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Charitable Tales from the Crypt 2016 Trust and Estate Planning Series

Thursday, June 2, 2016

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American Bankers Association Trust and Estate Planning Briefing Series Charitable Tales from the Crypt Thursday, June 2, 2016 • 1:00 – 3:00 p.m. ET

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II

Table of Contents

TABLE OF CONTENTS .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . II

SPEAKER & ABA STAFF LISTING .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . III

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CONTINUING EDUCATION CREDITS INFORMATION .. . . . . . . . . . . . . . . . . . . . . . . . . . . V

CPA SIGN-IN SHEET & CERTIFICATE OF COMPLETION REQUEST .. . . . . . . VI

CFP SIGN-IN SHEET & CERTIFICATE OF COMPLETION REQUEST .. . . . . VII

INSTRUCTIONS FOR REQUESTING CERTIFICATE OF COMPLETION .. VIII

PROGRAM INFORMATION .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ENCLOSED

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III

Speaker and ABA Staff Listing

Speakers

Thomas W. Abendroth Partner Schiff Hardin LLP 233 South Wacker Drive Chicago, IL 60606 (312) 258-5500 [email protected] Charles “Skip” D. Fox, IV Partner McGuireWoods LLP Court Square Building 310 Fourth Street, NE, Suite 300 Charlottesville, VA 22902 (434) 977-2500 [email protected]

ABA Briefing Staff

Cari Hearn Senior Manager (202) 663-5393 [email protected] Linda M. Shepard Senior Manager (202) 663-5499 [email protected]

American Bankers Association 1120 Connecticut Avenue, NW Washington, DC 20036


IV

PROGRAM OUTLINE TIMES SESSION AND SPEAKERS

12:45 – 1:00 p.m. ET

Pre-Seminar Countdown

1:00 – 1:05 p.m.

Welcome and Introduction 1Source International

1:05 – 1:30 p.m.

Part 1 – The Charitable Planning Landscape Skip Fox, McGuireWoods LLP

1:30 – 1:55 p.m.

Part 2 – Income Tax Charitable Deduction and Estate Tax Charitable Deduction Tom Abendroth, Schiff Hardin LLP

1:55 – 2:05p.m.

Questions and Answers

2:05 – 2:30 p.m.

Part 3 – Charitable Remainder Trusts and Charitable Lead Trusts

Skip Fox, McGuireWoods LLP

2:30 – 2:55 p.m.

Part 4 – Private Foundations, Conservation Easements and Fiduciary Income Tax Deductions for Trusts Tom Abendroth, Schiff Hardin LLP

2:55 – 3:00 p.m.

Questions and Answers Wrap-up


V

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VI

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VIII

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5/23/2016

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aba.com1-800-BANKERS

Charitable Tales from the Crypt2016 Trust and Estate Planning Briefing Series

American Bankers Association Briefing/WebinarThursday, June 2, 20161:00 – 3:00 p.m. ET


Disclaimer

This Briefing will be recorded with permission and isfurnished for informational use only. Neither the speakers,contributors nor ABA is engaged in rendering legal norother expert professional services, for which outsidecompetent professionals should be sought. All statementsand opinions contained herein are the sole opinion of thespeakers and subject to change without notice. Receipt ofthis information constitutes your acceptance of these termsand conditions.

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Presenters

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• Thomas W. Abendroth, Partner, Schiff Hardin LLP

• Charles D. Fox IV, Partner, McGuireWoods, LLP


Agenda

• The Charitable Planning Landscape

• Income Tax Charitable Deduction

• Estate Tax Charitable Deduction

• Charitable Remainder Trusts

• Charitable Lead Trusts

• Private Foundations

• Conservation Easements

• Qualified Appraisals

• Fiduciary Income Tax Deductions for Trusts

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THE CHARITABLE PLANNING LANDSCAPE

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The Charitable Planning Landscape

• Introduction

– Importance of Charitable Giving in estate plans

– Charitable Giving is an Untapped Market

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Pages A-1 – A-2

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2014 Charitable Giving

• Total $358.4 billion– $18.5 billion Increase from 2013

• Individuals -- $258.5 billion

• Bequests -- $28.3 billion

• Individuals contribute 72₵ of each dollar given to charity

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• Gift Tax—No Limitations

• Estate Tax—No Limitations

• Income Tax—Two Limitations– Percentage Limitations

– Valuation Limitation

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• What type of property?

– Cash

– Appreciated property• Who is recipient?

– Public charity

– Private foundation

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Special Rules for Valuing Gifts of Appreciated Property

• Public charities—step down

• Private foundations—reduction to basis

• All charities—tangible personal property unrelated to exempt purpose or function—only deduct basis

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Pages A-7 – A-8

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• Substantiating the Charitable DeductionThe IRS may disallow an individual’s income tax charitable deduction is it is not properly substantiated.

– Recordkeeping

– Appraisal Requirements

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Pages A-8 – A-11


TALES FROM THE CHARITABLE CRYPT

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Income Tax Charitable Deduction

• Letter Ruling 9631004 (April 30, 1996). IRS disallows charitable deduction for scholarship fund limited to recipients with the same surname of the decedent.

• Gust Kalapodis v. Commissioner, T.C. Memo 2014-205. Tax Court concludes that taxpayers are not entitled to an income tax charitable contribution deduction for scholarship payments made by irrevocable trust created in memory of deceased son.

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Pages B-1 – B-2



• Letter Ruling 201334043 (August 23, 2013). Trust established to support widow and her children is not entitled to tax exempt status because it operates for the private benefit of the designated individuals.

• Ferguson v. Comm’r., 93 AFTR 2d ¶99-648 (9th Cir. 1999). Court imputes gain to donor for gift of appreciated stock shortly before the sale of a closely-held company.

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Pages B-2 – B-4

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• Technical Advice Memorandum 200341002 (October 10, 2003). Taxpayer not allowed either charitable deduction or annual exclusion for gifts to trust subject to Crummey Powers in charities.

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Pages B-4 – B-5


Estate Tax Charitable Deduction

• Marine Estate v. Comm’r, 990 F.2d 136 (4th Cir. March 30, 1993) (affirming 97 T.C. 368 (1991)). Charitable deduction denied because amount was unascertainable.

• Zabel v. United States, 995 F. Supp. 1036 (D. Nebraska 1998). Estate tax charitable deduction denied for a decedent’s estate because a testamentary split interest trust failed to meet the requirements for a charitable remainder annuity trust, a charitable remainder unitrust, or a pooled income fund.

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Pages B-5 – B-6

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• Letter Ruling 201004022 (January 29, 2010). IRS rules that estate is not entitled to charitable deduction for amount paid to charity pursuant to a settlement agreement.

• Technical Advice Memorandum 200437032 (September 10, 2004). Residuary bequest to member of religious order who has taken a vow of poverty does not qualify for the estate tax charitable deduction.

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Pages B-6 – B-8



• Letter Ruling 201333006 (August 16, 2013). Judicial reformation of a charitable trust is a qualified reformation and the present value of the remainder interest in reformed trust may be deducted under Section 2055(a).

• Estate of Dieringer v. Commissioner, 146 T.C. No. 8 (2016). Estate Tax charitable deduction limited by post-death events.

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Pages B-8 – B-10

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Enter your Question in the Box Below and Press ENTER / SUBMIT.

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Charitable Remainder Trusts

• Atkinson v. Commissioner, 309 F.3d 1290 (11th Cir. 2002). Trust not administered as a charitable remainder annuity trust, so charitable deduction denied.

• Estate of Jackson v. United States, 408 F.Supp. 2d 209 (N.D. W.Va. 2005). Testamentary split interest trust qualifies for estate tax charitable deduction even though it is not a charitable remainder trust.

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Pages B-10 – B-11

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• Galloway v. United States, No. 05-50 (W.D. Pa. May 9, 2006). Testamentary trust failed to qualify as charitable remainder trust and estate tax charitable deduction was denied.

• CCA 200628028 (July 14, 2006). Sloppy administration of charitable remainder trust results in disqualification of trust.

• Tamulis v. Commissioner, 509 F.3d 343 (7th Cir. 2007). Trust is not to be treated as charitable remainder trust and estate tax charitable deduction is denied.

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Pages B-11 – B-14



• Mohamed v. Commissioner, T.C. Memo 2012-152. Tax Court denies income tax charitable deduction for property donated to a charitable remainder unitrust.

• Letter Ruling 201321012 (May 24, 2013). IRS rules favorably on tax consequences of gift of unitrust interest to charity.

• Letter Ruling 201426006 (June 27, 2014). Judicial reformation of charitable remainder unitrust trust will not result in self-dealing.

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Pages B-14 – B-15

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• Letter Rulings 201325018, 201325019, 201325020, and 201325021 (June 21, 2013). IRS finds that the early termination of net income only with makeup provisions charitable remainder unitrusts will not be an act of self-dealing by the husband and wife grantors.

• Letter Ruling 201321012 (May 24, 2013). IRS rules favorably on tax consequences of gift of unitrust interest to charity.

• Letter Rulings 201332011 and 201332012 (August 9, 2013). Changes to net income makeup charitable remainder unitrustordered by court will not affect status as charitable remainder unitrust.

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Pages B-16 – B-17



• Letter Ruling 201133004 (August 19, 2011). Judicial reformation of charitable remainder unitrust from a net income charitable remainder unitrust with makeup provisions into a standard charitable remainder unitrust does not violate Section 664.

• Letter Ruling 201030015 (July 30, 2010). Reformation of net income charitable remainder unitrust into fixed percentage unitrustpermitted.

• Letter Ruling 201011034 (March 19, 2010). IRS rules that reformation of charitable remainder unitrust to permit remainder interest to pass to private foundation will not affect trust’s qualification as a charitable remainder unitrust and will not be an act of self-dealing.

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Pages B-18 – B-19

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• Letter Ruling 201040021 (October 8, 2010). The return of the assets of a charitable remainder annuity trust to its grantors allowed because the trust was void ab initio because it failed the ten percent test.

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Page B-20


Charitable Lead Trusts

• Letter Ruling 200328030 (July 11, 2003). Grantor’s retained power to change beneficiaries of charitable lead unitrust disqualifies the trust.

• Letter Rulings 201421023 and 201421024 (May 23, 2014). IRS concludes that annuity payments from charitable lead annuity trusts pursuant to the terms of previously executed charitable pledge agreements will not constitute self-dealing.

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Pages B-20 – B-22

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Charitable Lead Trusts

• Letter Ruling 201323007 (June 7, 2013). IRS finds no adverse gift or estate tax consequences with respect to charitable lead trust whose charitable beneficiary is a private foundation established by grantor of the charitable lead trust.

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Page B-22


Private Foundations

• Todd v. Commissioner, 118 T.C. No. 19 (April 19, 2002). Stock transferred to private foundation was not qualified appreciated stock, and must be valued at its basis, not its fair market value.

• Letter Ruling 201303021 (January 18, 2013). Nonvoting shares in closely held corporation to be held directly by private foundation are not excess business holdings under Section 4943 and family and charitable trusts are not disqualified persons with respect to the private foundation under Section 4946.

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Pages B-23 – B-24

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Private Foundations

• Foxworthy v. Commissioner, T. C. Memo. 2009-203. Tax Court rules that charitable income tax deduction for gifts to private foundation should not be denied because husband and wife making the gifts controlled the private foundation.

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Page B-25


Conservation Easements

• Whitehouse Hotel Ltd. Partnership v. Commissioner, 755 F.3d. 236 (5th Cir. 2014). Court of Appeals affirms Tax Court’s ruling disallowing a significant portion of a tax deduction for historic conservation easement but permits the use of the good faith exception to prevent imposition of a 40% gross overstatement penalty.

• Schmidt v. Commissioner, T.C. Memo. 2014-159. Government loses on valuation of conservation easement.

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Pages B-25 – B-27

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• Scheidelman v. Commissioner, T.C. Memo 2013-18. Tax Court finds that charitable façade easement has no value.

• Mountanos v. Commissioner, T.C. Memo 2013-138. Charitable income tax deduction for conservation easement was denied because taxpayer failed to establish that easement had any value.

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Pages B-27 – B-28



• Graev v. Commissioner, 140 T.C. No. 17 (June 24, 2013). Taxpayers are not entitled to income tax charitable deductions for gifts of cash and conservation easement because the receiving organization promised to refund the cash and remove the easement if the deductions were disallowed.

• Gorra v. Commissioner, T.C. Memo 2013-254. Value of façade easement greatly reduced and taxpayers were responsible for gross valuation misstatement penalties regarding the income tax charitable deduction.

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Pages B-28 – B-30

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Qualified Appraisals

• Estate of Evenchik v. Commissioner, T.C. Memo 2013-34. Court denies charitable deduction for lack of qualified appraisal.

• Freidman v. Commissioner, T.C. Memo 2010-45. Tax Court denies income tax charitable deduction and imposes accuracy related penalties because taxpayers failed to properly substantiate the charitable contribution and provide contemporaneous written acknowledgements of donations of medical equipment.

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Pages B-30 – B-31


Qualified Appraisals

• CCA 201024065 (May 17, 2010). If someone other than the person conducting an appraisal for income tax charitable deduction purposes signs the appraisal summary, the appraisal is not a qualified appraisal and the claimed deduction may be disallowed.

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Pages B-31 – B-32

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Fiduciary Income Tax Charitable Deduction for Trusts and Estates

• CCA 201042023 (October 22, 2010). IRS’s chief counsel concludes that trust’s charitable contribution deduction claimed in respect to appreciated property that it purchased from its accumulated gross income is limited to the adjusted basis of the property and not the fair market value at the time of contribution.

• Green v. United States, 116 AFTR 2d 2015-6668 (W.D. Okla. Nov. 4, 2015).Trust allowed charitable income deduction for fair market value of and not basis in appreciated real estate to charity.

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Pages B-32 – B-33



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2016 Trust and Estate Planning Series

Briefing Date Briefing Topic

Sep 8, 2016 Issues with Art and Other Collectibles in the Administration of Trusts and Estates

Oct 6, 2016 Are You a Fiduciary?

Nov 3, 2016 Twenty Steps to Avoid Fiduciary Litigation

Dec 1, 2016 Recent Developments in Estate and Trust Administration

Recordings Now Available

Life Insurance in a 21st Century Estate Plan

Uniform Fiduciary Access to Digital Assets Act (UFADAA) and Digital Assets

The New Paradigm in Trusts and Estate Valuation

Fiduciary Litigation Roundtable

Charitable Tales from the Crypt

37

Register Now at www.aba.com/trustbriefings

American Bankers Association Telephone Briefing

Tales from the Charitable Crypt

Thursday, June 2, 2016 1:00 p.m. to 3:00 p.m. E.T.

