This post was originally published on Forbes Feb 24, 2015
The Tax Court decision in the Estate of Eileen S. Belmont is probably one of good intentions gone awry. Ms. Belmont wanted to provide something for her brother, who had issues, and have the bulk of her estate go to the Columbus Jewish Foundation. Unfortunately, a lack of clarity caused a good chunk of her estate to be spent on litigation and a substantial income tax hit that might have been avoided. The tax court decision is of course about the income taxes. The litigation that created the income tax problem was in California state courts.
Thus, for an estate to properly claim a charitable contribution deduction pursuant to section 642(c)(2), three criteria must be met: (1) the charitable contribution must be an amount from the estate's gross income; (2) the charitable contribution must be made pursuant to the terms of a governing instrument; and (3) the charitable contribution must be permanently set aside for purposes specified in section 642(c)(2). Respondent does not dispute that the $219,580 distribution was to be from the estate's gross income (i.e., income in respect of a decedent) or that the money was designated for the foundation pursuant to the terms of a governing instrument (i.e., decedent's will). The parties agree that in order for an amount to be “permanently set aside” for a charitable purpose, the estate must be able to establish that “under the terms of the governing instrument and the circumstances of the particular case the possibility that the amount set aside, or to be used, will not be devoted to such purpose or use is so remote as to be negligible.” Sec. 1.642(c)-2(d), Income Tax Regs. The parties are in disagreement over whether this standard was met.
On April 2, 2008, David filed a creditor's claim with the Los Angeles County Probate Court claiming an alleged breach of contract on the basis that an oral agreement (agreement) existed between him, decedent, and their mother, giving him a life tenancy interest in the Santa Monica condo despite the agreement not being reflected in decedent's will. Peter Gelblum, a prominent California attorney, represented David pro bono. David was a client of a local mental health organization in California where Mr. Gelblum is a member of the board of directors.6 On April 24, 2008, David filed a Lis Pendens, Notice of Pendency of Action (lis pendens) with the California Recorder's Office and the Los Angeles County Probate Court to alert third parties of potential action against the Santa Monica condo.
The estate faced the possibility that David would engage in prolonged and expensive litigation over his interest in the Santa Monica condo. David's actions leading up to the estate filing its Form 1041 on July 17, 2008, provided information indicating that he would put up a litigious fight. First, David did not vacate the Santa Monica condo and did not agree to the request made in Ms. Sater's letter dated February 14, 2008, to vacate the Santa Monica condo in exchange for a "$10,000 stipend”. Second, on April 2, 2008, David filed a creditor's claim with the Los Angeles County Probate Court asserting information supporting his claim to a life tenancy interest in the Santa Monica condo. Third, on April 24, 2008, David filed a lis pendens action with the California Recorder's Office and the Los Angeles County Probate Court. Fourth, David filed an 850 petition with the Los Angeles County Probate Court on May 30, 2008, asserting the basis for his claims. The estate was aware of these claims and filed its objections. Finally, David retained a prominent California attorney, pro bono, to represent his interests in the Santa Monica condo. All of these events occurred and were known to the estate before July 17, 2008, when the estate claimed a $219,580 charitable contribution deduction on its Form 1041.
These facts and circumstances provided an indication to the estate that the possibility of David litigating his alleged interest in the Santa Monica condo was more than negligible. Nevertheless, the estate failed to inform Ms. Becker—the C.P.A. who prepared the return in question—of David's claims against the Santa Monica condo.
This is a textbook case why IRD should not be transferred to the estate, but through selecting the charity as a designated beneficiary. While some IRD transfers through the estate are qualified, the tax disaster in this case highlights the evident risk. The charitable recipient waited eight years and lost approximately one-half of the value due to litigation costs and income tax.