Green v. United States , 880 F.3d 519 ( 2018 )

FILED
United States Court of Appeals
Tenth Circuit
January 12, 2018
PUBLISH Elisabeth A. Shumaker
Clerk of Court
UNITED STATES COURT OF APPEALS
TENTH CIRCUIT
MART D. GREEN, Trustee of the
David and Barbara Green 1993
Dynasty Trust,
Plaintiff - Appellee,
v. No. 16-6371
UNITED STATES OF AMERICA,
Defendant - Appellant.
Appeal from the United States District Court
for the Western District of Oklahoma
(D.C. No. 5:13-CV-01237-D)
Geoffrey J. Klimas, Attorney, Tax Division (David A. Hubbert, Acting Assistant
Attorney General and Teresa E. McLaughlin, Attorney, Tax Division, with him on
the briefs), Department of Justice, Washington, DC, appearing for Appellant.
Charles E. Geister, III (J. Leslie LaReau, Len Cason, and Michael A. Furlong,
with him on the brief), Hartzog Conger Cason & Neville, LLP, Oklahoma City,
Oklahoma, appearing for Appellee.
Before BRISCOE, EBEL, and MATHESON, Circuit Judges.
BRISCOE, Circuit Judge.
Plaintiff Mart Green, as Trustee of the David and Barbara Green 1993
Dynasty Trust (the Trust), filed this action seeking a refund of federal income
taxes paid by the Trust for the taxable year ending December 31, 2004. At issue
is the amount of the charitable deduction that the Trust may take pursuant to 26
U.S.C. § 642(c)(1) in connection with its donation of three parcels of real
property. The district court granted partial summary judgment in favor of the
Trust, concluding that the Trust was statutorily authorized to a deduction
equivalent to the fair market value of the properties as of the time of donation.
The parties reached an agreement regarding the fair market value of two of the
properties, and the district court held a jury trial to determine the fair market
value of the third property. The district court then entered judgment in favor of
the Trust. The government now appeals. Exercising jurisdiction pursuant to 28
U.S.C. § 1291, we reject the district court’s interpretation of § 642(c)(1) and
conclude that the amount of the deduction thereunder is limited to the Trust’s
adjusted basis in the donated properties. Consequently, we reverse the judgment
of the district court and remand with directions to enter summary judgment in
favor of the government.
I
Factual background
a) The Trust and its relevant provisions
In December 1993, David M. Green and Barbara A. Green (the Greens)
2
executed an instrument creating the Trust. App., Vol. 1 at 14. The Trust
instrument named Mart Green as the initial trustee (the Trustee). Article II,
Section 2.1 of the Trust instrument, entitled “General Guide for Trustee,” outlined
the Greens’ expressions of intent for the Trust:
We want to provide for the relative health, education and
maintenance needs of our children and descendants during the term
of this Trust, and to provide for charity. In the absence of competing
considerations, the Trustee should make an effort to primarily
provide for the health and maintenance needs of our children.
However, we recognize that different needs may and probably will
arise as between our children and their descendants, particularly as to
educational expenses and perhaps also with respect to their health
and medical needs.
Id. at 20.
Article I, Section 1.6 of the Trust instrument, entitled “Distributions to
Charities,” stated as follows:
A distribution may be made from the Trust to charity only when both
the purpose of the distribution and the charity are as described in
Section 170(c) of the [Internal Revenue] Code. Notwithstanding
anything else contained in the Trust to the contrary, the number of
charities that would be eligible to receive a distribution under this
Trust at any given time will be limited to a number that will not
prevent the Trust from qualifying either as an Electing Small
Business Trust (“ESBT”) or otherwise as an S corporation
shareholder under the Code.
Id. at 19. Section 1.6 did not specify whether distributions to charity were limited
to the Trust’s principal, or instead could come from its income.
Exhibit A to the Trust was entitled “STANDARD TRUST PROVISIONS.”
Id. at 31. Article IV, Section 4.5 thereof, entitled “Trustee’s Power to Determine
3
Income and Principal,” stated, in pertinent part: “The Trustee shall have full
power and authority to determine the manner in which expenses are to be treated
and in which receipts are to be credited as between income and principal and to
determine what shall constitute income or principal.” Id. at 52.
b) GDT CG1 LLC
GDT CG1 LLC (GDT) is a single-member limited liability company that is
wholly owned by the Trust. As such, GDT is disregarded for federal income tax
purposes. In other words, all of GDT’s income, deductions and credits are passed
through to and reported by the Trust.
c) The Trust’s interest in and income from the Hob-Lob Limited
Partnership
Hob-Lob Limited Partnership (Hob-Lob) owns and operates most of the
“Hobby Lobby” retail stores that are located nationwide. Between 2002 and
2004, the Trust held a 99 percent ownership interest in Hob-Lob; in other words,
the Trust was the 99 percent limited partner in Hob-Lob.
