Ferguson v. Commissioner, 108 T.C. 244 (1997)
Background.
Donors occasionally attempt to “assign” their right to receive income to a church, assuming that they are avoiding any receipt of taxable income.
Example. Rev. T is senior pastor of First Church. He conducts a service at Second Church, and is offered compensation of $500. Rev. T refuses to accept any compensation, and asks the pastor of Second Church to put the $500 in the church’s building fund. Rev. T, and the treasurer at Second Church, assume that there is no income to report. Unfortunately, they may be wrong.
The United States Supreme Court addressed this issue in a landmark ruling in 1940. Helvering v. Horst, 311 U.S. 112 (1940). The Horst case addressed the question of whether or not a father could avoid taxation on bond interest coupons that he transferred to his son prior to the maturity date. The Supreme Court ruled that the father had to pay tax on the interest income even though he assigned all of his interest in the income to his son. It observed: “The power to dispose of income is the equivalent of ownership of it. The exercise of that power to procure the payment of income to another is the enjoyment and hence the realization of the income by him who exercises it.” The Supreme Court reached the same conclusion in two other landmark cases. Helvering v. Eubank, 311 U.S. 122 (1940), Lucas v. Earl, 281 U.S. 111 (1930).
Example. A taxpayer earned an honorarium of $2,500 for speaking at a convention. He requested that the honorarium be distributed to a college. This request was honored, and the taxpayer assumed that he did not have to report the $2,500 as taxable income since he never received it. The IRS ruled that the taxpayer should have reported the $2,500 as taxable income. It noted that “the amount of the honorarium transferred to the educational institution at the taxpayer’s request … is includible in the taxpayer’s gross income [for tax purposes]. However, the taxpayer is entitled to a charitable contribution deduction ….” The IRS further noted that “the Supreme Court of the United States has held that a taxpayer who assigns or transfers compensation for personal services to another individual or entity fails to be relieved of federal income tax liability, regardless of the motivation behind the transfer” (citing the Horst case discussed above). Revenue Ruling 79 121.
A recent Tax Court ruling.
The Tax Court has issued an important ruling addressing the assignment of income to a church. Don owned several shares of stock in Company A. On July 28, Company A agreed to merge with Company B. Pursuant to the merger agreement, Company B offered to purchase all outstanding shares of Company A for $22.50 per share (an 1,100% increase over book value). On August 15, Don informed his stockbroker that he wanted to donate 30,000 shares of Company A to his church. On September 8 Don deposited 30,000 shares in his brokerage account and on September 9 signed an authorization directing his broker to transfer the shares to his church. A few days later the church issued Don a receipt acknowledging the contribution. The receipt listed the “date of donation” as September 9. The church sold all of the shares to Company B for $22.50 per share. Don claimed a charitable contribution deduction for $675,000 (30,000 shares at $22.50 per share). He did not report any taxable income in connection with the transaction..
Audit findings
The IRS audited Don, and conceded that a gift of stock had been made to the church. It insisted, however, that Don should have reported the “gain” in the value of his stock that was transferred to the church. Not so, said Don. After all, he never realized or “enjoyed” the gain, but rather transferred the shares to the church to enjoy.
The IRS asserted that Don had a legal right to redeem his Company A shares at $22.50 per share at the time he transferred the shares to the church. As a result, Don had “assigned income” to the church, and could not avoid being taxed on it.
Tax Court gets involved
The Tax Court agreed with the IRS. It began its opinion by addressing the date of Don’s gift. Did the gift to the church occur before he had a legal right to receive $22.50 per share for his Company A stock? If so, there was no income that had been assigned and no tax to be paid. Or, did Don’s gift occur after he had a legal right to receive $22.50 per share? If so, Don had “assigned income” to the church and he would have to pay tax on the gain. The court concluded that Don’s gift occurred after he had a legal right to receive $22.50 per share. It quoted the following income tax regulation addressing the timing of gifts of stock:
Ordinarily, a contribution is made at the time delivery is effected …. If a taxpayer unconditionally delivers or mails a properly endorsed stock certificate to a charitable donee or the donee’s agent, the gift is completed on the date of delivery or, if such certificate is received in the ordinary course of the mails, on the date of mailing. If the donor delivers the stock certificate to his bank or broker as the donor’s agent, or to the issuing corporation or its agent, for transfer into the name of the donee, the gift is completed on the date the stock is transferred on the books of the corporation.
