Distributions from split-interest trust are not included in distributable amount; Regs. Sec. 53.4942(a)-2(b)(2) is invalid.
The IRS assessed excise taxes on these distributions, for F's undistributed income, based on Regs. Sec 53.4942(a)-2(b)(2). The Tax Court (opinion Tannenwald, J.) holds for F, invalidating the regulation and ruling that none of the Trust's distributions were includible in F's undistributed income.
The issue before us is straight-forward: Does the increase in the distributable amount st forth in Regs. Sec. 53.4942(a)-2 constitute an unwarranted extension of the statutory provision that defines "distributable amount" in terms of "minimum investment return," or is it a reasonable interpretation of that provision which carries out the intent of congress?
An understanding of the historical framework of the statutory provisions and the regulations involved is an essential element in the resolution of this issue. Sec. 4942 was first enacted as part of the Tax Reform Act of 1969, which imposed the excise tax on the "undistributed income" of a private foundation. Undistributed income was defined as the excess of "distributable amount" over "qualifying distributions" and "distributable amount" was defined as an amount equal to "minimum investment return or the adjusted gross income (wichever is higher)" reduced by the amount of specified taxes. Thus, there was a dual basis for the tax. Sec. 4942(g)(3) specified that a contribution from one private foundation to another private foundation would constitute a "qualifying distribution" only if the recipient foundation prior to the close of the next tax year distributed an amount equal to the contribution for exempt purposes. the abuse to which Sec. 4942 was directed was the opportunity then existing for individuals to receive an immediate benefit of deductible charitable contributions while deferring the actual transfer of funds for charitable purposes. This was the origin of the minimum investment return. Congress wanted to be sure that a foundation did not invest in lowyield assets to skirt the requirement of distributing net income.
The Tax Reform Act of 1969 also enacted Sec. 4947, which dealt with nonexempt trusts, including split-interest trusts such as the trust involved here, and imposed various restrictions, comparable to those imposed on private foundations in respect of self-dealing, retention of excess business holdings, and the making of speculative investments or taxable expenditures but not including a mandatory income distribution requirement (such as that imposed on a private foundation). Sec. 4947 was enacted to prevent taxpayers from using the split-interest trust device to avoid the restrictions being imposed on private foundations. This law also contained significant limitations on the availability of charitable deductions, in respect of contributions to trusts, for income, estate and gift tax purposes; the result was to preclude J from an income tax deduction in respect of the transfer to the Trust but to allow her a gift tax deduction.
In 1971, Regs. Sec. 53.4942(a)-2 was proposed to implement Sec. 4942. This regulation excluded from the definition of assets to be taken into account, in computing "minimum investment return," any future interest of a trust described in Sec. 4947(a)(2) but included the assets of such a trust to which a current interest of the trust was attributable. After receiving criticisms of the proposed regulation, relating principally to the fact that such a provision saddled a private foundation with having to pay out an amount in respect of assets over which it had no control and with respect to which it had a limited or non-existent right to receive income currently, the regulation involved was released; the restriction excluding a future interest from the assets of a private foundation (Regs. Sec. 53.4942(a)-2(c)(2)(i)) was retained.
The next event in this legislative scenario occurred when the Economic Recovery Tax Act of 1981 was enacted. At that time, Congress was concerned that, because of inflationary pressures, the net income requirement as a measure of the required distribution under Sec. 4942 was having an adverse effect on the investiment policies of private foundations. accordingly, Sec. 4942 was amended to eliminate the dual distribution requirement and to limit the required distribution to a single basis, i.e., the "minimum investment return."
F argues that the legislative history shows clearly that Congress deliverately intended to relieve split-interest trusts from the mandatory distribution requirement applicable to private foundations and that the regulationin effect mandates a distribution by such a trust to the private foundation beneficiary. We think F presses its position too far. The regulation does not require such a trust to distribute any amount; it only attempts to define how a distribution that is made should be treated in the hands of the receipient private foundation.
The IRS contends that Congress sought to ensure that the income of private foundations and split-interest trusts be used currently for charitable purposes and that the regulation represents a reasonable way of achieving that purpose. We disagree with this point of view as well; we are convinced that, accepting the fact that Congress had such a purpose, it simply did not provide a sufficient foundation to enable that purpose to be achieved by regulation. It may well be that there is a gap which Congress ought to close but we are not at liberty to add to, or alter, the language of a statute in order to accomplish such a result. In so concluding, we think it significant that Congress dealt, to a limited degree, with the type of problem that concerns the IRS by imposing limitations in respect of distributions from one private foundation to another private foundation.
The fact that the regulation has been on the books for 18 years or that, during that period, Congress has twice adjusted the distribution requirement in an effort to fine tune the balance between curbing abuses and the economic realities faced by private foundations does not provide a basis for our sustaining the regulation. In this connection, we note that the keying of "distributable amount" to "adjusted net income," as well as to "minimum investment return" in the statutory language in effect prior to 1981, may have provided, under some circumstances, a sufficient basis for sustaining the regulation as applied to pre-1982 years. But that basis was eliminated in 1981 and with it the possibility of sustaining the regulation.
The simple fact is that "distributable amount" is now statutorily defined in terms of "minimum investment return," which in turn is defined in terms of a fixed percentage (currently 5%) to the foundation's "assets." Given this clear statutory linkage of the three terms, there is simply no statutory basis for the regulation, which by its terms pulls assets of a split-interest trust, which makes a distribution to a private foundation, into the "assets" of the foundation. To sustain the Service's prosition would require us to accord a broader interpretation to the word "assets" than its ordinary, everyday meaning.
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|Author:||Fiore, Nicholas J.|
|Publication:||The Tax Adviser|
|Date:||Feb 1, 1992|
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