Life and Death Planning for Retirement Benefits

Chapter 7: Charitable Giving

379

Why does the regulation go to the trouble of spelling this out? Because IRD, being an asset owned by the decedent at death and includible in the decedent’s gross estate for federal estate tax purposes, would typically be considered part of the trust’s “principal” for trust accounting purposes (see ¶ 6.1.02 ). The regulation clarifies that even though this asset is “principal” for trust accounting purposes it is “gross income” for income tax purposes, including for purposes of the trust income tax deduction under § 642(c) . Retirement plan death benefits are IRD to the extent they are includible in the recipient’s gross income. Rev. Rul. 92-47, 1992-1 CB 198; Reg. § 1.663(c)-5 , Example 9. Retirement plan death benefits generally are wholly includible in gross income when received by the beneficiary, but there are exceptions (see ¶ 2.1.06 ). Ben Example: Ben dies leaving his $1 million IRA (all of which is pre-tax money, includible in gross income as ordinary income when distributed) and no other assets to his trust. The trust authorizes the trustee to pay income and/or principal to charity and/or to Ben’s daughter. Under applicable state law, the $1 million date-of-death balance of the IRA is considered principal for trust accounting purposes. The day after Ben dies, the trustee withdraws $40,000 from the IRA, and distributes $10,000 of it to the charity and $30,000 to Ben’s daughter, reducing the IRA value to $960,000. Over the remaining months of the trust’s taxable year, the trust takes no other IRA distributions and receives no other income. The trust’s income tax return for the year will show $40,000 of gross income (the IRA distribution), with a charitable deduction of $10,000 and a $30,000 DNI deduction, producing taxable income of zero. The trust is entitled to deduct the $10,000 payment to the charity because it was paid out of “gross income.” D. Out of gross income, Part II: Authorization. Suppose the trust instrument directs the trustee to pay $x to charity (so the payment is “pursuant to the governing instrument”), and the trustee actually makes the payment out of the trust’s gross income (so the “tracing requirement” is met), but nothing in the governing instrument specifically indicates that the payment to the charity is to come out of the trust’s gross income . Can the trust take the deduction? This one is a bit murky. The IRS will look to applicable state law to determine whether the payment is deemed to come from the trust’s “income.” In Rev. Rul. 68-667, 1968-2 CB 289, the decedent’s will left a formula pecuniary bequest to a charity and left the residue of the estate to a noncharitable trust. The will was “silent as to the disposition of income of the estate during the period of administration.” The estate made distributions to the charity and to the trust during the year. The IRS held that the payments to the charity were not deductible under § 642(c) because applicable state law required that “all income earned by an estate during the period of administration be distributed to the residuary legatee.” Thus, the estate’s “income” belonged to the noncharitable residuary trust, and the estate could not under applicable law have used such “income” as the source of the payments to the charity. Thus, it is not enough that the actual distribution to the charity can be traced to the trust’s gross income as its source. Either the governing instrument or applicable state law must indicate that the gross income can be (or must be) the source of such payment.