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Philanthropy Tax E-Letter
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The Law of Charitable Pledges

At its annual banquet, a major charity calls out the name of each attendee who then stands and announces the amount he pledges to the annual campaign.

One guy refused to satisfy his pledge; the charity sued him and won. Mistakenly, he was invited to the following year’s banquet and he attended. When his name was called, he stood and said, “I pledge $100,000—plus interest and court costs.”

State law determines a pledge’s enforceability. And, unless a pledge agreement specifies the applicable state law, a conflict-of-laws issue can arise if the donor and the charity are in different states.

Pledges have been held binding on one or more grounds:

• The pledge is an offer to contract that becomes binding when work obligated by the pledge has begun, or the charity relying on the pledge has otherwise incurred liability.

• The consideration for the donor’s pledge is its support by pledges of others.

• Donor’s pledge has induced other pledges.

• The charity’s acceptance of the pledge imparts a promise to apply the funds according to the donor’s wishes, and his pledge is supported by that promise.

• Public policy requires the donor’s liability on a pledge.

Recent New York case—multiple issues, multiple parties. The Educational Institute Oholei Torah—Oholei Menachem (Charity) asked the court to dismiss objections to its Feb. 1, 2012 petition to determine the validity and enforceability of its $1.8 million claim against Isaac Kramer’s estate. Charity based its claim on a pledge and promissory note (the Subscription) it asserted was executed in its favor by Kramer. He died on Feb. 20, 2008.

The details. Charity maintained that Kramer executed the Subscription on Aug. 14, 2006 and he agreed to donate $1.8 million to support Charity’s plans to construct a “ritualarium,” or mikveh, with two underground pools, showers and changing rooms (the Building Project). The promissory note’s maturity date was Aug. 14, 2007—one year from the date of its execution.

Four groups of family members and the Public Administrator opposed Charity’s $1.8 million claim. One family group said that Kramer’s signature wasn’t genuine. The Public Administrator asserted that the pledge wasn’t duly executed. All the family groups maintained that the pledge failed for lack of consideration. Some also asserted that the pledge was unfulfilled or lapsed on Kramer’s death. 

The Public Administrator and other family groups argued that the pledge was barred by the doctrines of laches* and unclean hands.** Still other family groups asserted that the claim was barred by the statute of limitations. Yet other family groups asserted that the Charity’s claim was barred on the ground of fraud or fraudulent inducement. Finally, some family groups asserted that the decedent lacked the mental capacity to make the pledge. 

The Charity responds:

Notwithstanding its failure to seek collection of the Subscription during Kramer’s lifetime, the Subscription is a charitable pledge enforceable against Kramer’s estate. It was freely made by him and he had the requisite mental capacity to make the gift. Kramer was a longtime and widely recognized supporter of the Charity’s work, and the Charity maintained that it had proceeded with the Building Project, including solicitation of additional donations and the relocation and expansion of the Building Project, in reliance on fulfillment of Kramer’s Subscription. The Charity further asserted that its claim, served on the Public Administrator, was timely and wasn’t barred by the statute of limitations or laches.

The Charity and all who opposed the pledge relied on identical case law to support their opposing conclusions regarding reliance.

It all came down to the issue of reliance. The court found that the Charity failed to satisfy its burden to demonstrate reliance on Kramer’s Subscription. 

In many of the cases cited by the parties, some substantive progress had been accomplished toward the charitable purposes for which the pledges were received. In Cohoes Memorial Hospital v. Mossey, 25 A.D.2d 476 (3d Dep’t 1966), a pledge in support of construction of a new hospital was enforceable because the hospital was actually built. In In re Lord’s Will, 175 Misc. 921, 927 (Sur. Ct. Kings County 1941), the  decedent’s pledge in support of the college’s plans for a library was enforceable because the college had employed and paid architects for plans and construction was under way. In Liberty Maimonides Hospital v. Felberg, 4 Misc. 2d 291 (N.Y. Co. Ct. Sullivan County 1957) a charitable pledge for construction of new hospital was enforced. The hospital demonstrated that additional pledges were raised and a construction loan had been obtained.

In some instances, charitable pledges have been enforced where partial payments were made. See, for example, Allegheny College v. National Chautauqua County Bank of Jamestown, 246 N.Y. 369 (1927).

Finally, in a number of cases charitable pledges were enforceable where the facts demonstrated actions in reliance by the charities as well as partial pledge payments by the donors. See, for example, Woodmere Academy v. Steinberg, 41 N.Y. 2d 746 (1977).

