Originally published on Forbes.com.
Hobby Lobby became well known for its challenge to the contraceptive mandate under the Affordable Care Act (Obamacare) succeeding in carving out an exemption under the Religious Freedom Restoration Act in the Supreme Court decision Burwell v Hobby Lobby. Founder David Green ranks number 88 in the Forbes 400. A decision earlier this month in the United States District Court For The Western District of Oklahoma (Green v US) besides being a potentially important precedent gives just a bit of information about Hobby Lobby’s structure.
About Hobby Lobby
Hobby Lobby is a chain of arts and crafts stores. Between 2002 and 2004. many, but not all of the stores were owned by Hob-Lob Limited Partnership. The David and Barbara Green 1993 Dynasty Trust is a 99% limited partner in Hob-Lob. David and Barbara Green, Hobby Lobby’s founders are the settlers and Mart Green, their son, is the trustee. The trust also owns GDT CG1, LLC, a single member limited liability company which is disregarded for federal income tax purposes. The “disregarded” means that whatever the LLC does is considered to have been done by the trust.
In 2002 Hob-Lob distributed $38,722,126 to the trust and passed through $72,465,646 in ordinary income. In 2003 distributions were $41,076,436 and income was $68,303,318 and in 2004 it was $29,480,397 in distributions and $60,543,215 in income. Trust income tax rates are similar to individual rates.
The Donations
GDT purchased 109 acres and two industrial buildings in Lynchburg, VA in 2002. Lynchburg, by the way, is the home of Liberty University , an organization, like Hobby Lobby, dedicated to running on Christian principles. If you want to visit Appomattox Court House, you may end up staying in Lynchburg, because Appomattox, despite its great significance in our nation’s history is a little light on lodging. At any rate, GDT contributed the buildings and most of the land to National Christian Foundation Real Property, Inc. just over a year after the purchase.
From looking at the 990s, it appears that NCF Real Property Inc sells properties it receives and turns the proceeds over to National Christian Foundation, which runs donor advised funds. NCF is quite substantial. According to its most recent Form 990, it took in over $800 million in 2013.
The IRS and the trust are still arguing about the fair market value of the property. For purposes of the summary judgment motions that the district court was ruling on, they agreed that FMV was greater than the trust’s basis in the property – $10,368,113.
In 2002, GDT purchased a church building and several outbuildings in Ardmore, OK from Trinity Baptist Church. The property was donated to Southwest Oklahoma District Church of the Nazarene in 2004. Adjusted basis was $160,477 and fair market value was $355,000.
In 2003 a property in Texas was purchased of $145,000 and donated to Lighthouse Baptist Church in 2004. FMV was $150,000.
The Returns
The Trust filed its 2004 return on October 15, 2005 claiming a charitable contribution of $20,526,383. On October 15, 2008 the trust filed an amended return upping the charitable deduction to $29,654,233 and claiming a refund of $3,194,748. That is a pretty slick move, although you have to have plenty of cash in order to use it. In the event the IRS finds other issues on the return besides the higher charity, they can only be used to offset the refund. As long as it is not being frivolous the Trust has no penalty exposure and the interest clock is running in the taxpayer’s favor.
The Issue
The IRS argues that in the case of a trust charitable contribution is limited to the basis of the property contributed rather than its fair market value. Even though trusts are taxed in a very similar manner to individuals, there is a big difference when it comes to charity. Individual charitable contribution deductions are limited to 50% of adjusted gross income (30% in the case of gifts of appreciated property). (See Note)
Trusts are allowed deductions up to 100% of income, but it gets a little tricky, at least in the IRS view. In order to be deductible, the charitable contributions have to have their source in gross income. Taking the Texas church building as an example, the IRS argues that the nearly $200,000 in unrealized appreciation never generated any gross income.
The court ruled against the IRS.
Under the facts of this case, using adjusted basis as the valuation standard would allow no consideration for the appreciation of real property donated in kind, regardless of whether such property was donated in the year of acquisition or in subsequent tax years. Defendant asks the Court to read a limitation into the statute where none expressly exists.
It Is Not Over
They still have to duke it out over the valuation of the Virginia property, which is presumably where most of the money is. The trust will probably have to make a case, that its purchase of the property was very favorable. That could be quite plausible, since it was a deep pocket buyer able to pay cash and possibly close quickly.
The IRS staked out its position in CCA 201042023, which I am willing to bet a dollar was referring to this case. It did admit that it might be stretching.
We find no prior cases or other authority in which the Service has so limited a § 642(c) deduction and there is at least one source of counter-authority. One commentator interprets Old Colony as authority for a § 642(c) deduction up to the amount of gross income for that year in any case where the controlling document does not specifically designate the payment as coming from principal, whether made from “prior years’ cash accumulations, principal, or income receipts in hand, such as stock dividends or borrowings, as well as principal assets . . . .” Abbin, Byrle M., Income Taxation of Fiduciaries and Beneficiaries, § 4128.3 (2006). On balance, however, the majority view of the court’s and commentators as well as our own points to the view that Trust may not claim a charitable contribution deduction greater than its adjusted basis of the properties purchased from accumulated gross income under § 642(c)
It will be interesting to see if there is an appeal.
Planning Notes
There seems to be some really interesting planning going on here. I’d love to dig into the estate planning involved in the establishment of the trust. The SALT (state and local tax) issues of the trust are also pretty mind-boggling to contemplate.
As far as the value of the decision as a precedent goes, it is somewhat limited. I discussed the case with Professor Adam Chodorow and he indicated that district court decisions do not cut a lot of ice in the Tax Court, where most tax cases are initially litigated, since the forum is open to taxpayers who haven’t already paid the disputed tax.
This case strikes me as one in which the taxpayer caught the agent from hell. AFH is not the most technically sharp knife in the drawer, but he or she has a nose for something not being quite right. The trust’s donation flipping could strike one as just a little too cute. Instead of giving you money to buy a church, we’ll buy a church hold onto it for a bit over a year and then claim twice our cost as a deduction. If the appraisal stands up, which seems like a bit of a weak link in the plan, it works and a normal agent would apply Reilly’s First Law of Tax Planning – It is what it is. Deal With it. AFH is made of sterner stuff and manages to get the chief counsel to rule that even though nobody has ever raised the issue, there is no time like the present.
Other Coverage
Ed Zollars of Current Federal Tax Developments gives a nice summary, noting:
As well, given other charitable trust deduction cases recently it seems that the IRS has begun to take a closer look at claims for charitable contributions on Forms 1041. Thus advisers should be sure to understand the special rules applicable to charitable deductions on the income tax returns of trusts and estates.
Chuck Rubin of Rubin on Tax also did a good summary and noted the limited value as a precedent.
Since the case is not an appellate court case but only an interpretation of a District Court, the precedential value of the decision is limited. Given the substantial amounts at issue, the IRS may appeal.
Note
Commenter yosefklein pointed out that Code Section 681 puts trusts on the same footing as individuals with a 50%/30% limit to the extent that contributions source to unrelated business taxable income. I was blissfully unaware of that and it didn’t get discussed in the decision. The comment did motivate me to actually spend some money and dig further into the case on PACER. Among the exhibits were the trust instrument, which was not all that exciting and the amended return. That was interesting, because it turns out the basis of the refund claim was the fine points of computing the limitation. The income flowing to the trust is, not surprisingly, UBTI. So apparently the IRS is challenging the refund claim on an unrelated issue.