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Breaking Up Really May Be That Hard To Do: Preparing To Reconcile Irreconcilable Differences Between Donors and Charity

Christopher P. Woehrle examines the issues arising from two hypothetical gifts “gone bad.”

In my February and April 2017 columns,1 I discussed how a divorce between spouses can be coordinated with prior or future philanthropy in a tax-efficient manner. Charitable remainder trusts (CRTs) and charitable gift annuities (CGAs) can be structured to fund an alimony obligation.2

What are the tax planning opportunities arising from a different type of divorce; namely, between a donor and a charity? Let’s examine the issues arising from two hypothetical gifts “gone bad.”

Two Scenarios

Here are two scenarios in which gifts went bad for different reasons.   

Donee university can’t fulfill terms. With an annual forecasted adjusted gross income of $3 million, Penny Prepared feels financially secure to make a gift of a lifetime. She pledges $5 million to her alma mater for an endowment whose earnings will be used to support recruitment and retention of international students. In recognition of her generosity, the student union for international students will bear her name. The gift agreement preserves the naming rights for perpetuity. It also requires annual reporting to Penny about the donee’s efforts in increasing the number of international students. Should the alma mater not achieve agreed benchmarks for enrollment, the funds will be transferred to another publicly supported charity within the meaning of Internal Revenue Code Section 501(c)(3). At the end of Year 4, Penny fulfills her pledge commitment. Each of her annual installments of $1.25 million was deductible. After 10 years of shaky stewardship, Penny’s alma mater doesn’t seem to have the ability to fulfill the terms of the gift. Penny asks the state Attorney General (AG) to approve the transfer to another university contingently named in the gift agreement, which has already demonstrated the ability to recruit international students. 

Donor indicted for insider trading. A prominent Wall Street titan, Paul Philanthropist, contributes $5 million to a national research cancer center affiliated with an internationally acclaimed medical center. The cancer center bears his name. The gift agreement is silent about the duration of the naming rights and doesn’t name a contingent beneficiary. After Paul’s indictment for insider trading charges, which his counsel vigorously disputes, the medical center removes his name. The financial press also breaks the story that Paul has been accused of inappropriate behavior with one of his direct reports at his company. Paul negotiates out-of-court settlements with the Securities and Exchange Commission and his former co-worker. Paul sues the charity, demanding that the center bear his name. In satisfaction of Paul’s lawsuit for specific performance of the naming rights, the medical center and Paul negotiate an out-of-court settlement rumored to be $5 million—the amount of the original gift. 

Tax Benefit Rule

The return of funds to the donor raises the impact of the tax benefit rule. The IRC permits the exclusion from gross income of amounts recovered in a taxable year to the extent that the amount was a deduction in a prior year but didn’t reduce the amount of the taxpayer’s income tax in the prior year.3 The amount of tax owed for the year of recovery is based on the tax rates for the year of recovery. If the rates are lower, the taxpayer benefits. If the rates are higher, the Treasury Department reaps the windfall. Alice Phelan Sullivan Corp. v. United States4 relied on the annual accounting principle to tax a recovery at that year’s higher rates.

Gift Agreement

Donors and charities should address the events triggering the tax benefit rule in a thoughtfully crafted gift agreement that covers these following fundamental issues: 

Perpetuity of naming rights. The agreement should express the duration of the naming opportunity. Endowments for scholarships, professorships and special support projects will likely be perpetual. Rights for a building or a major space or lab within the building or an academic program might not be perpetual. If the duration is less than permanent, perhaps it can be for the lifetime of the donor or a fixed period of time after the passing of the donor. 

In a reminder to both donors and charities that “forever” means forever, a New York State court enforced the perpetuity of the naming of Paul Smith’s College of Arts & Sciences.5 Joan Weill, a nationally prominent philanthropist and long-time supporter, sought her name on the college in recognition of a contingent $20 million gift.6

Notwithstanding the likely “transformative impact” of a $20 million gift to an institution with an operating budget of only $33 million, the court refused to allow the renaming, noting the institution was to be “forever known” by the name of the founding donor.7 

If the naming rights are bought out after the donor’s death, other issues might arise. Are the funds paid to the heirs of the deceased donor an asset of the decedent’s gross estate? Are the funds paid to the heirs excludible from gross income under the IRC as an inheritance? Or, are they otherwise taxable? If the legal settlement wasn’t deemed owned by the donor at death, the recipients of the settlement should have difficulty arguing they received an inheritance. Though they shouldn’t have income under the tax benefit rule as they derived no income tax benefit, they did receive cash of undeniable economic benefit. But, then the next question becomes, do they have a basis in the asset they gave up? Or, was it their asset to give? Space limitations of this column prevent a detailed analysis. But, you can sense this is an area meriting more research.