Charles D. Fox IV McGuireWoods LLP

Court Square Building 310 Fourth Street, NE, Suite 300 Charlottesville, Virginia 22902

(434) 977-2500 [email protected]

Copyright © 2016 by Schiff Hardin LLP and McGuireWoods LLP

Thomas W. Abendroth Schiff Hardin LLP

233 S. Wacker Drive, Suite 6600 Chicago, Illinois 60606

(312) 258-5501 [email protected]

CHARLES D. (“SKIP”) FOX IV is a partner in the Charlottesville, Virginia office of the law

firm of McGuireWoods LLP and head of its Private Wealth Services Industry Group. Prior to

joining McGuireWoods in 2005, Skip practiced for twenty-five years with Schiff Hardin LLP in

Chicago. Skip concentrates his practice in estate planning, estate administration, trust law,

charitable organizations, and family business succession. He teaches at the American Bankers

Association National Trust School and National Graduate Trust School where he has been on the

faculty for over twenty-five years. Skip was an Adjunct Professor at Northwestern University

School of Law, where he taught from 1983 to 2005, and is currently an Adjunct Professor at the

University of Virginia School of Law. He is a frequent lecturer across the country at seminars on

trust and estate topics. In addition, he is a co-presenter of the long-running monthly

teleconference series on tax and fiduciary law issues sponsored by the American Bankers

Association. Skip has contributed articles to numerous publications and is a regular columnist for

the ABA Trust Letter on tax matters. He was a member of the editorial board of Trusts & Estates

for several years and was Chair of the Editorial Board of Trust & Investments from 2003 until

2012. Skip is a member of the CCH Estate Planning Advisory Board. He is the co-editor or

author of seven books on estate planning subjects. Skip is a Fellow of the American College of

Trust and Estate Counsel (for which he is Vice President) and is listed in Best Lawyers in

America. In 2008, Skip was elected to the NAEPC Estate Planning Hall of Fame. He is also

Chair Emeritus of the Duke University Estate Planning Council and a member of the Advisory

Committee of the Heckerling Institute on Estate Planning and the Princeton University Planned

Giving Advisory Council. Skip has provided advice and counsel to major charitable

organizations and serves or has served on the boards of several charities, including Episcopal

High School (from which he received its Distinguished Service Award in 2001) and the

University of Virginia Law School Foundation. He received his A.B. from Princeton, his M.A.

from Yale, and his J.D. from the University of Virginia. Skip is married to Beth, a retired trust

officer, and has two sons, Quent and Elm.

THOMAS W. ABENDROTH is a partner in the Chicago law firm of Schiff Hardin LLP

and practice group leader of the firm’s Private Clients, Trusts and Estates Group. He

concentrates his practice in the fields of estate planning, federal taxation, and business

succession planning. Tom is a 1984 graduate of Northwestern University School of Law, and

received his undergraduate degree from Ripon College, where he currently serves on the Board

of Trustees. He has co-authored a two-volume treatise entitled Illinois Estate Planning, Will

Drafting and Estate Administration, and a chapter on sophisticated value-shifting techniques in

the book, Estate and Personal Financial Planning. He is co-editor of Estate Planning Strategies

After Estate Tax Reform: Insights and Analysis (CCH 2001). Tom has contributed numerous

articles to industry publications, and served on the Editorial Advisory Board for ABA Trusts &

Investments Magazine. He is a member of Duke University Estate Planning Council. Tom is a

frequent speaker on tax and estate planning topics at banks and professional organizations. In

addition, he is a co-presenter of a monthly teleconference series on estate planning issues

presented by the American Bankers Association. Tom has taught at the American Bankers

Association National Graduate Trust School since 1990. He is a Fellow of the American College

of Trust and Estate Counsel.

INDEX

PART A – The Charitable Planning Landscape

PART B – Tales from the Charitable

Crypt

PART A

The Charitable Planning

Landscape

Part A - 1


I. Introduction

A. Charitable giving is an important part of many individuals’ estate plans, both during life and at death. On the surface, charitable giving does not appear to be very complex. One need only select the organizations to which he wishes to make donations and either transfer the property during life or make a specific gift in his will. If one makes a lifetime gift, he can then claim a charitable deduction on his income tax return. The procedure just outlined is not so simple, however.

1. If a charitable deduction is to be allowed, the donor or his estate must be prepared to substantiate the value of the donation through written records. For individuals who make large lifetime charitable gifts, the substantiation requirements are significant.

2. There are a variety of complex rules for valuing property for income tax charitable deduction purposes, and limitations on the amount that can be deducted in any given year.

3. Individuals need to know these requirements and limitations so that their charitable giving will produce the desired tax results.

4. Furthermore, individuals need to know that the economic benefits of a charitable transfer by them may vary depending on the type of property given, when it is given, and the form of the gift.

B. Charitable Giving Is An Untapped Market

1. An ongoing study by Bank of America/US Trust shows that charitable giving is an untapped market at many banks and trust companies. “Study of High Net-Worth Philanthropy.” Bank of America and The Center on Philanthropy at Indiana University, 2006, as last updated in 2014.

a. High Net-Worth Households was defined as households with more than $200,000 in annual income and assets in excess of $1 million (excluding the value of their home.)

b. Surveys were mailed to over 20,000 households in the United States.

c. The findings included:

(1) 98.4% of the households made a gift to charity in 2013.

(2) Educational organization drew the greatest percentage of High Net-Worth Households (85%) followed by basic

Part A - 2

needs (81%), arts (70%), health (67%) and religious (67%) organizations.

(3) Over 40% have made a bequest to charity in their wills, 26% have established a foundation or donor advised fund, and 16% use a charitable remainder trust.

(4) Most respondents felt that repeal of the estate tax would not affect their charitable giving. 50% of the respondents said that elimination of the charitable income tax deduction would not cause their charitable giving to decline.

2. Moreover, a large amount is estimated to pass to charity. A 2003 study, which updated a 1998 study, found that at least $41 trillion would pass from older generations to younger generations between 1998 and 2052. Charities would receive between $6 trillion and $25 trillion during this period. John Havens and Paul Schervish. “Why the $41 Trillion Wealth Transfer Estimate is Still Valid.” Planned Giving Design Center (Gift Planner’s Digest, January 27, 2003).

3. One must conclude, based upon the numbers cited above, that many opportunities exist for enhanced charitable giving by trust and private banking customers. This is especially true when one examines the history of charitable giving by Americans.

a. Americans are among the most generous people, ranking second only to Canadians in terms of average donations to charity.

b. In 2014, Americans gave $358.4 billion to charities, This was a $18.5 billion increase over charitable giving in 2013 (Giving USA 2015: The Annual Report on Philanthropy for the Year 2014. Giving USA Foundation and researched and written by the Center on Philanthropy at Indiana University).

c. Individuals gave $258.5 billion and contributed 72¢ of each dollar given to charity in 2014.

d. Bequests totaled $28.13 billion in 2014.

e. Corporate giving was $17.77 billion in 2014.

f. More than one million charities are presently recognized by the IRS.

4. Given the generosity of individuals, coupled with the overwhelming value of the future transfer of wealth between generations, trust departments and private banking departments must seize the opportunity to explain the benefits of charitable giving to customers and private foundations.

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II. Income Tax Deduction for Charitable Contributions

A. The deductibility of charitable contributions for income tax purposes is subject to two types of limitations.

1. Percentage Limitations. There are “percentage limitations” on the amount that an individual may claim as a charitable deduction against his gross income in any tax year.

2. Valuation Limitations. With respect to certain appreciated property contributed to charity, the individual may be required to use the property’s tax basis, rather than its fair market value at the time of the contribution, for the purpose of determining the deductible amount of the contribution.

3. These limitations in each case affect only the income tax charitable deduction. They do not apply to the estate tax and gift tax charitable deductions.

4. In addition to the percentage and valuation limitations, the “Pease limitation” included in the American Taxpayer Relief Act of 2012 puts a limit on most itemized deductions, including the income tax charitable deduction, for high-income taxpayers (individuals with more than $250,000 of income and joint filers with more than $300,000 in income). Most itemized deductions will be reduced by the lesser of (1) three percent of the amount by which adjusted gross income exceeds those limitations, or (ii) eighty percent of the total itemized.

B. The maximum amount that an individual may claim as a charitable contribution deduction in a given year is 50 percent of his “contribution base.”

1. An individual’s contribution base is defined as his adjusted gross income computed without regard to any net operating loss carryback for the year (IRC § 170(b)(1)(F)).

2. The 50 percent limitation is available only for direct contributions to “public charities” (which category includes so-called private operating foundations and conduit foundations) (IRC § 170(b)(1)(A)). Organizations that fall into this category are often called “50-percent-type organizations.”

3. Not all gifts to such organizations are eligible for this 50 percent deduction, however. Contributions of certain appreciated property are subject to special limitations, discussed later. Further, contributions in trust are treated as “for the use of,” rather than “to,” the charity and also do not qualify for the 50 percent deduction (Treas. Reg. § 1.170A-8(a)(2)).

C. Deductions for contributions to organizations that are not public charities (so-called 30-percent-type organizations, which are primarily private nonoperating

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foundations), and contributions for the use of any charity, are subject to a more restrictive limitation of 30 percent of the individual’s contribution base, or, if less, the difference between 50 percent of the individual’s contribution base and the amount of the individual’s contributions to 50-percent-type organizations (IRC § 170(b)(1)(B)).

EXAMPLE: In 2016, an individual contributes $25,000 in cash to a public charity and $15,000 in cash to a private nonoperating foundation. If the individual’s contribution base is $60,000, the donation to the public charity falls within the 50 percent limitation for the individual ($30,000) and is fully deductible in 2016. The amount of the donation to the private foundation that the individual may deduct is whichever is less, (a) 30 percent of his contribution base ($18,000) or (b) the difference between his 50 percent limitation and his donation to the public charity ($30,000 - $25,000 = $5,000). Thus, the individual may deduct only $5,000 of his contribution to the foundation in 2016.

D. A five-year carryover rule applies to amounts that an individual cannot deduct in a given taxable year (IRC § 170(d)). The individual in the preceding example could therefore carry over the remaining $10,000 contribution that was not deductible in 2015 and, subject to the same percentage limitations, claim it as a charitable deduction in the first available succeeding year through the year 2021.

E. The percentage limitations just discussed apply only to contributions of cash and ordinary income property (property which, if sold, would not result in long-term gain). In addition, in the case of ordinary income property, the amount of the contribution for which an individual may claim a charitable deduction is limited to the contributed property’s cost, not its fair market value (IRC § 170(e)(1)).

F. If an individual contributes long-term capital gain property to charity, different limitations may apply.

1. If the charity is a 50-percent-type organization, the percentage limitation on the deduction is 30 percent of the individual’s contribution base if the individual is valuing the property at its fair market value (IRC § 170(b)(1)(C)(i)).

a. Step Down. The individual can increase the limit to 50 percent of his contribution base by electing to “step down” (reduce) the amount for which he is claiming a deduction by the amount of the long-term gain that would have been taxable had he sold the contributed property at its fair market value (IRC § 170(b)(1)(C)(iii)).

EXAMPLE: In 2016 an individual contributes $45,000 of appreciated securities to a public charity. The individual held the securities for more than one year before making the contribution. The individual’s basis in the securities is $25,000. If the

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individual’s contribution base is $60,000, he may deduct only $18,000 (30% of $60,000) of the contribution if he values the securities at fair market value for charitable deduction purposes. However, the individual may elect to step down the value of the securities for purposes of the deduction to $25,000 and deduct this amount in full, because it does not exceed 50 percent of his contribution base ($30,000). By stepping down the value, the individual has increased his charitable deduction for the current year.

b. An individual must consider the carryover rules when deciding whether to make the step-down election. In the preceding example, if the individual does not make the step-down election, he may carry over the $27,000 that is not deductible in 2016 to subsequent tax years. If he is in a 39.6 percent tax bracket, these additional deductions will create $10,692 in tax savings. If he makes the step-down election, the full $25,000 reduced value is deductible in 2016 but there is no carryover of any excess and no future tax savings from the contribution. In each case, the value of a larger immediate tax saving through a step-down election must be compared with the present value of future tax saving if step down is not elected.

c. Step down can be more attractive where the amount of appreciation is small or the donor dies after making a large contribution so that there are no succeeding years of the donor to which the excess contribution may be carried.

2. Automatic Reduction to Basis. If the donee of long-term capital gain property is a 30-percent-type organization, the percentage limitation on the deduction is whichever is less, (a) 20 percent of the donor’s contribution base, or (b) the excess of 30 percent of the contribution base over the amount of contributions of long-term capital gain property to 50-percent-type organizations (IRC § 170(b)(1)(D)). In addition to this percentage limitation, there is an automatic reduction of the amount for which an individual can claim a deduction in the case of long-term capital gain property (other than certain public securities, as is discussed later) donated to a private nonoperating foundation (but not to any other 30-percent-type organization). The reduction again lowers the deductible amount to the adjusted cost basis of the property (IRC § 170(e)(1)(B)(ii)).

EXAMPLE: An individual contributes real estate valued at $10,000 to a private nonoperating foundation in 2016. The individual held the real estate for more than one year before the contribution. His basis in the property is $8,000 and his contribution base for the year is $50,000. If the individual made no other contributions during the year, he may claim a charitable contribution deduction of $8,000 for the contribution, which is

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his adjusted basis in the real estate. If the individual made the contribution to a 30-percent-type organization that is not a private nonoperating foundation, he could claim a deduction for the full $10,000 value of the real estate. In either case the contribution would be fully deductible since the deductible amount does not exceed 20 percent of his contribution base.

EXAMPLE: The individual in the preceding example also contributed a second parcel of real estate worth $10,000 to a public charity in 2016. In this case, the individual may deduct only $5,000 of the gift to the 30-percent-type organization (whether or not a nonoperating private foundation), because his deduction for the latter gift is limited to the difference between 30 percent of his contribution base ($15,000) and the $10,000 value of the long-term capital gain property given to the public charity.

a. For the purpose of applying the limitation on long-term capital gain property contributed to a 30-percent-type organization, the individual must value the long-term capital gain property that he contributed to 50-percent-type organizations in the same year at its fair market value, regardless of whether the individual made the step-down election with respect to the property contributed to the 50-percent-type organizations. Thus, in the preceding example, if the individual stepped down the value of the real estate contributed to the public charity to his adjusted basis of $5,000, he must nevertheless value that property at its $10,000 fair market value in calculating the limitation for his donations to 30-percent-type organizations.

b. The automatic reduction rule for gifts of long-term capital gain property to private nonoperating foundations does not apply to a donation of “qualified appreciated stock.” This is defined as stock that is readily tradable on an established securities market.

G. Special value reduction rules apply to contributions of tangible personal property held for more than one year (and therefore subject to long-term capital gain treatment) if use of the property by the charitable donee is unrelated to its exempt purpose or function. Such property is always reduced for deduction purposes by the amount of long-term gain that would have been taxable had the taxpayer sold the property at its fair market value. This rule applies to contributions to both 50-percent-type and 30-percent-type organizations (IRC § 170(e)(1)(B)(i)).

H. The 2006 Pension Protection Act addresses tangible personal property that is sold, exchanged, or otherwise disposed of by the donee before the last day of the taxable year in which the donor made the contribution and with respect to which the donee has not in a written statement signed by an officer of the donee under the penalties of perjury either (1) certified that the use of the property was related to the donee’s exempt purpose or function and described how the property was

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used and how such use furthered such purpose or function of the donee or (2) stated the intended use of the property by the donee at the time of contribution and certified that such use has become impossible or infeasible to implement.

1. If the property is disposed of after the close of the taxable year of the contribution and within three years of the date of the contribution (unless the donee makes the certification described above), the Act requires the recapture of the charitable deduction in an amount equal to the difference between the amount claimed as a deduction and the property’s basis.

2. The Act also imposes a $10,000 penalty (in addition to any criminal penalties) on any person who identifies property as exempt use property knowing that the property is not intended for such a use.

3. The recapture provisions apply to contributions made after September 1, 2006. The penalty provisions apply to identifications of property made after the date of enactment.

4. The Act denies a deduction for any contribution by an individual, corporation, or partnership of clothing or a household item unless such item is in good used condition or better. Further, the Internal Revenue Service may, by regulation, deny a deduction for any contribution of clothing or a household item of minimal monetary value.

5. These limitations do not apply to any contribution of a single item for which a deduction of more than $500 is claimed if the taxpayer includes with the taxpayer’s return a qualified appraisal of the item.