During the year ending December 31, 2002, the Trust’s distributive share of
Hob-Lob’s ordinary business income totaled $72,465,646 and, during that same
year, the Trust received distributions of $38,722,126 from Hob-Lob.
During the year ending December 31, 2003, the Trust’s distributive share of
Hob-Lob’s ordinary business income totaled $68,303,318 and, during that same
year, the Trust received distributions of $41,076,436 from Hob-Lob.
4
During the year ending December 31, 2004, the Trust’s distributive share of
Hob-Lob’s ordinary business income totaled $60,543,215, and the Trust received
distributions of $29,480,397 from Hob-Lob.
d) The Virginia property
On February 19, 2003, GDT purchased 109 acres of land and two industrial
buildings in Lynchburg, Virginia for approximately $10.3 million dollars. GDT
obtained the money to purchase the property through a distribution from Hob-Lob
to the Trust in 2003. This distribution was part of the distributive share of
ordinary business income from Hob-Lob to the Trust in 2003.
On March 19, 2004, GDT donated to the National Christian Foundation
Real Property, Inc. (NCF) approximately 73 of the 109 acres of land and the two
industrial buildings. As of the date of the donation, NCF was an organization of
the type described in 26 U.S.C. § 170(b)(1)(A) (Internal Revenue Code
§ 170(b)(1)(A)).
The Trust reported on a Form 8283, Noncash Charitable Contributions,
attached to its 2004 income tax return that its adjusted basis in the Virginia
property was $10,368,113 as of March 19, 2004, the date of the donation. The
Virginia property had a fair market value in excess of $10,368,113 on the date of
the donation.
5
e) The Oklahoma property
In August 2002, GDT purchased a church building and several outbuildings
in Ardmore, Oklahoma from Trinity Baptist Church for $150,000. GDT obtained
the $150,000 to purchase the property through a distribution from Hob-Lob to the
Trust in 2002. This distribution was part of the distributive share of ordinary
business income from Hob-Lob to the Trust in 2002.
On October 5, 2004, GDT donated the Ardmore property to the Southwest
Oklahoma District Church of the Nazarene (SODCN). As of the date of the
donation, SODCN was an organization described in Internal Revenue Code
§ 170(b)(1)(A).
The Trust reported on a Form 8283, Noncash Charitable Contributions,
attached to its 2004 income tax return that its adjusted basis in the Oklahoma
property was $160,477 on October 5, 2004, the date of the donation. It is
undisputed that the Oklahoma property had a fair market value of $355,000 on the
date of the donation.
f) The Texas property
In June 2003, GDT purchased approximately 3.8 acres of land in
Dickinson, Texas from Marina Bay Development Corp., Inc./Travis Moss for
$145,000. GDT obtained the $145,000 to purchase the property through a
distribution from Hob-Lob to the Trust in 2003. This distribution was part of the
distributive share of ordinary business income from Hob-Lob to the Trust in 2003.
6
On October 5, 2004, GDT donated the Texas property to the Lighthouse
Baptist Church. As of the date of the donation, the Lighthouse Baptist Church
was an organization described in Internal Revenue Code § 170(b)(1)(A).
The Trust reported on a Form 8283, Noncash Charitable Contributions,
attached to its 2004 income tax return that its adjusted basis in the Texas property
was $145,180 on October 5, 2004, the date of the donation. It is undisputed that
the Texas property had a fair market value of $150,000 on the date of the
donation.
g) The Trust’s 2004 tax return
In October 2005, the Trust filed its income tax return for 2004. The return
reported income of approximately $58.8 million, of which $58,712,171 was
unrelated business income. The return claimed a charitable deduction totaling
$20,526,383. This included the donations of real property, as well as a
$1,851,502.42 cash donation to the Reach the Children Foundation, Inc. The
return reported that the Trust’s total adjusted basis in the three donated real
properties was approximately $10.7 million and that the properties’ fair market
value at the time of donation was approximately $30.3 million. At no point in
2004 or any other tax year did the Trust report as income the properties’
unrealized appreciation of approximately $19.6 million (i.e., the claimed fair
market value minus the adjusted basis).
