Some actions made by a trust may not payoff in tax deductions.
Chances are you have heard of Hobby Lobby.
Especially if you know anyone who crafts.
With more than 32,000 employees and 800 stores, the business is successful.
According to the recent The Wealth Advisor article in “Hobby Lobby Trust Loses $3.2M Tax Deduction,” the founders created the David and Barbara Green 1993 Dynasty Trust Agreement (DBGDT) a little over twenty years after starting their business.
It will also limit their taxable estate when they pass.
When it comes to beneficiaries, they can add stipulations.
The type of trust they chose has benefits.
It allows them to allocate funds to beneficiaries as needed.
It also allows for more charitable contributions.
Still, in some instances, an intentionally defective grantor trust (IDGT) may have been better.
This type of trust may have avoided a recent tax bill and litigation.
It is a pretty long story.
I will try and summarize.
For 2004, DBGDT paid $8.4 million on its original return.
There was $57 million included in income in flow through from the trust's 99% interest in Hob-Lob Limited Partnership, which is where most of the stores were.
The refund of $3.2 million was based on increasing charitable deductions by $9.1 million to $29.7 million. Contributions by trusts are generally unlimited, but there is a limitation based on Unrelated Business Taxable Income (UBTI). That was not at issue here, but rather it was the ability to take deductions at fair market value.
A charitable deduction by an individual will typically be based on the fair market value of the property. In this case, there were three properties, but the bulk of the appreciation was contained in one of them in Virginia, which was donated to the National Christian Foundation.
The jury found the property to be worth $28,500,000. The property had been acquired less than a year before, with a basis of less than $11 million.
The IRS argued that charitable deductions for trusts are limited to basis, because the trust's charitable deduction is from gross income, and the inclusion of unrealized appreciation in income is questionable. The district court ruled in favor of the trust, but the Tenth Circuit reversed.
The Tenth Circuit found the arguments of the IRS unpersuasive and said the district court misconstrued the statute, relying in part on §642(c)(1)'s use of the phrase “without limitation.”
The Supreme Court held that the phrase “without limitation,” as used in the predecessor statute to §642(c)(1), was intended only to make clear that the percentage limits outlined in §170 that apply to charitable deductions made by individuals and corporations do not apply to charitable deductions made by estates and trusts.
The Tenth Circuit said that presumably the same holds true for §642(c)(1). Thus, §642(c)(1)'s use of the phrase “without limitation” cannot be construed as a signal by Congress to authorize the extent of the deduction sought by the Trust in this case.
Are you still with me?
The district court also relied on a Supreme Court decision for the proposition that charitable giving should be encouraged and thus, that §642(c)(1) should be construed in a broad manner. But the Tenth Circuit said this statement was made solely in the context of deciding whether the authorized deduction should be limited to amounts “paid from the year's [gross] income.”
Finally, the district court concluded, in part, that because §170 in certain instances allows individuals to claim a deduction for the fair market value of donated property, it is okay to interpret §642(c)(1) in the same way.
The language of §170 expressly discusses the fair market value of donated real property, the court said, whereas §642(c)(1) merely refers to gross income and does not otherwise incorporate §170's discussion of the fair market value of donated real property.
If Congress intended for the concept of “gross income,” in this instance, to extend to unrealized gains on property purchased with gross income, it would have said so, the Tenth Circuit held.
Curiously, if this had been an IDGT, there would not have been a problem using the fair market value, although there would have been a 30% limitation with which to deal. Nevertheless, that might have been a problem for the Greens, who are committed to being very philanthropic.
Remember: “An ounce of prevention is worth a pound of cure.” When making your financial, tax and estate plans, do not go it alone. Be sure to engage competent professional counsel.
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Reference: Wealth Advisor (January 26, 2018) “Hobby Lobby Trust Loses $3.2M Tax Deduction”