6. Household items include furniture, furnishings, electronics, appliances, linens, and similar items. Food, paintings, antiques, and other art objects, jewelry and gems, and collections are not included within these rules.

I. Before 1993, an individual who made a charitable contribution of appreciated long-term capital gain property also needed to be concerned with the alternative minimum tax (“AMT”). The Revenue Reconciliation Act of 1993 eliminated as a tax preference item for AMT purposes the “capital gains” portion of appreciated property contributed to a charitable organization. (RRA § 13171).

J. A provision of the 2004 Tax Act revised the rules for claiming tax deductions for charitable donations of motor vehicles, boats and airplanes valued at over $500. Section 731 of the Act limits the allowable amounts of such deductions to the gross proceeds received by the charity from the sale of the donated vehicle and requires the charity to provide donors with a written acknowledgment of their contributions within 30 days of the donation for all gifts after December 31, 2004.

K. The 2006 Pension Protection Act generally denies an income tax and gift tax charitable deduction for an undivided portion of a donor’s entire interest in tangible personal property unless all interests in the property are held by the

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taxpayer or the taxpayer and the donee immediately before the contribution. The Internal Revenue Service may, by regulation, provide exceptions to the general rule for situations where all persons who hold an interest in the property make proportional contributions of an undivided interest.

1. The Act provides that in the case of any contribution of additional interests in the property, the fair market value of the contribution is the lesser of the fair market value of the property at the time of the initial contribution of a fractional interest and the fair market value of the property at the time of the contribution. Similar rules apply for estate tax purposes where the decedent made fractional interest contributions before death. This means that appreciation in value after the initial gift cannot be taken into account.

2. The new rules require that any charity that receives a fractional interest in tangible personal property must take complete ownership of the property within 10 years or upon the death of the donor, whichever occurs first. In addition, the charity must have had substantial physical possession of the property during the 10-year period as long as the donor is living and used it in connection with its exempt purpose.

3. If these rules are not met, the Act requires recapture of the tax benefits associated with the contribution and imposition of a 10- percent penalty tax on the amount of the recapture. Recapture rules, as well as a 10-percent penalty tax, also apply for purposes of the gift tax.

III. Substantiating the Charitable Deduction

The IRS may disallow an individual’s income tax charitable deduction if it is not properly substantiated. Recordkeeping requirements apply to all charitable contributions. Additional appraisal requirements apply to certain large contributions of property, other than cash or publicly traded securities.

A. Recordkeeping

1. For cash contributions to charitable organizations under the 2006 Pension Protection Act, a taxpayer may not claim a deduction for any cash or other monetary gift unless the taxpayer maintains as a record of the contribution a bank record or other written communication from the donee showing the name of the donee, the date of the contribution, and the amount of the contribution.

2. If an individual makes a charitable contribution of property other than cash, he should obtain a receipt from the charity that shows the charity’s name, the date and location of the contribution, and a description of the property contributed. If obtaining a receipt is impractical (e.g., because the donation is made at an unattended site, such as a clothing drop-off box) the donor may substitute his own written records (Treas. Reg. § 1.170A-13(b)(1)).

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3. In addition to obtaining a receipt, a property donor should keep written records of any other information that may be necessary to substantiate the deduction (Treas. Reg. § 1.170A-13(b)(2)(ii)). For example, if the donor reduced the value of the property to its adjusted basis for purposes of the deduction, his records should include evidence of the property’s basis.

4. Charitable contributions over $250, whether in cash or kind, to any donee must be substantiated by a “contemporaneous” written acknowledgment by the charitable organization. Without such substantiation, the deduction will be disallowed. An acknowledgment will be considered to be contemporaneous if it is made on or before the earlier of the date the return is filed or the due date for filing the return. The acknowledgment must include (1) the amount of cash and a description (but not value) of other property donated, and (2) a description and estimate of the value of any goods or services provided by the charity in consideration of the donation. The substantiation requirement applies to all charities, including family private foundations, which means that acknowledgments must now be obtained for donations over $250 to family foundations. (IRC § 170(f)(8)). The IRS has issued final regulations in this area with an effective date of December 12, 1996 (Treas Reg. § 1.170A-13(f)).

5. If a deduction for a gift of property exceeds $500, the donor must maintain additional records. These records must contain information on the manner in which the donor acquired the property, the approximate date of acquisition, and, for property other than marketable securities, the cost or other basis of the property. If the donor held the property for more than six months before the contribution, the regulations require the maintenance of records on the property’s basis only if such information is available (Treas. Reg. § 1.170A-13(b)(3)(i)).

B. Appraisal Requirements

1. Pursuant to a directive in TRA 1984, the Treasury Department has enacted temporary regulations that impose detailed appraisal requirements on individuals who make charitable contributions of property (other than cash or publicly traded securities) with a value in excess of $5,000. These regulations generally provide that no income tax charitable deduction will be allowed for contributions of such property unless the donor obtains a “qualified appraisal,” and attaches a completed “appraisal summary” to the return on which he first claims the deduction. These requirements apply in addition to the recordkeeping requirements previously discussed.

2. Among the more important requirements for a qualified appraisal are that the appraisal must be made not more than 60 days before the date of contribution, describe the property appraised and the method of valuation used, be signed by the appraiser, and recite the appraiser’s address, taxpayer identification number, and professional qualifications (Treas.

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Reg. § 1.170A-13(c)(3)). In addition, the appraisal must include a description of the fee arrangement between the donor and the appraiser. The appraiser generally cannot base his fee on a percentage of the appraised value of the property (Treas. Reg. § 1.170A-13(c)(6)(i)).

3. The appraiser used for a qualified appraisal must meet various requirements set forth in the regulations. The appraiser must hold himself out to the public as an appraiser and must be qualified to make appraisals of the type of property being valued. In addition, the appraiser may not be connected in any way to either the donor or the charity. The regulations specifically prohibit the donor, the charitable donee, or an employee of either from acting as the appraiser. With certain limited exceptions, a party to the transaction in which the donor acquired the property that is being appraised, or an employee of that party, cannot be the appraiser. The regulations also contain a catch-all provision that disqualifies any appraiser whose relationship to any of the foregoing described parties would cause a reasonable person to question his independence (Treas. Reg. § 1.170A-13(c)(5)).

4. In addition to obtaining a qualified appraisal, the donor must complete an appraisal summary on a form prescribed by the IRS (currently Form 8283). The donor must obtain the signatures of the appraiser and the charitable donee on the form and attach it to the income tax return on which he first claims the deduction (Treas. Reg. §§ 1.170A-13(c)(2)(i)(B); 1.170A-13(c)(4)). In Hewitt v. Comm’r, 109 T.C. 258 (1997), the charitable deduction was reduced because of an improperly completed Form 8283 and the absence of a “qualified appraisal.”

5. For the purpose of determining whether his contributions of property exceed $5,000, the donor must aggregate the values of similar items of property. For example, an individual who donates a number of paintings to different charities must aggregate the value of the paintings and satisfy the appraisal requirements if the aggregate value exceeds $5,000 (Treas. Reg. § 1.170A-13(c)(7)(iii)).

6. As previously mentioned, publicly traded securities are exempt from the appraisal requirements. Any share of stock, subscription right, bond, debenture, or other evidence of corporate indebtedness for which market quotations are readily available on an established securities market fall in this exempt category (Treas. Reg. § 1.170A-13(c)(7)(xi)).

7. The appraisal requirements are relaxed for charitable contributions of non-publicly traded stock where the claimed value of the donation exceeds $5,000 but does not exceed $10,000. In that case, no qualified appraisal is required and the donor must complete only part of the appraisal summary (Treas. Reg. § 1.170A-13(c)(2)(ii)).

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8. Under Rev. Proc. 96-15, 1996-1 C.B. 627, the IRS permits a donor to receive from the IRS a binding statement of value for purposes of fixing the charitable deduction for certain donations of artwork. The artwork must have been appraised at $50,000 or more. A taxpayer can rely on a statement of value absent a misrepresentation of material facts in the application.

PART B


Part B - 1


I. Income Tax Charitable Deduction

1. Letter Ruling 9631004 (April 30, 1996). IRS disallows charitable deduction for scholarship fund limited to recipients with the same surname of the decedent.

The question of whether a “charitable” trust or gift benefits a broad enough class of individuals to be considered a deductible charitable transfer has been litigated frequently. The issue often arises in connection with scholarship funds. Several cases have held that a trust which limits scholarships to a limited class of individuals bearing the family surname is a “private trust” that will not qualify for the gift tax or estate tax charitable deduction. See, e.g., Davis v. Comm’r, 55 T.C. 416 (1970); Estate of Dorsey v. Comm’r, 19 T.C. 493 (1952). Conversely, cases have held that if the surname provision merely states the decedent’s preference for individuals sharing the same surname and allows the trustee to select other scholarship recipients, then a charitable deduction will be allowed for the trust. See Estate of Sells v. Comm’r, 10 T.C. 691 (1948); Commonwealth Trust Co. of Pittsburgh v. Granger, 57 F. SUPP. 502 (W.D. Pa. 1944).

The IRS applied this case law in Letter Ruling 9631004. The IRS determined that the trust in question was a private trust because it limited the class of persons eligible as scholarship recipients to individuals with the same surname of the decedent, the family name was the surname of only 603 families in the United States, and the trustee was limited to distributing trust funds to only two universities in the same city as the decedent’s residence.

The IRS added that a trust deemed to be private trust cannot avail itself of the cy pres doctrine to change the terms of the trust. The cy pres doctrine may be invoked by a court to deviate from the trust’s original purpose or purposes and modify the trust provisions to apply the trust funds as closely to the settlor’s plan as possible. However, the cy pres doctrine applies only to charitable trusts and not to private trusts and thus cannot be used to turn a private trust into a charitable trust.

Theoretically, a taxpayer could place a surname requirement on a scholarship program if the name is extremely common; for example, Smith or Jones. However, the safer route is to make the provision precatory, and allow the trustee also to select recipients without the family surname. Other viable options also may be available. In Estate of Sells v. Comm’r, 10 T.C. 691 (1948), the court approved charitable status for a trust which permitted the trustee to choose scholarship recipients not bearing the family name only after a determination that there were no eligible individuals with the surname.

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2. Gust Kalapodis v. Commissioner, T.C. Memo 2014-205. Tax Court concludes that taxpayers are not entitled to an income tax charitable contribution deduction for scholarship payments made by irrevocable trust created in memory of deceased son.

In 2006, Mr. and Mrs. Kalapodis received $75,000 in life insurance proceeds as a result of the death of their son. That same year, the Kalapodises used the life insurance proceeds to establish a memorial scholarship fund in honor of their son. The scholarship fund was structured as an irrevocable trust. The trust agreement stated that the income from the trust is to be used exclusively for educational purposes. The trust did not apply for tax-exempt status as a charitable organization. During 2008, the trust made payments of $2000 each to three high school students. Each payment was made by check directly to the student from an account owned solely in the name of the trust.

When the Kalapodises filed their 2008 individual income tax return, they did not include the investment income from the trust in their gross income; however, they claimed a $6,000 charitable income tax deduction for the payments made to the students. The IRS disallowed the charitable income tax deduction claimed by the Kalapodises.

The Tax Court held that the Kalapodises were not entitled to the $6,000 income tax charitable contribution for three reasons. First, an irrevocable trust and not the Kalapodises paid the money out as scholarships. No provision of the trust agreement would permit the Kalapodises to report the tax attributes of the trust on their personal income tax return. Second, even if the Kalapodises could report the tax attributes of the irrevocable trust on their personal return, the trust payments did not qualify as charitable contributions. Section 170(c) has specific rules for who are permissible recipients of a contribution or a gift in order for the payment to qualify as a charitable contribution for which an income tax charitable deduction is permitted. Students did not fall into any of the permissible categories of recipients. Finally, the Kalapodises failed to produce any evidence of a contemporaneous written acknowledgement of the charitable contribution since the amount was over $250 as required by Section 170(f)(8)(A).

3. Letter Ruling 201334043 (August 23, 2013). Trust established to support widow and her children is not entitled to tax exempt status because it operates for the private benefit of the designated individuals.

A trust was formed for the benefit of a widow and her unmarried children for the health, education and support of the widow and her unmarried children to the extent that they could not earn sufficient income from gainful employment and other business endeavors. The trust was to operate in a manner to qualify as an exempt organization under Section 501(c)(3). The trust was referred to as a foundation.

During the exemption application process, the trust modified its activities to provide assistance to the family of the widow and to other families in similar situations. In a final amendment, the reference to the widow was removed from the purpose clause. Instead the purpose stated that the trust was formed for the benefit of any Jewish family where a

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parent died in a fatal accident. According to the IRS, this amendment was not signed and there was no evidence that the amendment was adopted.

The IRS found that the trust met neither the organization test nor the operational test. It failed the operational test because it was not organized exclusively for charitable purposes. It failed the operational test because it more than substantially benefited the widow and her family.

4. Ferguson v. Comm’r., 83 AFTR 2d ¶99-648 (9th Cir. 1999). Court imputes gain to donor for gift of appreciated stock shortly before the sale of a closely-held company.

A gift of appreciated stock to charity before a sale of the underlying company can produce an income tax charitable deduction for the full value of the stock and avoid the income tax on the unrealized appreciation in the stock. However, the gift to charity must occur before the donor is bound by the sales transaction. If the donor is committed to the sale, he or she still will receive a charitable income tax deduction, but the donor will be treated as having sold the stock before donating, and will have to recognize the capital gain on the unrealized appreciation.

In this case, the donors, members of the Ferguson family, owned stock in American Health Companies, Inc. The Ferguson family had founded the business many years ago and had taken the business public in 1986. In May 1988, the company hired an investment banker to search for a purchaser, and, as a result, on August 3, 1988, a third party made a tender offer of $22.50 a share to accomplish a merger. The acquiring entity announced on September 12, 1988 that the necessary 85% of the company’s stock had been tendered and that it accepted all tendered stock. The final steps in the acquisition were consummated on October 14, 1988.

The Fergusons on August 15 and 16 notified the Mormon Church that they were donating a significant number of shares of the company to it. In addition, on August 26, the Fergusons organized two private foundations to which shares of stock would be donated.

The shares to be donated to both the church and the private foundations were deposited in new brokerage accounts in the donor’s names on August 16th and August 23rd. On September 8th, under an in-house entry by the broker, the stock was transferred from the new accounts to the accounts of the Morman Church and the two private foundations. The corporate secretary of the company reported the change in the ownership of the stock to the Securities and Exchange Commission on September 9, 1988.

The IRS argued that the stock “ripened” from an interest in a viable corporation into a fixed right-to-receive cash by the time of the August 3, 1988 tender offer. Thus, the Fergusons needed to make the gifts before August 3, to avoid recognizing the capital gain on the stock. The donors argued that the right to receive proceeds did not “ripen” until October 12, 1988 when the final steps were taken to implement the acquisition of the company.

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The court applied a constructive receipt approach under which it analyzed when that point of certainty in the stock transaction was reached to ensure completion of the merger. The Tax Court had concluded that the tender or guarantee of more than 50% of the outstanding shares was the functional equivalent to a vote by the shareholders approving the merger. The Ninth Circuit agreed and concluded that the stock ripened from an interest in a viable corporation into a fixed right to receive cash by August 31, 1988. Since the beneficial ownership of the donated stock was not transferred until September 8 or 9, the stock still belonged to the Fergusons as of the date of ripening and they had to recognize capital gain.