Public policy wasn’t enough to enforce Kramer’s pledge. “Despite the widely recognized public policy favoring enforcement of charitable pledges,” said the court, “consideration must actually be demonstrated by proof of meaningful and substantive actions in reliance thereon. The facts of the instant case, and the negligible proof submitted, necessitate a finding that [Charity] has neither commenced construction, formally engaged any design, engineering or building professionals to commence construction, nor incurred any obligations, legal, financial or contractual, with respect to the building project.” 

Court’s holding. The motion to dismiss the objections to the Charity’s petition for a determination of the validity and enforceability of Kramer’s pledge is denied. The cross-motions to dismiss Charity’s petition is granted.

Matter of Estate of Kramer, NYLJ, May 12, 2014 (Surr. Ct. Kings Co. #2008-2334/A) 

An earlier New York case involved a $5 million oral pledge by Joan Whitney Payson, former owner of the New York Mets. She was a trustee and benefactor of the Metropolitan Museum of Art. “In a casual conversation” with the president of the museum, she promised to donate $5 million for the construction of a new “American Wing.” Before her death, Mrs. Payson donated roughly $3.5 million in appreciated securities to the museum. Based on her pledge and the donations, the museum started building the American Wing and promised New York City that if it donated $3 million toward the wing, the museum would raise the balance.

Mrs. Payson’s executors refused to pay anything further to the museum and asked the Surrogate’s Court to determine the validity of the museum’s claim for the unpaid $1.5 million balance of the $5 million pledge. 

New York law says that charitable pledges “are enforceable on the grounds that they constitute an offer of a unilateral contract which, when accepted by incurring liability in reliance thereon, become a binding obligation.”

The Surrogate’s Court held. The Statute of Frauds (which requires written evidence to enforce certain promises) was satisfied because Mrs. Payson had signed a letter she received from her bank stating that it had paid $200,000 to the museum “on account of your $5,000,000 pledge.” But, said the court, the pledge would be enforceable on public policy grounds even if the Statute of Frauds were not satisfied.

But the court cautioned that donors and donees should be meticulous:

There is no more room for casual estate planning in charitable gift-giving than there is in any other estate planning device. This warning is issued to donors and charitable donees alike. The loss of litigation by donors’ estates should be no solace to charitable donees for such litigation, caused by inexcusable casualness, may cause less charitable gift-giving by others. These proceedings would not have been necessary if the Museum had followed reasonably prudent business methods and had the decedent sign a simple pledge form.

Estate of Payson, Surrogate’s Court, Nassau County (1978) 

The Florida Supreme Court, in a different case, held that a Miami hospital had no claim against the estate of a decedent who had pledged $80,000 to the hospital. The court refused to uphold the pledge on two grounds: (1) the pledge document didn’t specifically state the purpose for which the funds were to be used, and (2) the hospital couldn’t affirmatively show reliance on the pledge to its material detriment (for example, incurring a liability in reliance on the pledge). Thus, the pledge was a gratuitous promise and unenforceable.

Mount Sinai Hospital of Greater Miami, Inc. v. Jordan,

290 S.2d 484 (FL Sup. Ct, 1974)

Income Tax Deductibility Rules

When deductible. A charitable pledge is deductible on a donor’s income tax return in the year fulfilled, not when the pledge is made. IRC Section 170(a)(1).

Capital gain. Generally, satisfying a debt with appreciated property is the equivalent of selling the property and satisfying the debt with the proceeds: Capital gains tax must be paid on the appreciation. But a donor who satisfies a binding pledge with appreciated property doesn’t trigger capital gain tax on the difference between the property’s basis and its fair market value. Rev. Rul. 55-410, 1955-1 CB 297.

IRA distribution in satisfaction of a pledge. From 2006 through 2014, an individual age 70½ or older could make direct charitable gifts from an IRA, including required minimum distributions, of up to $100,000 per year to public charities (other than donor advised funds and supporting organizations) and not have to report the IRA distribution as taxable income on his federal income tax return. The Charitable IRA Rollover is likely to be extended again (efforts continue to make the provision permanent and expanded to allow rollovers for charitable life-income plans).

Situation. The donor made a legally enforceable pledge to give money or property to a charity and subsequently satisfied the pledge by making an IRC Section 408(d)(8) qualified charitable distribution directly from the donor’s IRA to the charity.

Interesting question. Is a donor subject to federal income tax if the donor satisfies a personal pledge to a charity with a distribution from an individual retirement account?

The IRS’s legal analysis. IRC Section 61 defines gross income as all income from whatever source derived, unless a specific exception applies. IRC Section 408(a) provides that the term “individual retirement account” means a trust created or organized in the United States for the exclusive benefit of an individual or her beneficiaries if the written governing instrument creating the trust meets specified requirements. The tax treatment of distributions from an IRA is governed by IRC Section 408(d). IRC Section 408(d)(8)(A) provides generally that so much of the aggregate amount of qualified charitable distributions with respect to a taxpayer made during any taxable year which does not exceed $100,000 shall not be includable in gross income of the taxpayer for the taxable year.