7
h) The amended 2004 tax return
On October 15, 2008, the Trust filed an amended Form 1041 income tax
return claiming a refund from the Internal Revenue Service (IRS) for $3,194,748
in income tax and increasing the Trust’s reported charitable deduction from
$20,526,383, as reported on the Trust’s original 2004 income tax return, to
$29,654,233.
i) The IRS’s disallowance of the refund
On December 8, 2011, the IRS sent the Trustee a Notice of Disallowance of
the Trust’s refund claim. That Notice stated, in pertinent part: “The charitable
contribution deduction for the real property donated in 2004 is limited to the basis
of the real property contributed.” Aplt. App., Vol. I at 162.
Procedural background
On November 21, 2013, the Trustee initiated this action by filing a
complaint in the Western District of Oklahoma against the United States seeking
recovery of federal income tax for the taxable year ending December 31, 2004.
The complaint alleged, in pertinent part, that “the Trust made charitable
contributions during 2004 of real properties to qualified organizations operated
exclusively for religious purposes” and that “[t]he fair market value of these real
properties at the respective dates of contribution totaled $30,313,000.” App.,
Vol. 1 at 12. The complaint in turn alleged that “the Commissioner erroneously”
concluded “that the charitable deduction for the real property donated in 2004 was
8
limited to the basis of the real property contributed, in addition to the applicable
[Unrelated Business Taxable Income (UBTI)] limitation.” Id. at 13. The
complaint alleged that, due to the Commissioner’s error, the Trust “ha[d] overpaid
[its 2004] income tax . . . by $3,194,748, and [wa]s entitled to a refund of such
overpayment plus interest as provided by law.” Id.
In early 2015, the parties filed cross motions for summary judgment. The
Trust’s motion asked the district court to rule as a matter of law that the
deduction allowed by § 642(c)(1) should be based on the fair market value of the
donated property. The government’s motion, in contrast, argued that the
deduction allowed by § 642(c)(1) is limited to the adjusted basis of the donated
property.
The district court subsequently granted the Trust’s motion for partial
summary judgment and denied the government’s motion for summary judgment.
Following the district court’s rulings, the parties reached an agreement regarding
the fair market values of the donated Oklahoma and Texas properties. That left
one remaining issue of fact: the fair market value of the Virginia property at the
time of its donation. That issue was tried to a jury in October 2016.
On November 4, 2016, the district court entered judgment in accordance
with its summary judgment ruling, the stipulations of the parties, and the jury’s
verdict. The judgment awarded the Trust $2,754,514, plus interest, in overpaid
taxes.
9
On December 28, 2016, the government filed a timely notice of appeal.
II
In this appeal, the government challenges the district court’s grant of
summary judgment in favor of the Trust, arguing that the district court’s holding
is contrary to the language of § 642(c)(1) and effectively “allows a duplicative tax
benefit, in the form of a deduction for an amount that was never taxed.” Aplt. Br.
at 20. As outlined in greater detail below, we agree with the government.
Standard of review
We review the district court’s grant of summary judgment de novo. United
States v. ConocoPhillips Co., 744 F.3d 1199, 1204 (10th Cir. 2014). “In
conducting this review, we will affirm if there was no genuine dispute over a
material fact and” the Trust “was entitled to judgment as a matter of law.” Id.
Further, “[i]n applying this test, we view the evidence in the light most favorable
to” the government, the non-moving party. Id.
Section 642(c)(1) of the Internal Revenue Code
Generally speaking, the Internal Revenue Code (the Code) treats charitable
contributions made by trusts differently than charitable contributions made by
10
individuals and corporations. 1 In particular, § 642(c)(1) of the Code, entitled
“Deduction[s] for amounts paid or permanently set aside for a charitable
purpose,” sets forth the following special charitable deduction rules for trusts:
(1) General rule.--In the case of an estate or trust (other then [sic] a
trust meeting the specifications of subpart B), there shall be allowed
as a deduction in computing its taxable income (in lieu of the
deduction allowed by section 170(a), relating to deduction for
charitable, etc., contributions and gifts) any amount of the 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) (determined without regard to section
170(c)(2)(A)). If a charitable contribution is paid after the close of
such taxable year and on or before the last day of the year following
the close of such taxable year, then the trustee or administrator may
elect to treat such contribution as paid during such taxable year. The
election shall be made at such time and in such manner as the
Secretary prescribes by regulations.
26 U.S.C. § 642(c)(1). 2
1
Section 170 of the Code governs charitable deductions made by
individuals and corporations and limits the total amount of charitable deductions
to 20, 30, or 50% of the individual’s or corporation’s contribution base (i.e., their
adjusted gross income, subject to certain adjustments).
2
Section 681, entitled “Limitation on charitable deduction,” is a second and
related Code provision that governs charitable deductions made by trusts.
