Allocation and apportionment of charitable contributions under section 861.
On January 23, the Internal Revenue Service requested comments on the paperwork burdens associated with the proposed section 861 regulations, relating to the allocation and apportionment of charitable contributions. The regulations were issued on March 11, 1991, and were the subject of a public hearing in August of that year. Tax Executives Institute, which filed comments on the proposed regulations, favors the expeditious promulgation of final regulations and hopes that the January 23 notice signals the intention to include the project on the 1997 Business Plan. We believe, however, that the regulations should be revised, both to minimize taxpayer burdens and to harmonize the tax policy underlying the section 1.861-8 regulations and the country's well-established interest in encouraging charitable contributions.
Treas. Reg. [sections] 1.861-8(e)(9)(iv), which has been in effect since 1977, provides that the deduction for charitable contributions allowed by section 170 will "generally" be considered as not definitely related to any gross income. Consequently, those deductions must be ratably apportioned among U.S. and foreign sources in accordance with Treas. Reg. [sections] 1.861-8(c). Although many charitable contributions are apportioned based on gross income under the extant regulations, a taxpayer in certain circumstances may properly allocate the deduction to one or more classes of gross income.
In Notice 89-91, 1989-2 C.B. 408, the IRS announced its intention to modify the section 861 regulations essentially to eliminate the word "generally," thereby requiring taxpayers to ratably apportion the deduction for charitable contributions to all classes of gross income on an affiliated group basis. Many commentators, including TEI, voiced policy and administrative concerns about the rule announced in Notice 89-91, and the IRS attempted to respond to those concerns in developing the 1991 proposed regulations. Specifically, the proposed regulations reject the notion that all charitable contributions should be ratably apportioned and set forth special rules for the allocation of charitable contribution deductions solely to U.S.-source gross income or, alternatively, solely to foreign-source gross income. Thus, Prop. Reg. [sections] 1.861-8(e)(12)(i) provides that a charitable contribution deduction will be allocated to U.S.-source gross income if --
(A) The taxpayer, at the time of
the contribution, both
designates the charitable
contribution for use solely in the
United States and reasonably
believes that the contribution
will be so used; and
(B) The contribution is not described
(e)(12)(ii) of this section
[relating to charitable
contribution deductions allocated
solely to foreign source gross
Paragraph (e)(12)(ii) of Prop. Reg. [sections] 1.861-8 provides that a deduction will be allocated solely to foreign-source gross income if the taxpayer, at the time of the contribution, knows or has reason to know that --
(A) The charitable contribution
will be used solely outside the
United States; or
(B) The charitable contribution
may necessarily be used only
outside the United States.
Under Prop. Reg. [sections] 1.861-8(e)(12)(iii), charitable contribution deductions that fall within neither of the foregoing special rules will be apportioned ratably on the basis of gross income in accordance with Treas. Reg. [sections] 1.861-8(c)(3). The proposed regulations, which would apply for taxable years beginning after March 12, 1991, also contain a special rule for private foundations.
Allocation of the Charitable
Solely to U.S.-Source Income
Is Consistent With the Policy
Basis Underlying Treas. Reg.
The practical effect of the proposed regulations is to deny a taxpayer having excess foreign tax credits any benefit from contributions for use outside the United States. Because of this effect, the regulations were criticized in 1991 as both dampening the climate for philanthropy at a time when such contributions are desperately needed and being inconsistent with the government efforts to encourage charitable giving and volunteerism -- as evidenced most recently by President Clinton's January 24 announcement of an April 1997 summit on volunteerism (in which former President Bush and retired General Colin Powell, among others, will also participate). Thus, even if the proposed regulations can be justified on tax policy grounds, they have been properly criticized as undermining the national interest in encouraging corporations and other taxpayers to make contributions for use outside the United States, especially for disaster relief and humanitarian efforts.
TEI shares this concern. We recognize, however, that the meshing of the principles underlying section 861(b) with the tax and social policy imperatives of section 170 cannot be easily accomplished. Nevertheless, we submit that reasonable allocation rules for the charitable contribution deduction can be developed that are congruent with, and indeed advance, the national interest in encouraging charitable contributions.
