CCA 200850027: the charitable deduction clears the percentage limitation and is then denied by a different rule

Plain-English summary

A four page Office of Chief Counsel memorandum, control number "POSTN-126676-08", dated August 28, 2008 and released 12/12/2008. It answers two questions put by a field attorney in Manhattan about a corporation that holds a residual interest in a real estate mortgage investment conduit, a REMIC. The subject line is "Charitable contributions and REMICs".

The facts are spare. In the years at issue the taxpayer recognised excess inclusion income, abbreviated EII, and otherwise had only net operating losses. In Year 1 it had EII of $X, unspecified net operating losses, and made a charitable contribution of $Y. It argued that $Y was deductible because $Y was less than 10 percent of its EII, an amount the memorandum calls $Z.

The taxpayer wins the first question and loses anyway. That two step structure is the whole interest of the document.

On question one, the answer is that taxable income for the corporate charitable contribution ceiling in § 170(b)(2)(A) "means taxable income under § 63 as adjusted for EII under § 860E." The reasoning is a closed list argument. Section 170(b)(2)(C) and § 1.170A-11(a) set out the only five adjustments to taxable income for this purpose, covering the charitable deduction itself, the special corporate deductions other than § 248, net operating loss carrybacks under § 172, § 199, and capital loss carrybacks under § 1212(a)(1). "Section 170(b)(2)(C) does not provide an adjustment for EII under § 860E." Because the list does not exclude it, the § 860E floor stands, and so "pursuant to § 860E (and despite Taxpayer's NOLs), Taxpayer's taxable income in Year 1 is $X." The ceiling is therefore 10 percent of $X, which is $Z, and the contribution $Y sits under it.

On question two, that turns out not to matter. Section 860E does more than set a floor under taxable income. Under § 1.860E-1(a), quoted at length, "Excess inclusion cannot be offset by otherwise allowable deductions", and the regulation works the point through an example: a holder with $100 of gross income, $25 of it an excess inclusion, and $90 of business deductions has taxable income of $25 and a net operating loss of $15. So the deduction cannot reach the EII. It can only be taken against other taxable income, and this taxpayer had none. The conclusion is that "no part of the $Y charitable contribution is deductible in Year 1."

Put plainly, the percentage limitation was never the operative constraint. The taxpayer framed the case as a computation question about the size of the ceiling. The memorandum answers that question in the taxpayer's favour and then points out that the ceiling is irrelevant, because a separate rule keeps the deduction away from the only income there is. The advice is careful to say the deduction is not destroyed but stranded: the taxpayer "may only deduct $Y to the extent Taxpayer's other taxable income exceeds its EII."

The memorandum's authorship reflects the seam it sits on. It goes out over two signatures from two different branches, "John P. Moriarty, Branch Chief, Branch 1 (Income Tax & Accounting)" and "Susan Thompson Baker, Assistant Branch Chief, Branch 2 (Financial Institutions & Products)". It routes follow up questions the same way, splitting them by issue rather than by document: questions on the § 170 issue go to Nancy Lee in CC:ITA:B01, questions on the § 860E issue go to Richard LaFalce in CC:FIP:B02. The charitable contribution half and the REMIC half were each answered by the branch that owns that part of the Code, and the memorandum does not pretend otherwise.

Two extraction and drafting points, recorded rather than repaired, since the document came from a clean text layer.

First, the legend heading is doubled. The line reads "LEGENDLEGEND", the only occurrence of the word in the document, with the six defined terms following it.

Second, a number disagreement in the statement of the rule: "deductions for charitable contributions made by a corporation is limited to a maximum of 10 percent of the corporation's taxable income for the taxable year." Plural subject, singular verb. Nothing turns on it, and it is reproduced as released.

Like the six railroad coordination memoranda released on the same day, docs/2008/0850033.md, docs/2008/0850032.md, docs/2008/0850031.md, docs/2008/0850030.md, docs/2008/0850029.md and docs/2008/0850028.md, this memorandum prints no section 6110 disclosure paragraph of its own. The string 6110 does not appear anywhere in it, which was verified against the released text of all seven documents before this entry was written. The not for precedent banner above is supplied by this corpus, not quoted from the document.

