Allocation and apportionment of charitable contributions under section 861

Tax Executive, The, March-April, 1997

On January 31, 1997, Tax Executives Institute submitted the following comments to the U.S. Department of the Treasury and the Internal Revenue Service concerning proposed regulations under section 861 of the Internal Revenue Code on the allocation and apportionment of charitable contributions. The comments, which took the form of a letter from TEI President James R. Murray to Assistant Treasury Secretary Donald C. Lubick and IRS Commissioner Margaret M. Richardson, were prepared under the aegis of the Institute's International Tax Committee, whose chair is Joseph S. Tann, Jr. of Ameritech Corporation.

On January 23, the Internal Revenue Service requested comments on the paperwork burdens associated with the proposed section 861 regulations, relating to the allocation and apportionment of charitable contributions. The regulations were issued on March 11, 1991, and were the subject of a public hearing in August of that year. Tax Executives Institute, which filed comments on the proposed regulations, favors the expeditious promulgation of final regulations and hopes that the January 23 notice signals the intention to include the project on the 1997 Business Plan. We believe, however, that the regulations should be revised, both to minimize taxpayer burdens and to harmonize the tax policy underlying the section 1.861-8 regulations and the country's well-established interest in encouraging charitable contributions.

Overview

Treas. Reg. [sections] 1.861-8(e)(9)(iv), which has been in effect since 1977, provides that the deduction for charitable contributions allowed by section 170 will "generally" be considered as not definitely related to any gross income. Consequently, those deductions must be ratably apportioned among U.S. and foreign sources in accordance with Treas. Reg. [sections] 1.861-8(c). Although many charitable contributions are apportioned based on gross income under the extant regulations, a taxpayer in certain circumstances may properly allocate the deduction to one or more classes of gross income.

In Notice 89-91, 1989-2 C.B. 408, the IRS announced its intention to modify the section 861 regulations essentially to eliminate the word "generally," thereby requiring taxpayers to ratably apportion the deduction for charitable contributions to all classes of gross income on an affiliated group basis. Many commentators, including TEI, voiced policy and administrative concerns about the rule announced in Notice 89-91, and the IRS attempted to respond to those concerns in developing the 1991 proposed regulations. Specifically, the proposed regulations reject the notion that all charitable contributions should be ratably apportioned and set forth special rules for the allocation of charitable contribution deductions solely to U.S.-source gross income or, alternatively, solely to foreign-source gross income. Thus, Prop. Reg. [sections] 1.861-8(e)(12)(i) provides that a charitable contribution deduction will be allocated to U.S.-source gross income if --

(A) The taxpayer, at the time of

the contribution, both

designates the charitable

contribution for use solely in the

United States and reasonably

believes that the contribution

will be so used; and

(B) The contribution is not described

in paragraph

(e)(12)(ii) of this section

[relating to charitable

contribution deductions allocated

solely to foreign source gross

income].

Paragraph (e)(12)(ii) of Prop. Reg. [sections] 1.861-8 provides that a deduction will be allocated solely to foreign-source gross income if the taxpayer, at the time of the contribution, knows or has reason to know that --

(A) The charitable contribution

will be used solely outside the

United States; or

(B) The charitable contribution

may necessarily be used only

outside the United States.

Under Prop. Reg. [sections] 1.861-8(e)(12)(iii), charitable contribution deductions that fall within neither of the foregoing special rules will be apportioned ratably on the basis of gross income in accordance with Treas. Reg. [sections] 1.861-8(c)(3). The proposed regulations, which would apply for taxable years beginning after March 12, 1991, also contain a special rule for private foundations.

Allocation of the Charitable

Contribution Deduction

Solely to U.S.-Source Income

Is Consistent With the Policy

Basis Underlying Treas. Reg.

[sections] 1.861-8

The practical effect of the proposed regulations is to deny a taxpayer having excess foreign tax credits any benefit from contributions for use outside the United States. Because of this effect, the regulations were criticized in 1991 as both dampening the climate for philanthropy at a time when such contributions are desperately needed and being inconsistent with the government efforts to encourage charitable giving and volunteerism -- as evidenced most recently by President Clinton's January 24 announcement of an April 1997 summit on volunteerism (in which former President Bush and retired General Colin Powell, among others, will also participate). Thus, even if the proposed regulations can be justified on tax policy grounds, they have been properly criticized as undermining the national interest in encouraging corporations and other taxpayers to make contributions for use outside the United States, especially for disaster relief and humanitarian efforts.