Tuesday, July 03, 2007

Charitable Deduction Denied - Single Trust has Charities and Non-Charities as Beneficiaries

Category: Estate Planning, Estate and Inheritance Tax,

The U.S. Court of Appeals for the Third Circuit (which controls District Court decisions in New Jersey) finds that the Internal Revenue Code prohibits an estate from claiming a charitable deduction when the proceeds of a single trust are distributed to both charitable and non-charitable beneficiaries. Galloway v. U.S. (3rd Cir. 6-21-2007), No. 06-3007.

James Galloway created a single trust under which the beneficiaries -- his two children and two charitable entities -- would receive an equal, one-quarter share in the proceeds. Upon Mr. Galloway’s death, the Pennsylvania Department of Revenue determined that $399,079.33 would be distributed to charitable entities.

Before reading on, some better solutions to meet Mr. Galloway's goals might have been have been:

  • Flat amount bequest to chartity
  • Percentage bequest to charity before transferign the balance to a trust (ie - make the division to the charities and then directe that the amoun to the children go in a trust)
  • Set up a Charitable Remainder Trust or Charitable Lead Trust, which are statuorially authortized divisions of bequests between a charity and one or more induviduals
  • Name the charity as a beneficiary on a non-probate asset such as an IRA or other retirement plan

The trustee of the estate, Edmond Galloway, then claimed a charitable deduction in that amount on the federal estate tax return. Based on Internal Revenue Code § 2055(e), the IRS disallowed this charitable deduction and computed the estate’s liability to be $306,604.57. Mr. Galloway paid the additional tax due and then filed a refund claim, which was denied by the IRS.

Mr. Galloway filed a complaint in the U.S. District Court for the Western District of Pennsylvania claiming that the trust did not fall under the purview of IRC § 2055(e). Mr. Galloway argued that the only kind of such “split-interest” trusts that Congress intended § 2055(e) to cover are trusts in which a non-charitable beneficiary has a life interest and the charitable beneficiary has a remainder interest. The complaint was denied and Mr. Galloway appealed.
The U.S. Court of Appeals, Third Circuit, affirms and holds that the clear, unambiguous language of IRC § 2055(e) disallows any charitable deduction where an interest in the same property passes to both charitable and non-charitable beneficiaries.

To download the full text of this decision in PDF format, go to: http://www.ca3.uscourts.gov/opinarch/063007p.pdf .

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