Trust Charitable Deduction

Filing a 645 election estate/trust return and could use the expertise and experience of the board.
Decedent last to die, all trust assets to go to charity...no other beneficiaries.

The assets consist of several qualified and non-qualified annuities, liquidated, mostly taxable income.

642(c) allows a charitable deduction

(1)General rule
In the case of an estate or trust (other than a trust meeting the specifications of subpart B), there 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

The trust document has the following provisions:

Ultimate Distribution: Upon the death of the surviving Grantor, the Successor Trustee shall deal with the trust property as follows:
...
4. The entire trust estate shall be distributed outright, discharged of the trust, equally to the following charitable organizations:

(a list follows)

VI. Powers of Trustee. The Grantors hereby grant to Trustee of each Trust established hereunder (including any successor Trustee) the continuing, absolute, discretionary power to deal with any property, real or personal, held in any trust, as freely as they might in the handling of their own affairs.

In researching various papers and cited court cases, I'm concerned that the quoted provisions do not adequately meet the requirements of 642(c), pursuant to the terms of the governing instrument. The trust doesn't precisely say that a charitable deduction may be made from gross income. The service doesn't readily relinquish it's claim to tax from the cases I've read, although I couldn't find any with the same fact pattern. I'm not comfortable with claiming a charitable deduction, but perhaps I'm being overly cautious?

As you state, in order to claim a charitable income tax deduction, the charitable payments must be traced to income and must generally be made pursuant to the terms of the governing instrument that require income to be paid to a charity. In ILM 200848020 there apparently weren't any instructions to distribute income to a charity and consequently the trust could not claim a charitable income tax deduction. There is no legal authority on point where instructions in a governing instrument to make a charitable disposition of IRD that assures a charitable income tax deduction. There is no court case, regulation or ruling. A typical provision taken from one of Prof Hoyts papers is below and also from my own Living Trust. Since your provision lacks specificity with respect to IRD(not wrt contributions to charities),

Has there been distributions to the charities? If so can it be traced to the IRD? I had a 1041 similar to your situtaion and the IRD hit the trust prior to distributions to charity and each check sent to each charity had in the memo area "income from annuity xx". What do you have interms of income tracing?

Typcial provison: I instruct that all of my charitable gifts, bequests and devises shall be made, to the extent possible, from "income in respect of a decedent" (as that term is defined under the U.S. income tax laws) included in gross income and shall qualify for a charitable income tax deduction under Section 642(c) of the Internal Revenue Code of 1986 and any corresponding future tax laws.
My Trust: " Our trustee shall satisfy all charitable gifts and bequests, to the extent possible, from property that constitutes income with respect of a decedent(IRD)."

Pursuant to the terms" etc. refers to the requirement that the charitable contribution be authorized in the trust instrument The requirement that it be paid from gross income, as said above, is met by tracing. I've listed some reading on point.

https://www.cpajournal.com/2017/09/15/g ... ributions/ :

https://www.cicf.org/wp-content/uploads ... utions.pdf

https://www.irs.gov/pub/irs-wd/201651013.pdf

https://www.thetaxadviser.com/issues/20 ... ry-05.html

What do you have in terms of income tracing?

Donations to the charities were made after receiving the annuity proceeds but there was no specific identification accompanying the donations tying them to the annuities. Also, forgot to mention there was some cash already in the trust prior to cashing in the annuities so it could be argued that the donations came at least partly from trust principal or from trust principal first. My understanding is there are two requirements. Pursuant to the trust document AND tracing. It's the former that concerns me.

Thanks Len for the links...I had already found all of them before my initial post, read them and followed the citations. No exact scenario (trust document stating that everything goes to charity without specifying income) but many disallowed charitable deductions to make me concerned about the sloppy trust document.

My understanding is there are two requirements. Pursuant to the trust document AND tracing. It's the former that concerns me.. That's mine too. But you and I construe the "pursuant to trust document" differently:

You - Document must specifically provide for charitable contribution and that it must be made from gross income.

Me - Document must specifically provide for charitable contribution. Tax law says that it must be made from gross income, which gets proved by tracing.

And a third interpretation as provided by TAXMASTER:

the charitable payments must be traced to income and must generally be made pursuant to the terms of the governing instrument that require income to be paid to a charity. In ILM 200848020 there apparently weren't any instructions to distribute income to a charity and consequently the trust could not claim a charitable income tax deduction.

See my concern?

Sorry health no longer permits me to be a contributor. Not clear why you think in the case of a grantor trust death of grantor produces an estate. No need for specific language when charitable beneficiary is the owner of the income.

Sorry to have PM'd you seeking your expertise and experience Dennis, I did not know you were ill. I wish you a speedy recovery.

Given the charities were the sole named beneficiaries in the trust but not on the individual annuities your response surprised me, that no specific language was needed to satisfy 642(c), but hey...I'm the novice. I'm certain I can trace the donations chronologically to deduct them, it remains to be seen when I get the full accounting from the trustee which he prefers to hold until the 1099-R's are issued. The 1099-R's, based on cover letters included with the checks will be issued to the trust EIN.