The section 1.861-8 regulations have long provided that deductions definitely related to a class of gross income are to be allocated to that class and that such determinations are to be made on the basis of the factual relationship of the deductions to gross income. Before the issuance of Notice 89-91, taxpayers were able to directly allocate certain contributions to either U.S.-source gross income or to foreign-source gross income on the basis of the general rule set forth in Treas. Reg. [sections] 1.861-8(a)(2). Notice 89-91 threatened to disturb that practice by announcing the IRS's intention to revise the section 1.861-8 regulations to provide that the deduction for charitable contributions must always be ratably apportioned on the basis of gross income. TEI objected to that notion and specifically urged the IRS to adopt a rule whereby contributions to U.S.-based charities for use in the United States would be allocated exclusively to U.S.-source gross income.
Consequently, the Institute commends the IRS for concluding in the proposed regulations that in appropriate cases charitable contribution deductions can be definitely related to a class of gross income. The question becomes, however, whether the direct-allocation rule set forth in Prop. Reg. [sections] 1.861-8(e)(12)(i) should be complemented by additional rules that foster the tax policy goals of section 861(b) while furthering the national interest in encouraging charitable contributions for certain international causes. TEI submits that ample justification exists for broadening the proposed regulations to provide that certain charitable contributions, especially for international disaster relief and other humanitarian efforts, will be allocated exclusively to U.S.-source gross income.
1. Use of Contribution
Solely in the United
The proposed regulations properly conclude that a contribution that is to be used solely in the United States is directly related to U.S.-source gross income. Prop. Reg. [sections] 1.861-8(e)(12)(i)(A) sets forth a designation or "earmarking" requirement that will ensure the presence of the requisite factual connection while providing taxpayers (and the IRS) with an easily administrable rule. The desire for clarity, however, should not preclude the exclusive allocation of other U.S.-use contributions in the absence of a designation. Thus, we recommend that the regulations be revised to provide the deduction for charitable contribution may be allocated exclusively to U.S.-source gross income where the contribution may necessarily be used only in the United States. For example, if a taxpayer contributes the use of U.S. real property, the deduction for that contribution should be allocated exclusively to U.S.-source gross income because the non-U.S. use of such a contribution is impossible. In other words, the rule for exclusive U.S.-source contributions should parallel the rule set forth in Prop. Reg. [sections] 1.861-8(e)(12)(ii)(B) for contributions to be allocated exclusively to foreign-source gross income.
2. Use of Contribution
Outside the United States
If a U.S. corporation makes a charitable contribution to a U.S.-based charity for use in the United States, the factual connection between the contribution and U.S.-source gross income is palpable. Any goodwill that accrues from the contribution will accrue in the United States. Thus, if a corporation makes a contribution to a Boys Club in St. Louis or to the Kennedy Center in Washington, the contribution is more properly associated with the corporation's U.S. activities (and gross income) than its worldwide activities (and income). The proposed regulations confirm this result as long as a U.S.-use designation is made.
On the other hand, if the same corporation makes a contribution to a U.S.-based charity for use outside the United States, it does not necessarily follow that the contribution should be associated with the corporation's foreign activities (and income), or even be ratably apportioned, because no goodwill outside the United States will ordinarily accrue from the contribution.(1) For example, if a corporation makes a contribution to a U.S.-based international relief organization to alleviate the suffering of the Bosnian refugees, the recipients of the assistance will most often not even be aware of their benefactor, but rather will identify the contribution with the organization distributing the assistance. Thus, the U.S.-based charity can be said to distance the contributing corporation from the foreign use of the contribution, thereby attenuating the relationship between the charitable contribution deduction (and any goodwill accruing from it) and the corporation's foreign-source gross income. Similarly, a contribution to a U.S.-based charity promoting worldwide literacy would advance the U.S. national interest in education without producing any worldwide benefit to the donor, since the nexus between the contribution and foreign-source gross income is muted by the intervening charity.
In other words, the designation rule set forth in Prop. Reg. [sections] 1.861-8(e)(12)(i)(A) produces the correct result in respect of those contributions designated for U.S. use. This does not mean, however, that only those deductions are properly allocable to U.S.-source gross income. Indeed, given the overriding social policy underlying section 170,(2) TEI believes that the IRS would be justified in promulgating regulations holding that a U.S. corporation's deduction for charitable contributions should always be allocated exclusively to U.S.-source gross income, without regard to whether the contribution is used in or outside the United States. Assuming, however, that the IRS will not adopt an exclusive U.S. allocation rule, the proposed regulations can be refined to further the national interest in making charitable contributions without abrogating the tax policy under the section 1.861-8 regulations. Our specific recommendations are set both below.
