The gross income requirement for trusts' charitable deductions.

• Author: Schafer, Frances

Trusts are hybrids of entities that pay tax on all their income, like corporations, and entities that pass all their income through to others, like partnerships. Trusts are taxed on income that is retained by the trust and receive a distribution deduction for income treated as distributed to the beneficiaries. The beneficiaries are then taxed on the income that is treated as distributed to them. Only beneficiaries who receive distributions of a specific sum of money or of specific property are exempt from the income distribution rules. For other beneficiaries, trusts are generally not required to trace the source of distributions made to them because the concept of distributable net income, introduced in the Internal Revenue Code in 1954, eliminates the need for such tracing. Distributable net income operates by presuming that distributions are made first from income and allocating that income among the beneficiaries receiving distributions.

Distributions from a trust to charitable organizations are not considered distributions to beneficiaries for purposes of the distribution deduction (Regs. Sec. 1.663(a)-2). (See also U.S. Trust Co., 803 F.2d 1363 (5th Cir. 1986); Mott, 462 F.2d 512 (Ct. Cl. 1972); Rev. Rul. 68-667; and Rev. Rul. 2003-123.) Rather, distributions to charities are deductible only if they meet the requirements of Sec. 642(c).

Under Sec. 642(c)(1), a trust is allowed a deduction in computing its taxable income for any amount of gross income, without limitation, that under the terms of the governing instrument is, during the tax year, paid for a charitable purpose. Because a charitable deduction is available only if the source of the contribution is gross income, tracing the contribution is required to determine its source. As the Tax Court explained in Van Buren, 89 T.C. 1101, 1109(1987):

Tracing is required since the statute specifically requires that the source of the contribution be gross income. See Riggs National Bank v. United States, 173 Ct. Cl. 479, 352 F.2d 812, 814 (1965). This specific reference forms the basis for a limited exception to the general removal of the tracing requirement accomplished by subchapter J. The exception is limited to the area of charitable deductions. See Mott, 199 Ct. Cl. 127, 462 F.2d 512,518-519(1972). In Rev. Rul. 2003-123, the trust owned parcels of real estate that had been transferred to the trust at its formation. The terms of the trust agreement authorized the trustee to make...