Rev. Rul. 55-410, 1955-1 C.B. 297, provides that the satisfaction of a pledge to a charitable organization by means of a donation or gift of property that has either appreciated or depreciated in value does not give rise to a taxable gain or a deductible loss. In effect, Rev. Rul. 55-410 holds that a charitable pledge does not create a debt for federal income tax purposes and is not a legal obligation for purposes of IRC Section 677. Rev. Rul. 64-240, 1964-2 C.B. 172. See also Rev. Rul. 57-506, 1957-2 C.B. 65.

IRS rules. By analogy to Rev. Rul. 64-240, a taxpayer who satisfied a pledge by making a qualified charitable distribution under IRC Section 408(d)(8) from his or her IRA directly to a charitable organization would not include the distribution in gross income.

IRS’s caveat. “This letter is an ‘information letter’, which calls attention to a well-established interpretation or principle of tax law without applying it to a specific set of facts. It is intended for informational purposes only and does not constitute a ruling. See section 2.04 of Rev. Proc. 2010-1 2010- I.R.B. 1,7.”

August 20, 2010 Information Letter to Harvey P. Dale, 

University Professor of Philanthropy and the Law, 

Director, National Center on Philanthropy and the 

Law at New York University Law School

written by Michael J. Montemurro, 

Office of Associate Chief Counsel

Gift Tax Deductibility Rules

When deductible. The gift tax deductibility rules differ from the income tax rules. For gift tax purposes, a gift is deemed made at the time a binding pledge is made. No gift tax is payable, however, because a gift tax charitable deduction is allowed.

• Gifts that qualify for the $14,000 annual-per-donee exclusion aren’t reportable whether made to an individual or a charity.

• Outright charitable gifts of cash (including any IRA transfers) regardless of the amount and property gifts (regardless of the value) qualify for the unlimited gift tax charitable deduction and generally aren’t reportable.

• An outright charitable gift of a partial interest (for example, an undivided one-fifth interest in Greenacre) is reportable. But, no gift tax is payable because it qualifies for the unlimited gift tax charitable deduction.

“If you are required to file a return to report noncharitable gifts and you made gifts to charities, you must include all your gifts to charities on the return.” Instructions for Form 709 United States Gift (and Generation Skipping Transfer) Tax Return. (This is from the instructions for 2014. The instructions for 2015 haven’t been issued yet. However, the annual instructions have been saying this for a number of years). Presumably “all” means outright charitable gifts to any charity during the year totaling more than $14,000.

Letter Ruling 8230156 deals with when a pledge gift is deemed made for gift tax purposes. Donor agreed with a charity that he would donate $30,000 over a period of time. The gift was to be paid in installments, and each installment was to be made at Donor’s election. However, he would become personally liable under local law to complete any installment of the gift when the following events occurred: (1) the IRS issued a favorable ruling relating to the gift, and (2) the charity received specified contributions from other sources.

IRS ruled. When Donor’s promise to make a charitable contribution became a binding legal obligation under local law, the gift was complete and he was entitled to a gift tax charitable deduction (presumably if he had to file a gift tax return). On the other hand, he wouldn’t get an income tax charitable deduction until cash or property was actually transferred to the charity.

Fulfilling another’s pledge. The donor pledged $10,000 to Charity in January, promising to fulfill the pledge before June. Charity incurred expenses in March, making improvements to its real property in reliance on the pledge. Donor lacked the funds in May to satisfy his pledge, so Friend paid Donor’s pledge, advising charity that donor’s debt was being paid. Friend told Donor that the payment was a gift and that Friend did not expect any reimbursement from Donor.

IRS rules:

1. Friend’s payment of Donor’s pledge to Charity was not a charitable gift by Friend under IRC Section 2522 (gift tax) because the pledge was a binding obligation of Donor’s.

2. Friend’s payment to Charity was a gift from Friend to Donor.

3. For gift (but not income) tax purposes, Donor was considered to have made a gift to Charity when the pledge became enforceable. Under local law, a pledge to contribute to a charity is a revocable offer. However, the offer becomes irrevocable and legally binding when the charity takes action in reliance on the promise. So for gift tax purposes, Donor made a gift to Charity in March, when Charity incurred expenses in reliance on his pledge.

4. For income tax purposes, Donor could not deduct his charitable contribution until payment was actually made to Charity. Thus (although the ruling doesn’t say so in as many words), Donor was deemed to have made a gift in May and would be entitled to an income tax deduction on that year’s return. 