Proposed Modifications to
Harmonize Treas. Reg. [sections]
1.861-8 With the National
Interest Underlying Section
TEI recommends that the regulations be revised to include a special rule for contributions relating to international disaster preparedness and humanitarian relief In addition, consideration should be given to certain other special rules.
The proposed special rule for contributions to disaster preparedness and relief efforts would be based on the conclusion that such contributions cannot be directly associated with any class of foreign-source gross income (which Prop. Reg. [sections] 1.861-8(e)(12)(ii) would presume) and that the tax and social policies underlying section 170 of the Code merit the allocation of such contributions solely to U.S.-source gross income. Stated differently, because the charitable contributions are in furtherance of the national interest (often reducing the amount, or otherwise enhancing the effectiveness, of direct U.S. government assistance) and because they create goodwill (if at all) in the United States,(3) the special rule would hold that the deduction for such contributions should be allocated exclusively to U.S.-source gross income.
To effectuate the Institute's recommendations, Prop. Reg. [sections] 1.861-8(e)(12)(i) should be revised to read, as follows:
A taxpayer shall allocate a deduction
for a charitable
contribution solely to United States
source gross income if --
(A) The taxpayer knows, or has
reason to know, that the
contribution will be used solely
in the United States; or
(B) The charitable contribution
may necessarily be used only
in the United States.
A taxpayer shall be deemed
to satisfy the requirement of
paragraph (e)(12)(i)(A) if the
taxpayer, at the time of the
contribution, both designates
the charitable contribution
for use solely in the United
States and has no reason to
believe that the contribution
will not be so used.(4)
Prop. Reg. [sections] 1.861-8(e)(12)(ii), relating to the exclusive allocation to foreign-source gross income, should be revised to read, as follows:
Except as provided in
paragraph (e)(12)(vi)(5), the
taxpayer shall allocate a deduction
for a charitable contribution
solely to foreign source gross
income if the taxpayer, at the
time of the contribution,
knows or has reason to know
(A) The charitable contribution
will be used solely outside the
United States; or
(B) The charitable contribution
may necessarily be used only
outside the United States.
In addition, the following new special rule should be added to the regulations:
[New [sections] 1.861-(e)(12)(vi).]
Special rule for contributions
relating to international
disaster preparedness and
Notwithstanding paragraph (e)(12)(ii), a
taxpayer shall allocate a
deduction for a charitable
contribution solely to United
States gross income if the
contribution is made to a
qualified organization for use
in international disaster
preparedness and humanitarian
Another alternative, though perhaps more burdensome and therefore less practical, would be to permit the U.S. sourcing of the deduction for contributions to facilitate humanitarian relief upon the formal designation by the Secretary of the Treasury (presumably in consultation with the Secretary of State) that contributions to the particular effort would be in the national interest. Although such a designation rule would encourage U.S. corporations to make contributions to disaster relief once a designation is made, the uncertainty pending any such designation might inhibit contributions needed for immediate disaster relief. Not only might a designation rule produce a "log-jam," it could also lead to unseemly, and potentially time-consuming, lobbying between different charities -- for example, Burundian refugee relief versus hurricane relief in the Caribbean basin.(7) More fundamentally, an event-sensitive rule would arguably inhibit corporations from making more efficacious contributions to disaster preparedness programs. In contrast, a generic rule (such as proposed above) would bring clarity to this area, thereby furthering the policy goals underlying the Code's charitable contribution provisions.(8)
Certain non-disaster related contributions that advance the national interest, however, may be more susceptible to a Secretarial designation rule and may merit an additional special rule. Under the proposed regulations, contributions to support the training of the U.S. Olympic team would be allocated to U.S.-source gross income, whereas contributions to finance the team's foreign travels and competition would be allocated solely to foreign-source gross income under Prop. Reg. [sections] 1.861-8(e)(12)(ii). Such an anomalous result could be avoided by providing a special rule under which contributions would be allocated to U.S.-source gross income where the Secretary of the Treasury formally designates the charity as promoting the national interest (e.g., because of the strong identification of the U.S. Olympic team with the United States as a whole).
