Estates and Trusts with Charitable Beneficiaries Rights to Charitable Set Aside Deductions Limited in 2015 Case of Estate of Belman v. Commissioner.

Estates and trusts with charitable beneficiaries routinely seek to employ   the IRS Code Section 642(c) charitable set aside deduction for income earned by the estate and trust that will eventually (but not in thecurrent tax year) be distributed to the charitable organization. This deduction is needed when the income cannot be currently distributed, since in that case neither a distribution deduction nor a charitable deduction would otherwise be available. Oftentimes, income cannot be currently distributed because it is too early in the administrative process to distribute to the beneficiary, especially when the beneficiary is a residuary beneficiary. A recent case out of the US Tax Court (a Federal Court) has changed the modern application of this rule slightly and those involved in Florida Probate should take note and consult an experienced Florida Probate Attorney.

1. Code Section 642(c) will allow a deduction to the estate or trust in the year income is earned if the income is permanently set-aside for a charitable purpose. 
2. Treas. Reg. §1.642(c)-2(d) states that no amount will be considered permanently set aside  “unless under the terms of the governing instrument and the circumstances of the particular case, the possibility that the amount set aside…will not be devoted to such purpose or use is so remote as to be negligible.’ 

This case caught my eye and it should catch yours as well:

• In a recent case, there was a charitable residuary beneficiary, and income earned in a year that was not paid out to the charity that taxable year. Subsequent to the earning of the income, the estate was engaged in litigation with another beneficiary. The charity did not receive all of the previously earned income due to expenses of the litigation.
• The IRS argued, and the Court agreed with them, that the charging of the set-aside amounts with litigation expenses was not “so remote as to be negligible,” and thus disallowed the charitable set-aside deduction.
• The Court said that at the time of the set-aside under these facts there was areasonable likelihood  of litigation and that such costs could alter the funds that would ultimately pass through to the charitable beneficiary.
• The estate did not lose the set-aside deduction only on the set-aside funds actually expended on the litigation, but on the entire set-aside amount even though a large portion of the set-aside was not applied to the litigation expenses. It is not a question of the actual amount of funds applied out of the set-aside that is relevant – what is relevant is how much of the set-aside is at risk of being lost such that the risk of loss is not “so remote as to be negligible.”

The question this case leaves us is this:  Can this case can be applied to support an interpretation that the entire set-aside can be lost even if only a portion of the income that was set-aside was at risk which risk was more than so remote as to be negligible.

Want to read more check out the entire case: Estate of Belmont v. Commissioner.