IRS Chief Counsel Fights Against Remainder Trust Abusive Promotion

• Date: 01 September 2020
• Published date: 01 September 2020
• DOI: http://doi.org/10.1002/npc.30765

Bruce R. Hopkins’ NONPROFIT COUNSEL

September 2020 5

THE LAW OF TAX-EXEMP T ORGANIZATIONS MONTHLY

Bruce R. Hopkins’ Nonpr ofit Counsel DOI:10.10 02/n pc

majority (7-2) wrote: “When a school with a religious

mission entrusts a teacher with the responsibility of

educating and forming students in the faith, judicial

intervention into disputes between the school and

the teacher threatens the school’s independence in

a way that the First Amendment does not allow.”

[10.3(c)]

• The Court, on June 30, ruled (5-4) that states, once

having implemented a program providing financial

assistance (such as scholarships) for access to private

schools, cannot exclude religious schools from partic-

ipation in the program (Espinoza v. Montana Depart-

ment of Revenue). The state’s supreme court struck

down such a program, on the grounds it violates the

state’s constitution. The Supreme Court, however,

concluded the state court ruling violated the First

Amendment’s Free Exercise Clause. [10.1(a)(i)] ◆

IRS CHIEF COUNSEL FIGHTS

AGAINST REMAINDER TRUST

ABUSIVE PROMOTION

In an advice memorandum released on June 26, the

IRS’s Office of Chief Counsel concluded that a promo-

tion that uses an ostensible charitable remainder annuity

trust as the basis for the position that capital gain on the

sale of highly appreciated property is permanently elim-

inated fails to “produce the claimed tax results” (Chief

Couns. Adv. Mem. 2020-006). The scheme involves a

CRAT funded with interests in a closely held business

and farmland. The annuity amount is provided by means

of the purchase of annuities, including single-premium

immediate annuities.

The Office recommended that the validity of the

CRAT be challenged on the basis that there are disqual-

ifying terms in the trust instrument, with the tax law

results being that the claimed charitable deductions are

to be disallowed and the trust regarded as a taxable

entity, causing sales of the contributed property to be

taxable. The IRS’s lawyers also advanced an assign-

ment-of-income argument by which gain on the assets’

sales is taxed to the grantors.

Other arguments are posited, on the assumption that

the CRAT is qualified. One argument is that the CRAT dis-

tributed the annuity contract to the income beneficiaries

but in doing so violated the rule that no amount other

than the annuity amount may be paid to any person other

than the remainder interest charity (because the value of

the policy would far exceed the required annuity pay-

ment). The other argument is that the beneficiaries have

incorrectly reported by including only the ordinary income

on the annuity contract (IRC § 72) and not the current or

accumulated capital gain on the sale of the assets as part

of their distribution (IRC § 664(b)). [12.2] ◆

HOW COULD THIS BE

OTHERWISE?

Tax professionals are familiar with the law that a tax de-

duction is not allowed for an amount that is allocable to

tax-exempt income (IRC § 265(a)(1)). The rule applies where

a taxpayer incurred expenses for purposes for which tax-ex-

empt income was received; to permit the deduction would

be to permit a double tax benefit (e.g., Rev. Rul. 83-3).

The IRS’s Office of Chief Counsel was asked whether

this no-deduction law applies in connection with the char-

itable contribution deduction that is generally allowed in

computing unrelated business taxable income (IRC § 512(b)

(10)). This issue arose because, in most instances, all of a

tax-exempt organization’s income, other than unrelated

business income, is tax-exempt income. Quite sensibly (and

fortunately), the IRS’s lawyers ruled that the no-deduction

rule does not apply to this deduction because a charitable

contribution “is not allocable to tax-exempt income, but

instead arises from a donor’s charitable intent to volun-

tarily transfer money or property without receiving any

benefit in return” (Chief Couns. Adv. Mem. 202027003).

It was noted in this memorandum that courts have

looked to whether the expenses were “intended to

be covered” by tax-exempt income or whether the

expenses would not exist “but for” the exempt income

(e.g., Induni v. Commissioner (2d Cir. 1993)). It may

also be noted that the deduction statute states that the

deduction is allowed whether or not directly connected

with the carrying on of a trade or business. [25.7(b)] ◆

NEW TAXPAYER ADVOCATE

PERPETUATES FORM 1023-EZ

BASH

The Office of the National Taxpayer Advocate, newly

headed by Erin M. Collins, issued its latest annual report to

Congress on June 29. The report charges, as does its prede-

cessors in recent years, that the Form 1023-EZ ap plication

process is enabling many entities to become recognized by

the IRS as exempt charitable organizations even though

they fail the organizational test. The report’s recommen-

dations in this regard include greater IRS scrutiny of or-

ganizing documents and review of applicants’ websites.

The IRS responded to this criticism, first by asserting “legal

inaccuracies” in the report. Indeed, the advocate’s report

opens with the startling observation that “[o]rganizations

recognized by the IRS as exempt under Internal Revenue

Code § 501(c)(3) may be exempt from federal tax.” Having

boldly staked out that position, the report states that the IRS

“confers” tax-exempt status, which, of course, it does not

do. The IRS correctly points out that the application’s request

for a statement of purpose complies with the tax regulations.