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Pending Dispute Over Estate Proceeds Precludes Charitable Tax Deduction on 1041.

(Parker Tax Publishing March 4, 2015)

The Tax Court held that because a pending dispute with the decedent's brother over a California condo could significantly deplete estate funds, amounts earmarked for a charitable contribution were not "permanently set aside" under Code Sec. 642(c)(2), and the estate could not take the associated deduction on its income tax return. Est. of Belmont v. Comm'r, 144 T.C. No. 6 (2015).

Background

Eileen S. Belmont died on April 1, 2007. At the time of her death, she resided in Ohio and her only heirs were a brother, David Belmont, who lived in California and a half-sister in Ohio. At the time of her death, the decedent owned a condominium in California, in which her brother David resided. Her will directed that David receive $50,000 and for the remainder of her estate to be left to a charitable organization in Ohio. The estate claimed a $219,580 charitable contribution deduction on its Form 1041, representing the amount to be left to the organization.

During the protracted administration of the estate, David took a variety of legal actions and asserted a life tenancy interest in the condominium, which he was eventually awarded in 2012. The cost of litigation over the condominium and the costs of the administration of the estate depleted the estate to a point where it lacked sufficient funds to pay the amount previously deducted as a charitable contribution. Consequently, the IRS disallowed the deduction, asserting the funds were not permanently set aside as required under Code Sec. 642.

Analysis

Under Code Sec. 642(c)(2), an estate may take a charitable contribution deduction for any amounts permanently set aside for charitable purposes. An amount is not be deemed "permanently set aside" for a charitable purpose under Code Sec. 642(c)(2) unless the possibility that the amount will be devoted to a different purpose is "so remote as to be negligible" (Reg. Sec. 1.642(c)-2(d)).

The Tax Court noted three requirements for an estate to properly claim a charitable contribution deduction:

(1) the contribution must be an amount from the estate's gross income;

(2) the contribution must be made pursuant to the terms of a governing instrument; and

(3) the contribution must be permanently set aside.

The parties disagreed only over whether the third requirement was met.

The estate argued that it was not reasonably foreseeable that it would incur unanticipated costs associated with litigating David's claims on the California condominium. The IRS countered that there was a substantial possibility of a prolonged and expensive legal fight which would have required the estate to access the funds it supposedly set aside for the foundation in order to pay for the litigation and additional administrative costs of several years of probate proceedings.

After considering the facts, the court determined that the possibility that the estate would need to invade the money set aside for the foundation was not "so remote as to be negligible." Prior to filing its return and claiming the deduction, and after accounting for the funds ostensibly set aside, the estate's residuary was approximately $65,000. The estate had no income-producing assets, and it was responsible for various additional administration expenses and attorney fees that would be paid out of the residue. The court noted that David's actions leading up to the litigation over his interest in the condo created a real possibility that the funds set aside for the charity would be invaded in order to continue the estate administration.

Because David's litigation and the pending administrative costs were known to the estate prior to claiming the charitable contribution deduction, the court reasoned it was not "so remote as to be negligible" that the funds set aside for the charity would be depleted. Accordingly, the court held that the $219,580 was not "permanently set aside" as required by Code Sec. 642(c)(2) and Reg. Sec. 1.642(c)-2(d) and consequently the estate could not take the claimed charitable contribution deduction.

For a discussion on estate income tax charitable deductions, see Parker Tax ¶ 53,110. (Staff Editor Parker Tax Publishing)

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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