26 U.S.C. § 681. Subsection (a) thereof, entitled “Trade or business income,”
provides as follows:
In computing the deduction allowable under section 642(c) to a trust,
no amount otherwise allowable under section 642(c) as a deduction
shall be allowed as a deduction with respect to income of the taxable
year which is allocable to its unrelated business income for such
year. For purposes of the preceding sentence, the term “unrelated
business income” means an amount equal to the amount which, if
such trust were exempt from tax under section 501(a) by reason of
section 501(c)(3), would be computed as its unrelated business
(continued...)
11
The parties to this appeal generally agree that § 642(c)(1) governs the
Trust’s donations of real properties during the taxable year 2004. They disagree,
however, on the allowable amount of the deduction stemming from those
donations.
The requirements imposed by § 642(c)(1)
In resolving this question, “[w]e begin ‘where all such inquiries must
begin: with the language of the statute itself.’” Caraco Pharm. Lab., Ltd. v. Novo
Nordisk A/S, 566 U.S. 399, 412 (2012) (quoting United States v. Ron Pair Enter.,
Inc., 489 U.S. 235, 241 (1989)). As an initial matter, it is apparent that
§ 642(c)(1) applies only to estates and trusts (“In the case of an estate or trust”).
Section 642(c)(1) proceeds to state that estates and trusts are entitled to (“shall be
allowed”) a “deduction in computing [their] taxable income.” The parameters of
that deduction are then outlined as follows: “any amount of the 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) (determined
without regard to section 170(c)(2)(A)).” Focusing on the latter portions of this
statutory language, it is clear that the donation must be authorized by the
2
(...continued)
taxable income under section 512 (relating to income derived from
certain business activities and from certain property acquired with
borrowed funds).
26 U.S.C. § 681(a).
12
instrument establishing the estate or trust, be made during the taxable year at
issue or, alternatively, during the calendar year following the taxable year at
issue, and qualify as a “charitable contribution” under § 170(c) of the Code.
Thus, to restate, it is clear and indisputable that § 642(c)(1) imposes the
following requirements for a donation to qualify as a charitable deduction:
1) the taxpayer is an estate or trust;
2) during the taxable year at issue, or, alternatively, within the
calendar year following the taxable year at issue, the taxpayer
makes a qualifying charitable contribution under I.R.C.
§ 170(c); and
3) the charitable contribution must be authorized by the terms
of the instrument that established the taxpayer, i.e., the estate
or trust.
That, of course, leaves the central question at issue in this appeal: what is
the authorized amount of a deduction under § 642(c)(1)? The answer to that
question presumably lies in the statutory phrase “any amount of the gross
income.” One possible interpretation of the statutory phrase “any amount of the
gross income” is that a charitable contribution must be made out of gross income
earned by the trust in the taxable year in question. Indeed, the IRS urged that
very interpretation before the Supreme Court in Old Colony Trust Co. v. Comm’r,
301 U.S. 379 (1937), a case involving § 642(c)(1)’s predecessor statute. Notably,
however, the Court rejected that interpretation. 301 U.S. at 384. In particular,
the Court stated: “There are no words limiting [deductible contributions] to
13
something actually paid from the year’s income.” Id. The Court proceeded no
further in interpreting the statutory language, however, because the charitable
contributions at issue before it were made out of an accumulated gross income
account. Thus, the Court left unresolved the precise meaning of the phrase “any
amount of the gross income.”
A second possible meaning, and one consistent with the holding in Old
Colony but not urged by either party in this case, is that a charitable contribution
must be made exclusively out of gross income earned by the trust at some point in
time, so long as that gross income is, from the time it is earned until it is donated,
kept separate from the trust’s principal. See Old Colony, 301 U.S. at 384
(“Congress sought to encourage donations out of gross income . . . .”); see also
W. K. Frank Trust of 1931 v. Comm’r, 145 F.2d 411, 413 (3d Cir. 1944)
(interpreting predecessor statute to § 642(c)(1) as limiting deductible
contributions to those made from gross income). This interpretation, which is the
most restrictive one possible given the statutory language, would effectively
preclude the Trust in this case from being able to deduct any of the donations of
real property because none of those properties constituted gross income to the
Trust.
A third possible meaning, and the one that both parties in this case appear
to be urging, is that a charitable contribution need not be made directly from, but
instead must simply be traceable to, current or accumulated gross income. As
14
applied to contributions of real property, that would mean that the real property
must have been purchased with, i.e., sourced from, the trust’s current or
accumulated gross income. At least one treatise on federal taxation supports this
interpretation of § 642(c)(1). See 9 M ERTENS L AW OF F EDERAL I NCOME
T AXATION §§ 36:72, 36:75 (Eric D. Spoth ed., Dec. 2017).
