Charitable Deduction Due to a Partial Disclaimer

The Eighth Circuit upheld the Tax Court’s decision to allow a charitable deduction involving a disclaimer by an heir of a portion of her interest in an estate. The Tax Court had held the disclaimer was not qualified under IRC § 2518 with respect to property that passed to a charitable lead trust, but was qualified with respect to property passing directly to a private foundation that was also the lead beneficiary of the trust. The courts also allowed an increased charitable deduction by the estate based on an increased valuation of the gross estate after examination by the IRS.

Helen Christiansen died in April 2001, leaving all of her assets to her only child, Christine Hamilton. Her estate plan anticipated that Hamilton would disclaim a portion of her inheritance in favor of a charitable trust and a charitable foundation. The Helen Christiansen Testamentary Charitable Lead Trust was set up to last for 20 years, with any remaining assets then passing to Hamilton if she survived. During its existence, the trust would pay an annuity of 7% of the corpus’s net fair market value, as determined at the decedent’s death, to the Matson, Halverson, Christiansen Foundation, which qualified as a charitable organization under section 501(c)(3).

As anticipated, Hamilton disclaimed the amount of the estate’s fair market value in excess of $6,350,000. The main amount passed to the charitable foundation and the charitable trust. Hamilton did not disclaim her contingent interest in the charitable trust, and consequently, no deduction was allowed for the property passing to the charitable trust as a result of the partial disclaimer. The partial disclaimer was not a qualified disclaimer under section 2518.

After an IRS audit of Christiansen’s estate tax return, the fair market value of some of the assets was increased, increasing the gross estate from $6,512,223 to $9,578,895 and increasing the amount passing to the foundation. The IRS, however, disallowed a corresponding increase in the charitable deduction, saying the amount was dependent on a “precedent event” in violation of Treas. Reg. § 20.2055-2(b)(1). The Tax Court disagreed and allowed the increased charitable deduction.

On appeal, the Eighth Circuit agreed with the Tax Court and rejected the IRS’ interpretation of Treas. Reg. § 20.2055-2(b)(1). The regulation pertains to a transfer at the date of death rather than its final accounting valuation, the courts noted.

The IRS did not distinguish between post-death events that change the value of the estate versus those that are merely part of the legal or accounting process of determining the date-of-death values. Treas. Reg. § 20.2055-2(e)(2)(vi)(a) recognizes that references to values “as finally determined for federal estate tax purposes” are sufficiently certain to be considered “determinable” for the purposes of qualifying as a guaranteed annuity interest. References to value “as finally determined for estate tax purposes” are not references dependent upon post-death contingencies that might disqualify a disclaimer. Here, the only uncertainty was the amount the foundation was to receive in excess of $6.35 million.

The IRS also argued that the court should disallow fractional disclaimers that have a practical effect of disclaiming all amounts above a fixed-dollar amount. According to the IRS, such disclaimers fail to preserve a financial incentive to audit an estate’s tax return. By allowing the disclaimer, any post-challenge adjustment to the value of an estate could consist entirely of an increased charitable deduction. This provides no possibility of enhanced tax receipts as an incentive to audit the tax return. The IRS argued such disclaimers should be disqualified as against public policy.

The Eighth Circuit also disagreed with this argument. The IRS’ role is to enforce the tax laws, not to maximize tax receipts, it said, adding that there was no clear evidence of congressional intent to maximize incentives for the IRS to audit tax returns.

Prepared by Gary D. Rider, J.D., instructor of business, and Darlene Pulliam, CPA, Ph.D., McCray professor of business and professor of accounting, both of the College of Business, West Texas A&M University, Canyon, Texas.