Finally, TEI believes it may be appropriate to craft a special rule under which the deduction for in-kind contributions under section 170(e)(3) would be allocated exclusively to U.S.-source income. Section 170(e)(3) of the Code was enacted specifically to encourage corporations to make contributions of inventory to facilitate the care of the ill, needy, or infants (without regard to where those needing assistance are located) and, by its terms, encompasses contributions to humanitarian relief efforts. Given the public policy underlying section 170(e)(3) (which itself limits the deduction), a special rule may be appropriate to ensure that the policy is not frustrated by the expense allocation and apportionment rules.
TEI believes that the adoption of one or more of the foregoing rules could effectively harmonize the national interest in encouraging contributions to international relief efforts with the tax policy underlying the section 1.861-8 regulations. It would also satisfy the desire for a clear, administrable rule. In this regard, we wish to emphasize the important role that certainty plays in encouraging charitable contributions. If a potential donor does not know the proper sourcing of its deduction for charitable contributions, it may delay making the donation. Consequently, the promulgation of clear rules should be an immediate goal.
De Minimis Rule
TEI recommends that the regulations be revised to include a de minimis rule or, alternatively, a special rule for corporate contributions made as part of an employer's matching contribution program. Such a rule is necessary to ameliorate the administrative burden that would otherwise attend the application of the proposed regulations to a large number of nominal contributions. For example, many corporations have established programs under which the corporation will match -- often, dollar for dollar up to a certain limit (say, $5,000) -- contributions made to eligible charities. Experience teaches that most matching contributions are made to employee alma maters, local hospitals, and community-based eleemosynary organizations and are thereby used exclusively in the United States, though concededly a small portion of the matching contributions may appropriately be considered foreign. In addition, local (domestic) units of U.S. corporations frequently make direct contributions of modest size to local charities.
The administrative burden of tracking the respective foreign and U.S. use of relatively small contributions will be immense, especially when compared to the incremental tax revenues that would flow to the fisc as a result of the ratable allocation of such contributions. The need for a de minimis exception is especially pronounced in light of Prop. Reg. [sections] 1.861-8(e)(12)(v), under which the deduction for charitable contributions are to be allocated and apportioned in accordance with Temp. Reg. [sections] 1.861-14T(e) (i.e., on an affiliated-group basis).(9) Consequently, TEI recommends that the regulations exempt from the allocation and apportionment rules contributions of $5,000 or less per charity. An alternative would be to provide a special rule providing for the exclusive allocation to U.S.-source gross income of contributions made through an employer matching program.
Special Rule for Private
Under Prop. Reg. [sections] 1.861-8(e)(12)(iv), a taxpayer who is a "substantial contributor" to a private foundation is required to take actions to ensure that U.S.-use designated contributions to the foundation (i) are placed in a restricted account and (ii) are in fact used solely in the United States. The proposed regulations cross-reference, and in large measure are redundant with, the detailed provisions generally applying to private foundations (in particular, the "expenditure responsibility" requirements of Treas. Reg. [sections] 53.4945-5). Thus, each contribution would require a pre-donation inquiry by the taxpayer, a grantee report, and a detailed written commitment by the grantee.
TEI submits that the layering of the private foundation rules on the requirements of Prop. Reg. [sections] 1.861-8(e)(12)(i) is unnecessary. All that should be required is that the private foundation follow the same rules that. govern direct giving by taxpayers. Hence, at the end of each year, the private foundation should notify each "substantial contributor" of the following:
* the amount of the foundation's gross income;
* the amount of its contributions allocable exclusively to U.S.-source gross income;
* the amount of its contributions allocable exclusively to foreign-source gross income; and
* the amount of its contributions ratably apportionable on the basis of gross income.
Each "substantial contributor" would then undertake to comply with the regulations, by allocating its contributions to the private foundation on the same basis as the foundation's contributions to charitable donees are allocated.
As promulgated, the proposed regulations would apply to taxable years beginning after March 12, 1991. TEI recommends that taxpayers be accorded an election to apply the regulations to all open years. In making this recommendation, we realize that certain modifications may have to be made to the designation rule set forth in Prop. Reg. [sections] 1.861-8(e)(12)(a)(i)(A). We submit, however, that the burden associated with the formulation of such modifications will pale compared with the certainty that could flow from the application of the proposed rules to all open years. Specifically, because of the clarity of the proposed regulations (especially if TEI's proposed special rules are adopted),(10) both taxpayers and the IRS will be spared much of the burden of applying the pre-1991 regulations.