Regarding the estate, I've already made the 645 election and will file accordingly. This gives me the option of choosing a fiscal or calendar year for the trust/estate.

Thank you Len and TAXMASTER for your assistance.

In the typical situation when all unexpired interests are charities, death of grantor creates
a charitable trust. (Collect assets, pay bills, distribute)
Sometime you have to dodge around a reasonable period of administration requirement.

I would worry that your §645 election might create a tax and would defer to Jeff.

Any further thoughts on this issue? It seems like a highly technical interpretative issue, as more or less laid out in Post #5, as expanded upon in Post #6.

Pretend this is the fact pattern: We have two equal estate residuary beneficiaries, a charity and an individual. The estate holds $50k in cash, received from the decedent at his death. And then the estate collects $50k of income. So we have $100k in the pot. Each bene will get $50k.

The governing instrument (i.e., the Will) of course dictates a payment to the charity (which is $50k in this case). But does the governing instrument have to specifically state that it is the charity that is to receive the gross income (in order to claim a charitable deduction)? I don’t think it does. I don’t think it has to be that specific and direct.

But I do think there must be something in the governing instrument that gives discretion to the executor to pay out gross income. In that case, if the executor exercises that discretion and “documents” that the $50k paid out to the charity is a payout of estate income, I think that would be enough…because that discretionary act truly is “pursuant to the government instrument.” And by “documents,” I mean a written internal document coupled with a separate bank account to receive the income and then that same bank account is used to make payments to the charities. And then memos on the checks say, “Payment of Estate Gross Income” and each charitable check is perhaps accompanied by a letter indicating that it is a payout of estate gross income. Also, I think the guidance under 642(c) would tell us that not only must the government instrument call for payouts of gross income to charities (either with very direct/precise gross income language or via the exercise of discretion), it must be actual gross income that is paid out. For example, if the executor does have discretion to pay out gross income, but distributes, to the charitable bene, a stock that was held by the decedent on his DOD, that would fail this requirement.

I think the rule is a bit confusing, but let me know if you agree with the above.

And note: If there is no charitable deduction here at all, we need to play that out. If $50k and $50k is distributed, the estate won’t owe any income tax. The $50k estate income would be carried out on the K1 to the individual bene. That individual would owe personal tax. At 30%, that’s $15k. Thus, the individual ends up with $35k and the estate ends up with $50k.

However, if the estate takes in the income in Year1 and pays, let’s say, the same $15k of tax, now there’s $85k left to distribute. And let’s say that gets paid out in Year2. Each bene would get $42.5m. Thus, the income tax effectively gets charged one-half to each share.

And some pushback on this…

In ILM 200848020 there apparently weren't any instructions to distribute income to a charity and consequently the trust could not claim a charitable income tax deduction.

That’s really not what happened. What happened was that the Trust was reformed and because of that reformation, the IRS took the position that whatever the charity got wasn’t pursuant to the “governing instrument.” A reformed instrument will only be viewed as the original governing instrument when the reformation was undertaken to resolve a conflict. That’s not what happened here. The reformation took place not to resolve a conflict, but so the trust would be viewed as the IRA’s designated beneficiary, thereby qualifying for stretched payouts.

Reasoning from general principles...

The key statutory language in 642(c) is "any amount of the gross income". I don't read that to require tracing. Rather, it is the gross income of the trust that matters. That is, the deduction can't exceed the trust's gross income. The reason for that is the principal may have already been deducted. Besides how does one trace money in a bank account which has funds from multiple sources? If that were the rule there would have to be segregation, which makes no economic sense.

In Jeff's fact pattern in #10, it seems the correct deduction would be $25k. I arrive at that by multiplying the gross income by the charity's share of the remainder. I do that because it is not OK to allocate all the gross income to the charity. There would be no income for the individual who owned the other 50%. That is, pursuant to the terms of the trust the charity is entitled to $25k of principal (not an income tax deduction) and $25k of trust income (deductible) and the other beneficiary gets $25k of principal and $25k of income.

Thanks, Gator. Chomp Chomp.

Everything you write is logical. But a few points:

Tracing (to gross income) is definitely required. It has to be. If the requirement is a payment out of gross income (to get a charitable deduction), the payment must necessarily be traced to gross income. See Nilodop’s 4th link in Post #3, for example:

https://www.thetaxadviser.com/issues/20 ... ry-05.html

If that were the rule there would have to be segregation, which makes no economic sense.

I think segregation would help, like I outlined in Post #10 via use of a separate bank account. But I also think tracing can be invoked via documentation and general record keeping. And “gross income” doesn’t have to be current year gross income. The link referenced directly above gets into that issue.

As to your comment about “economic sense,” I hear you. But I also think this:

If we go back to my example, if the charity gets $50k and the individual bene gets $50k and we trace the charity’s payment to the $50k of gross income (and assuming all other requirements have been met), it sure seems the estate will have a $50k charitable deduction. I agree it makes no economic sense. But I tend to think it would be allowable, even with a specific bequest where it is directed to be paid out of gross income. (Although I haven’t entirely researched that issue).

