Internal Revenue Service
Revenue Ruling

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 Rev. Rul. 78-24

1978-1 C.B. 196

Sec. 642
Sec. 661
Sec. 662
Sec. 663

IRS Headnote

Terminating trust; charitable and noncharitable bequests; capital gains. A trust that is terminating and sells certain assets at a gain to meet the requirement of its governing instrument that it pay a bequest of a specified dollar amount from its corpus in a single payment to a noncharitable trust, the remainder of its corpus being payable to a charitable organization, is entitled to deduct under section 642(c)(1) of the Code the lesser of the amount of the charitable distribution or the capital gain realized, subject to the requirements of section 642(c)(4). The amount paid to the noncharitable trust is not deductible by the terminating trust under section 661, and is not includible in the noncharitable trust's gross income.

Full Text

Rev. Rul. 78-24

Advice has been requested concerning the treatment, for Federal income tax purposes, of amounts distributed by a trust under the circumstances described below.

An individual taxpayer died in 1950. Under the terms of the taxpayer's will, two trusts were established. One trust, for the benefit of the taxpayer's child was funded with 10x dollars and the other trust, for the benefit of the taxpayer's spouse, was funded with the residue of the taxpayer's estate. The will further provided that on the death of the taxpayer's spouse the residuary trust for the spouse's benefit was to terminate and that 20x dollars of its corpus was to be paid to the child's trust. The remaining corpus was to be transferred irrevocably to an organization described in section 170(c) of the Internal Revenue Code of 1954. At the time of the spouse's death in 1976, the value of the corpus of the spouse's trust exceeded 20x dollars but the cash in the corpus amounted to only 3x dollars. In order to facilitate division and distribution of the assets of the trust, the trustee of the residuary trust sold certain trust assets having a value of 17x dollars. This sale resulted in a gain to the trust of 4x dollars. The 20x dollars in cash was paid to the child's trust and the remainder of the corpus property was conveyed to the charity in 1976, the same tax year in which the 17x dollars worth of assets had been sold. Section 642(c)(1) of the Code provides, in part, that in the case of an estate or trust (other than a trust meeting the specifications of subpart B) there shall be allowed as a deduction in computing its taxable income (in lieu of the deduction allowed by section 170(a), relating to deductions for charitable, etc., contributions and gifts) any amount of the gross income, without limitation, which, pursuant to the terms of the governing instrument, is, during the taxable year, paid for a purpose specified in section 170(c) (determined without regard to section 170(c)(2)(A)).

A trust meeting the specifications of subpart B is one that is required to distribute all of its income currently and is not required to pay or permanently set aside amounts for a charitable purpose.

Section 642(c)(4) of the Code provides that to the extent that the amount otherwise allowable as a deduction under subsection (c) consists of gain from the sale or exchange of capital assets held for more than 6 months [9 months for taxable years beginning in 1977 and 12 months for taxable years beginning after 1977], proper adjustment shall be made for any deduction allowable to the estate or trust under section 1202 (relating to deduction for excess of capital gains over capital losses).

In Bowers v. Slocum, 20 F.2d 350 (2d Cir. 1927), the court held that income accumulated during the administration of an estate was permanently set aside for charity pursuant to the terms of the governing instrument because it was included in the residuary estate that, under the will of the testatrix, was destined to pass to charity. The court concluded that the charity should be regarded as having the right to receive the income in question, since the charity was at risk with respect to the amount of income earned, as any gain realized by the estate would ultimately be the gain of the charity.

Under the rationale of Bowers v. Slocum, in those cases in which the remainder interest in trust assets is payable to charity subject to noncharitable bequests of a specified amount, the charity will also always be at risk with respect to any capital gains income to the extent the total trust corpus exceeds the specific non-charitable bequests.

Accordingly, a deduction under section 642(c)(1) of the Code is allowable in the present case for the lesser of the capital gains realized (4x dollars) or the amount of the distribution of the remainder of the corpus to the charity.

Pursuant to section 642(c)(4) of the Code, to the extent that the capital gains in the instant case arose from the sale or exchange in 1976 of capital assets held for more than 6 months, the amount of the section 642(c)(1) deduction must be adjusted for any deduction provided in section 1202. See examples in section 1.642(c)-3(c) of the Income Tax Regulations for the computation of the section 642(c) and section 1202 deductions in such cases.

Section 661(a) of the Code provides that in any taxable year there shall be allowed as a deduction in computing the taxable income of an estate or trust (other than a trust to which subpart B applies) the sum of--(1) any amount of income for such taxable year required to be distributed currently (including any amount required to be distributed that may be paid out of income or corpus to the extent such amount is paid out of income for such taxable year) and (2) any other amounts properly paid or credited or required to be distributed for such taxable year, but such deduction shall not exceed the distributable net income of the estate or trust.

Section 662(a) of the Code provides, generally, the rules for determining the amount to be included in the gross income of a beneficiary to whom an amount specified in section 661 is paid, credited, or required to be distributed.

Section 663(a) of the Code provides, in part, that there shall be excluded from the provisions of section 661(a) and 662(a) any amount which, under the terms of the governing instrument, is properly paid as a bequest of a specific sum of money and that is paid all at once or in not more than three installments.

Accordingly, since the amount of 20x dollars paid by the residuary trust was properly paid as a bequest of a specific sum of money in a single payment, it is neither deductible by the residuary trust under the provisions of section 661 of the Code nor includible in the gross income of the trust of which the child was the beneficiary under section 662.