The first page carries the memorandum's label column, so "to:", "from:", "date:" and "subject:" sit at the left margin while the text beside them is indented. That is the document's own layout and the text has been kept exactly as extracted.

Every authority cited is a Code section or a Treasury regulation; no case is cited. The citation check this corpus normally runs could not be performed because the legal research tool is unavailable in this session, so the cites are reproduced exactly as released and none has been supplied or corrected from memory.

Ruling snapshot

• Question: Does EII count in taxable income when computing the 10 percent corporate charitable contribution ceiling under § 170(b)(2)(A), and may a REMIC residual interest holder whose only income is EII deduct a charitable contribution that falls under that ceiling?
• Outcome: Advice given. Yes to the first: taxable income for this purpose is § 63 taxable income as adjusted for EII under § 860E, because § 170(b)(2)(C) lists the only adjustments and EII is not among them. No to the second: § 860E and § 1.860E-1(a) bar EII from being offset by otherwise allowable deductions, and with no other taxable income the contribution is not deductible in Year 1.
• Key authorities: §§ 63(a), 170, 170(b)(2)(A), 170(b)(2)(C), 172, 199, 248, 860E, 860E(a)(1), 1212(a)(1); Treas. Reg. §§ 1.170A-11(a) and 1.860E-1(a).

Full text (IRS public release)

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Office of Chief Counsel
Internal Revenue Service
Memorandum
Number: 200850027
Release Date: 12/12/2008
CC:ITA:B01: ---------
POSTN-126676-08

UILC: 170.08-00, 860E.01-00

date: August 28, 2008

 to:   Elizabeth S. Martini
       Attorney (Manhattan, Group 3)
       (Large & Mid-Size Business)

from: John P. Moriarty
Branch Chief, Branch 1
(Income Tax & Accounting)

       Susan Thompson Baker
       Assistant Branch Chief, Branch 2
       (Financial Institutions & Products)

subject: Charitable contributions and REMICs

LEGENDLEGEND

       Taxpayer = ----------------------------------------
       Year 1 = -------
       Year 2 = -------
       $X = --------------
       $Y = ---------------
       $Z = ---------------

       FACTS

       Taxpayer is a corporation that holds a residual interest in a real estate mortgage
       investment conduit (REMIC). In tax years Year 1 through Year 2, Taxpayer recognized
       excess inclusion income (EII) but otherwise had only net operating losses. Specifically,
       for tax year Year 1, Taxpayer recognized EII in the amount of $X, had unspecified net
       operating losses (NOLs), and made a charitable contribution in the amount of $Y.

POSTN-126676-08 2

Taxpayer asserts that its taxable income for purposes of calculating the percentage
limitation under § 170(b)(2)(A) of the Internal Revenue Code includes its EII under
§ 860E. Further, taxpayer asserts that its $Y charitable contribution in Year 1 is
deductible under § 170 because $Y is less than 10 percent of Taxpayer’s EII for that
taxable year, or $Z.

ISSUES

(1) Does taxable income for purposes of calculating the percentage limitation under
§ 170(b)(2)(A) of the Internal Revenue Code on corporate charitable contribution
deductions include Taxpayer’s EII under § 860E?

(2) May Taxpayer in Year 1 deduct $Y as a charitable contribution deduction under
§ 170 when Taxpayer only has EII and net operating losses during the taxable year of
the charitable contribution?

CONCLUSIONS

(1) Taxable income for purposes of calculating the percentage limitation under
§ 170(b)(2)(A) means taxable income under § 63 as adjusted for EII under § 860E.

(2) Taxpayer in Year 1 may not deduct $Y as a charitable contribution deduction
under § 170. In general, a holder of a residual interest in a REMIC may not offset EII by
an otherwise allowable charitable contribution deduction, and, in this case, the taxpayer
did not have other taxable income in Year 1.

LAW AND ANALYSIS

Section 63(a) generally provides that “taxable income” means gross income minus the
deductions allowed by chapter 1 of the Code (other than the standard deduction).
Under § 860E(a)(1) the taxable income of any holder of a residual interest in a REMIC
for any taxable year is not less than the holder’s excess inclusion for such taxable year.