The critical issue was whether Don’s broker was acting as Don’s agent or the church’s agent in handling the transaction. The court concluded that the broker had acted as Don’s agent. The broker “facilitated” Don’s gift of stock to the church, and was acting on the basis of Don’s instructions. The court concluded:
[Don has] failed to persuade us that depositing stock in his brokerage account with instructions to [the stockbroker] to transfer some of the stock to the [church] constituted the unconditional delivery of stock to a charitable donee’s agent …. [Don] has failed to persuade us that depositing stock in [his] brokerage account with instructions to [his stockbroker] to transfer some of the stock to the [church] constituted the unconditional delivery of stock to a charitable donee’s agent pursuant to [the regulations] …. Based on the circumstances surrounding the gift … we believe that [the stockbroker] acted as [Don’s] agent in the transfer of the stock and that [he] relinquished control of the stock on September 9 when the letters of authorization were executed, and we so find. The gift to the [church], therefore, was complete on September 9.
Court’s conclusions
The court decided that on the date of the gift (September 9) Don had a legal right to receive $22.50 per share for all his shares of Company A, and therefore his gift to the church was a fully taxable “assignment of income.” The court observed:
It is a well-established principle of the tax law that the person who earns or otherwise creates the right to receive income is taxed. When ]the right to income has matured at the time of a transfer of property, the transferor will be taxed despite the technical transfer of that property …. An examination of the cases that discuss the anticipatory assignment of income doctrine reveals settled principles. A transfer of property that is a fixed right to income does not shift the incidence of taxation to the transferee …. [T]he ultimate question is whether the transferor, considering the reality and substance of all the circumstances, had a fixed right to income in the property at the time of transfer.
It also concluded that Don did have a “fixed right to income” at the time he donated the 30,000 shares to his church. According to the terms of the merger agreement between Company A and Company B, each outstanding share of Company A was “converted” into a right to receive $22.50 per share in cash. In essence, the stock in Company A “was converted from an interest in a viable corporation to a fixed right to receive cash.”
Conclusions.
Here are a few principles for church treasurers to consider:
* Charitable contribution reporting.
Note that the “assignment of income” doctrine does not bar recognition of a charitable contribution. Both the Tax Court and IRS conceded that Don was eligible for a charitable contribution deduction as a result of his gift of stock.
* Timing of a gift of stock.
This case will provide helpful guidance to church treasurers in determining the date of a gift of stock. The income tax regulations (quoted above) contain the following three rules:
(1) Hand delivery.
If a donor unconditionally delivers an endorsed stock certificate to a charity or an agent of a charity, the gift is completed on the date of delivery.
(2) Mail.
If a donor mails an endorsed stock certificate to a charity or an agent of a charity, the gift is completed on the date of mailing
(3) Delivery to an agent.
If a donor delivers a stock certificate to his or her bank or stockbroker as the donor’s agent (or to the issuing corporation or its agent) for transfer into the name of a charity, the gift is completed on the date the stock is transferred on the books of the corporation
* Notification of income consequences.
While certainly not required, church treasurers may want to inform some donors about the assignment of income doctrine. It often comes as a shock to donors (such as Don) to discover that their charitable contribution is “offset” by the taxable income recognized under the assignment of income doctrine. Assignments of income most often occur in connection with donations of stock rights or compensation for services already performed.
* Gifts of appreciated stock not affected.
Many donors give stock that has appreciated in value to their church. Such transactions are not affected by the court’s ruling or by the assignment of income doctrine because the donor ordinarily has no “fixed right to income” at the time of transfer. Don’s case was much different. He had a contractual right to receive $22.50 per share for all of his shares of Company A stock as a result of the merger.
Key point. Persons who donate stock often can deduct the fair market value of the stock as a charitable contribution (there are some important limitations to this rule) and they have no “assigned income” to report.
Example.
Jill is employed by a local business. Her company declares a $1,000 Christmas bonus. Jill asks her supervisor to send the bonus directly to her church. The supervisor does so. The church treasurer should be aware of the following: (1) Jill will be taxed on the bonus under the assignment of income doctrine. The church treasurer may want to point this out to Jill, although this is not required. There is no need for the church to report this income, or issue Jill a W-2 or 1099. (2) Jill should be given credit for a charitable contribution in the amount of the bonus. Since the bonus was in excess of $250 the receipt issued by the church should comply with the charitable contribution substantiation rules that apply to contributions of $250 or more.
Richard R. Hammar is an attorney, CPA and author specializing in legal and tax issues for churches and clergy.