The fourth and final possible meaning, and one that neither party in this
case has urged, is that the amount of the charitable deduction is capped or limited
by the amount of the gross income earned by the taxpayer in the tax year in
question. Arguably, the following language in Old Colony supports this
interpretation: “Section 162(a) [the predecessor to § 642(c)(1)] permits them [i.e.,
deductible contributions] to the full extent of gross income.” 301 U.S. at 384.
Further, at least one tax treatise argues in favor of this interpretation. See Byrle
M. Abbin, I NCOME T AXATION OF F IDUCIARIES AND B ENEFICIARIES , § 4128.3
(2006). But one federal district court has expressly rejected this proposed
interpretation as inconsistent with the general scheme outlined in Subchapter J of
Chapter 1 of the IRC for the taxing of trusts and estates. See Crestar Bank v.
I.R.S., 47 F. Supp. 2d 670, 675–76 (E.D. Va. 1999).
All of which leads us to conclude that the statutory phrase “any amount of
the gross income,” as employed in § 642(c)(1), is ambiguous. See Chickasaw
Nation v. United States, 534 U.S. 84, 90 (2001) (noting that a statute is
ambiguous if it is capable of being understood in two or more possible ways); see
15
Nat’l Credit Union Admin. Bd. v. Nomura Home Equity Loan, Inc., 764 F.3d
1199, 1226 (10th Cir. 2004) (“A statute is ambiguous if it is reasonably
susceptible to more than one interpretation”) (internal quotations omitted).
The IRS’s regulation interpreting § 642(c)(1)
In resolving this ambiguity, we note that the IRS has implemented a
regulation purporting to interpret § 642(c)(1). That regulation, 26 C.F.R.
§ 1.642(c)-1, states, in pertinent part:
(a) In general. (1) Any part of the gross income of an estate, or
trust which, pursuant to the terms of the governing instrument is paid
(or treated under paragraph (b) of this section as paid) during the
taxable year for a purpose specified in section 170(c) shall be
allowed as a deduction to such estate or trust in lieu of the limited
charitable contributions deduction authorized by section 170(a). In
applying this paragraph without reference to paragraph (b) of this
section, a deduction shall be allowed for an amount paid during the
taxable year in respect of gross income received in a previous taxable
year, but only if no deduction was allowed for any previous taxable
year to the estate or trust, or in the case of a section 645 election, to
a related estate, as defined under § 1.645–1(b), for the amount so
paid.
26 C.F.R. § 1.642(c)-1(a)(1).
It is well established, under Chevron, U.S.A., Inc. v. Nat’l Res. Def.
Council, Inc., 467 U.S. 837 (1984), that we must defer to an agency’s regulation
that reasonably interprets an ambiguous statute. See Keller Tank Servs. II, Inc. v.
Comm’r, 854 F.3d 1178, 1195 (10th Cir. 2017). As the Supreme Court noted in
Chevron, “considerable weight should be accorded to an executive department’s
construction of a statutory scheme it is entrusted to administer.” 467 U.S. at 844.
16
“This deference applies to Treasury regulations.” Keller, 854 F.3d at 1195. “For
a construction to be permissible, we need not conclude it was the only one the
agency could reasonably have adopted or that we would have rendered the same
interpretation if the question arose initially in a judicial context.” Id. at 1196.
Instead, “we look only to whether the implementing agency’s construction is
reasonable.” Id.
In our view, the IRS’s regulatory construction of § 642(c)(1) is reasonable
and thus permissible. 3 That construction effectively construes the statutory
phrase “any amount of the gross income” to mean that charitable donations must
be made out of a trust’s gross income. In other words, the IRS’s regulatory
construction is consistent with the second and third interpretations that we
outlined above. Unfortunately, however, it does not otherwise appear to
distinguish between those two interpretations. More specifically, nothing in the
regulation discusses whether real property purchased with gross income can be
treated as the equivalent of gross income for purposes of the deduction outlined in
§ 642(c)(1). So, in the end, the IRS’s regulation narrows the possible
3
We recognize that some Justices have questioned the constitutionality of
Chevron deference. E.g., Michigan v. Envtl. Prot. Agency, 135 S. Ct. 2699, 2712
(2015) (Thomas, J., concurring) (“Either way, Chevron deference raises serious
separation-of-powers questions.”). Even if that ultimately proves to be correct, it
is of no consequence in this case because we would still arrive at the same
conclusion because we believe that the IRS’s position, as outlined in the
regulation, is the most reasonable interpretation of the statute.