One problem here, unlike many other similar transactions, is that the stock was publicly traded. Numerous hurdles must be cleared when control persons, such as the donors, make contributions of stock subject to restrictions under the securities laws. For example, in this case, the broker’s legal department had to approve the transfer, which caused a delay in completing the transfer. This case serves as a reminder that, when making gifts of appreciated stock to a charity before a contemplated merger or sale, the gifts should be completed as soon as possible to prevent the making of any sort of a ripening argument.

5. Technical Advice Memorandum 200341002 (October 10, 2003). Taxpayer not allowed either charitable deduction or annual exclusion for gifts to trust subject to Crummey Powers in charities.

This ruling reviewed the effect of Crummey powers of withdrawal given to four charities with respect to gifts to an irrevocable trust. It appears that the taxpayer was attempting to use the charities to transfer additional property into the trust tax-free. It also seemed, however, that the taxpayer actually may have intended to benefit the charities.

The trust in question provided that distributions could be made to the trust beneficiaries in the trustee’s discretion. The designated beneficiaries were two children of the grantor, one child’s spouse, and four named charities. Upon the death of the grantor any remaining trust property was to be distributed 60% to the individual beneficiaries, 25% to one charity, and 5% each to the remaining three charities. The trust also granted the beneficiaries powers of withdrawal over contributions to the trust in the percentages indicated, not to exceed $10,000 per beneficiary per annual contribution. None of the charities ever exercised their withdrawal rights.

On his gift tax return, the grantor characterized the transfers to the trust, which were subject to the charities’ withdrawal rights as present interest gifts, which qualified for the charitable deduction. The IRS denied both the charitable deduction and the annual exclusion. It concluded that the transfers did not qualify for the charitable deduction under Section 2522 because none of the charities exercised a withdrawal power and therefore no property actually passed to charity in connection with the gifts. The IRS noted that, other than by virtue of the Crummey powers, there was no guarantee the charities would receive anything because of the trustee’s discretionary distribution powers during the term of the trust. The IRS cited Commissioner v. Estate of Sternberger, 348 U.S. 187 (1955), for the proposition that there is no statutory authority

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for a gift tax charitable deduction where there is no assurance that the charity ever will receive a specific amount.

The ability of the trustee to divert all the assets to individual beneficiaries also was the critical factor in leading the IRS to determine that no annual exclusion was available. The IRS stated that, in light of the fiduciary obligations of the officers and directors of a charity to protect and preserve the charity’s property and property rights, no charity would decline to exercise a withdrawal right unless there was certainty that it would recoup the property later. Since there was no certainty in this case, the IRS concluded that there must have been an unwritten “impediment” to exercising the withdrawal rights.

II. Estate Tax Charitable Deduction

1. Marine Estate v. Comm’r, 990 F.2d 136 (4th Cir. March 30, 1993) (affirming 97 T.C. 368 (1991)). Charitable deduction denied because amount was unascertainable.

In this case, a charitable deduction was denied for residuary gifts left to two universities because the amount of the gifts were rendered unascertainable by provisions in the decedent’s will that gave his personal representatives discretion to make bequests to “persons who had contributed to his well-being during his lifetime.”

One of the requirements for the charitable deduction under Code Section 2055 is that the amount that the charity will receive must be ascertainable at the decedent’s death. In this case, the decedent caused the residuary bequests under his will to be unascertainable when he executed a codicil giving his personal representatives sole and absolute discretion to make specific bequests of up to one percent of the decedent’s gross estate to one or more persons who had misted the decedent during his life. There was no limit on the number of bequests that the personal representatives could make, so the bequests conceivably could have consumed the decedent’s entire estate. As a result, the estate was denied a charitable deduction that would have exceeded over $24 million, even though the personal representatives actually made only two bequests under the codicil totaling $25,000.

The personal representatives argued that the charitable gifts were rendered ascertainable when the personal representatives obtained a court order approving payment of bequests to the two individuals and closing the class of beneficiaries who could be named. The IRS rejected this argument because the court order was not issued until nearly two years after the decedent’s death.

Clearly, the best way to avoid this problem would have been for the decedent to identify the specific bequests he wished to make rather than leaving discretion to the personal representatives. It also may have been possible for the personal representatives to preserve the charitable deduction by disclaiming this power to make specific bequests before the filing of the federal estate tax return. See, e.g. Letter Ruling 9151012 (September 19, 1991). In order to do so, however, it appears that the personal representatives would have had to decline to exercise the power at all. Any exercise of

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the power would prevent the disclaimer from being qualified under Sections 2055(a) and 2518.

2. Zabel v. United States, 995 F. Supp. 1036 (D. Nebraska 1998). Estate tax charitable deduction denied for a decedent’s estate because a testamentary split interest trust failed to meet the requirements for a charitable remainder annuity trust, a charitable remainder unitrust, or a pooled income fund.

Decedent’s residue, which was worth approximately $1.8 million, was bequeathed to a testamentary trust. Fifty percent of the net trust income was to be distributed to two relatives until the first to occur of their death or 21 years and the balance of the trust income was to be distributed to two charities. The charities were also named as the remainder beneficiaries. The court found that the trust was not entitled to a charitable deduction under Section 2055. In order for a split interest trust to qualify for the estate tax charitable deduction, the trust or gift must be in the form of a charitable annuity trust, a charitable unitrust, or a pooled income fund. This trust complied with none of those requirements.

3. Letter Ruling 201004022 (January 29, 2010). IRS rules that estate is not entitled to charitable deduction for amount paid to charity pursuant to a settlement agreement.

Upon decedent’s death, it was determined that the decedent’s will, as amended by three codicils, lack a residuary provision. The will first provided for the payment of taxes and expenses out of the residuary. It next established a charitable trust. The decedent next devised real property to be held in trust for the use of his Son and Son’s wife during their lifetimes. Upon the death of the second to die of Son and Son’s wife, the real property was to be sold and the proceeds added to the charitable trust. Then, the decedent bequeathed a specific amount in trust for the benefit of Son under which the Son received mandatory income payments and principal could be invaded to pay for medical expenses. If Son’s wife survived, the income was to be paid to Son’s wife. Upon the second death, the remaining property was to be paid to the charitable trust. Trusts similar to the one for Son and Son’s wife were created with gifts of specific amounts for the benefit of other relatives.

Son claimed that as decedent’s sole intestate heir, he was entitled to the residuary estate. The charitable trust claimed that it was the lawful beneficiary of the residuary estate and that the omitted residuary clause was the result of a drafting error. The attorney who drafted the will and the codicils stated in an affidavit that the decedent told him that he intended for the residue to pass to the charitable trust.

Son and the charitable trust settled the dispute through a settlement agreement under which Son received a specific sum outright and free and clear of all expenses and taxes. The amount remaining after the outright payment to Son and after the payment of expenses and taxes (including the taxes on the distribution of the specific amount to Son) was to be paid to the charitable trust. The settlement agreement was approved by a local court without an evidentiary hearing.

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The IRS ruled that the amount passing to the charitable trust did not quality for the estate tax deduction since the property did not pass to the charitable trust. The Service looked at Ahmanson Foundation v. United States, 674 F.2d 761 (9th Cir. 1981), which determined that an amount received by a surviving spouse pursuant to a lower state court judgment is treated as passing for federal estate purposes (and thereby qualifying for the marital deduction) if “the interest reaches the spouse pursuant to state law, correctly interpreted—not whether it reached the spouse as a result of a good faith adversary confrontation.” A good faith settlement or judgment of a lower state court must be based on an enforceable right under state law properly interpreted to qualify as “passing” for purposes of the estate tax marital deduction.

The IRS used the Ahmanson test for “passing” to qualify for the marital deduction in this ruling to see if the property “passed” to the charitable trust and would qualify for the charitable deduction. It determined that the charitable trust did not have an enforceable right under the governing law to the settlement proceeds in this case. It noted that the governing law provided that a testator who executed a will is presumed to intend to dispose of his entire estate and avoid intestacy. However, such a presumption is met by an equal presumption that an heir is not to be disinherited except by plain words or necessary implication. The extrinsic evidence, including the attorney’s affidavit, indicated that the residuary clause was erroneously omitted, and failed to create an ambiguity. The son was entitled to receive the residuary as the sole heir of decedent. Since the charitable trust did not have an enforceable right, the amount it received as the result of the settlement agreement failed to qualify for the estate tax charitable deduction.

4. Technical Advice Memorandum 200437032 (September 10, 2004). Residuary bequest to member of religious order who has taken a vow of poverty does not qualify for the estate tax charitable deduction.

A decedent left the residue of his estate to his sister. Prior to the death of the decedent, the sister had joined a religious order and taken a vow of poverty. The sister’s religious order was the designated taker in default. The sister, who also acted as executor of the decedent’s estate, transferred the assets of the estate to the order more than nine months after the decedent’s death. The issue in this technical advice memorandum was whether the gift could qualify for the estate tax charitable deduction.

The IRS first addressed the issue of whether the gift to an individual, which the individual is required to transfer to a religious order pursuant to a vow of poverty at the time of the decedent’s death, would qualify for the estate tax charitable deduction under Section 2055. The IRS found that the property did not pass from the decedent to the religious order pursuant to the terms of the testamentary instrument. Rather, the property passed to the religious order from the individual subject to the vow of poverty, pursuant to a contractual arrangement between the individual and the order. The IRS cited Revenue Ruling 68-459, 1968-2 C.B. 411, and Revenue Ruling 55-759, 1955-2 C.B. 607 for this construction. A similar result was reached in Estate of Callaghan v. Commissioner, 33 T.C. 870 (1960). Because the bequest did not pass directly to the order, it would not qualify for the estate tax charitable deduction.

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The next issue was whether the sister’s vow of poverty constituted a qualified disclaimer meeting the requirements of Section 2518(a). If it did qualify as a disclaimer, the sister would be treated as predeceasing the decedent and the disclaimed interest would pass to the order pursuant to the residuary clause of the decedent’s will.

The IRS found that a vow of poverty entered into by the sister was not a qualified disclaimer under Section 2518. It did not satisfy the state law requirements for a valid disclaimer, such as being filed with the appropriate probate court. The vow did not have the effect of treating the sister as predeceasing the decedent for inheritance purposes.

In addition, the IRS concluded that the transfer of the assets to the order did not meet the requirements of Section 2518(c)(3), which treats certain written transfers of property as disclaimers. The IRS stated that Section 2518(c)(3) will apply only if a state law disclaimer was not available at the time of the transfer. It stated that the provision could not be viewed as a catch-all provision to save defective or disqualified disclaimers. Here, the IRS focused on the failure of the sister to make a disclaimer within the nine month period after the decedent’s death. In addition, the IRS rejected the estate’s argument that the sister’s vow of poverty resulted in the termination of the sister’s interest in the bequest.

This ruling points out the importance of following the requirements for a valid disclaimer under Section 2518. One of the most important of those requirements is that the disclaimer be made within nine months of the date of the decedent’s death in order for it to be valid. The failure to obtain the estate tax charitable deduction in this situation could have been avoided if the sister had made a qualified disclaimer within nine months of her brother’s death.

5. Letter Ruling 201333006 (August 16, 2013). Judicial reformation of a charitable trust is a qualified reformation and the present value of the remainder interest in reformed trust may be deducted under Section 2055(a).

Decedent created a revocable trust which became irrevocable upon decedent’s death. Under the residuary provision, an amount equal to the amount of the unified credit exclusion amount would pass to a charitable trust. The remaining assets after funding the charitable trust would comprise Share A which was to be distributed outright to three charities. The charitable trust was to annually pay a percentage of the trust corpus out of income of the trust to two children. Upon the death of both children, the principal was to be distributed to the same charities as the outright distributions made from Share A.

Because decedent died in 2010 when there was no estate tax, a question arose as to the amount of the unified credit exclusion amount. As a result of this confusion, the parties agreed to fund the charitable trust with a certain amount and to divide the charitable trust into two trusts. One trust would be reformed to qualify as a charitable remainder unitrust under Section 664. The proceeding to reform the trust was begun before the ninetieth day after the last date for filing the decedent’s estate tax return.

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The IRS found that this proposed reformation was a qualified reformation under Section 2055(e)(3)(A). Consequently, an estate tax charitable deduction would be allowed for the value of the remainder interest in the reformed charitable remainder unitrust.

6. Estate of Dieringer v. Commissioner, 146 T.C. No. 8 (2016). Estate Tax charitable deduction limited by post-death events.

Decedent and family members owned DPI, a closely held real property management corporation. Decedent was the majority shareholder to DPI and owned 425 of the 525 voting shares and 7,736.5 of the 9,920.5 non-voting shares. While she was alive, decedent established a revocable trust and a foundation. Her son was the sole trustee of both the trust and the foundation. Decedent’s will left her entire estate to the trust. Pursuant to the terms of the trust, $600,000 was to pass to various charities and decedent’s children received minor amounts of her personal effects. The remainder of the estate, which would consist primarily of the DPI stock, was to be distributed to the acting trustee of the foundation. An appraisal determined the date of the death value of decedent’s DPI non-voting and voting shares at $14,182,471. The voting stock was valued at $1,824 per share with no discount and the non-voting stock was valued at $1,733 per share which included a 5% discount to reflect the lack of the voting power. Numerous events occurred after decedent’s death, but before decedent’s property was transferred to the foundation. Seven months after decedent’s death, DPI elected S-corporation status. DPI also agreed to redeem all of decedent’s shares from the trust. DPI and the trust amended and modified the redemption agreement. DPI agreed to redeem all 425 of the voting shares and 5,600.5 of the 7,736.5 non-voting shares. In exchange for the redemption, the trust received a short-term promissory note for $2,250,000 and a long term promissory note for $2,968,462. At the same time, three of these of decedent’s sons purchased additional shares in DPI. The foundation later reported that it had received three non-cash contributions consisting of the short-term and long-term promissory notes and non-voting DPI shares. The total value of the two promissory notes was $5,218,462.

An appraisal of decedent’s DPI stock for purposes of the redemption and subscription agreements determined that the voting shares had a fair market value of $916 per share and non-voting shares had a fair market value of $870 per share. The value of the DPI stock reported as received by the foundation from the trust was $1,858,961. The appraisal of the voting stock included discounts of 15% for lack of control and 35% for lack of marketability. The appraisal of the non-voting stock included the lack of control and marketability discounts plus an additional 5% discount for the lack of voting power at shareholder meetings.

On the federal and state estate tax returns, the estate reported no estate tax liability and claimed an estate tax charitable deduction of $18,812,181 which included the date of death value of decedent’s DPI shares. The estate argued that the charitable deduction should not depend upon or be measured by the value received by the foundation. The IRS argued that the amount of the charitable contribution should be determined by post-death events.

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The IRS agreed that normally that the value of the estate tax charitable deduction is to be determined as of the moment of death and also agreed that the estate did not elect alternate valuation under Section 2032. It did argue that there are circumstances where the appropriate amount of a charitable contribution deduction does not equal the date of death value of the contributed property, citing Ahmanson Foundation v. US, 674 F.2d. 761 (9th Cir. 1981).

The court agreed with the IRS and found that the value of the charitable contribution to the foundation was less than the date of death market value of bequeathed property because numerous events occurred after decedent’s death that changed the nature of and reduced the value of the property actually transferred to the foundation and held that the estate was liable for an accuracy related penalty. The amount of additional estate tax owed was $4,124,717 and the accuracy related penalty was $824,943.

