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HARTWICK COLLEGE v. UNITED STATES

February 25, 1985

HARTWICK COLLEGE, AURELIA OSBORN FOX MEMORIAL HOSPITAL SOCIETY and RAILROAD AND LOCAL MEN'S CHRISTIAN ASSOCIATION OF ONEONTA, Plaintiffs,
v.
UNITED STATES OF AMERICA, Defendant



The opinion of the court was delivered by: MCCURN

MEMORANDUM-DECISION AND ORDER

 This is an action by four residuary beneficiaries of the Dewar estate to recover an alleged overpayment of income taxes by the estate for the taxable year ending April 30, 1977. Presently before the court is a motion to determine the proper method of calculating the estate's charitable deduction for income tax purposes under section 642(c)(2) of the Internal Revenue Code. For the reasons set forth below, the court holds that "interrelated computations" is not appropriate for calculating the estate's charitable deduction for income tax purposes and the estate is entitled to a "straight charitable deduction".

 BACKGROUND

 The court has considered the merits of the present action on two previous occasions. Briefly, the facts are as follows: Jessie Smith Dewar died testate on May 28, 1976, leaving an estate of approximately $ 49 million. Her will provides that first, all debts, expenses, and taxes be paid from the general estate; second, specific bequests be made to the named beneficiaries; and last, the residuary estate be divided among five named charitable organizations. After paying approximately $ 34 million in administrative expenses and taxes, no funds were left in the residuary estate and a deficit of $ 304,534.19 remained, necessitating an abatement of the non-residuary beneficiaries' distributions.

 For the year ending on April 30, 1977, the estate reported a taxable income of $ 2,431,065.00 and paid $ 1,728,879.00 in income taxes. The estate did not claim a charitable deduction on the fiduciary federal income tax return because no residuary estate for the charities was left after the administrative costs and taxes were paid.

 Plaintiffs in the present action are four of the charitable organizations named as residuary beneficiaries in the Dewar will. On March 5, 1980, they filed an amended income tax return for the estate requesting a refund. The Internal Revenue Service took no action. On March 27, 1981, plaintiffs filed the current action to recover the overpayment of the estate's 1976 income taxes. The complaint alleges that all of the estate's earned income qualified for the charitable deduction provided by section 642(c)(2) of the Internal Revenue Code, 26 U.S.C. § 642(c)(2). The deduction, if allowed, would leave money in the residuary estate for the residuary beneficiaries.

 In a ruling from the bench, the court granted plaintiffs summary judgment. The court held that "(b)y naming the charities in the residuary clause, without conditions or contingencies, she (the testatrix) 'permanently set aside' the amount of income that would constitute the residuary estate." The estate was therefore entitled to a charitable deduction in the amount that the residuary beneficiaries would have received. An order was signed on March 15, 1984, and further proceedings to determine the amount of the income to be refunded were scheduled.

 The court subsequently vacated the March 15, 1984 order on defendant's motion for reconsideration because the order did not accurately reflect the court's oral ruling. *fn1" In its May 31, 1984 decision, the court states, "Thus, the court was of the view then (referring to the court's previous oral decision), as it is now, that the amount of the estate income which was 'permanently set aside' for charitable purposes was not the entire $ 2.4 million reported as 'taxable income' on the fiduciary return, but only the amount that the residuary beneficiaries would have received but for the income tax." The court noted that the $ 304,534.19 deficit, abated from the non-residuary beneficiaries' distributions, "would have to be paid, with after-tax dollars, from the estate income before the amount of income that would have constituted the residuary estate could be ascertained". The court ordered the matter referred to a special master for a hearing on the "calculation of the amount of deduction to which the estate is entitled and the amount of refund to which the plaintiffs are entitled".

 The parties subsequently requested the court to hold the appointment of a special master in abeyance to afford them an opportunity to reach a mutually agreeable calculation on their own. Their effort in this regard has resulted in a disagreement over whether "interrelated computations" or a "straight deduction" method should be used to calculate the charitable deduction allowable under section 642(c)(2) of the Internal Revenue Code, 26 U.S.C. § 642(c)(2). Resolution of this issue, now before the court, will enable the parties to agree on the amount of the refund, if any, to be awarded pursuant to the court's May 31, 1984 Memorandum-Decision and Order.

 DISCUSSION

 Analogizing to estate taxes, the government contends that "interrelated computations" must be used to determine charitable deductions for income tax purposes. The government argues that for the year in question the estate had $ 2.4 million of taxable income. One million dollars of that income was used to pay nondeductible, administrative estate expenses and was taxable. As a result, only $ 1.4 million was left for the residuary estate. The estate's tax bracket was 70%. If the estate were allowed a $ 1.4 million charitable deduction, it would owe $ 700,000 in taxes (70% of $ 1 million net taxable estate). However, the government argues that the $ 700,000 in taxes must be paid out of the $ 1.4 million residuary estate, thereby reducing the amount of money available to the charities. According to the government, the amount of the charitable deduction must be reduced accordingly. Reducing the charitable deduction would in turn increase the income tax owed and further reduce the residuary estate and charitable deduction allowed. The government contends that to determine the correct amount of the estate's charitable deduction, these pyramiding calculations must continue until the point where the charitable deduction actually equals the money left to pay the charities. The calculations proposed by the government can be made by a complicated algebraic formula, and the process is known as "interrelated computations".

 The government concedes that if "interrelated computations" are used in the present case, the estate's income taxes will be ore than $ 1.4 million and no money will be left for the charities. Such a result would also effectively circumvent the court's previous decisions in this action.

 Although plaintiffs agree that "interrelated computations" are proper in calculating estate taxes under 26 U.S.C. § 2O55(c), plaintiffs contend that Congress did not intend that "interrelated computations" be used for calculating income taxes under 26 U.S.C. § 642(c). Plaintiffs rely on Edwards v. Slocum, 264 U.S. 61, 68 L. Ed. 564, 44 S. Ct. 293 (1924). In Edwards the Supreme Court was asked to decide whether the government could use an algebraic formula to determine the amount of the charitable deduction which was exempt from estate taxes ...


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