17
constructions of the statute, but does not completely resolve them.
The IRS’s interpretation of § 642(c)(1)
Although 26 C.F.R. § 1.642(c)-1 does not address the precise question
before us, the IRS articulated an official position regarding the construction of
§ 642(c)(1) when it administratively rejected the Trust’s request for a refund, and
it continues to stand by that construction in this litigation. We need not decide
whether the IRS’s construction is entitled to any deference under Chevron
because, even assuming it is not, we would adopt the same construction because
we conclude it is the most reasonable one in light of the Code as a whole.
As an initial matter, the IRS asserts, and the Trust agrees, that the statutory
phrase “any amount of the gross income” means that charitable donations must be
made out of a trust’s gross income, but that real property purchased with gross
income can also be treated as the equivalent of gross income for purposes of the
deduction outlined in § 642(c)(1). This, we conclude, is an entirely reasonable
interpretation of the statutory language. More specifically, this interpretation is
consistent with the statutory language, and also encourages charitable donations
to a greater degree than an interpretation that fails to include a sourcing
component, i.e., an interpretation that limits the deduction to donations made
18
exclusively from gross income. 4 See Old Colony, 301 U.S. at 384 (“Congress
sought to encourage donations out of gross income . . . .”).
That still leaves open the question of the allowable amount of a deduction
for donated real property that was purchased with a taxpayer’s gross income. The
IRS has consistently asserted, both in addressing the Trust’s claim for a refund
and in this litigation, that the deduction amount is limited to the taxpayer’s
adjusted basis in the donated real property, i.e., the amount of gross income the
taxpayer originally paid for the real property. Without granting any deference to
the IRS’s position, we conclude that it is the most reasonable interpretation of the
statutory language, particularly when considered in light of the Code as a whole.
It is well established that tax deductions are generally considered a matter
of “legislative grace” and “only as there is clear provision therefor can any
particular deduction be allowed.” New Colonial Ice Co. v. Helvering, 292 U.S.
435, 440 (1934); see Green Solution Retail, Inc. v. United States, 855 F.3d 1111,
1121 (10th Cir. 2017) (noting that deductions are not a matter of right, but rather
a matter of legislative grace, and also rejecting the notion that the disallowance of
a deduction constitutes a penalty). Consequently, it is the taxpayer’s burden to
4
In reaching this conclusion, we note that the Government has not cited to
any section of the Code, any regulation, or even any treatise or basic accounting
principle that directly supports its proposed interpretation.
19
establish its entitlement to the claimed deduction. 5 Knight v. Comm’r, 552 U.S.
181, 192 (2008). That said, the Supreme Court has stated that tax provisions
allowing for charitable deductions are an expression of “public policy” rather than
legislative grace, and consequently should be liberally construed in favor of the
taxpayer. Helvering v. Bliss, 293 U.S. 144, 150–51 (1934).
As we have concluded, it is consistent with this latter principle—of
construing charitable deductions liberally in favor of taxpayers—to construe the
term “gross income,” as used in § 642(c)(1), to extend to properties purchased
with gross income. The Trust argues, and the district court agreed, that this same
principle of liberal construction should authorize the deduction to the full extent
of the fair market value of the donated property. 6 We agree with the IRS,
however, that the better argument is that, construing § 642(c)(1) in light of other
provisions of the Code, the amount of the deduction must be limited to the
adjusted basis of the property.
The term “gross income” is generally defined in the Code to mean “all
income from whatever source derived,” 26 U.S.C. § 61(a), and it specifically
includes “[g]ains derived from dealings in property.” 26 U.S.C. § 61(a)(3). “The
Code does not define the term ‘dealing’ and it does not expressly state that gains
5
The Trust’s counsel conceded at oral argument that the burden in this case
lies on the Trust to establish its entitlement to its claimed deduction.
6
Never has the Supreme Court said that this canon of liberal construction
regarding charitable deductions means that a taxpayer must win in every case.
20
and losses are disregarded until an act constituting ‘dealing’ in property takes
place.” San Antonio Sav. Ass’n v. C.I.R., 887 F.2d 577, 581 (5th Cir. 1989). But
an applicable Treasury regulation reasonably, albeit implicitly, construes the term
“dealing” to mean that such gains occur only upon “the sale or exchange” of the
property at issue:
Gain realized on the sale or exchange of property is included in gross
income, unless excluded by law. For this purpose property includes
tangible items, such as a building, and intangible items, such as
goodwill. Generally, the gain is the excess of the amount realized
over the unrecovered cost or other basis for the property sold or
exchanged. The specific rules for computing the amount of gain or
loss are contained in section 1001 and the regulations thereunder.
