(c)(2).

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