Section 170 provides a deduction for qualified charitable contributions. However, under
§ 170(b)(2)(A), deductions for charitable contributions made by a corporation is limited
to a maximum of 10 percent of the corporation’s taxable income for the taxable year.

For purposes of calculating the percentage limitation under § 170(b)(2)(A), a
corporation’s taxable income is defined as taxable income under § 63 computed without
regard to—

  (1)    the deduction for charitable contributions under § 170;

POSTN-126676-08 3

   (2)     the special deductions for corporations allowed under part VIII (except
           § 248, relating to organizational expenditures), subchapter B, chapter 1 of
           the Code;
   (3)     any net operating loss carryback to the taxable year under § 172;
   (4)     section 199; and
   (5)     any capital loss carryback to the taxable year under § 1212(a)(1).

Sec. 170(b)(2)(C); § 1.170A-11(a) of the Income Tax Regulations.

Under section 860E, the taxable income of a holder of a residual interest in a REMIC is
not less than the holder’s excess inclusion. Taxable income for purposes of calculating
the percentage limitation under § 170(b)(2)(A) on corporate charitable contributions is
adjusted only by the items listed in § 170(b)(2)(C). Section 170(b)(2)(C) does not
provide an adjustment for EII under § 860E. Therefore, the general rule that the taxable
income of a holder of a residual interest in a REMIC is not less than the holder’s excess
inclusion applies. That is, pursuant to § 860E (and despite Taxpayer’s NOLs),
Taxpayer’s taxable income in Year 1 is $X. As a result, Taxpayer’s percentage
limitation under § 170(b)(2)(A) is 10 percent of $X, or $Z.

Under § 170(b)(2)(A), Taxpayer’s deduction for charitable contributions made in Year 1
is limited to $Z. However, even though $Y is less than $Z, Taxpayer may not
necessarily deduct its Year 1 qualified charitable contribution. Instead, Taxpayer’s
otherwise allowable deductions (including the charitable contribution deduction under
§ 170) may be limited under other provisions of the Code such as § 860E.

Under § 860E a taxpayer’s EII may not be offset by otherwise allowable deductions.
Section 1.860E-1(a) provides as follows:

            Excess inclusion cannot be offset by otherwise allowable deductions—(1) In
   general. Except as provided in paragraph (a)(3) of this section, the taxable income of
   any holder of a residual interest for any taxable year is in no event less than the sum of
   the excess inclusions attributable to that holder's residual interests for that taxable year.
   In computing the amount of a net operating loss (as defined in section 172(c)) or the
   amount of any net operating loss carryover (as defined in section 172(b)(2)), the amount
   of any excess inclusion is not included in gross income or taxable income. Thus, for
   example, if a residual interest holder has $100 of gross income, $25 of which is an
   excess inclusion, and $90 of business deductions, the holder has taxable income of $25,
   the amount of the excess inclusion, and a net operating loss of $15 ($75 of other income
   - $90 of business deductions).

Under § 1.860E-1(a) of the regulations (subject to an exception relating to certain
financial institutions not here relevant), the taxable income of any holder of a residual
interest for any taxable year is in no event less than the sum of the excess inclusions
attributable to that holder’s residual interests for that taxable year. Accordingly, to the
extent of EII, the taxable income of the holder of the residual interest in the REMIC may
not be offset by a charitable contribution deduction otherwise allowable to the holder
POSTN-126676-08 4

under § 170. Assuming all other requirements under § 170 are satisfied, Taxpayer in
Year 1 may only deduct $Y to the extent Taxpayer’s other taxable income exceeds its
EII. In this case, Taxpayer has no other taxable income, and, therefore no part of the
$Y charitable contribution is deductible in Year 1.

If you have any questions regarding the § 170 issue, please call Nancy Lee
(CC:ITA:B01) at --------------------, and if you have any questions regarding the § 860E
issue, please call Richard LaFalce (CC:FIP:B02) at ---------------------.
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