Rev. Rul. 81-110, 1981-1 C.B. 479

Suppose Friend, in this ruling, owed money to Donor and paid the debt with appreciated property instead of cash. Friend would have to report capital gain equal to the property’s appreciation.

By the same token, if Friend paid his debt to Donor by transferring appreciated property to Charity (in satisfaction of Donor’s pledge), Friend would still have to report capital gain on the property’s appreciation.

Qualified Charitable IRA distributions aren’t prohibited transactions — even if used to satisfy pledges. The Department of Labor, which has interpretive jurisdiction under IRC §4975(d), has advised the IRS that a distribution made by an IRA trustee directly to an IRC §170(b)(1)(A) organization (as permitted by IRC §408(d)(8)(B)(i)) will be treated as a receipt by the IRA owner under IRC §4975(d)(9), and thus isn’t a prohibited transaction and that’s so even if the IRA owner had an outstanding pledge to the receiving charity.

IRS Notice 2007-7

Estate Tax Deductibility Rules

Binding pledges. A legally binding pledge that isn’t satisfied by a donor during lifetime is treated as a debt of the donor’s estate and is deductible by the estate as a debt—not as a charitable contribution if: (1) the amount of the unfulfilled pledge is paid to charity; (2) an estate tax charitable deduction would have been allowed if the gift had been made by the donor’s will; and (3) the donor’s promise was enforceable against the donor’s estate. Reg. Section 20.2053-5. State law determines whether a pledge is enforceable.

Non-binding pledges. If an unfulfilled pledge isn’t enforceable against the donor or his estate, no estate tax deduction is allowable. But if a donor makes a non-binding pledge during lifetime and provides in his or her will that any unfulfilled pledge be satisfied by his estate, the donor is deemed to have made a charitable gift that qualifies for the estate tax charitable deduction.

Deductible as debt of estate? Before he died, a donor signed a memo pledging $250,000 to a university for a school building campaign. Construction began after the state legislature appropriated funds. He died before making any payments on the pledge. The estate asked the IRS whether the payment was deductible as a debt of the estate.

The IRS ruled. The pledge was deductible as a debt of the estate rather than as a charitable deduction. To make a lifetime pledge unfulfilled at death a claim enforceable against the estate, the IRS said, applicable state law requires that: (1) the document containing the pledge state the specific purpose for which the funds must be used, and (2) the charity show substantial reliance on the pledge. The pledge in this case met those requirements because the pledge memorandum signed by the donor said that the pledged funds would pay construction costs. The university demonstrated reliance on the pledge by beginning construction before the decedent satisfied his pledge.

Letter Ruling 9718031

Some Private Foundation Considerations

Private foundation pays an individual’s pledge. Don’t do it. The IRC Section 4941 excise taxes on self-dealing will be imposed. Also, the remainder interest of a charitable remainder trust shouldn’t be used to satisfy a donor’s pledge. 

Individual’s pledge to private foundation. Milton was a substantial contributor to Foundation; thus, he was a “disqualified person.” Over the years he made a number of pledges to Foundation, promising to transfer cash or marketable assets. The pledges provided that Foundation could use them as collateral to borrow money. On several occasions, Milton substituted a larger pledge due at a later date. He fulfilled two of his pledges with real property. Wondering whether Milton’s actions were self-dealing, the District Director asked IRS for technical advice.

IRS rules—pledge substitutions. Under IRC Section 4941(d)(1), loans or other extensions of credit between a private foundation and a disqualified person are acts of self-dealing. A pledge motivated by charitable intent isn’t an “extension of credit,” at least until the pledge is due. Replacing a pledge with a larger one presents no problem if both are due at the same time. But when the new pledge has a later due date, “we must ask whether the foundation has been compensated at fair market rates for any delays in payment, in order to determine if there has been . . .  benefit to the disqualified person.”

The IRS didn’t receive data on the fair market return in effect when the original pledges were due. Still, Milton’s substitutions resulted in an equivalent annual return of more than 20 percent, so IRS was confident that Foundation had received more than adequate compensation for the delays. It added that substituting a pledge with a later due date but with no increase in amount would be an act of self-dealing.

  Letter Ruling 8723001

*The doctrine of “laches” is based on the maxim that equity aids the vigilant and not those who slumber on their rights. Laches is not to be confused with latkes (Yiddish for potato pancakes).

**Under the “unclean hands” doctrine, equity will not grant relief to a party who seeks to set judicial machinery in motion and obtain a remedy if the party in his prior conduct has violated conscience, good faith or other equitable principles. One, of course, shouldn’t eat latkes if he doesn’t have clean hands.

© Conrad Teitell 2015. This is not intended as legal, tax, financial or other advice. So, check with your adviser on how the rules apply to you.

TAGS: Philanthropy
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