Retained Management Control Over Donated Property Didn't Defeat Charitable Deductions

In two identical private letter rulings, an individual and a limited liability company proposed to donate cash and securities to a university under an agreement that called for the contributions to be placed in a brokerage account that would be managed by the donors. In each case, IRS concluded that this retention of management control would not defeat the income or gift tax charitable contribution deduction.

Facts. An individual, whom we'll call Beth, and a limited liability company, which we'll call LLC, propose to make donations of cash and traded securities to a tax-exempt college.
At the time of the donation, Beth and LLC will enter into a separate agreement with College. The agreements are identical except for the donor's identity and the contributed assets. Under each agreement's terms, any donation to College is to be placed in an investment or brokerage account, established in the name of College exclusively for its benefit. Each donation will be unconditional and irrevocable. Beth and LLC will surrender all rights to retain or reclaim ownership, possession or a beneficial interest in any donation, and Beth and LLC may not divert the assets held in the account to any person. Under each agreement, Beth or LLC, or her or its investment manager, may manage the investments in the account under a limited power of attorney. Neither Beth nor LLC may engage in any act of self-dealing with respect to assets in the account.
There are these investment restrictions and limitations on management of the account by Beth or LLC:
    • investments will be made only in U.S. equities, U.S. open-end mutual funds, U.S. closed-end mutual funds, U.S. fixed income securities (including, but not limited to treasuries and mortgage-backed, asset-backed and high-yield securities), offshore/onshore hedge funds, REITS, and private placements;
    • no investments may be made in companies in which either Beth or LLC owns, directly or indirectly, more than 5% of the outstanding shares of stock;
    • assets in the account may not be pledged or encumbered by either Beth or LLC (or her or its advisor), or used to satisfy any of their debts or liabilities;
    • neither Beth nor LLC may vote any stock or other securities held in the account;
    • assets in the account may not be commingled with Beth or LLC's assets outside the account;
    • the power to manage investments terminates 10 years from the date of the donation (unless sooner terminated as discussed below); and
    • no investments may be made in short sales, forward settling transactions, derivatives, or any borrowings.

College has the right at any time or for any purpose and in its sole discretion to withdraw any or all of the assets held in the account or to terminate the limited power of attorney and the agreement. Also, the agreement will terminate automatically in severe loss cases, as determined by College in its sole discretion, and may be terminated at any time by either party upon written notice to the other party.

Income tax deduction allowed. IRS concluded that the retention of investment management control by Beth and LLC, subject to the restrictions and limitations contained in the agreements, is not substantial enough to affect the deductibility of the property contributed, and does not constitute the retention of a prohibited partial interest under Code Sec. 170(f)(3). Accordingly, IRS said that Beth and LLC may deduct their contributions of the cash and publicly traded securities to College for income tax purposes.

Background on gift tax deduction. Charitable gifts are deductible in computing taxable gifts for the calendar year. (Code Sec. 2522) If, as of the date of the gift, a transfer for charitable purposes is dependent upon the performance of some act or the happening of a precedent event in order that it might become effective, no deduction is allowed unless the possibility that the charitable transfer will not become effective is so remote as to be negligible) If an interest has passed to, or is vested in, a charity on the date of the gift and the interest would be defeated by the performance of some act or the happening of some event, the possibility of occurrence of which appeared on that date to be so remote as to be negligible, the deduction is allowable.

If a donor transfers an interest in property to a charity and retains an interest in the subject property, no deduction is allowable for the transferred interest unless the transaction is structured to conform to specified statutory and regulatory requirements. (Code Sec. 2522(c)(2) and Reg. § 25.2522(c)-3(c)(1)(i))

Gift tax deduction allowed. IRS concluded that the retained power to manage investments is not the retention of an interest in the property for purposes of Code Sec. 2522(c)(2) and Reg. § 25.2522(c)- 3(c)(1). It also found that the retained power does not cause the gifts to be subject to a condition or power under Reg. § 25.2522(c)-3(b). Accordingly, IRS said that a gift tax deduction will be allowable under Code Sec. 2522 to Beth and "the appropriate individual with respect to the gift by" LLC.

RIA observation: Beyond suggesting that LLC was owned by only one individual, the ruling did not otherwise provide any information about who held the ownership interest in LLC or how it was classified for Federal tax purposes. Thus, there is no way to know exactly who gets the gift tax deduction resulting from LLC's gift. If LLC is taxed as a corporation, the gift would be treated as made by the shareholder under Reg. § 25.2511-1(h)(1) . The ruling did cite this reg in its examination of background material. Thus, one might presume that LLC was treated as a corporation but it is not entirely clear.

RIA Research References: For charitable contributions of partial interests, see FTC 2d/FIN ¶ K-3437; United States Tax Reporter ¶ 1604.45; TaxDesk ¶ 331,619; TG ¶ 19,201.
 
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