A recent IRS private letter ruling, PLR 201825003, highlights the important differences between U.S. federal income tax and gift tax treatment of charitable donations. The IRS found an agreement transferring artwork to be a completed gift for gift tax purposes, notwithstanding the fact that the transfer would not have been eligible for a corresponding income tax charitable deduction since the taxpayer retained possession of the works.
Under the facts of the PLR, the taxpayer and her late spouse had entered into a Deed of Transfer (DOT) with two non-U.S. museums regarding their collection of artwork. The taxpayers had agreed that possession of the artwork would transfer to the museums upon the death of the surviving spouse. The museums were granted legal title immediately on the effective date of the DOT, with the taxpayers retaining a life estate interest in the collection. Under the DOT, the taxpayers only retained the power to revoke the disposition to the museums if a few specified conditions were not satisfied. These conditions included events such as the museums becoming privately owned or the museums not complying with the requirements regarding the housing, display and exhibition of the artwork as set forth in the DOT.
Treasury Regulation Section 25.2511-2(b) provides that a gift of property (or interest therein) is complete when the donor has so parted with dominion and control as to leave in him no power to change its disposition. The IRS found that none of the conditions that could lead to a possible revocation of the DOT were in the control of the taxpayer, and therefore the taxpayer did not retain dominion and control over the artwork. The transfer would have been a completed gift as to the remainder interest in the works but for a provision that made the DOT ineffective in the event of an unfavorable PLR ruling (i.e. one finding a completed gift).
For the purposes of obtaining a charitable income tax deduction, Section 170(a)(3) of the Internal Revenue Code (IRC) states that a donation of a future interest in tangible personal property is treated as being made only when all intervening interests in, and rights to, the actual possession or enjoyment of such property are no longer in the hands of the taxpayer. Here, the taxpayers retained a life estate in the collection, meaning they would have possession of the art until the death of the surviving spouse. Thus, the transferors would not be eligible for an income tax deduction for the value of the future interest in the artwork.
When reviewing this ruling, one may ask why the ruling was requested by the taxpayer in the first place, since gifts made to charitable organizations are allowed an unlimited deduction on an individual's gift tax return under Section 2522(a) of the IRC. Unlike the income tax rules, which for the most part do not allow a charitable deduction for gifts made to foreign charitable organizations, gifts made to foreign organizations are deductible for gift tax purposes as long as the organization would qualify as tax-exempt under Section 501(c)(3) of the IRC. In this fact pattern, the museums located in a foreign country would presumably be tax-exempt under Section 501(c)(3). However, Section 2522(c)(2) states that a gift tax deduction is disallowed where a donor transfers an interest in property and retains an interest in the same property. (This section provides an exception for transfers to charitable remainder trusts.) Section 2522(c)(2) would apply in the PLR's fact pattern since the taxpayers transferred a remainder interest in the artwork and retained a life estate. Therefore, a charitable deduction would not be available to offset the completed gift. If the gift were deemed to be incomplete however, the gifted artwork would be included in the surviving taxpayer's estate, and when the works passed to the museums on her later death, they would be eligible for the unlimited estate tax charitable deduction as bequests to foreign charities under Section 2055.