The court noted that the same appraiser valued the DPI stock for purposes of determining the date of death value of the property as well as the value for purposes of the redemption. The appraiser testified that for purposes of the redemption, he was specifically instructed to value that DPI stock as a minority interest. The court found that the brothers had thwarted decedent’s testamentary plan by altering the date of death value of decedent’s intended donation through a redemption of a majority interest as minority interest. It cited Treas. Reg. § 20.2055-2(b)(1) to the effect that if a trustee “is empowered to divert the property… to a use or purpose which would have rendered it, to the extent that it is subject to such power, not deductible had it been directly so bequeathed...the deduction will be limited to the portion, if any, of the property or fund which is exempt from an exercise of the power.”

III. Charitable Remainder Trusts

1. Atkinson v. Commissioner, 309 F.3d 1290 (11th Cir. 2002). Trust not administered as a charitable remainder annuity trust, so charitable deduction denied.

Most trusts that fail to qualify as charitable remainder trusts do so because of deficiencies in their terms. As drafted, the trust in the case satisfied all the necessary requirements. However, as implemented and administered, it did not qualify. In 1991, Melvine B. Atkinson placed approximately $4 million in the Melvine B. Atkinson Charitable Remainder Annuity Trust. The trust provided that Atkinson would receive a 5% annuity during life. Upon his death, the 5% annuity was to continue for various individuals, but only if each individual furnished his or her share of the federal and state death taxes that might be owed because of the inclusion of the charitable remainder annuity trust in Atkinson’s estate. During Atkinson’s life, none of the required quarterly payments were made to him from the charitable remainder annuity trust. Atkinson died in 1993. Upon his death, only one of the secondary beneficiaries of the charitable remainder annuity trust elected to take her share. However, this individual informed the trustee that Atkinson had indicated that she would not be liable for her share of the estate taxes and she had a notarized document from Atkinson to that effect. Her claims were settled by obtaining an order for the payment of any estate taxes out of a separate irrevocable trust

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Atkinson had created. It later turned out that the assets in the irrevocable trust were insufficient to pay the death taxes and the charitable remainder annuity trust had to be invaded to pay those taxes.

The court first found that although the charitable remainder annuity trust met the letter of the statutory requirements, the trust was not managed in accordance with its terms. For example, as noted above, none of the requested annuity payments were made. The executor argued that checks were remitted to Atkinson, but were not cashed. However, no canceled or uncancelled checks were presented to the court nor did the executor present any evidence demonstrating a gap in the checks’ sequence. In addition, the charitable remainder annuity trust failed to qualify because estate taxes were paid from the trust. See Revenue Ruling 82-128, 1982-2 C.B. 71.

2. Estate of Jackson v. United States, 408 F.Supp. 2d 209 (N.D. W.Va. 2005). Testamentary split interest trust qualifies for estate tax charitable deduction even though it is not a charitable remainder trust.

Decedent’s trust provided that after his death, income would be payable to a nephew and three nieces. Upon the death of each, ¼ of the trust corpus was to pass to a charity. This trust did not qualify as the charitable remainder trust because it paid neither an annuity nor a unitrust amount to the nephew or the nieces.

When the decedent died on November 28, 1999, the attorney for the trust became concerned about possible conflicts of interest and the dissatisfaction of the beneficiaries at being limited to income. To resolve the problem, the trustee and the beneficiaries agreed to terminate the trust and to distribute the actuarial value of their respective interests to the income beneficiaries and the charity. $229,000 was distributed to the charity as its share. The estate deducted this amount on the estate tax return as a charitable deduction. As one might expect, the IRS denied the deduction.

The parties agreed that the trust was not a valid split interest trust and that it had not been reformed as permitted under Section 2055(e)(3). However, the court used a policy argument to grant the estate tax charitable deduction. It found that the goal of the statute was to ensure that the charitable deduction equals the value received by the charity. Here, because the charity received the amount to which it was entitled, there was no reason to deny the charitable deduction. The court rejected the government’s assertion that Section 2055(e)(3) is only applicable where the non-deductible split interest is terminated in the settlement of a will or to avoid an imminent breach of fiduciary duty. The court also noted that neither the trustees nor the beneficiaries were aware of the requirements of Section 2055(e) for reforming a trust.

3. Galloway v. United States, No. 05-50 (W.D. Pa. May 9, 2006). Testamentary trust failed to qualify as charitable remainder trust and estate tax charitable deduction was denied.

When James Galloway died on July 22, 1998, his revocable living trust provided for the residue of his estate to pass in four equal shares to his granddaughters and two charities.

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The trust provided for distributions to each of the four beneficiaries on two separate dates. Each of the residual beneficiaries received fifty percent of their total expectancy in early 2006. The remaining corpus of the trust was to be paid to the beneficiaries in four equal shares in 2016 and the trust would then terminate.

On the federal estate tax return, the trust claimed an estate tax charitable deduction of $399,079.33 for the portion of the corpus that the trustee anticipated would ultimately pass to the charities. On audit, the IRS denied the deduction. The IRS stated the trust was a “split interest trust” in that it divided the same property between charitable and non charitable entities. Because the trust did not qualify as a charitable remainder trust under Section 2055(e)(2), the IRS assessed an additional $160,394.13 in federal estate tax. Both the taxpayer and the IRS, after suit was filed in the federal district court, filed cross motions for summary judgment, after the estate filed a refund in the federal district court.

The Court first noted that Section 2055(e)(2) permits a split interest trust to receive an estate tax charitable deduction only if the trust is a charitable remainder trust, a charitable lead trust, or a pooled income fund. The government contented that this case involved a classic split interest where an interest in the same property passed to both charitable and non charitable beneficiaries. The taxpayer argued that Section 2055(e) did not apply to the Galloway trust because the trust did not split interests in the same property. Instead, the trust for all intents and purposes was two separate trusts.

The Court then looked at the Zabel v. United States, 995 F.Supp. 1036 (D. Nev. 1998) where the income generated by the trust was to be split between charitable and individual beneficiaries for 21 years with the remaining corpus to be distributed to the charitable beneficiaries at the expiration of the 21 year period. The Zabel court had denied a charitable deduction, even though separate accounts were maintained for the charitable and individual beneficiaries. This was because the language of the Zabel trust failed to create a split interest trust as defined by Section 2055. The Court noted that a similar result was reached in Estate of Edgar v. Commissioner, 74 TC 983 (1989), aff’d., 676 F.2d 685 (3rd Cir. 1982). The court felt that, as in Zabel and Edgar, the Galloway trust split a single estate between charitable and non-charitable interests. Since the trust was a split interest trust and did not meet the statutory requirements for a charitable remainder trust, charitable lead trust or pooled income fund, the charitable deduction was denied.

4. CCA 200628028 (July 14, 2006). Sloppy administration of charitable remainder trust results in disqualification of trust.

The IRS was asked to examine a trust to determine if it was a charitable remainder unitrust in this Chief Counsel’s Advisory Opinion. Under Section 664(d)(2), a charitable remainder trust is a trust in which a fixed percentage (not less than five percent nor more than 50 percent) of the net fair market value of its assets valued annually is paid to one or more private individuals.

One basic requirement of a charitable remainder unitrust is that no amount other than the unitrust amount can be paid to or for the use of a private individual. Section 664(d)(1)(D). Under the facts submitted here, the grantor, A, as trustee had written

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checks from the trust checking account to himself, his wife, and third parties on a random basis and essentially treated the account as a personal bank account. One example was the payment of monthly installment payments on a pickup truck that A owned personally for two years. The trust had also allowed A to use real estate held by the trust rent free. In addition, the trust prepaid A’s rent for 10 years in a building owned by a third party.

Because of these flagrant abuses, the IRS held that the trust was not a charitable remainder trust. Instead, the trust was a grantor trust for income tax purposes and A was to be treated as the owner of the trust under Section 677.

5. Tamulis v. Commissioner, 509 F.3d 343 (7th Cir. 2007). Trust is not to be treated as charitable remainder trust and estate tax charitable deduction is denied.

A Catholic priest died in 2000 leaving an estate of $3.4 million. The bulk of his estate was left in a trust that was to continue for the longer of ten years or the joint lives of the priest’s brother and the brother’s wife. During that period, they would have a life estate in a house owned by the trust and the trust would pay the real estate taxes on the house. The net income of the trust was to go to two of the priest’s nieces, less $10,000 annual payments to a third niece until the third niece graduated from medical school. Upon the termination of the trust at the end of the ten year term, the assets would pass to a downstate Illinois Catholic Diocese.

On the federal estate tax return, a $1.5 million charitable estate tax deduction was claimed for the present value of the charitable remainder, which was described as “the residue following ten-year term certain charitable remainder unitrust at 5% quarterly payments to the grandnieces.”

The trustee/executor and the diocese realized that the trust as written did not qualify as a charitable remainder trust. However, more than eight months after the priest’s death elapsed before the executor prepared a complaint to file in an Illinois state court to start a reformation action. For some reason, the complaint was never filed. Instead, the executor circulated to the income beneficiaries a proposed reformation of the trust to make it a valid charitable remainder trust. Two of the three nieces signed on to the proposed reformation, but the third did not. Illinois law required the consent of all the beneficiaries for a reformation to qualify the trust as a charitable remainder trust. As a result, the trust was never reformed, although the trustee administered it in accordance with the requirements of the Internal Revenue Code for a charitable remainder trust. The estate argued that the trustee’s continued administration of the trust as if it were a qualified charitable remainder trust should be deemed substantial compliance even though there was not literal compliance.

The Seventh Circuit rejected any attempt to apply a doctrine of substantial compliance to permit the estate tax charitable deduction. It found that the doctrine of substantial compliance should only apply to cases in which the taxpayer had a good excuse (though not a legal justification) for failing to comply with either an unimportant requirement or one unclearly or confusingly restated in the statute or regulations. This charitable

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remainder trust flunked the test. The executor/trustee was represented by counsel and was aware that a substantial estate tax deduction was at stake. The executor/trustee had no excuse for failing to bring the required judicial proceeding to reform the trust. It found that the requirements for a reformation were neither unimportant nor were they stated unclearly or confusingly in either the Internal Revenue Code or regulations.

Moreover, the inability under Illinois law to have a reformation of the priest’s trust without the consent of all the beneficiaries was not a reason to reverse the result. Therefore the doctrine of substantial compliance could not be used to excuse the failure to comply with those rules.

6. Mohamed v. Commissioner, T.C. Memo 2012-152. Tax Court denies income tax charitable deduction for property donated to a charitable remainder unitrust.

Joseph and Shirley Mohamed donated real estate to a charitable remainder unitrust in 2003 and 2004 but failed to follow the requirements for documenting the donations. In 2003, the Mohameds donated five properties worth millions of dollars to the charitable remainder trust. Joseph Mohamed completed the 2003 federal income tax return and admitted that he did not read the instructions before completing the return. Mohamed used his own appraisals of the parcels rather than engaging an independent appraiser to do a qualified appraisal. He did not report the basis in the donated properties and he did not attach an appraisal summary to the income tax return. In 2004, the Mohameds donated a shopping center to the charitable remainder unitrust and again Mohamed performed the appraisal of the shopping center for purposes of the income tax charitable deduction and failed to attach an appraisal summary to the income tax return.

The government moved for summary judgment to deny any charitable income tax deductions. Although the court obviously felt that this was a harsh result, it granted summary judgment because the Mohameds failed to follow the rules in the regulations requiring a qualified appraisal performed by an independent appraiser and an appraisal summary to be attached to the income tax return for the charitable deduction. The court also upheld the regulations and rejected the Mohameds’ argument that they had substantially complied with the regulations. It noted that there was a line of reasoning that a taxpayer cannot substantially comply if the taxpayer fails to comply with an “essential requirement” of the governing statute. The failure to obtain a qualified appraisal could not be excused since it is an essential requirement. As a result, the income tax charitable deduction was denied.

7. Letter Ruling 201321012 (May 24, 2013). IRS rules favorably on tax consequences of gift of unitrust interest to charity.

Husband and Wife, on different dates, created two charitable remainder unitrusts (CRUT) under which the unitrust amount would be paid to them until the death of the survivor. Upon the death of the survivor, the unitrust amount would pass to a designated charity. Subsequently, Husband and Wife entered into an agreement with the designated charity under which they would relinquish any right to change the charitable beneficiaries of the

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two CRUTs, acknowledge that the charity was the sole remainder beneficiary of the two CRUTs, and convey to charity all of their respective rights to all remaining unitrust amounts.

Based on these facts, the IRS found that because Husband and Wife would irrevocably relinquish any right to change the charitable beneficiaries of the trust and because they would acknowledge that the charity was the sole remainder beneficiary of the trust, the gift of the remainder interest in the trust to charity would be complete. As a result, they would be entitled to a gift tax charitable deduction for the value of the remainder interests in the trust transferred to charity. They would also be entitled to both a gift tax deduction and an income tax deduction for the value of the unitrust interests in the two trusts transferred to the charity.

8. Letter Ruling 201426006 (June 27, 2014). Judicial reformation of charitable remainder unitrust trust will not result in self-dealing.

Husband and Wife created a charitable remainder unitrust trust which provided for distributions to Husband and Wife and their two children for each of their lifetimes with a designated charity as the remainder beneficiary. Husband and Wife passed away leaving the two children as trustees and sole remaining beneficiaries. Husband and Wife intended to create a standard charitable remaining unitrust. However, Husband and Wife’s attorney used a form that created a net income charitable remaining unitrust which provided for an annual payout of the lesser of the net income of the trust or the fixed percentage of the fair market value of the assets.

The trustees asserted that it was not the intent of Husband and Wife to have an income limitation on the payouts. The trust had always been administered as a standard charitable remainder unitrust. The annual payout had at all times been the fixed percentage of the value of the assets despite trust income of less than that fixed percentage. The trust filed a state court petition seeking authority to reform the trust, and the court granted an order correcting and reforming the trust into a standard charitable remainder unitrust.

The Service found that the judicial reformation of the trust would not violate Section 664 and would not be an act of self-dealing. Because the reformation of the trust based on the scrivener’s error would have the effect of increasing the annual amount payable to income beneficiaries, reformation might give rise to an act of self-dealing under Section 4941 as a transfer to or for the benefit of the disqualified person. However, the circumstances presented indicated that there was no self-dealing and the IRS was satisfied that the grantors never intended to create a net income charitable remainder unitrust. The evidence supporting this intention included the determination of the court that there was a scrivener’s error; the administration of the trust as a standard charitable remainder unitrust; and the affidavit of one of the beneficiaries and the beneficiary’s spouse indicating that the creators of the trust and the drafting attorney had several times stated that that there would be an annual payout of a fixed percentage. There was also no evidence that the income beneficiaries were reducing their own taxes or using the benefit of hindsight in making the change to the trust.

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9. Letter Rulings 201325018, 201325019, 201325020, and 201325021 (June 21, 2013). IRS finds that the early termination of net income only with makeup provisions charitable remainder unitrusts will not be an act of self-dealing by the husband and wife grantors.

The IRS first noted that it normally does not issue letter rulings about the termination of a charitable remainder unitrust before the end of the term in which the trust beneficiaries receive their respective actuarial shares of the value of the trust assets. However, these ruling requests predated the no-ruling position first published in 2008 in Revenue Procedure 2008-4, 2008-1 C.B. 121.

In each of these letter rulings, the husband and wife established a net-income-only charitable remainder unitrust with provisions that made them the beneficiaries of the unitrust payments. The trust was funded with shares of stock that were subsequently sold many years ago. Upon the surviving spouse’s death, the trustee was to distribute the remaining trust assets to one charity.

The husband and wife became disappointed with the investment returns. Their investment priorities changed and were no longer compatible with the structure provided by a charitable remainder unitrust. The husband, wife, charity, and trustee determined that it was in the best interests of all parties to terminate the trust and distribute the assets. Upon termination, the trustee would distribute the actuarial value of the unitrust interest to husband and wife. The value would be based upon the discount rate in effect under Section 7520 on the date of termination, the life expectancies of the husband and wife on the date of termination, and the methodology under Treas. Reg. § 1.664-4. The balance of the trust assets would be distributed to the charity.

