Deductibility of Designated Contributions

IRS says contributions meant for specific individuals aren’t deductible.

The IRS has clarified the deductibility of contributions that "earmark" a specific individual.

Many churches have collected special offerings for the benefit of a particular individual. For example, a church collects an offering to help pay the medical expenses of a person with a catastrophic and uninsured illness. Or, a church collects an offering to benefit an unemployed family, or a family whose house has been destroyed by fire or some other disaster. Are such "designated" offerings tax-deductible as charitable contributions by the donors? This has been a very difficult question to answer. The problem is that charitable contributions are tax-deductible only to the extent that they are made to a tax-exempt organization. The IRS ruled in 1962:

If contributions to the fund are earmarked by the donor for a particular individual, they are treated, in effect, as being gifts to the designated individual and are not deductible. However, a deduction will be allowable where it is established that a gift is intended by a donor for the use of the organization and not as a gift to an individual. The test in each case is whether the organization has full control of the donated funds, and discretion as to their use, so as to insure that they will be used to carry out its functions and purposes. Revenue Ruling 62-113.

In other words, if a donor contributes funds to a church, and stipulates that the funds must be used for a particular individual (for example, a named student or needy person), then the contribution is not tax-deductible since the church does not have "full control of the donated funds, and discretion as to their use, so as to insure that they will be used to carry out its functions and purposes." This is the conclusion reached by the IRS in a recent announcement.

In Announcement 92-128, the IRS addressed the question of the deductibility of contributions made for the benefit of victims of Hurricane Andrew. The IRS noted that it had "received questions from taxpayers regarding the tax consequences of contributions earmarked for Hurricane Andrew relief to organizations currently recognized by the IRS as tax exempt."

The IRS concluded that "such contributions will be fully deductible," but cautioned that "taxpayers may not deduct contributions earmarked for relief of a particular individual or family." What does this mean? The IRS is saying that donors can make tax-deductible contributions to a church or other charity even if those contributions specify that they are to be used for "Hurricane Andrew relief." Such contributions are deductible since the donor does not know who the ultimate recipient will be.

Therefore, it is reasonable to assume that the intent of the donor is to contribute to the charity which in turn will make the decision of how the funds will be distributed. In other words, the charity in such a case exercises "full control of the donated funds, and discretion as to their use, so as to insure that they will be used to carry out its functions and purposes." On the other hand, if a donor contributes funds to a church for hurricane relief, but specifies a particular individual or family who is to receive the contributed funds, then this contribution is not tax-deductible since the church did not maintain "full control of the donated funds, and discretion as to their use, so as to insure that they will be used to carry out its functions and purposes."

Note, however, that the IRS ruled privately in 1987 that a contribution to a charity may be tax-deductible even if it designates a particular individual so long as the designation is "advisory" rather than mandatory. The IRS concluded: "From the information submitted and representations made, [the charity] is to have complete legal and equitable control over the funds contributed by [the donor]. [The donor's] right to suggest distributees will be advisory in nature and will not be binding on [the charity]. Moreover, the fund will be used in the furtherance of [the charity's] stated purposes. Private Letter Ruling 8752031.

What this means for churches

While private letter rulings apply only to the parties covered by the ruling and may not be used as precedent in support of a particular position, they reflect the thinking of the IRS on a particular issue and as a result can be of considerable relevance.

This private letter ruling suggests that contributions to a church benevolence fund can be deductible even if the donor mentions a beneficiary, if the facts demonstrate that (1) the donor's recommendation is advisory only, (2) the church retains "full control of the donated funds, and discretion as to their use," and (3) the donor understands that his or her recommendation is advisory only and that the church retains full control over the donated funds, including the authority to accept or reject the donor's recommendations.

How can these facts be established? One possible way would be for a church to adopt a "benevolence fund policy" making all distributions from a benevolence fund subject to the unrestricted control and discretion of the church board, and to communicate such a policy to all prospective donors. It can be argued that donors willing to make a designated contribution to a church benevolence fund under these conditions are manifesting an intent to make a contribution to the church rather than to the designated individual.

Churches adopting such a policy should make copies available to any person wanting to make a designated contribution to the church benevolence fund. A sample policy is reproduced in the Richard Hammar's Church and Clergy Tax Guide. There is no guaranty that such a policy will render a designated contribution deductible. But it does appear that such an interpretation is reasonable, if the church in fact exercises full control over the earmarked funds.

Obviously, a church can administer a program in such a way as to jeopardize the deductibility of contributions. For example, a church can adopt a benevolence fund policy yet honor every "recommendation" made by a donor. Clearly, it is doubtful that donors could deduct their earmarked contributions under these circumstances, since the "control" exercised by the church is illusory. IRS Announcement 92-128.

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