Internal Revenue Service
Revenue Ruling

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 Rev. Rul. 73-95

1973-1 C.B. 322

Sec. 642

IRS Headnote

An amount set aside for charitable purposes is not deductible under section 642(c) of the Code if the trustee has discretionary power under the will to allocate gains from the sale or other disposition of property, constituting principal, to income or principal.

Full Text

Rev. Rul. 73-95

Advice has been requested whether, under the circumstances described below, a trust is allowed a deduction for an amount permanently set aside under the provisions of section 642(c) of the Internal Revenue Code of 1954.

Under the provisions of his will and in accordance with State law the residuary estate of an individual who died on January 1, 1968, was placed in trust. The income of the trust was to be paid in equal shares to two individual beneficiaries. On the death of one of the individuals the entire income of the trust is to be paid to the survivor for life and at his death the trust principal is payable to a charitable organization described in section 170(c)(2) of the Code. The will also provides that any gains from the sale or other disposition of property constituting principal may, in the absolute discretion of the trustee, be allocated either to income or to principal. This provision is not contrary to the local law.

In 1971 the trust realized a gain on the sale of securities held in the principal account. The trustee, in his discretion, credited two-thirds of the gain to the income beneficiaries and claimed a deduction for the trust under section 661(a)(2) of the Code. He credited the remaining one-third of the gain to the principal account and claimed a deduction under the provisions of section 642(c) of the Code.

Section 642(c) of the Code, prior to its amendment by the Tax Reform Act of 1969 P.L. 91-172, 1969-3 C.B. 10, allowed, in part, a deduction to trusts for any amount of gross income, without limitation, which pursuant to the terms of the governing instrument was, during the taxable year, permanently set aside for a purpose specified in section 170(c) of the Code. Section 642(c) of the Code, after its amendment by the Tax Reform Act of 1969, allows, in part, a similar deduction to a trust but only as to gross income earned with respect to amounts transferred to the trust before October 9, 1969. In Colt v. Duggan, 25 F. Supp. 268 (1938), the court held, in part, that the words "permanently set aside" for charitable uses, as intended under section 162(a) of the Revenue Act of 1932 (predecessor of section 642(c) of the Internal Revenue Code of 1954), mean an irrevocable appropriation to charitable uses pursuant to the governing instrument and that otherwise, under the guise of a charitable deduction, individuals may elude taxation.

Thus, in order to satisfy the "permanently set aside" requirements of section 642(c), an amount of gross income must be irrevocably appropriated for the charitable purpose pursuant to the terms of the governing instrument. If an amount set aside for a charitable purpose is dependent on the discretion of the trustee, and the trustee has discretionary power to allocate amounts received either to principal or income, it cannot be said to have been permanently set aside.

In the instant case, the trustee, by exercising his authority under the governing instrument, may subject amounts previously set aside to diminution by losses affecting corpus so that there is no assurance that an amount previously set aside will ultimately become available to the charitable organization.

An illustration of the above paragraphs is the case of a trust whose principal consisted of two blocks of stock. One block had a basis of $1,000 and a fair market value of $10,000 while the other block had a basis of $10,000 and a fair market value of $1,000. Assume that a long-term capital gain of $9,000 had been set aside for charity in a previous year. In the current year the trustee sold both blocks at their fair market value and in accordance with his discretionary authority allocated the gain of $9,000 to income and distributed it to the noncharitable income beneficiaries. Since the gain was allocated to the income beneficiaries, only $2,000 remained in principal after the distribution (sales proceeds of $11,000 less $9,000 distribution). The result was that principal was diminished and a substantial portion of the amount previously set aside is no longer available for the charity.

Accordingly, it is held that where, as in the instant case, a trustee has discretionary power under the will to allocate gains from the sale or other disposition of property constituting principal either to principal or to income, any amount the trustee elects to set aside will not qualify for a deduction under section 642(c) of the Code since it has not been permanently set aside for a charitable purpose.