By Deborah M. Beers, Esq.
Buchanan Ingersoll & Rooney PC, Washington, DC
Under the facts of PLR 201246003, "Estate" is the sole member of "Corporation," a professional limited liability company treated as an S corporation for federal tax purposes. Estate's residuary beneficiary is "Foundation," a private foundation exempt from federal income tax under §501(c)(3).
Corporation, a cash method taxpayer, owns certain receivables, and intends to make a non-liquidating distribution of a portion of its unrealized receivables to Estate. Upon receiving the distribution of the receivables from Corporation, Estate will use the receivables to satisfy remaining estate liabilities and then, either will distribute the receivables to Foundation or will permanently set aside the receivables into a segregated account for the benefit of Foundation.
The distribution of the receivables will result in Corporation, a cash method taxpayer, recognizing ordinary income equal to the fair market value of the receivables under §§311(b) and 1221(a)(4). Estate, as corporation's sole member, is required to take that income into account under §1366(a) (requiring an S Corporation shareholder to take into account its pro rata share of certain items of income, loss, deduction and/or credit of the S Corporation).
On the above facts, the IRS ruled that Estate will be allowed a charitable deduction under §642(c) to the extent the Corporation actually distributes the receivables to Estate, and Estate either pays or "sets aside" those receivables for Foundation.
The IRS noted that §642(c)(1) provides that, in the case of an estate or trust, there shall be allowed as a deduction in computing its taxable income, in lieu of the income tax charitable deduction allowed to other types of taxpayers by §170(a), any amount of the gross income of the estate or trust, without limitation, which pursuant to the terms of the governing instrument is, during the taxable year, paid for a qualified charitable purpose.
Section 642(c)(2) and applicable Treasury regulations1 provide that, in the case of an estate (and/or a revocable trust that, under §645, elects to be treated as an estate), there shall also be allowed as a deduction in computing its taxable income any amount of the gross income, without limitation, which pursuant to the terms of the governing instrument is, during the taxable year, permanently "set aside" for a purpose qualified charitable purpose, or is to be used exclusively for such purposes.
Regs. §1.642(c)-2(d) provides that no amount will be considered to be permanently set aside, or to be used for a qualified charitable purpose unless under the terms of the governing instrument and the circumstances of a particular case, the possibility that the amount set aside, or to be used, will not be devoted to such purpose or use is so remote as to be negligible.
Section 1.642(c)-3(b)(1) provides that, if pursuant to the terms of the governing instrument an estate, pooled income fund, or other trust pays, permanently sets aside, or uses any amount of its income for a purpose specified in §642(c)(1), (2), or (3), and that amount includes any items of estate or trust income not entering into the gross income of the estate or trust, the deduction allowable under Regs. §1.642(c)-1 or Regs. §1.642(c)-2 is limited to the gross income so paid, permanently set aside, or used.
Therefore, the IRS ruled that Estate may deduct those amounts of the receivables which are paid to or set aside under §642(c) to the extent that those amounts are includible in the gross income of the Estate for the taxable year as a result of the distribution of the receivables to Estate from Corporation.
Note: Several cases have held that, where the income originates in an S Corporation or partnership the income of which is taxed directly to the shareholders (or partners), no charitable deduction is available to an estate under §642(c) unless that income is distributed by the entity to the estate.2 The theory of these cases is that income of such entities never comes within the dominion and control of the executors, as opposed to the corporate (or partnership) entity. Although some practitioners believe that these cases were wrongly decided, those executors who wish to claim a charitable deduction for pass-through income that is designated for charity would be well advised to receive a distribution of that income from the pass-through entity prior to claiming the deduction. It is notable that the receivables in PLR 201246003 were distributed from the S Corporation to the estate, thus satisfying this requirement.
For more information, in the Tax Management Portfolios, see Acker, 852 T.M., Income Taxation of Trusts and Estates, and in Tax Practice Series, see ¶6120, Estate and Trust Income Taxation.
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