IRS Finds Pecuniary Gift of IRA to Charity is Taxable

IRS Finds Pecuniary Gift of IRA to Charity is Taxable

In its recently released legal memorandum, ILM 200644020, the IRS Chief Counsel found that satisfying a pecuniary charitable bequest with an IRA will result in a trust having to recognize taxable income. The Chief Counsel also concluded that the estate could not claim a charitable income tax deduction to offset the gift to charity! The debate over whether satisfying a pecuniary bequest with an IRA or qualified plan has been on going, so whether or not one agrees with the Chief Counsel’s conclusions in this legal memorandum, a possible benefit of the memorandum is that it may lead to a final resolution of this debate.

The facts of this case are as follows: A trust was designated as the beneficiary of the decedent’s IRA. The trust provided for specific “pecuniary bequests” to three different charities. A pecuniary gift is a gift that is designated in terms of a dollar amount, such as “upon my death, give $100,000 to my church.” The decedent’s trust gave the trustee the power to distribute trust assets among the designated charitable and non-charitable beneficiaries in any manner the trustee found proper. The trustee therefore instructed the IRA custodian to divide the IRA into shares for each of the charitable beneficiaries. In this manner each of the charities became the beneficiary of an IRA equal in value, at the time of division, to the dollar amount it was entitled to under Trust.

The Chief Counsel held that the trust had taxable income when the IRA was used to satisfy the pecuniary bequest and that the trust would not be entitled to an offsetting charitable income tax deduction. The memorandum stated:

The amount of the balance in IRA at Decedent’s death, less any nondeductible contributions, is IRD under section 691(a)(1). If an estate or trust satisfies a pecuniary legacy with property, the payment is treated as a sale or exchange. See Kenan v. Commissioner, 114 F.2d 217 (2nd Cir. 1940). Because Trust used IRA to satisfy its pecuniary legacies, Trust must treat the payments as sales or exchanges. Therefore, under section 691(a)(2), the payments are transfers of the rights to receive the IRD and Trust must include in its gross income the value of the portion of IRA which is IRD to the extent IRA was used to satisfy the pecuniary legacies.

The conclusion by the IRS Chief Counsel illustrates the tax trap of an executor or trustee using an appreciated asset to satisfy a gift of a specific dollar amount. The Kenan court, as well as many others, have analogized the satisfaction of a pecuniary gift with an appreciated asset to be the equivalent of the sale of the appreciated asset by the executor or trustee and the use of the cash proceeds to satisfy the gift of the specific dollar amount. Because the courts have treated the transaction as if the appreciated asset were sold, the estate or trust is required to recognize taxable income. The analysis gets even more complicated and ambiguous when income in respect of a decedent (“IRD”) assets are used to satisfy a pecuniary bequest in a will. IRD assets are assets that would have been taxable to the decedent had he or she received distributions from them while the decedent was alive. There are many examples of IRD assets – deferred annuities, promissory notes from lifetime installment sales of property, savings bonds, royalty payments, accrued but unpaid wages at the time of death – but arguably the largest source of IRD are distributions from IRAs and qualified retirement accounts.

Other pronouncements by the IRS on this subject had been murky. In PLR 9123036, PLR 9315016 and PLR 9507008 the IRS found that using savings bonds and installment notes in satisfaction of pecuniary bequests resulted in recognition of income. These rulings have been criticized by many commentators on the grounds that several courts have held that the law of IRD trumps the law of DNI. Later PLRs that involved retirement account distributions to satisfy pecuniary spousal shares did not assert the sale principle. (See PLRs 9524020, 9608036, 9623056 and 9808043.)

This IRS Memorandum illustrates how a wrong step in planning or administering estates and trusts with large retirement assets can result in unanticipated and unintended income and estate tax consequences. These unanticipated and unintended results have been the subject matter of much litigation against financial planners, accountants, and attorneys. In this case, the income tax consequences could have easily been avoided through thoughtful planning and drafting by an experienced estate planning attorney familiar with the unique income and estate tax ramifications of working with large retirement assets.

Our firm focuses on advanced estate planning strategies, especially planning strategies involving clients with large retirement assets. Please contact us to schedule an appointment to learn how we might be able to assist your clients.