When a part of a larger property is sold, the cost or other basis of the
entire property shall be equitably apportioned among the several
parts, and the gain realized or loss sustained on the part of the entire
property sold is the difference between the selling price and the cost
or other basis allocated to such part. The sale of each part is treated
as a separate transaction and gain or loss shall be computed
separately on each part. Thus, gain or loss shall be determined at the
time of sale of each part and not deferred until the entire property has
been disposed of.
26 C.F.R. § 1.61-6(a). Further, case law provides that an “exchange” occurs
when a taxpayer gives an asset to another entity and, in return, receives a
materially different asset from the other entity. E.g., San Antonio Sav. Ass’n,
887 F.2d at 583 (recognizing “the principle that the receipt of something
materially different . . . from that which the taxpayer had previously is necessary
for an exchange to be considered a realization event”).
21
Defining the term “dealing” to include only sales or exchanges is consistent
with the concept of realization. The Supreme Court has held that a gain
“constitutes taxable income when its recipient has such control over it that, as a
practical matter, he derives readily realizable economic value from it.” Rutkin v.
United States, 343 U.S. 130, 137 (1952). Section 1001(a) of the Code
incorporates this concept, noting that “[t]he 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.” 26 U.S.C.
§ 1001(a). Further, § 1001(b) states that “[t]he amount realized from the sale or
other disposition of property shall be the sum of any money received plus the fair
market value of the property (other than money) received.” 26 U.S.C. § 1001(b).
As the IRS correctly notes in this case, because the Trust never sold or
exchanged the properties at issue, it never realized the gains associated with their
increases in market value and was therefore never subject to being taxed on those
gains. Thus, construing § 642(c)(1)’s deduction to extend to unrealized gains
would be inconsistent with the Code’s general treatment of gross income. 7
7
The Code, as the government correctly notes, excludes from gross income
the appreciation in the value of real property, unless and until the taxpayer
realizes the gain by selling or exchanging the property. Aplt. Br. at 28 (citing
Cottage Savings Assoc. v. Comm’r, 499 U.S. 554, 559 (1991)). This “realization
requirement,” the Supreme Court has held, “is implicit in § 1001(a) of the Code .
. . which defines the gain or loss from the sale or other disposition of property as
the difference between the amount realized from the sale or disposition of the
(continued...)
22
Consequently, unless and until Congress acts to make clear that it intended for the
§ 642(c)(1) deduction to extend to unrealized gains associated with real property
originally purchased with gross income (similar to what Congress did in § 170,
which, as we have noted, addresses charitable contributions by individuals and
corporations), we conclude that we cannot construe the deduction in that manner. 8
Finally, we note that this interpretation finds support in a leading tax
treatise, see 9 M ERTENS L AW OF F EDERAL I NCOME T AXATION , § 36:75 (Eric D.
Roth ed., Dec. 2017) (“Where appreciated property purchased from accumulated
gross income is donated, the amount of the deduction is limited to the adjusted
basis of the property, rather than based on the fair market value of the donated
property.”), as well as, at least in part, an older Third Circuit case dealing with
§ 642(c)(1)’s predecessor statute. See W. K. Frank Trust of 1931 v. Comm’r, 145
F.2d 411, 413 (3d Cir. 1944) (holding that the appreciated value of shares of
7
(...continued)
property and its adjusted basis.” Cottage Savings, 499 U.S. at 559.
Consequently, it is clear, and the Trust concedes, “that giving away appreciated
property does not result in gross income to the donor.” Aplt. Br. at 29; see App.,
Vol. II at 288 (“No one disputes that unrealized appreciation is not part of a
taxpayer’s ‘gross income.’”).
8
The government also cites, persuasively in our view, to other Code
provisions that employ the phrase “amount of the gross income,” all of which
have been interpreted to mean the amount of gross income earned and reported by
the taxpayer. See Aplt. Br. at 41–42.
23
donated stock, which was the result of them being “worth more on the market
when the gift was made than . . . when the trust got them,” “was not gross
income”). 9
The district court’s reasoning
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 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.
9
To be clear, W. K. Frank differs from the instant case because the donated
stock at issue in that case was not purchased with the Trust’s gross income.
24
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.
25
The Trust’s § 512(b)(11) theory
That leaves one remaining issue we must address. In its appellate response
brief, the Trust argues, in part, that the “Donated Properties were allocable to the
Trust’s UBI [unrelated business income]” and that, consequently, 26 U.S.C.
