Hobby Lobby describes itself as the largest privately owned arts-and-crafts retailer in the world, with more than 800 stores and 32,000 employees in 47 states. Hobby Lobby started as a home business by David and Barbara Green in 1970. They created the David and Barbara Green 1993 Dynasty Trust Agreement (DBGDT), with their son Mart named as the trustee. The Trust included a clause that it was intended to "carry out the mission of our family to serve the Lord."
Putting everything into the trust is a great estate planning strategy because future appreciation won’t be included in the Green estates. They might have used an "intentionally defective grantor trust" (IDGT), which would have avoided the income tax complications of fiduciary returns during their lifetimes. However, having the trust as a separate income tax entity has some significant advantages, like being able to distribute income to descendants based on current needs and a generous entity level charitable deduction. But there was an unexpected charitable deduction problem that gave rise to the litigation.
The beneficiaries of the trust are the descendants of the Greens, with one possible exception: "Any child or descendant who is born to persons out of wedlock shall not be considered as a "child" or "descendant" of such persons for purposes of this Trust Agreement.”
For 2004, DBGDT paid $8.4 million on its original return. There was $57 million included in income in flow through from the trust's 99% interest in Hob-Lob Limited Partnership, which is where most of the stores were. The refund of $3.2 million was based on increasing charitable deductions by $9.1 million to $29.7 million. Contributions by trusts are generally unlimited, but there’s a limitation based on Unrelated Business Taxable Income (UBTI). That wasn’t an issue, rather it was the ability to take deductions at fair market value.
A charitable deduction by an individual will typically be based on the fair market value of the property. In this case, there were three properties, but the bulk of the appreciation was contained in one of them in Virginia, which was donated to the National Christian Foundation. The jury found the property to be worth $28,500,000. The property had been acquired less than a year before, with a basis of less than $11 million.
The IRS argued that charitable deductions for trusts are limited to basis, because the trust's charitable deduction is from gross income, and the inclusion of unrealized appreciation in income is questionable. The district court ruled in favor of the trust, but the Tenth Circuit did not buy in.
The Court of Appeal found the IRS’s arguments unpersuasive and said that the district court misconstrued the statute, relying in part on §642(c)(1)'s use of the phrase “without limitation.” The Supreme Court held that the phrase “without limitation,” as used in the predecessor statute to §642(c)(1), was intended only to make clear that the percentage limits outlined in §170 that apply to charitable deductions made by individuals and corporations do not apply to charitable deductions made by estates and trusts. The Tenth Circuit said that presumably the same holds true for §642(c)(1). Thus, §642(c)(1)'s use of the phrase “without limitation” can’t be construed as a signal by Congress to authorize the extent of the deduction sought by the Trust in this case.
The district court also relied on a Supreme Court decision for the proposition that charitable giving should be encouraged and thus, that §642(c)(1) should be construed in a broad manner. But the Tenth Circuit said this statement was made solely in the context of deciding whether the authorized deduction should be limited to amounts “paid from the year's [gross] income.”
Finally, the district court concluded, in part, that because §170 in certain instances allows individuals to claim a deduction for the fair market value of donated property, it’s okay to interpret §642(c)(1) in the same way. Not so. The language of §170 expressly discusses the fair market value of the donated real property, the court said, whereas §642(c)(1) merely refers to gross income and does not otherwise incorporate §170's discussion of the fair market value of donated real property.
If Congress intended for the concept of “gross income”, in this instance, to extend to unrealized gains on property purchased with gross income, it would’ve said so, the Tenth Circuit held.
If this had been an IDGT, there wouldn’t have been a problem using the fair market value, although there would have been a 30% limitation to deal with, which might have been a problem for the Greens, who are committed to being very philanthropic.
Reference: Wealth Advisor (January 26, 2018) “Hobby Lobby Trust Loses $3.2M Tax Deduction”