The IRS found that, although the husband and wife were disqualified persons for purposes of the private foundation no-no rules that apply to charitable remainder unitrusts, the terminating payments to the husband and wife were not direct or indirect acts of self-dealing under Section 4941. This was because the proposed allocation method was reasonable and did not result in a greater allocation of trust assets to the husband and wife than appropriate to the detriment of the charity. Next, the IRS found that any capital gain recognized by the husband and wife upon termination of the trust would be long-term capital gain. It also found, that the early termination of the trust would not result in the imposition of a termination tax under Section 507 if the proposed calculation for determining the respective interests of the husband, wife, and charity upon termination of the trust was appropriate under Treas. Reg. § 1.664-4.

10. Letter Ruling 201321012 (May 24, 2013). IRS rules favorably on tax consequences of gift of unitrust interest to charity.

Husband and Wife, on different dates, each created two charitable remainder unitrusts (CRUT) under which the unitrust amount would be paid to them until the death of the survivor. Upon the death of the survivor, the unitrust amount would pass to a designated charity. Subsequently, Husband and Wife entered into an agreement with the designated charity under which they would relinquish any right to change the charitable beneficiaries

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of the two CRUTs, acknowledge that the charity was the sole remainder beneficiary of the two CRUTs, and convey to charity all of their respective rights to all remaining unitrust amounts.

Based on these facts, the IRS found that because Husband and Wife would irrevocably relinquish any right to change the charitable beneficiaries of the trust and because they would acknowledge that the charity was the sole remainder beneficiary of the trust, the gift of the remainder interest in the trust to charity would be complete. As a result, they would be entitled to a gift tax charitable deduction for the value of the remainder interests in the trust transferred to charity. They would also be entitled to both a gift tax deduction and an income tax deduction for the value of the unitrust interests in the two trusts transferred to the charity.

11. Letter Rulings 201332011 and 201332012 (August 9, 2013). Changes to net income makeup charitable remainder unitrust ordered by court will not affect status as charitable remainder unitrust.

In each of these letter rulings, grantor created a net income makeup charitable remainder unitrust (“NIMCRUT”) and contributed common stock in one company to the NIMCRUT. The trustee had a limited power to amend the NIMCRUT to ensure that it continued to qualify as a charitable remainder unitrust.

Following the creation of the NIMCRUT, the IRS issued final regulations under Treas. Reg. § 1.664-3 which provided, in part, that the proceeds from the sale or exchange of corpus contributed to a unitrust must be allocated to the unitrust corpus and not to the income.

The NIMCRUT conformed to the Treasury Regulation with respect to the corpus which was used for the initial funding. However, it failed to comply with the final regulation in that the final regulation prevented the trustee from accepting additional contributions because the trust agreement did not conform to the final regulations.

The trustee, based on its limited power to amend the trust agreement, petitioned the state court to permit reformation. The attorney general of the appropriate state acquiesced to the reformation. The court ordered the reformation and added a new provision to the NIMCRUT that required the trustee to allocate to corpus any proceeds from the sale or exchange of any corpus contributed by grantor to it and not to income. The IRS concluded that the judicial reformation of the trust agreement would not cause the trust to fail to qualify as a NIMCRUT and found that the judicial reformation was necessary to achieve the intent of the grantor and to enable the trust to qualify as a charitable remainder trust under Section 664. Consequently, there was no act of self-dealing.

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12. Letter Ruling 201133004 (August 19, 2011). Judicial reformation of charitable remainder unitrust from a net income charitable remainder unitrust with makeup provisions into a standard charitable remainder unitrust does not violate Section 664.

Donor wished to create a standard charitable remainder unitrust for the benefit of a third party under which the third party would receive a fixed percentage of the value of the assets in the charitable remainder unitrust as revalued annually. The donor’s attorney, however, used a net income with makeup provisions charitable remainder unitrust form. As a result, the annual distributions to the third party were limited to the lesser of the net income of the trust or the fixed percentage.

The attorney acknowledged that the inclusion of the net income with makeup provision was a scrivener’s error and that the donor intended that the trust be a standard fixed percentage charitable remainder unitrust form the time of its establishment. In addition, the trust was administered as a standard charitable reminder unitrust during its initial years while the attorney and the third party served as co-trustees. The mistake was discovered when a bank replaced the attorney as co-trustee. The co-trustees filed a reformation action to reform the trust into a standard charitable remainder unitrust ab initio. All beneficiaries consented to the proposed formation. Because the IRS was satisfied that the parties to the trust never intended to create a net income only charitable remainder unitrust, the IRS permitted the reformation. Evidence supporting this intent included:

1. an affidavit from the draftsperson stating that the intention of the donor was to create a standard charitable remainder unitrust and that the creation of a net income charitable remainder unitrust was a scrivener’s error;

2. the administration of the trust as a standard charitable remainder unitrust for the initial years of its existence;

3. the affidavit of the third-party beneficiary of his understanding that he was to receive distributions of the fixed percentage of the value of the trust as revalued annually; and

4. no evidence that the third-party beneficiary reduced his own taxes or used the benefit of hindsight in requesting the change to the trust.

13. Letter Ruling 201030015 (July 30, 2010). Reformation of net income charitable remainder unitrust into fixed percentage unitrust permitted.

Husband and Wife created a charitable remainder unitrust with the intention that it pay out a fixed percentage of the value of the trust property each year. Husband was the trustee of the trust. The lifetime beneficiary of the trust was the Child of Husband and Wife. Due to a drafting error, the attorney included certain net income charitable remainder trust provisions from an earlier draft of the trust under which the amount payable to Child would be the lesser of the trust income during the taxable year or the fixed percentage.

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In order to correct the error, the trustee sought an order from the court authorizing a reformation of the trust into a fixed percentage charitable remainder unitrust from inception. The court permitted the reformation subject to the Internal Revenue Service issuing a letter ruling that the reformation would not disqualify the trust as a charitable remainder trust.

The taxpayer sought rulings that the reformation of the trust would not cause the trust to lose its qualification as a charitable remainder trust and that the judicial reformation of the trust would not constitute an act of self-dealing. The IRS found that, because the attorney indicated that he had made a mistake in the drafting, the judicial reformation of the trust into a fixed percentage charitable remainder unitrust would not violate Section 664. Moreover, the IRS indicated that the circumstances showed that there was no act of self-dealing in the reformation since Husband and Wife never intended to create a net income charitable remainder unitrust. Facts showing this intent included the affidavit submitted by the drafting attorney that the trust was supposed to be a fixed percentage charitable remainder unitrust and an affidavit by Husband and Wife that the net income provision was a drafting error and they never intended to create a net income charitable remainder unitrust. The trustee also represented that after the trust was created and funded, the trust was administered as a fixed percentage charitable remainder unitrust in accordance with his understanding of Husband and Wife’s intent.

14. Letter Ruling 201011034 (March 19, 2010). IRS rules that reformation of charitable remainder unitrust to permit remainder interest to pass to private foundation will not affect trust’s qualification as a charitable remainder unitrust and will not be an act of self-dealing.

Grantor created a charitable remainder unitrust under which at grantor’s death, the remainder interest would pass to a private foundation created by grantor. After grantor died, it was discovered that the instrument creating the charitable remainder unitrust defined a “charitable organization” to which the remainder interest could pass to include only public charities and to exclude private foundations. As a result, the private foundation established by the grantor could not be the remainder beneficiary of the trust. A state court reformation action was begun to expand the definition of “charitable organization” to include private foundations. The estate submitted affidavits from the trustee and the draftsperson stating that the grantor’s specific and strong intention was that the private foundation receive the remainder interest. The state court permitted the reformation subject to a favorable ruling from the Internal Revenue Service.

The IRS held that the judicial reformation of the trust did not cause the trust to fail to qualify as a charitable remainder unitrust. Also, the reformation would not be considered an act of self-dealing under Section 4941 because no disqualified persons would benefit from the reformation. Instead, the only interested parties would be the private foundation or a public charity.

This ruling points up the need in drafting definitions in a charitable remainder trust to be clear as to whether private foundations may or may not be beneficiaries of the charitable remainder interest.

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15. Letter Ruling 201040021 (October 8, 2010). The return of the assets of a charitable remainder annuity trust to its grantors because the trust was void ab initio because it failed the ten percent test is permitted.

A charitable remainder annuity trust was created to pay a seven-percent annuity to the two grantors during their lifetimes. Upon the death of the last to die of the two grantors, the remaining principal was to be distributed to charity. After the creation of the trust, the trustee computed the present value of the charity’s remainder interest. The trustee obtained calculations of the charitable remainder at payout rates of both seven percent and five percent. Both calculations showed that the charity’s remainder interest had a negative value. Consequently, the trust violated the requirement of Section 664(d)(1)(D) that a charitable remainder annuity trust have a remainder interest that has a value of at least ten percent of the initial fair market value of all the property placed into the trust at inception. As a result, the grantors, the trustee, and the charitable remainderman executed a rescission agreement that was subsequently approved by the State Attorney General to treat the trust as void ab initio. The assets of the trust were returned to the grantors.

The IRS found that because the trust was never a charitable remainder trust, none of the rules applicable to a charitable remainder trust involving self-dealing under Section 4941, taxable expenditures under Section 4945, and the tax on terminations of private foundations under Section 507 would apply. Under Section 4947(a)(2), those sections only apply to a trust for which a charitable deduction is allowed. Here, no charitable deduction was allowed. Consequently, the assets of the trust could be returned to the grantors without penalty.

IV. Charitable Lead Trusts

1. Letter Ruling 200328030 (July 11, 2003). Grantor’s retained power to change beneficiaries of charitable lead unitrust disqualifies the trust.

In a charitable lead trust, the charitable beneficiaries receive a stated amount each year for a specified term of years or the life or lives of an individual or individuals. At the end of the period, the remaining corpus is distributed to or in trust for the grantor’s descendants or other non-charitable beneficiaries. A charitable lead trust enables a person to satisfy current charitable intentions and, at the same time, transfer significant amounts of property to private beneficiaries at a reduced transfer tax cost.

A charitable lead trust is very flexible and can be set up as either an annuity trust or a unitrust. It may allow the trustee to determine which charities will receive payments or it can provide for specific charities. Unlike a charitable remainder trust, there is no minimum payout for a charitable lead trust and it can be for any term of years. In creating a charitable lead trust, a grantor makes a charitable gift of the present value of the charities’ right to receive payments. This gift qualifies for the federal gift tax charitable deduction. The grantor also makes a taxable gift of the remainder, which is often offset by the grantor’s $1 million gift tax applicable exclusion amount.

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In this ruling, a grantor proposed to create a charitable lead unitrust under which the trustee would pay a private foundation a 5% unitrust amount for a 20-year period. The grantor retained the power to remove the current charitable beneficiary, add or substitute other charities, and change the shares of any one or more charities.

The IRS pointed out that the grantor’s retained power to change the charitable beneficiaries made the transfer incomplete for gift tax purposes under Section 2511. The IRS cited to Revenue Ruling 77-275 1977-2 CB 346, under which a retained power to designate charitable beneficiaries of a trust renders a transfer to a charity incomplete for gift tax purposes. In addition, upon the grantor’s death before the end of the charitable term, the retained right to designate the charities would be considered a retained power to control the enjoyment of the property under Section 2036(a)(2) and the assets of the charitable lead trust would be fully includable in the settler’s gross estate.

As the ruling indicates, the grantor’s retained power to change the charitable beneficiaries disqualifies a charitable lead trust. It is possible, however, to grant other individuals (including a spouse or child) the power to designate or change the charitable beneficiaries.

2. Letter Rulings 201421023 and 201421024 (May 23, 2014). IRS concludes that annuity payments from charitable lead annuity trusts pursuant to the terms of previously executed charitable pledge agreements will not constitute self-dealing

Revocable living trusts created by each of Husband and Wife provided for testamentary Charitable Lead Annuity Trusts (“CLATS”) to be created and funded at each settlor’s death to satisfy the terms of previously executed, but still outstanding, charitable pledge agreements. The annuity payments from the CLATs were to be paid to a private foundation of which Husband and Wife were trustees. After the ruling request was submitted, Husband passed away.

One charitable pledge arose because various members of Husband and Wife’s extended family agreed to donate money to support the creation of a new hospital foundation. Under the funding agreement for the hospital foundation, Husband and Wife’s foundation was to donate a specific sum in ten equal installments. In addition, Husband agreed to contribute an additional amount under the agreement by funding the CLAT either during life or at death. For the second pledge, Husband and Wife caused the co-trustees of their private foundation to agree to donate certain sums to a museum. Wife, as trustee of her revocable trust, also agreed to donate certain funds to a museum. Part of this funding was to come through a testamentary CLAT to be created upon Wife’s death.

The IRS first determined that Husband and Wife were disqualified persons with regard to both the foundation and the CLATs. In order to avoid any self-dealing, there would have to be a determination that the specified payments by the foundation of the annuity payments from the CLATs were not direct or indirect uses of the foundation’s assets for the benefit of disqualified persons since they were being used to satisfy the legal obligations of the Husband, Wife, or another disqualified person.

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The IRS found that the agreement between the foundation and the hospital ran from the private foundation to the hospital foundation and did not personally obligate the Husband or Wife. Consequently, payment of this obligation did not constitute self-dealing. In addition, the obligation to fund specified payments to the hospital foundation for a term of years ran from the hospital to the trustees of the trust and did not personally obligate Husband or Wife. Consequently, this did not constitute self-dealing. A similar analysis was made with respect to the agreement with the museum. Since Husband and Wife were not personal obligors under the museum agreement, the payment by the foundation would not satisfy a legal obligation by the Husband or Wife. The same was true of any payment by the charitable lead annuity trust.

3. Letter Ruling 201323007 (June 7, 2013). IRS finds no adverse gift or estate tax consequences with respect to charitable lead trust whose charitable beneficiary is a private foundation established by grantor of the charitable lead trust.

Taxpayer created a charitable lead annuity trust (CLAT) of which taxpayer’s son was the sole trustee. The beneficiary of the annuity interest was a private foundation established by taxpayer and taxpayer’s spouse. The foundation directors were the taxpayer, spouse, son one and son two.

The Board of Directors amended the by-laws of the foundation to provide that during any time when the foundation was the beneficiary of a charitable lead trust, a charitable remainder trust, or other similar trusts and the charitable trust was established by a director, officer or substantial contributor to the foundation, the director, officer or substantial contributor establishing the charitable trust would be prohibited from acting on or involvement in matters concerning the receipt, investment, grant or distribution of any or other decisions involving funds received by the foundation from such charitable trust. In addition, any funds received from a charitable trust would be segregated into a separate dedicated account and separately accounted for on the books and records of the foundation in a manner that clearly allowed the tracing of the funds into and out of such separate account.

The IRS first found that the funding of the CLAT will be a completed gift for federal gift tax purposes. This was because the taxpayer had not retained a power over the property transferred to the trust and had not retained any interest, reversion, or right to alter, amend or revoke the trust. The trust instrument specifically provided that the taxpayer could not serve as a trustee of the trust. In addition, although he was one of the directors of the foundation, he was not permitted to take any actions with respect to disbursements or grants of funds received from the CLAT.

