Tax Planning Failed! Gift Tax Applies to Foundation Beneficiary Who Did Not Receive Foundation Assets

 

William Delaney, EA
Westwood, MA

A private foundation was established for the purpose of “…the defrayal of expenses for the upbringing and education, the fitting out and furtherance, the livelihood in general, and the economic furtherance in the widest sense, of the relatives of certain families…”  That type of language is about as expansive as your Editor has ever seen.  It is a third-party funded needs foundation, and disbursements usually must be classified as income to the person who benefits (i.e. the current foundation beneficiary).  So far, so good.

 

Now, what happens if the foundation is legally dissolved and the principal (corpus) is to be paid-out?  Is there a way to by-pass the beneficiary and make payment to an unrelated third-party without there being any income to the beneficiary or without a gift tax being imposed on the beneficiary?

 

The Foundation Board of Foundation (I know it is a bit redundant but it has a nice ring to it) voted to “…distribute the total assets…to the beneficiary…and to bring such assets in alignment in accordance with his wishes…”  Translation:  We intend to dissolve and have decided to make distributions to whomever or whatever may be selected by the beneficiary and not to the beneficiary himself (i.e. this will by-pass the beneficiary).

 

The big question is whether or not this plan will work---no income or gift tax application to the current beneficiary.  Keep in mind that it is not the trustees who decided where/how the money is to be disbursed; they took their directions from the beneficiary.

As it turns out, the beneficiary decided to move the money from the checking account of the foundation to the checking account of a third-party.  The beneficiary did not, nor never had, dominion or control over the third-party checking account.

 

§2511(a)(1) imposes a gift tax on the transfer of wealth to all transfers by gift, whether direct or indirect.  The devil is in the details, and the devil here is that little word “indirect.”  Furthermore, Reg. §25.2511-2(a) states that the gift tax is a personal liability of the donor and is an excise upon his act of making the transfer.  Seems like that by-pass scheme may not work because the donor in this case is not the trust but the beneficiary who legally authorized the transfer.

 

However, we may be able to get creative here…what about a qualified disclaimer

[§2518(b)].  Cannot the donor/beneficiary just opt out by disclaiming any interest in the property.  Then it is as if the property had never been in the hands of the person making the qualified disclaimer.  Well, a few problems if we suddenly discover (after-the-fact) that someone needs to make a problem go away.  The refusal must be in writing and received by the foundation within nine months after the by-pass transfer occurred.  Furthermore, the beneficiary/donor has not received any benefit from the property transferred and the transfer occurred without any direction on the part of the person making the disclaimer.  Apparently, whoever drafted the vote of the foundation to dissolve and transfer did not consider that one, big, overriding requirement.

 

Something to think about if you ever encounter the dissolution of a trust or private foundation.  See CCA 2020045011 – 11/6/2020