Charitable Deductions and Section 642(c)

“Charitable Deductions and Section 642(c),” that’s the subject of today’s ACTEC Trust and Estate Talk.

Transcript/Show Notes

This is Travis Hayes, ACTEC Fellow from Naples, Florida.

In light of new rules enacted by the Tax Cuts and Jobs Act in 2017 and final regulations issued on charitable gift substantiation, which followed soon thereafter, taxpayers may discover that their personal donations to charity do not qualify for an income tax deduction. However, just because a charitable contribution fails to qualify for an individual income tax deduction, it’s possible that a deduction will not be precluded for purposes of trust and estate income taxes.

So, what do planners need to understand regarding the requirements for a trust or estate to qualify for an income tax charitable deduction under Section 642(c) of the Internal Revenue Code? ACTEC Fellow Jere Doyle from Boston, Massachusetts is here today to make sure we understand the ins and outs of qualifying a distribution to a qualified charity from a trust or estate for the income tax charitable deduction. Welcome, Jerry.

Distinction from Individual Charitable Deductions

Thank you, Travis. What everybody has to understand is that the income tax rules that apply to individuals and the rules that apply for an estate and gift tax charitable deduction are not the same for a fiduciary income tax charitable deduction. So, if an estate or a trust wants to get an income tax charitable deduction, they have to follow the requirements of Section 642(c) of the Code.

Under Section 642(c) of the Code, there are two really important requirements. The first requirement is that the amount that is paid to the charitable organization from the trust or the estate has to be paid from gross income. The other requirement is that the amount that’s paid has to be paid pursuant to the governing document. Let’s take a look at those two requirements.

Section 642(c) Requirement 1: Payment from Gross Income

The first requirement is that the amount has to be paid from gross income. What do we mean by gross income? If you look at Section 643(b) of the Code, you’ll discover that what they mean by gross income is taxable income, not trust accounting income. The amount that has to be paid from the trust to the estate has to be taxable income, which means that you can pay an amount that is capital gain or income of a respective decedent that normally is allocable to trust accounting income because those items are taxable income, those will qualify for an income tax charitable deduction. So, the first thing that’s important is you have to pay the amount from taxable income.

Section 642(c) Requirement 2: Payment Pursuant to the Governing Document

The second requirement is that it’s got to be paid pursuant to the governing document. And this is where things get a little confusing and a little messed up. There has to be authority in the governing document- the will or the trust- to direct the payment of that gross income to charity. If you don’t have that language in the document, then you don’t qualify. So one of the issues is whether or not it is a mandatory payment of gross income.

Discretionary Payments and Historical Context

Can you have discretionary payment of income? Yes, you can. There’s an old case, the Old Colony Trust case from back in the early 1900s, that said just simply having the discretion to pay the amount to charity, that language in the document will allow you to qualify for an income tax charitable deduction. So those are the two big requirements.

Comparison with Individual Deductions

This is completely different from the income tax charitable deduction for an individual because, for an individual, they’re limited to a certain percent of their adjusted gross income. Unlike an individual, the 642(c) deduction is unlimited in amount, so you’re not limited by your percent of adjusted gross income like it is for an individual. Furthermore, if you don’t meet these requirements, there’s no fallback provision in claiming an income tax distribution deduction- An income distribution deduction for a trust or estate- you either qualify under the requirements of Section 642(c) or, if you don’t you can’t take an income distribution deduction.

Unlike individuals, what will happen is the amount that is allowable for a charitable deduction can either be paid in the current year- you pay the amount this year and you take an income tax charitable deduction- or alternatively, you could pay the amount next year and claim it for this year. So you have a two-year window period where you can claim an income tax charitable deduction.

Also, unlike individuals, the 642(c) deduction is allowed for a distribution to a foreign charity. Individuals, generally speaking, can only get a charitable deduction for distribution to a domestic charity.

Set-Aside Deductions and Special Exceptions

One of the other things that people have to realize about the Section 642(c) deduction is that the deduction is basically allowed for an amount that is set aside for an estate. An estate can get a deduction if they simply set aside the amount for charity, they don’t actually have to pay it. There is also an exception for some trusts that were executed before 1969, they can also get a set-aside deduction. But as a general rule, a trust as opposed to an estate, has to actually pay the amount to charity.

Requirements for Purpose and Public Charity

The other issue that crops up that is different from an individual income tax charitable deduction is the fact that the code says you only have to pay the amount to charity for a purpose that is set forth in Section 170(c); you don’t have to actually have a public charity, so to speak. I wouldn’t recommend that people set it aside for a purpose. They ought to actually pay it up to charity, to a public charity. But, those are the requirements.

Key Considerations and Drafting Issues

The bigger requirements, like I said, paid from gross income and it’s got to be paid pursuant to the governing document. Where we see most of the mistakes made is where there is no authority in the document to take an income tax charitable deduction. So that is an important drafting consideration; putting in documents the fact that, if you want to get an income tax charitable deduction, there’s authority in the document to actually pay that amount to charity. That’s basically a quick summary of a very complicated Section of the Internal Revenue Code.

Travis Hayes: Thank you, Jerry, for educating us on the operation of Section 642(c) and the requirements for a trust or estate to qualify for the charitable income tax deduction.

 

Additional Resources

• Planning Ahead for the Sunsetting of the Tax Cuts and Jobs Act Exemptions (May 2024)

This podcast was produced by The American College of Trust and Estate Counsel, ACTEC. Listeners, including professionals, should under no circumstances rely upon this information as a substitute for their own research or for obtaining specific legal or tax advice from their own counsel. The material in this podcast is for information purposes only and is not intended to and should not be treated as legal advice or tax advice. The views expressed are those of speakers as of the date noted and not necessarily those of ACTEC or any speaker’s employer or firm. The information, opinions, and recommendations presented in this Podcast are for general information only and any reliance on the information provided in this Podcast is done at your own risk. The entire contents and design of this Podcast, are the property of ACTEC, or used by ACTEC with permission, and are protected under U.S. and international copyright and trademark laws. Except as otherwise provided herein, users of this Podcast may save and use information contained in the Podcast only for personal or other non-commercial, educational purposes. No other use, including, without limitation, reproduction, retransmission or editing, of this Podcast may be made without the prior written permission of The American College of Trust and Estate Counsel. If you have ideas for a future ACTEC Trust & Estate Talk topic, please contact us at ACTECpodcast@ACTEC.org. © 2018 – 2024 The American College of Trust and Estate Counsel. All rights reserved.