Rev. Rul. 83-75

ISSUES

(1) Does a distribution by a trust of corpus consisting of appreciated securities in satisfaction of its obligation to pay a fixed annuity to a qualified charitable organization result in taxable gain to the trust?

(2) Is the trust entitled to a charitable deduction equal to the amount of gain resulting from the distribution of appreciated securities?

FACTS

On December 31, 1978, A, an individual taxpayer, established an irrevocable trust and funded it with 400x shares of Z corporation stock. Under the terms of the trust, the trustee is required to pay to qualified charities an annuity equal to eight percent of the initial net fair market value of the transferred stock. Qualified charities are defined by the trust instrument as organizations described in section 170(c) of the Internal Revenue Code. The annuity is to be paid annually for a term of 10 years and one month after the date of the trust's creation. To the extent current ordinary income is insufficient for making payments, the trustee is to make payments out of capital gains and, if necessary, from corpus. Upon termination of the trust, the trustee will distribute the corpus to A's children or their survivors.

In 1983, there was insufficient ordinary income and capital gains to satisfy the annuity to be paid to the qualified charities. Therefore, the trustee paid the deficiency by distributing out of corpus some of the shares of stock of Z corporation. The stock distributed had a fair market value at the time of distribution of 48x dollars. The basis of the stock in the hands of the trustee was 38x dollars.

LAW AND ANALYSIS

Section 642(c)(1) of the Code provides that in the case of an estate or trust, there shall be allowed as a deduction in computing its taxable income any amount of 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).

Section 642(c)(4) of the Code provides that to the extent an amount otherwise allowable as a deduction under subsection 642(c) consists of gain from the sale or exchange of capital assets held for more than one year, 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).

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, the sum of (1) any amount of income for such taxable year required to be distributed currently (including any amount required to be distributed which 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 amount 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.

Under section 1.661(a)-2(f)(1) of the Income Tax Regulations, if an estate or trust distributes property in kind, and if the distribution satisfies a right to receive a distribution in a specific dollar amount or in specific property other than that distributed, then the distribution will cause the estate or trust to realize gain or loss.

In Kenan v. Commissioner, 114 F.2d 217 (2d Cir. 1940), the trustees of a trust were directed to pay a beneficiary five million dollars when the beneficiary reached age 40. The trustee paid the beneficiary partly in cash and partly in appreciated securities. The court held that the beneficiary had a general claim against the trust corpus, and the satisfaction of this general claim for an ascertainable value by a transfer of specific assets was an exchange that caused the trust to realize gain.

In Suisman v. Eaton, 15 F. Supp. 113 (D. Conn. 1935) aff'd per curiam, 83 F.2d 1019 (2d Cir. 1936), cert. denied, 299 U.S. 573 (1936), the trustee transferred appreciated stock to the beneficiary. The court held that the trust realized gain on the transfer because an exchange had occurred when the beneficiary gave up a right to receive 50,000 dollars in return for the appreciated stock.

Section 662(a) of the Code provides rules for including in the gross income of a beneficiary of an estate or trust described in section 661 the amounts specified in section 661(a) that are paid, credited, or required to be distributed.

Section 663(a) of the Code and the regulations thereunder, however, described certain distributions that are not included within the scope of sections 661(a) and 662(a) of the Code. Section 663(a)(2) provides that any amounts paid or permanently set aside or otherwise qualifying for the deduction provided in section 642(c) shall not be included as amounts falling within sections 661(a) and 662(a).

Section 1.663(a)-2 of the regulations provides that amounts paid, permanently set aside, or to be used for charitable purposes are deductible by estates or trusts only as provided in section 642(c).

Section 1001(a) of the Code provides that the gain from the sale or other disposition of property shall be the excess of the amount realized therefrom over the adjusted basis provided in section 1011 for determining gain.

Section 1202(a) of the Code provides that if for a taxable year a taxpayer other than a corporation has a net capital gain, 60 percent of the amount of the net capital gain shall be a deduction from gross income. Section 1202(b) provides specific provisions for capital gains in the case of an estate or trust.

The trustee was obligated to pay a fixed annuity to qualified charitable organizations. Under the principles of section 1.661(a)-2(f)(1) of the regulations and the case law cited, the distribution of appreciated securities causes the trust to realize gain or loss if the distribution satisfies a right to receive a distribution in a specific dollar amount. Although the trustee has authority to pay the annuity to qualified charities of the trustee's choice, the distribution satisfies a right to receive a specified dollar amount. It is not necessary or practical to identify a particular qualified charity with the right to receive a specified dollar amount. In Kenan, the court stated that the word "exchange" does not necessarily have the connotation of a bilateral agreement which may be said to attach to the word "sale". Thus, the distribution in this case is an exchange even though the trustee consulted with no one before satisfying the obligation to pay the annuity by using the appreciated securities.

Section 1.663(a)-2 of the regulations prevents an estate or trust from claiming as a deduction, under section 661(a)(2) of the Code, any amount distributed to a charitable beneficiary except as permitted by section 642(c). In Mott v. United States, 462 F.2d 512 (Ct. Cl. 1972), cert. denied, 409 U.S. 1108 (1973), the United States Court of Claims rejected the argument that a distribution of corpus to a qualified charitable organization qualifies as any other amount paid within the meaning of section 661(a)(2), and, thus, gives rise to the income tax deduction permitted by that section. The court concluded that section 1.663(a)-2 of the regulations is valid and prevents an estate from claiming as a deduction under section 661(a)(2) any amounts distributed to a charitable beneficiary except as permitted by section 642(c). Under the facts of this case, the principles of section 1.661(a)-2(f)(1) is consistent with section 663(a) when applied for purposes of determining the estate's or trust's gain or loss from distributions in kind.

Pursuant to section 642(c)(4) of the Code, to the extent that capital gains in the present case arose from the sale or exchange, as described above, of capital assets held for more than one year, the amount of the section 642(c)(1) deduction must be adjusted for any deduction provided in section 1202.

HOLDINGS

1. The distribution by the trust of corpus consisting of appreciated securities in satisfaction of its obligation to pay a fixed annuity to a qualified charitable organization is a sale or exchange of the securities that results in taxable gain to the trust.

2. The trust is entitled to a charitable deduction equal to the amount of gain recognized upon the distribution of appreciated securities after making adjustment for any deduction provided under section 1202.