§ 512(b)(11) “provides an alternative path for a deduction for charitable
contributions by a trust that are sourced from UBI.” Aplee. Br. at 26-27. More
specifically, the Trust argues that through the operation of § 512(b)(11), its
“contribution of the Donated Properties was . . . deductible under § 170,” and
“[b]ecause § 170 unquestionably applies a fair market value standard to the value
of donated noncash property, it follows that the Trust was permitted to deduct the
Donated Properties at fair market value, subject only to the 50% limitation
imposed by § 170(b)(1)(A).” Id. at 29. The government, in its appellate reply
brief, argues that the Trust “never raised this argument in its refund claim” and
thus we “lack[] jurisdiction to consider it under the variance doctrine.” Aplt.
Reply Br. at 26.
“A taxpayer may not sue the United States for the recovery of income taxes
unless it has timely filed a refund claim at the [IRS] in the manner prescribed by
regulation.” Lockheed Martin Corp. v. United States, 210 F.3d 1366, 1371 (Fed.
Cir. 2000) (citing 26 U.S.C. § 7422(a)). “The regulations require that the
26
taxpayer submit with its tax refund claim the supporting evidence necessary to
prove its claim.” Id. (citing Treasury Reg. § 301.6402-2(a)). In addition, the
regulations expressly state that:
No refund or credit will be allowed after the expiration of the
statutory period of limitation applicable to the filing of a claim
therefor except upon one or more of the grounds set forth in a claim
filed before the expiration of the period. The claim must set forth in
detail each ground upon which a credit or a refund is claimed and in
facts sufficient to apprise the Commissioner of the exact basis
thereof.
Treasury Reg. § 301.6402–2(b)(1). “This regulation distinguishes between the
ground for the claim—that is, the legal theory upon which the refund is
claimed—and facts ‘sufficient to apprise the Commissioner of the exact basis
thereof.’” Lockheed, 210 F.3d at 1371.
Together, § 7422(a) and Treasury Reg. § 301.6402-2(b)(1) give rise to what
courts have described as the “substantial variance” rule. Id. This rule “bars a
taxpayer from presenting claims in a tax refund suit that ‘substantially vary’ the
legal theories and factual bases set forth in the tax refund claim presented to the
IRS.” Id. Of relevance here, “‘[a]ny legal theory not expressly or impliedly
contained in the application for refund cannot be considered by a court in which a
suit for refund is subsequently initiated.’” Id. (quoting Burlington N. Inc. v.
United States, 684 F.2d 866, 868 (Ct. Cl. 1982)).
As the government correctly notes, the Trust’s refund claim made no
mention of its § 512(b)(11) legal theory. See App., Vol. 1 at 75-77. We therefore
27
agree with the government that the § 512(b)(11) arguments contained in the
Trust’s appellate response brief constitute a substantial variance of the legal
component of refund claim it originally filed with the IRS. These arguments are
thus barred by the substantial variance rule.
In addition, we note that the Trust’s § 512(b)(11) theory was never clearly
raised in or resolved by the district court. To begin with, the complaint made no
mention of § 512(b)(11). In turn, the Trust’s motion for partial summary
judgment focused exclusively on the amount of the deduction that was allowable
under § 642(c)(1). To be sure, the Trust stated in a footnote that a § 642(c)(1)
“deduction is subject to a limitation for amounts allocable to unrelated taxable
income (‘UBTI’).” App., Vol. I at 190. But immediately following that
statement, the Trust in turn stated: “There may be a dispute in this case regarding
Trustee’s UBTI calculation, but that is beyond the scope of this motion.” Id. The
government, in its own motion for summary judgment, also focused exclusively
on the amount of the deduction allowed under § 642(c)(1). Nowhere did the
government discuss or even cite to § 512(b)(11). Ultimately, the district court, in
its order granting partial summary judgment in favor of the Trust, did not attempt
to determine how much, if any, of the money spent to purchase the properties
came from the Trust’s UBTI, and in turn did not address the Trust’s purported
entitlement to a deduction under § 512(b)(11). All of which means that,
independent of the substantial variance rule, the issue has been waived by the
28
Trust. See Campbell v. City of Spencer, 777 F.3d 1073, 1080 (10th Cir. 2014)
(“We have held that an appellant waives an argument if she fails to raise it in the
district court and has failed to argue for plain error and its application on
appeal.”).
III
The Trust’s motion to file a surreply brief is GRANTED. The judgment of
the district court is REVERSED and the case REMANDED to the district court
with directions to enter summary judgment in favor of the government.
29