The IRS also ruled that the taxpayer would be entitled to a gift tax charitable deduction for the fair market value of the annuity on the date of the gift. Finally, the IRS found that taxpayer had not retained any interest under either Section 2036 or Section 2038 which would cause the property in the CLAT to be included in taxpayer’s estate at his death. At the end of the annuity term, the remaining trust property was to be distributed to an existing trust for the benefit of taxpayer’s three sons. Taxpayer could not serve as trustee

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of the trust and could not participate in any action of the foundation concerning the annuity funds. Thus, taxpayer retained no interest or reversion in the trust and had no right to alter, amend or revoke the trust that would cause inclusion in taxpayer’s estate at taxpayer’s death.

V. Private Foundations

1. Todd v. Commissioner, 118 T.C. No. 19 (April 19, 2002). Stock transferred to private foundation was not qualified appreciated stock, and must be valued at its basis, not its fair market value.

John and Tate Todd formed the Todd Family Foundation, and subsequently transferred 6,350 shares of stock in Union Colony Bancorp to it. In filing their income tax return, the Todds claimed an income tax charitable deduction of $553,847, the fair market value of the stock. On the return, the Todds provided information concerning the gift, including their original cost ($33,338), the fair market value of shares ($553,847), and a statement of the method used for determining fair market value (sale). The Todds, however, did not complete the portion of the form that provides for appraiser certification. Nor did the Todds attach an appraisal summary.

On audit, the IRS disallowed the charitable deduction (except for $33,338 – the Todds’ basis). The IRS asserted that the shares were not qualified appreciated stock and, therefore, the gift to the private foundation must be valued at its basis. Alternatively, the IRS argued that the Todds failed to comply with the substantiation requirements for claiming charitable contributions for gifts of appreciated property that exceed $5,000 in value and are not publicly traded stocks. The Tax Court agreed with both positions taken by the IRS.

Under Section 170, stock transferred to a private foundation must fall within the definition of qualified appreciated stock in order for the donor to claim a charitable income tax deduction for the fair market value of the stock. The court determined that market quotations with respect to the stock were not readily available on an established securities market. On the date of the transfer, Bancorp was not listed on any stock exchanges, nor were shares regularly traded in any over-the-counter market for which published quotations were available.

The court rejected the Todds’ claim that the market quotation requirement was met because Bancorp shares were occasionally traded through a placement agency. Although the placement agent provided a suggested share price based on the net asset value, shares were not necessarily then available for sale. Further, the placement agent charged 25 cents for each share placed, and acted as a placement agent as an accommodation to the bank. Therefore, the suggested share price by the placement agent was not a reliable proxy for a market valuation. Based on this conclusion, the court held that that there were no readily available market quotations and the shares were not qualified appreciated stock. The court further held that the transfers were subject to substantiation requirements, which the Todds had not met.

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2. Letter Ruling 201303021 (January 18, 2013). Nonvoting shares in closely held corporation to be held directly by private foundation are not excess business holdings under Section 4943 and family and charitable trusts are not disqualified persons with respect to the private foundation under Section 4946.

The founder created a private foundation and the founder, wife, and corporation were substantial contributors to the private foundation. The founder, family members, and various trusts for family members owned all of the voting shares and most of the nonvoting shares of corporation. The founder and wife intended to transfer their voting shares into four separate irrevocable trusts, each of which would have both charitable and non-charitable beneficiaries and each of which would not own more than 20 percent of the voting shares of the corporation. After the transfers of the voting shares to the four trusts, founder’s children would each own directly less than 20 percent of the voting shares. The non-charitable beneficiaries of the four trusts would be the children and grandchildren of founder and wife. The children and grandchildren would each have less than a 35 percent beneficial interest in each of the trusts, which interest would be solely an income interest. The charitable beneficiaries would have more than a 65 percent beneficial interest in each trust. Upon termination of each of the four trusts, each trust’s charitable beneficiaries would receive 100 percent of the trust assets as the only remaining beneficiaries.

The first issue was whether Section 4943, which requires that any excess business holdings held in a private foundation must be sold within five years of receipt, would apply in this situation. Private foundations are permitted to hold 20 percent of the voting stock in a corporation reduced by the percentage of voting stock owned by all disqualified persons. In any case in which all disqualified persons together do not own more than 20 percent of the voting stock of a corporation, non-voting stock held by a private foundation will be treated as a permitted holding. The IRS found that after the proposed transfers, disqualified persons would not own more than 20 percent of the voting stock of the corporation.

The next issue was whether the children and grandchildren would be deemed to own more than 35 percent of the non-voting stock as beneficiaries of the four trusts which cause the nonvoting stock to be considered owned by disqualified persons. The IRS found that because each of the children and grandchildren who were beneficiaries of the four trusts would have less than a 35 percent beneficial interest in each trust, the stock held in each trust would not be treated as being held by a disqualified person. Consequently, the non-voting shares in a corporation held by the private foundation would be permitted holdings and would not be excess business holdings, and the family and the four trusts would not be disqualified persons.

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3. Foxworthy v. Commissioner, T. C. Memo. 2009-203. Tax Court rules that charitable income tax deduction for gifts to private foundation should not be denied because husband and wife making the gifts controlled the private foundation.

This was a somewhat complicated case in which the Tax Court held that a husband, his wife, husband’s S Corporation, and another corporation owned by husband, were liable for various fraud penalties with respect to certain off-shore employee leasing transactions and other tax avoidance strategies.

One issue under review was charitable contributions ranging between $70,000 and $192,000 for five tax years to a private foundation created by the husband and wife. The IRS revenue agent testified that she disallowed the charitable income tax deductions because the private foundation was controlled by the husband and wife. The court noted that the IRS agent failed to provide any support for this contention. It then stated that control alone is not sufficient to defeat a charitable income tax deduction for a gift to a private foundation. Instead, control in the context of private foundations is an issue in determining the liability of a private foundation for excise taxes for self-dealing. The IRS did not contend that there was any self-dealing and did not challenge the tax-exempt status of the foundation. For that reason, the husband and wife were entitled to income tax charitable deductions for the contributions to the private foundation.

VI. Conservation Easements

1. Whitehouse Hotel Ltd. Partnership v. Commissioner, 755 F.3d. 236 (5th Cir. 2014). Court of Appeals affirms Tax Court’s ruling disallowing a significant portion of a tax deduction for historic conservation easement but permits the use of the good faith exception to prevent imposition of a 40% gross overstatement penalty.

Whitehouse was formed in 1995 to purchase the Maison Blanche building in New Orleans and then renovate and reopen it as a Ritz-Carlton hotel and condominium complex with retail space. On December 29, 1997, Whitehouse conveyed a conservation easement to the Preservation Alliance of New Orleans. The easement involved maintaining the appearance of the ornate terra cotta façade of the building. On its 1997 tax return, Whitehouse claimed a $7.445 million income tax charitable deduction for the easement.

In 2003, the IRS allowed a charitable income tax deduction of only $1.15 million for the easement and assessed a gross valuation penalty of 40% of the underpayment of tax. Whitehouse challenged the valuation of the easement and the gross valuation penalty in the Tax Court in 2008. The government’s appraiser and the Whitehouse’s appraiser did not agree on what property was to be valued. Whitehouse’s appraiser included an adjacent building because it was to be brought under common ownership the day after the creation of the easement. The appraisers disagreed over the highest and best use of the Maison Blanche building. Whitehouse’s appraiser used three methods, the replacement cost, income, and comparable sales methods, to determine a $10 million value of the

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easement. The government’s appraiser used only the comparable sales method and concluded that Maison Blanche was worth $10.3 million pre- and post-easement and that the easement had no value. The Tax Court in 2008 determined that the easement had a value of $1.792 million and imposed a 40% payment for gross undervaluation.

Whitehouse appealed the 2008 Tax Court decision to the Fifth Circuit. The Fifth Circuit in 2010 remanded to the Tax Court and requested that the Tax Court reconsider all valuation methods, that it determine the parcel’s highest and best use for purposes of the valuation, and that it consider the effect of the easement on the adjacent building, even if the easement itself did not specifically burden that building under Louisiana law. It also directed the Tax Court to determine whether the highest and best use would be as the luxury hotel actually being built or instead as a non-luxury hotel. The Tax Court in 2012 found that, on the date of the imposition of the easement, the proper valuation was not of the development of the luxury hotel but of a shell building suitable for conversion to a hotel. It determined that the value of the easement was $1.857 million. This resulted, once again, in the application of the gross undervaluation penalty.

The Court of Appeals affirmed the Tax Court’s second decision. However, it vacated the enforcement of the gross undervaluation penalty. It found that obtaining a qualified appraisal, analyzing that appraisal, commissioning another appraisal, and submitting a professionally prepared tax return is sufficient to show a good faith investigation as required by law. It noted that it was skeptical of the Tax Court’s conclusion that following the advice of accountants and tax professionals, as had been the situation here, was insufficient to meet the requirements of the good faith defense, especially in regard to a complex task that involved many uncertainties.

2. Schmidt v. Commissioner, T.C. Memo. 2014-159. Government loses on valuation of conservation easement.

In 2000, Roy Schmidt purchased 40 acres of vacant land in Colorado for $525,000. He intended to subdivide and develop it. Subsequently, Schmidt agreed to develop his property with an adjacent property owned by another developer as a 108.8-acre subdivision. In 2003, Schmidt purchased the adjacent property which had yet to be developed.

At some point during the development process for the subdivision, Schmidt considered granting a conservation easement. An appraisal firm concluded that the value of the proposed conservation easement would be $1.6 million. Schmidt and his wife filed individual federal income tax returns for 2003, 2004, 2005, and 2006 for claiming a $1.6 million charitable deduction for the conservation easement. The deduction was too large to be taken in one tax year because of the percentage limitations applicable to charitable gifts.

The Service denied the income tax charitable deduction or alternatively determined that the value of the easement was $195,000 based on an appraisal it obtained.

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Schmidt’s appraiser had based his valuation on the value of the property as a subdivision. The Tax Court found that neither expert was convincing, and reduced the value of the easement to $1.15 million. However, the court did not impose the penalty for substantial understatement under Section 662 because it found that Schmidt had acted reasonably.

3. Scheidelman v. Commissioner, T.C. Memo 2013-18. Tax Court finds that charitable façade easement has no value.

This case returned to the Tax Court on remand from the United States Court of Appeals for the Second Circuit, Scheidelman v. Commissioner, 682 F.3d. 189, in which the Second Circuit determined that the appraisal relied upon on the homeowner’s 2004 tax return was a qualified appraisal for purposes of obtaining the income tax charitable deduction and, consequently, the income tax charitable deduction could not be denied for lack of a qualified appraisal. In this case, the Tax Court examined the value of façade easement to determine the amount of the income tax charitable deduction.

Scheidelman purchased property in the Fort Greene Historic District in Brooklyn, New York for $255,000 in 1997. In 2004, Scheidelman granted a façade conservation easement to the National Architectural Trust. An appraiser was hired to appraise the property and the value of the façade conservation easement. The appraiser determined that the market value of the property was $1,015,000 as of the appraisal date, using the three basic approaches to value (comparable sales, cost, and income). The appraisal noted that the façade easement value tended to be about 11 to 11.5 percent of the total value of the property for most attached row properties in New York City such as the subject property. It valued the façade conservation easement at $115,000, which reduced the value of the property to $900,000.

The Tax Court on remand rejected the reduction in value found in the appraisal. It focused on the manner in which the value was reached, the reliability of the methodology, and the persuasiveness of the appraisal as applied to the facts. The court noted that the appraiser based the discount not on comparables but on an analysis of the amount of the discount that the courts and the IRS had allowed in prior cases. The IRS produced valuation experts who concluded that the imposition of a façade conservation easement did not materially affect the value of properties such as the one under review. As a result, the court determined that the façade conservation easement had no value for purposes of the income tax charitable deduction.

4. Mountanos v. Commissioner, T.C. Memo 2013-138. Charitable income tax deduction for conservation easement was denied because taxpayer failed to establish that easement had any value.

The taxpayer owned 882 acres of undeveloped land in Lake County, Calif., which he had bought for the recreational use of his family. Except for one small area, federal land surrounded the ranch. There were various restrictions on the use of the land. For example, the taxpayer did not have the necessary permit to divert water from the creek that traversed the ranch. The ranch was also under a contract that limited its use and

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development pursuant to the California Land and Conservation Act of 1965 (also known as the Williamson Act).

In December 2005, the taxpayer conveyed a conservation easement on the ranch to the Golden State Land Conservancy and claimed a $4.7 million income tax charitable contribution deduction for the conservation easement. The taxpayer could only use $1.3 million of deduction in 2005 because of the percentage limitations on income tax charitable deductions. In this case, the IRS denied the claimed carryover deductions for later years.

Using the “before and after” approach to ascertain the value of the easement, the Tax Court concluded that the taxpayer failed to prove that the land was worth what he claimed. The taxpayer had three witnesses who testified that a combination of residential development, subdivision use, and vineyard use was the highest and best use of the land before the easement. However, the court noted the limitations imposed by the Williamson Act prevented the land from being used for any of those purposes and held that there was no change in the land’s value after the grant of the easement. Thus, the value of the easement was zero.

Under Section 6662, the IRS had imposed a forty percent gross valuation overstatement penalty for each year at issue. The court noted that the taxpayer had claimed a $4.7 million charitable contribution deduction for the value of the conservation easement, which the court had determined was worth zero. Consequently, the taxpayers claimed value was 400 percent or more of the correct amount. The court noted that a taxpayer is generally not liable for an accuracy-related penalty if that person acts with reasonable cause and good faith with respect to any portion of the under payment under Section 6664(c)(1). However, the reasonable cause exception does not apply in a case of a gross valuation overstatement with respect to property for which an income tax charitable deduction is claimed under Section 6664(c)(3).

5. Graev v. Commissioner, 140 T.C. No. 17 (June 24, 2013). Taxpayers are not entitled to income tax charitable deductions for gifts of cash and conservation easement because the receiving organization promised to refund the cash and remove the easement if the deductions were disallowed.

Graev purchased a New York City property that was listed on the National Register of Historic Places in 1999 for $4.3 million. Graev became interested in placing a charitable easement on the property because a neighbor across the street had contributed a façade easement to the National Architectural Trust (NAT). The neighbor had received a side letter from NAT that promised a return of the contribution if the charitable income tax deduction was disallowed. NAT entered into the same sort of transaction with Graev. He provided a façade conservation easement application to NAT on September 20, 2004, and he also made a cash contribution to NAT. On September 24, 2004, NAT sent the side letter to Graev indicating that if the IRS disallowed the income tax charitable deductions in their entirety, it would refund the cash contribution and work to remove the façade conservation easement from the property title.

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In October 2004, the appraisal firm appraised the property at $9 million and concluded that the easement would reduce its value by 11 percent or $990,000. In addition to the contribution of the façade easement, Graev made $99,000 in cash contributions to NAT. The IRS challenged the income tax charitable deduction because it was made subject to subsequent events and thus conditional. The IRS said that conditional gifts do not qualify for the income tax charitable deduction. The IRS’s denial related both to the $544,449 income tax charitable deduction claimed on the Graevs’ 2004 joint return and the carryover charitable income tax contribution deduction of $445,551 made on their 2005 joint return.

The court concluded that there was a substantial possibility that the IRS would challenge the Graevs’ income tax charitable deduction because of the reimbursement provision. It also rejected the Graevs’ argument that neither state nor federal law would prevent enforcement of the side letter. Even apart from the legal enforceability of the side letter, it reflected what NAT was likely to do in the event of disallowance by the IRS. Consequently, since the charitable gift was conditional, it did not meet the requirements of Section 170 for an income tax charitable deduction.

