In a recent Private Letter Ruling (“PLR”), the IRS ruled that the relevant estate (“Estate”) was allowed a charitable deduction for income tax purposes for amounts paid or to be paid to charity during estate administration which were traceable to taxable income, a requirement for the deduction under IRC 642(c).[1] Since the ruling is private, we are not provided the details on the names, percentages, or amounts at issue, but the ruling gives us enough details to understand the issues. And while the ruling is not binding on the IRS, it provides guidance on the IRS’s position and how they might rule in similar circumstances. I’ll note that we have previously written on charitable income tax deductions for trusts, and that article covers several items at issue in the PLR.[2]
In the PLR, we are told that the decedent left a Will which provides for certain specific bequests as well as administrative expenses and taxes to be paid off the top and then provided for a percentage of the residue to be paid to qualifying charities (we are not told what percentage). It appears the Will did not specifically authorize or prohibit income to be paid to charity as it was silent on the issue. In its ruling request, the Estate noted that the state in which the Estate was being administered (we are not told what state that is), estate income from assets not specifically bequeathed to a beneficiary must be paid out to the residuary beneficiaries. Further, the Estate was under an order from the probate court which mandated the same.
In the first two years of the Estate’s administration, the Estate paid out the pro-rata portion of estate income to charities and claimed a corresponding deduction on the Estate’s income tax return. The Estate is likely to continue in existence for several more years and plans to do the same in each of the following years.
At issue here is whether the payments of income to the charitable organization are deductible under IRC 642(c), which applies to charitable deductions for trusts and estates. IRC 642(c)(1) provides the following:
In the case of an estate or trust…there shall be allowed as a deduction in computing its taxable income (in lieu of the deduction allowed by section 170(a), relating to deduction for charitable, etc., contributions and gifts) any amount of the gross income, without limitation, which pursuant to the terms of the governing instrument is, during the taxable year, paid for a purpose specified in section 170(c) (determined without regard to section 170(c)(2)(A)). (emphasis added).
So, IRC 642(c)(1), on its face, only applies and allows the deduction where the income is paid “pursuant to the terms of the governing instrument”[3] (and the charitable distribution must actually be traceable to gross income). However, the document failing to specifically state that charity is to be paid out of gross income does not end the analysis. State law may still save the deduction when applicable. Under Rev. Rul. 68-667, where there is no provision addressing the issue of whether payments made to charitable organizations are to be made from corpus or income, then state law controls.
Also relevant to the issue is whether the IRS is bound by state law on the issue. This issue was determined in the Bosch case in 1967, where the Supreme Court held that the IRS was not bound by decisions of a state trial court when applying federal law, but that the highest court in the state did provide the best state law to be applied to the federal matter.[4] Under Bosch, where the state’s highest court has not ruled on the issue, the federal authority must determine the state law, but in doing so, must give “proper regard” to any other state court rulings.[5]
So, if state law, as determined and applied using the authority laid out in Bosch, requires the charitable payments to be made from income, then the deduction under IRC 642(c) will be allowed. While there is no detail or analysis on the state law here, nor do we even know what state it is, the facts represent that the state, and the local probate court, require that estate income be paid out to the residual beneficiaries unless such income is from an asset specifically bequeathed elsewhere. Under the present facts, this requires the Estate to pay out a portion of the income to the charities who are residuary beneficiaries. Accordingly, since the income is required to be paid out under state law, the requirements of IRC 642(c), when applying Rev. Rul. 68-667, are met. The PLR provided that the Estate was entitled to the deductions for the first two years for the amounts paid to charity and would also be allowed the deduction for future payments to charity in subsequent years.
In the present case, state law was able to save the charitable income tax deductions. And while this may happen often, it is a risky proposition to rely on. By providing proper guidance in the document itself, the whole issue can be avoided, and the Estate may not have needed to spend a great deal of time and money obtaining the PLR. As one can see from this PLR, charitable income tax deductions for trusts and estates are not as straightforward as one might think, so any time charities are involved, careful planning and analysis is required to maximize the tax benefits.
[1] PLR 202618006.
[2] https://esapllc.com/trust-charitable-deduction/
[3] IRC 642(c)(1).
[4] Comm’r v. Estate of Bosch, 387 US 456 (1967).
[5] Id.