That is, pursuant to the terms of the trust the charity is entitled to $25k of principal (not an income tax deduction) and $25k of trust income (deductible) and the other beneficiary gets $25k of principal and $25k of income.

I don’t necessarily see it that way. I see it as each bene being entitled to $50k of cash. And if the governing instrument says the charity’s piece must be paid with gross income, or if somehow there is discretion afforded to the executor to pay the charity out of gross income, then the charity got the gross income if the documentation and record keeping supports that result.

My main question with all of this is this part of the statute:

gross income, without limitation, which pursuant to the terms of the governing instrument

And this gets back to Posts #5 and #6. I think there has to be something in the governing instrument that calls for the charitable payment to be made out of gross income – either express language or some type of discretionary language that will get us there. One thing I was reading about can be found here:

https://papers.ssrn.com/sol3/papers.cfm ... id=2665128

See numbered pages 4 and 10, with respect to strategies that can be employed when the governing instrument lacks express language. One idea there was the notion of non-pro rata distributions.

I interpret "pursuant to the trust instrument" to mean that it's OK to pay the charity.
And I interpret the gross income requirement as distinguishing between principal and income. In that regard, IRD would be principal at the time fo contribution. I do not see that a separate bank account or special language is needed; and I'm not aware that such language is generally recommended.

I interpret "pursuant to the trust instrument" to mean that it's OK to pay the charity.

That’s just half of it. The other half is that the governing instrument (or state law) has to indicate that the charity’s payment comes out of gross income. Hence the recommended language in the last paragraph of Post #2.

And I interpret the gross income requirement as distinguishing between principal and income.

It’s not. It’s “gross income” as that phrase is used for income tax purposes.

I do not see that a separate bank account or special language is needed; and I'm not aware that such language is generally recommended.

The separate bank account idea, if feasible, is recommended for tracing purposes. And “such language” (payment comes from gross income) IS generally recommended. It’s pretty much required, otherwise there’s trouble. In the absence of such language, there are a few ways out from what I see, but none of them might be feasible, depending on the facts.

All in all, it sure seems like you’re just going off the cuff here with general thoughts that are not based on any specific tax law sources.

I have not seen anything yet that changes my view.

As long as the gross income is properly allocable to the charity under the terms of the trust (i.e., no funny business), the distribution of an amount of such income to the charity will be deductible under 642(c). To me, any tracing is little more than typical trust accounting. No extra language is needed.

We don't have to make it complicated. We only need a viable return position.

As long as the gross income is properly allocable to the charity under the terms of the trust (i.e., no funny business), the distribution of an amount of such income to the charity will be deductible under 642(c).

Are you saying that it would be “funny business,” and hence, not respected, if the will said something like, “Any amounts distributed to the charitable beneficiary will first be made from estate gross income?” It sounds like you are, since you say no extra language is needed.

As long as the gross income is properly allocable to the charity under the terms of the trust (i.e., no funny business), the distribution of an amount of such income to the charity will be deductible under 642(c).

I agree with that, because it satisfies the requirements. But in my example, it would not give the estate the greatest charitable deduction possible (using your analysis in your Post #12). Thus, if we want all gross income going to the charity, such that we have the greatest charitable contribution deductible possible, then that answer might not be satisfactory. If boilerplate trust provisions give us a $25k charitable deduction, but there is a way to get a $50k deduction, then something special needs to have happened with the drafting.

In #10, the charity ends up with $50k. Presumably there was a $25k deduction on contribution, so the additional $25k deduction is the logical limit, no matter how one drafts. If the grantor wants bigger charitable deductions, the trust language must give more than 50% to the charity. But that's a different estate plan.

In #10 I would be comfortable drafting with a simple 50/50 residuary without any tracing language. And I'm having trouble envisioning a fact pattern where I would feel the need to add tracing language to the trust indenture.

In #10, the charity ends up with $50k. Presumably there was a $25k deduction on contribution, so the additional $25k deduction is the logical limit, no matter how one drafts. If the grantor wants bigger charitable deductions, the trust language must give more than 50% to the charity. But that's a different estate plan.

I hear you. You previously made a comment about “economic sense” in Post #12. That idea is now baked into the regulations and is addressed here, in this 2020 treatise, starting on Page 26 (Out of Which Income). There is some pretty good discussion through Page 30.

https://www.mainecf.org/wp-content/uplo ... nefits.pdf

As an interesting sidenote, the same treatise can be found here, but the 2016 version. The same discussion starts on Page 29.

https://www.epcct.org/assets/Councils/C ... 202016.pdf

In #10 I would be comfortable drafting with a simple 50/50 residuary without any tracing language.

I’m not really talking about “tracing” language, but talking about “direction” language in the will identifying the source of income that will be paid to the charity. The tracing would only come later, after the gross income hits and after (or at the time) the distribution is made. But I think we’re saying the same thing.

yep