6. Gorra v. Commissioner, T.C. Memo 2013-254. Value of façade easement greatly reduced and taxpayers were responsible for gross valuation misstatement penalties regarding the income tax charitable deduction.

In 2006, Husband and Wife gave a conservation easement on their townhouse on East 91st Street in New York to the Trust for Architectural Easements which was then known as the National Architectural Trust. In addition, Husband and Wife donated $45,000 in cash to the Trust for Architectural Easements. Husband and Wife had the property appraised. Although the house had been listed for sale immediately prior to the donation of conservation easement at $5,295,000, the appraiser used a market value of $5,500,000 in determining the value of the easement. The appraisal stated that on the basis of the data and analysis presented, the value of the historic preservation easement was equal to 11% of the property’s market value or $605,000.

The IRS denied the income tax charitable deductions which were partially taken on each of their 2006 and 2007 income tax returns.

The court found that the easement had a conservation purpose, that it could not be extinguished by mutual agreement, and that it was contributed exclusively for conservation purposes. Both Husband and Wife and the IRS submitted reports regarding the value of the easements. The IRS and Husband and Wife agreed that the value of the townhouse before the placement of the conservation easement was $5,200,000. The IRS believed that the value after the conservation easement was $5,300,000 that the easement had not influence on the fair market value. Husband and Wife’s expert believed that the value was $4,735,000 after the easement resulting in an easement value of $465,000.

The court found first that the IRS was wrong in its assertion that the easement had no value. It noted that the easement was more restrictive than local law. But it also noted that the Husband and Wife failed to meet their burden of proof that the value of the easement

Part B - 30

was $465,000. The court, in reviewing the appraisals, determined that the value of the easement was $104,000.

The court also imposed the 40 percent penalty for gross valuation misstatement. It noted that the reasonable cause exception does not apply when a gross valuation misstatement applies to charitable donations.

VII. Qualified Appraisals

1. Estate of Evenchik v. Commissioner, T.C. Memo 2013-34. Court denies charitable deduction for lack of qualified appraisal.

Taxpayer, Harvey Evenchik, owned shares in a corporation known as the Chateau Apartments, Inc. The sole assets of the corporation were two apartment complexes in Tucson, Arizona.

In 2004, Evenchik donated approximately 15,534.67 shares in Chateau to Family Housing Resources, Inc., a nonprofit housing corporation. Evenchik’s gift represented approximately 72% of the capital stock of Chateau.

Evenchik and his wife reported the donation on their 2004 tax return and stated that the value of their gift was $1,045,289 based upon the appraised value of the underlying apartment complexes. This was based upon separate appraisals of each of the two apartment complexes.

Due to the restrictions on the amount of the income tax charitable deduction that a taxpayer may take in any given year, the Evenchiks were unable to claim the entire $1,045,289 as a deduction for 2004. Part of the income tax charitable deduction was claimed as a carry forward on the 2006 income tax return. The issue in this case was whether the Evenchiks submitted a qualified appraisal for the charitable deduction carry forward claimed on the 2006 income tax return.

The court found that the Evenchiks had not submitted a qualified appraisal. First, the appraisal did not appraise the correct asset. Instead of appraising the Chateau stock, the Evenchiks gave the commissioner appraisals of the underlying assets that Chateau held. Moreover, the Evenchiks contributed only a partial interest in Chateau and neither appraisal appraised the effect that this might have on the value of the donated property. The appraisals also woefully fell short of meeting the requirements for a qualified appraisal.

The Evenchiks tried to argue that they substantially complied with the regulations even if they did not strictly comply with the regulations. However, the court found that appraising the wrong asset was far from the only error in the appraisal submitted by the Evenchiks. This was a situation in which the appraisals had gaping holes of required information and those defects would prevent the IRS from properly evaluating the value of the property contributed.

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2. Freidman v. Commissioner, T.C. Memo 2010-45. Tax Court denies income tax charitable deduction and imposes accuracy related penalties because taxpayers failed to properly substantiate the charitable contribution and provide contemporaneous written acknowledgements of donations of medical equipment.

Newton and Vonise Freidman in each of 2001 and 2002 donated $217,500 in diagnostic and laboratory equipment to two charities, Global Operations and Development and the University of Southern California. To substantiate the 2001 donations, the Friedmans attached three Forms 8283-Noncash Charitable Contributions, to the 2001 income tax return. They included a separate written appraisal and a receipt from Global Operations only for one of the three forms 8283. Likewise, in 2002, a separate written appraisal summary and a receipt from Global Operations was only included for one of the three contributions.

Under Treas. Reg. § 1.170A-13(c)(2), for any noncash contribution exceeding $5,000, a donor must substantiate the deduction by obtaining a qualified appraisal, attaching a fully completed appraisal summary to the tax return, and maintaining records pertaining to the claimed deduction in accordance with the regulations. In addition to the substantiation requirements, the taxpayer must obtain a contemporaneous written acknowledgement from the charity which includes a description of the property contributed, a statement as to whether the charity provided any goods or services in exchange for the contribution, and a description and good faith estimate of the goods and services. The Friedmans conceded that they did not strictly comply with the rules of the Regulations, but that they substantially complied.

Under the substantial compliance doctrine, the question is whether the requirements relate to “the substance or essence of the statute”. Only procedural requirements may be fulfilled by substantial compliance. One cannot substantially comply if the requirements that were not complied with relate to the substance or essence of the statute.

Here the court concluded that the Friedmans did fail to comply with the requirements and this failure could not fall within the substantial compliance doctrine. They did not provide the necessary appraisal summaries and they did not provide the necessary contemporaneous written acknowledgements. Moreover, the Court agreed with the imposition of a twenty percent accuracy related penalty under Section 6662(a).

3. CCA 201024065 (May 17, 2010). If someone other than the person conducting an appraisal for income tax charitable deduction purposes signs the appraisal summary, the appraisal is not a qualified appraisal and the claimed deduction may be disallowed.

Treasury Department Regulations generally provide that no income tax charitable deduction will be allowed for contributions of property (other than cash or publicly traded securities) with a value in excess of $5,000 unless the donor obtains a “qualified appraisal,” and attaches a completed “appraisal summary” to the income tax return on which the donor first claims the deduction. In addition to obtaining the qualified

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appraisal, the donor must complete an appraisal summary on Form 8283. The donor must obtain the signatures of the appraiser and the charitable donee on the form and attach it to the income tax return.

According to this advisory, the person who signs the Form 8283 must be the appraiser who conducted the appraisal. Failure to have the appraiser sign the appraisal should lead to the disallowance of the income tax charitable deduction. The advisory notes that certain tax court cases have taken the view that “substantial compliance” with some of the substantiation requirements for the income tax charitable deduction under the regulations for Section 170 will be sufficient.

Under this advisory, if someone other than the appraiser signs the appraisal, then, according to the IRS, the appraisal is not a qualified appraisal and the claimed deduction may be disallowed, whether the individual signing the Form 8283 is or is not an appraiser is irrelevant.

VIII. Fiduciary Income Tax Charitable Deduction for Trusts and Estates

1. CCA 201042023 (October 22, 2010). IRS’s chief counsel concludes that trust’s charitable contribution deduction claimed in respect to appreciated property that it purchased from its accumulated gross income is limited to the adjusted basis of the property and not the fair market value at the time of contribution.

This advisory dealt with a charitable contribution deduction under Section 642(c)(1) taken by a complex trust. The charitable contribution deduction was based on the donation of three properties to three different charities. Each of the properties was purchased with gross income from prior years of the trust and could be traced to that gross income. Each property rapidly appreciated between the date of purchase and the date of the gift to charity. The trust agreement provided that the trustee could distribute to charity such amounts from the gross income of the trust as the trustee determined to be appropriate to help carry out the charitable mission. When the trust contributed each of the three properties, it claimed a charitable contribution deduction for the appraised fair market value of that property.

The IRS in analyzing the issue of whether the unrealized appreciation should be treated as gross income under Section 642(c) cited the Ferguson, Freeland, and Ascher Treatise, Federal Income Taxation of Estates, Trust, and Beneficiaries (2nd Edition) to state that the contribution of low basis property would yield a double tax advantage. The first advantage was the avoidance of tax on the potential capital gain. The second was the ability to deduct not only the basis, but also the gain from gross income. It then went on to cite W.K. Frank Trust of 1931, 145 F.2d 411 (3d Cir. 1944), to point out that appreciation in value, unrealized by sale or other disposition, would not be considered gross income. While noting that other commentators had interpreted Old Colony Trust Company v. Commissioner, 301 U.S. 379 (1937), to permit a Section 642(c) deduction up to the amount of gross income for a year, the Chief Counsel felt that the majority view of courts and commentators indicated that a trust may not claim a charitable contribution

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deduction greater than its adjusted basis in the properties purchased from accumulated gross income under Section 642(c). Consequently, unrealized appreciation was not treated as gross income since it was unrealized by any sale or other disposition.

2. Green v. United States, 116 AFTR 2d 2015-6668 (W.D. Okla. Nov. 4, 2015).Trust allowed charitable income deduction for fair market value of and not basis in appreciated real estate to charity.

This case may simplify and enhance the charitable contribution deduction for certain contributions of appreciated property by trusts. Green involved charitable donations of appreciated real estate in 2004 by The David and Barbara Green 1993 Dynasty Trust, which owned a 99 percent limited partnership interest in Hob-Lob Limited Partnership, which in turn owned or operated many Hobby Lobby stores. The trust deducted the adjusted basis of the properties on its 2004 federal income return and then amended the return exactly three years later to deduct the full fair market value of the properties. The IRS disallowed the refund, stating, a bit simplistically, that “[t]he charitable contribution deduction for the real property donated in 2004 is limited to the basis of the real property contributed.”

The District Court granted summary judgment to the trust. Citing opinions of other courts, it stated that “[t]he purpose of Congress in enacting [charitable contribution provisions] was to encourage charitable gifts” and that “statutes regarding charitable deductions … are not matters of legislative grace, but rather ‘expression[s] of public policy.’” As such, “[p]rovisions regarding charitable deductions should … be liberally construed in favor of the taxpayer.” The Government argued that Section 642(c) limits the deduction to “any amount of the gross income … paid.” The court was persuaded by the fact that the properties had been bought with gross income. The Government also argued that gross income does not include unrealized appreciation, but the court found no limitation to basis in Section 642(c).

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2016 ABA Trust and Estate Planning Briefing Series

The American Bankers Association announces the 2016 Trust and Estate Planning Briefing Series. Our featured speakers, Charles D. Fox IV, partner, McGuireWoods LLP and Thomas W. Abendroth, partner, Schiff Hardin LLP are nationally-recognized trust and estate attorneys and tenured teachers from the ABA Trust Schools. They will provide you and your staff with critical information on estate planning and trust administration topics. This series provides you with an excellent business development opportunity; invite outside counsel to attend these informative programs at your location. Make the most of this high-impact content! Save 10% when you spend $400 or more on 2016 Trust Series Briefings or recordings. Use the promo code LISTEN2LEARN.

February 4, 2016

Life Insurance in a 21st Century Estate Plan2.5 CRSP, 2.5 CTFA (Fin. Plan.), 2.0 CPEs for CPAs (Finance), 2.0 CFP credits

This briefing will help listeners understand the role of life insurance in current estate plans. Topics will include:

• Reasons for having Life Insurance• Types of Life Insurance and Specially Designed Insurance Products• Who Can Be Insured• Private Placement Life Insurance• Estate Tax Planning with Life Insurance• Premium Financing

March 3, 2016

Uniform Fiduciary Access to Digital Assets Act (UFADAA) and Digital Assets2.5 CTFA (FID), 2.0 CPEs for CPAs (Regulatory Ethics), 2.0 CFP credits

The current uniform law proposals, and planning options under current law will be reviewed during this program.

• Uncertain Current Federal and State Legislative Environment• Different Approaches of Tech Industries and Estate, Trust, and Financial

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Charles D. Fox IV Thomas W. Abendroth

April 7, 2016

The New Paradigm in Trusts and Estates Valuation 2.5 CISP, 2.5 CRSP, 2.5 CTFA (TAX), 2.0 CPEs for CPAs (Regulatory Ethics), 2.0 CFP credits

This briefing will discuss the new regulations and implications on estate planning. Topics to be discussed include:

• Legal and Economic Basis for Valuation Discounts• Past IRS Attempts to Regulate Discounts• Section 2704 Rules and Application to Family LPs and LLCs• New Valuation Regulations• Planning Under the New Regulations

May 5, 2016

Fiduciary Litigation Roundtable2.5 CISP, 2.5 CRSP, 2.5 CTFA (FID), 2.0 CPEs for CPAs (Business Law), 2.0 CFP credits

A panel of attorneys will discuss current trends in fiduciary litigation and how to minimize a trustee’s exposure. Topics will include:

• Current fiduciary litigation cases • Diversification and Other Investment Disputes• Keeping Beneficiaries Informed• Decanting• Closely-Held Assets in Trust

June 2, 2016

Charitable Tales from the Crypt2.5 CISP, 2.5 CTFA (TAX), 2.0 CPEs for CPAs (Taxes), 2.0 CFP credits

Frequent misuse of the charitable deduction, and the most recent errors made in charitable planning will be discussed during this briefing. Topics will include:

• Qualifying for the Estate Tax Charitable Deduction• Qualifying for the Income Tax Charitable Deduction• Avoiding the Imposition of Capital Gains on a

Charitable Foundation• Problems with Private Foundations• Challenges with Charitable Remainder Trusts

September 8, 2016

Issues with Art and Other Collectibles in the Administration of Trusts and Estates2.5 CTFA (INV), 2.0 CPEs for CPAs (Finance), 2.0 CFP credits

Best practices in dealing with these unique assets and protecting their value in the trust and estate administration context will be discussed. Topics will include:

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Heritage Limitations• Rights of Artists• Ways to Sell Art• Securing Art• Special Considerations with Collectibles such as Guns

October 6, 2016

Are You a Fiduciary?2.5 CISP, 2.5 CRSP, 2.5 CSOP, 2.5 CTFA (FID), 2.0 CPEs for CPAs (Administrative Practice), 2.0 CFP credits

This session will discuss some of the major issues surrounding the fiduciary role in wealth management. Topics will include:

• Fiduciary Role in Trusts• Non-Trustee Fiduciary Roles in Trusts• Fiduciary Roles under ERISA and New DOL Proposed Rules• Fiduciary Roles for Investment Advisers Outside of ERISA

November 3, 2016

Twenty Steps to Avoid Fiduciary Litigation2.5 CISP, 2.5 CRSP, 2.5 CSOP, 2.5 CTFA (ETH), 2.0 CPEs for CPAs (Administrative Practice), 2.0 CFP credits Best practices for minimizing claims will be discussed. Topics will include:

• Duty of Loyalty• Steps to Take in Opening Relationships• Steps to Take when Taking Over Another Trust Department• Communications with Beneficiaries• Fees• Accountings• Seeking Court Approval

December 1, 2016

Recent Developments in Estate and Trust Administration2.5 CISP, 2.5 CTFA (TAX), 2.0 CPEs for CPAs (Taxes), 2.0 CFP credits

A review of recent legislation, regulatory developments, cases, and public and private rulings in the estate, gift, generation-skipping tax, fiduciary income tax, and charitable giving areas will be provided. Some of the subjects to be discussed include:

• Marital Deduction Planning• Portability• Possible changes in the Estate Tax Laws• Valuation Issues• Gifts• The Availability of Discounts • Charitable Planning• Post Mortem Planning• The Generation-Skipping Tax• Asset Protection• Insurance• Fiduciary Income Tax

2016 ABA Trust and Estate Planning Briefing Series

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