Qualified contingent beneficiary if failure of gift purpose. To avoid the time and legal expense of the state AG approving an alternate purpose under the cy pres doctrine, Penny did the proactive planning that minimizes the legal cost and delay by redeploying her gift to an institution that can fulfill her philanthropic goals. 

Donor’s legal troubles. Bad behavior of a donor is easily captured courtesy of an iPhone and essentially 24/7 multimedia platforms ravenous for content of “humans behaving badly.” In this era of heightened political sensitivities, perhaps the standard for removal of a naming opportunity needs to be dramatically lower. In the past, a donor may have lost a naming opportunity for being convicted of a violation of criminal or civil law. But today, it’s enough if the donor is merely indicted for such an offense. Donors seeking significant recognition need to be aware their gift may come with the “price” of a much lower multimedia profile. 

Return of gift to donor for failure to receive a contemporaneous receipt. At first blush, the whole idea of asking for a return of a contribution on failure to issue a contemporaneous written receipt seems excessive. Every charity will issue them in the correct form, right? How hard can it be for the charity to issue a letter acknowledging receipt of the gift with the declaration that no goods and services were received?

Well, there’s one donor who wished he’d incorporated such a provision in the gift agreement. The limited liability company (LLC) 15 West 17th Street lost a $64.49 million deduction because of the failure to satisfy the contemporaneous written acknowledgment requirement. While the burden is on the donor to provide the receipt to the Internal Revenue Service,8 the donor likely thought the documentation from the charity was sufficient. Alas, the charity lacked the necessary statement about no goods and services being provided. The charity hoped the filing of an amended Form 990 listing the gift might preserve the donor’s deduction. But, the court in 15 West 17th Street LLC, et al. v. Commissioner9 correctly rejected all of the taxpayer’s arguments that the donee’s efforts created a valid contemporaneous announcement. The donor can’t rely on a Form 990 as a contemporaneous receipt.

Amounts Owed at Death

Will a charity ever decide to sue the estate of a donor for any unpaid balances owed under a legally binding pledge agreement? How large must a gift be to endure the public relations firestorm? One institution found out the hard way. Duke University filed a claim of nearly $10 million against the estate of one of its most generous donors, the former CEO of Chesapeake Energy, who was under indictment for bid rigging for the purchase of leases in Oklahoma. Ultimately, the university dropped the claim and was “deeply sorry for any pain this has caused the McClendon family.”10 Perhaps insuring the life of the donor to cover any unpaid balance is the more tactful strategy. 

While both marriage and philanthropy begin with the best of intentions, it’s always best to prepare for the worst. 


1. Christopher P. Woehrle, “Breaking Up May Not Be That Hard to Do: Unwinding Marriages and Philanthropies,” Trusts & Estates (February 2017), at p. 7; Christopher P. Woehrle, “Breaking Up May Not Be That Hard to Do: Unwinding Marriages and Philanthropies: Part II,” Trusts & Estates (April 2017), at p. 9. 

2. Could there ever be a form of “a charitable alimony” by which the payor-charitable donor has a charitable contribution deduction and the “payee” has no income inclusion as the gift has been directed to a charity of the donee’s choice? For example, a divorcing couple agrees one party will donate funds directly to charity as part of a divorce settlement. The case of Duberstein v. Commissioner, 363 U.S. 278 (1960) would say “no” because there’s a lack of “detached and disinterested generosity.” See also Treasury Regulations Section 1.1041-1T(c), Q&A 9, which would treat the transfer as being made by the recipient party.

3. See Internal Revenue Code Section 111(a). The tax benefit rule relieves the taxpayer of the burden of filing an amended return without the original deduction. Reporting the income in another year in lieu of filing an amended return assures the Internal Revenue Service will be paid additional tax. Were the requirement only to file an amended return, it could be that the normal 3-year statute of limitations has closed.

4. Alice Phelan Sullivan Corp. v. United States, 381 F.2d 399 (Ct. Cl. 1967).

5. In re Paul Smith’s College of Arts and Sciences, Index 2015-0597 (N.Y. Sup. Oct. 6, 2015).


7. Supra note 5, at p. 2.

8. IRC Section 170(f)(8)(A) imposes the requirement on the taxpayer, not the charity. See also S. Rpt. No. 103-36 (PL-103-66), at p. 222.

9. 15 West 17th Street LLC, et al. v. Comm’r, 147 T.C. No. 19 (2016).



TAGS: Philanthropy
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