February 20, 2017
Applicability of Charitable Deductions for Estates and Trusts
Fiduciary entities, other than specific charitable entities such as charitable remainder trusts, charitable lead trusts, or private foundations, are allowed many of the same deductions as an individual. Trusts have the same limitations for investment interest expenses, can take real estate tax deductions and have separate deductible items subject to the 2% floor. One of the major deviations that sets trusts apart from individuals is the applicability of deductions for charitable contributions.
Trusts can be grouped into several different categories, but two of the most common are simple trusts and complex trusts.
By definition, simple trusts are not permitted to make charitable contributions, as all the income generated through a simple trust must be distributed to the trust's beneficiaries. Complex trusts are able to contribute funds for charitable purposes, but only under specific conditions that must be stated clearly in its governing instrument. Unlike individuals, who are only eligible to take a charitable deduction of up to 50% of Adjusted Gross Income, complex trusts are able to deduct up to 100% of net income for any given year.
Charitable contributions must be paid out of the trust's gross income and not the underlying principal of the trust. No deduction is allowed for amounts distributed to charities that are not paid from items included in taxable gross income. Therefore, if the trust is solely generating tax-exempt income from municipal bonds, no deduction is allowed. The trust's governing instrument can specify the source of the income used to pay distributions to charities. However, the determination within the trust document must be deemed to have an economic effect rather than simply to be advantageous for tax purposes. The trust document must state both the type and the amount of contributions that will be paid out to charity. Additionally, specific bequests in the will or trust document are deemed to be made from principal, and therefore, no deduction is allowed.
In a current Tax Court case, Harvey C. Hubbell Trust, several years of charitable contribution deductions claimed by the trust were disallowed. In this case, the Hubbell Trust claimed charitable deductions for approximately 25 years without being challenged by the IRS. In 2009, the Service disallowed a charitable contribution deduction of $65,000 stating that for a trust to prevail in claiming the deductions, the trust must accomplish three things:
- Identify the "governing instrument" (i.e., trust document, will, etc.).
- Show that the charitable contributions were paid pursuant to the terms of the governing instrument as required by the Internal Revenue Code.
- Demonstrate that each contribution was paid for a charitable purpose.
The key to this case, as the IRS determined, was that the contributions were not made pursuant to the trust document. The document for the Hubbell Trust had no specific provision giving the trustees the ability to make charitable contributions.
The Tax Court found that the governing instrument was ambiguous as to the authority of the trustee to make charitable contributions. The Court stated that if the grantor of the trust intended to give the trustees the authority to make charitable contributions, he could have easily done so. The trustee must have the authority to make charitable contributions based on clear direction, although the governing document does not have to specify individual charities as potential recipients.
There are some circumstances that allow charitable contributions to be deducted, even though the trust document does not specifically state such. For example, a trust may be a partner in a partnership that makes pass-through charitable contributions.
If the ultimate intent of the grantor of the trust is to have a portion or all of the trust's assets be set aside for charitable purposes, the trust document should be drafted to give the trustee the flexibility to make charitable contributions as deemed necessary.
Making the determination of the deductibility of charitable deductions is a highly technical area. Contact your Marcum trust specialist to determine if your trust is eligible to claim the charitable deduction.