Tax Executives Institute appreciates this opportunity to present its views on the proposed regulations relating to the allocation and apportionment of the deduction for charitable contributions. If you have any questions, please call Joseph S. Tann, Jr., chair of TEI's International Tax Committee, at (312) 750-5074 or Timothy J. McCormally of the Institute's professional tax staff at (202) 638-5601.
(1) Section 170(c)(2) already requires that a charitable contribution must be made to a domestic corporation but does not impose any general use restriction on the donee organization.
(2) The predecessor of section 170 was enacted as part of the Revenue Act of 1935 to provide an independent basis for a charitable contribution deduction, without regard to whether such contributions are ordinary and necessary business expenses deductible under section 162 of the Code. See Marquis v. Commissioner, 49 T.C. 695, 698-99 (1968) (discussing the history of section 170). See also Boris I. Bittker & Lawrence Lokken, Federal Income Taxation of Income, Estates and Gifts at [Paragraph] 20.1.7 (2d ed. 1996).
(3) Indeed, the goodwill arguably accrues not to the corporate donor but rather to the United States as a whole.
(4) TEI recommends that the phrase "reasonably believes that the contribution will be so used" in Prop. Reg. [sections] 1.861-8(e)(12)(a)(i)(A) be inverted, so that a contribution will be covered by the U.S.-source rule as long as the taxpayer does not have any reason to believe that the contribution will not be used in the United States. This change would make it clear that a taxpayer is not required to obtain a certification from each donee that the contribution was in fact used solely in the United States. Clearly, the administrative burden associated with a certification rule is not necessary to vindicate the policy underlying section 861(b). Thus, we recommend that the final regulations make it clear that a taxpayer need not obtain such a donation-by-donation certification, but rather may rely on what it learns about the operations of the charity during its decision-making.
(5) For convenience' sake, the proposed special rule in respect of disaster preparedness and humanitarian relief is designated paragraph (e)(12)(vi) in the text. TEI recommends, however, that such special rule be designated (e)(12)((iii) and that current paragraphs (e)(12)(iii) through (e)(12)(v) be redesignated paragraphs (e)(12)(iv) through (e)(12)(vi), respectively.
(6) A "qualified" organization would be an organization described in section 170(c). It may also be appropriate for the IRS, through a revenue procedure, to provide additional guidance on the meaning of "international disaster preparedness and humanitarian relief efforts." For example, the revenue procedure could provide that contributions to certain educational efforts will fall within the scope of the special rule.
(7) At a minimum, the regulations implementing the special rule should make it clear that contributions to the designated effort made prior to the official Secretarial designation would be subject to the special rule.
(8) Still another alternative would be for the Secretary of the Treasury to provide that contributions, or a designated percentage of contributions, to certain U.S.-based charities would be allocated exclusively to U.S. source income, because of the historical scope of the designated charities' humanitarian efforts. Such an organizational designation rule would prevent the delays that could occur with an effort-by-effort designation regime.
(9) The statutory authority for the affiliated-group rule apparently lies in section 864(e)(6). That section, however, speaks to the allocation and apportionment of "expenses," whereas section 861(b) sets forth rules relating to the allocation and apportionment of "expenses, losses, and other deductions." Because charitable contributions are not "expenses" within the meaning of section 162 but rather are "other deductions" under section 170 (and section 861(b)), they literally fall outside the scope of section 864(e)(6). Accordingly, application of the affiliated-group rule to the charitable contribution deduction is arguably improper. In any event, the application of the regulations on an affiliated-group basis would greatly complicate the task of ensuring compliance and underscores the efficacy of a de minimis rule.
(10) Under Treas. Reg. [sections] 1.861-8(e)(9)(iv), a taxpayer can persuasively argue that the deduction for certain charitable contributions (e.g., those that may necessarily be used only in the United States) are properly allocable exclusively to U.S.-source gross income (because of the presence of the word "generally" in the provision stating that charitable contributions are subject to ratable apportionment). The retroactive application of the proposed regulations (which confirm the propriety of sourcing such deductions to the United States) would obviate any disputes between taxpayers and IRS examining agents over the meaning of the term
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|Date:||Mar 1, 1997|
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