The Tenth Circuit overruled a district court decision that granted the trust that owns Hobby Lobby a $3.2 million refund. The refund claim was based on charitable contributions of appreciated property.
The decision will be of interest to some planners. And then there is nosing through the documents for Hobby Lobby gossip, something which I found irresistible.
About Hobby Lobby
Hobby Lobby describes itself as the largest privately owned arts-and-crafts retailer in the world - over 800 stores, about 32,000 employees in 47 states.
Headquarters in Oklahoma include a 9.2 million square foot manufacturing, distribution and office complex. Although most corporate mission statements will talk about how much the corporation loves its customer and employees, Hobby Lobby also includes a specifically religious element - "Honoring the Lord in all we do by operating the company in a manner consistent with Biblical principles". Among other things that means that if you have an urgent compelling need for arts and crafts supplies on Sunday, Hobby Lobby is not your go to place . The Hobby Lobby people in accordance with the Fourth Commandment are remembering the Sabbath and keeping it holy.
Among those other things Hobby Lobby fought a requirement of the Affordable Care Act that required its health plan to fund certain forms of birth control that were considered abortifacients. The outcome of that fight was the Supreme Court decision in Burwell v Hobby Lobby. Hobby Lobby won that case, but there is plenty of other coverage, so we won't get into it here.
Hobby Lobby was started as a home business by David and Barbara Green in 1970.
So let's get to the stuff that you didn't already know.
The Trust
David and Barbara Green created the David and Barbara Green 1993 Dynasty Trust Agreement. Their son, Mart D. Green was named the trustee. The Trust included language that it was intended to "carry out the mission of our family to serve the Lord".
Putting everything into the trust is a great estate planning move, since it means future appreciation will not be included in the Green estates. They might have gone with an "intentionally defective grantor trust" (IDGT), which would have avoided the income tax complications of fiduciary returns during their lifetimes, but having the trust as a separate income tax entity has some significant advantages, such as being able to spray income to descendants based on current needs and a generous entity level charitable deduction. Although, as we will see, there was an unanticipated charitable deduction problem, which is what gave rise to the litigation.
Other than the indication that they sure have a lot of confidence in their son, the only other item of some interest is buried in the boilerplate section.
The beneficiaries of the trust are the descendants of the Greens, with one possible exception -"Any child or descendant who is born to persons out of wedlock shall not be considered as a "child" or "descendant" of such persons for purposes of this Trust Agreement " (There is a kind of shotgun marriage exception to the proscription).
Regardless it seems that disinheriting out-of-wedlock descendants does not align well with a strong pro-life view, but maybe that is just me.
To be fair the provision is boilerplate. I was presented with a trust instrument that included it for my own meager assets and had it modified.
The Claim
For 2004, DBGDT paid $8.4 million on its original return. Included in income was $57 million in flow through from the trust's 99% interest in Hob-Lob Limited Partnership, which apparently is where most of the stores were then (It seems like they have since shifted to corporations, but I have not dug that deep). The refund of $3.2 million was based on increasing charitable deductions by $9.1 million to $29.7 million. Contributions by trusts are generally unlimited, but there is a limitation based on Unrelated Business Taxable Income (UBTI). The UBTI limitation was not at issue. What was at issue was the ability to take deductions at fair market value.
A charitable deduction by an individual will generally be based on the fair market value of the property. There were three properties, but the bulk of appreciation was contained in one of them in Lynchburg, VA which was donated to the National Christian Foundation. The jury found the property to be worth $28,500,000. Since the property had been acquired less than a year before with a basis of less than $11 million that was one shrewd acquisitive.
IRS Argument
The IRS argued that charitable deductions for trusts are limited to basis. In a Chief Counsel Advice 201041044 (I think it is likely the CCA was in response to the refund claim in this case) the conclusion was that there should be a limitation to basis, because the trust's charitable deduction is supposed to be out of gross income and the inclusion of unrealized appreciation in income is questionable. The Advice noted that there was competing authority and that the question had never come up before (I found that a little surprising).
The Ruling
The district court had ruled in favor of the trust but the Tenth Circuit did not buy in.
We find unpersuasive the other bases cited by the district court for adopting the Trust's fair market value arguments. First, in concluding that the Trust was entitled to deduct the fair market value of the properties as of the time they were donated, the district court relied, in part, on § 642(c)(1)'s use of the phrase “without limitation.” That, however, was a misconstruction of the statute. In United States v. Benedict , 338 U.S. 692, 697 [38 AFTR 1208] n.8 (1950), the Supreme Court held that the phrase “without limitation,” as used in the predecessor statute to § 642(c)(1), was intended only to make clear that the percentage limits outlined in § 170 that apply to charitable deductions made by individuals and corporations do not apply to charitable deductions made by estates and trusts. Presumably, the same holds true for § 642(c)(1). Thus, contrary to the conclusion reached by the district court, § 642(c)(1)'s use of the phrase “without limitation” cannot be construed as a signal by Congress to authorize the extent of the deduction sought by the Trust in this case.
The district court also relied on the Supreme Court's decision in Old Colony for the proposition that charitable giving should be encouraged and, thus, that § 642(c)(1) should be construed in such a manner. To be sure, the Court in Old Colony stated that the “language [of § 642(c)(1)'s predecessor] should be construed with the view of carrying out the purpose of Congress—evidently the encouragement of donations by trust estates.” 301 U.S. at 384. But it made this statement solely in the context of deciding whether the authorized deduction should be limited to amounts “paid from the year's [gross] income.” Id . The statement cannot be taken as a command to construe the deduction in the broadest possible manner, particularly when there is no language in § 642(c)(1) to support it and when the Code in general weighs against it.
Lastly, the district court concluded, in part, that because § 170 in certain instances allows individuals to claim a deduction for the fair market value of donated property, it is proper to interpret § 642(c)(1) in a similar fashion. As the government correctly notes, however, the language of § 170 expressly discusses the fair market value of donated real property, whereas § 642(c)(1) merely refers to gross income and does not otherwise incorporate § 170's discussion of the fair market value of donated real property. Presumably, had Congress intended for the concept of “gross income” in this instance to extend to unrealized gains on property purchased with gross income, it would have said so.
Planning Note
Had this been an IDGT, there would have been not problem with using the fair market value, although there would have been a 30% limitation to deal with, which might have been a problem for the Greens who are committed to being very philanthropic. Some planners may find the notion that trust charitable contributions are limited to basis surprising. It may well be that they have been sliding by all these years and were just noticed because somebody put in a big refund claim.
Other Coverage
EY had a brief update on the decision and a note that Tax Alert is forthcoming.
I could not find anything else, which is a little surprising given the prominence of the litigants. I covered the district court decision. I also noted that forbes contributor Jerry Bowyer has interviewed David Green about his use of the trust ownership vehicle as a form of Christian stewardship.
