Section 265 does not bar a charitable deduction in calculating UBTI

Plain-English summary

A tax-exempt organization claimed a charitable-contribution deduction when calculating its unrelated business taxable income. Chief Counsel considered whether section 265(a)(1) disallowed the deduction on the theory that it was allocable to the organization's generally tax-exempt income. The memorandum concluded that section 265 did not apply. A charitable contribution arises from the donor's intent to transfer money or property without receiving a return benefit, rather than from earning or using a particular source of income. The organization therefore could claim the section 170 deduction permitted by section 512(b)(10), subject to that provision's 10-percent limit.

Ruling snapshot

• Question: Was the charitable-contribution deduction allowed in calculating UBTI disallowed as allocable to tax-exempt income under section 265(a)(1)?
• Outcome: advice given (section 265(a)(1) did not disallow the deduction)
• Key authorities: IRC §§ 170, 265(a)(1), 501(a), 501(c)(3), 512(a)(1), 512(b)(10)

Full text (IRS public release)

           Office of Chief Counsel
           Internal Revenue Service
           Memorandum
           CC:ITA:B07:JFLIECHTY                     Third Party Communication: None
           POSTU-102382-20                          Date of Communication: Not Applicable


           Number: 202027003
           Release Date: 7/2/2020

UILC:      265.00-00, 512.10-00, 170.00-00

  date:    June 04, 2020

     to:   John Q. Walsh, Jr.
           Area Counsel (Great Lakes Area Chicago)
           (TEGE Division Counsel)

  from:    Deena Devereux
           Senior Technician Reviewer, Branch 7
           Office of Associate Chief Counsel
           (Income Tax & Accounting)


subject:   Whether section 265 may be applied to disallow a section 170 charitable contribution
           deduction allowed under section 512(b)(10).


           This chief counsel advice responds to your request for assistance. This advice may not
           be used or cited as precedent.


           ISSUE

           Whether under section 265(a)(1) of the Internal Revenue Code, the charitable
           contribution deduction allowed under section 512(b)(10) is allocable to tax-exempt
           income and therefore not deductible in calculating unrelated business taxable income
           under section 512(a)(1)?

           CONCLUSION

           Section 265(a)(1) may not be applied to disallow a section 170 charitable contribution
           deduction allowed under section 512(b)(10) in calculating unrelated business taxable
           income under section 512(a)(1). This is because a charitable contribution is not
POSTU-102382-20                              2

allocable to tax-exempt income, but instead arises from a donor’s charitable intent to
voluntarily transfer money or property without receiving any benefit in return.


FACTS

An organization described in section 501(c)(3) (Organization) files a Return of
Organization Exempt from Income Tax (Form 990). Organization also files an Exempt
Organization Business Income Tax Return (Form 990-T). Organization files claiming a
charitable contribution deduction in calculating unrelated business taxable income
(UBTI).

LAW AND ANALYSIS

Section 265(a)(1) provides that no deduction is allowed for any amount otherwise
allowable as a deduction which is allocable to one or more classes of income wholly
exempt from the taxes imposed by Subtitle A, Income Taxes.

Section 512(b)(10) provides that in calculating UBTI, the charitable contribution
deduction allowed by section 170 is allowed whether or not directly connected with the
carrying on of the trade or business, but shall not exceed 10 percent of UBTI.

Section 170(a)(1) allows a deduction for any charitable contribution payment of which is
made within a taxable year. A charitable contribution is defined under section 170(c) as
a contribution or gift to or for the use of certain qualified donees (which include a section
501(c)(3) organization).

Other than UBTI, Organization’s income generally is not subject to tax under
section 501(a) and therefore falls within the classes of income considered tax-exempt
income for purposes of section 265(a)(1). In order to determine if expenses are
allocable to tax-exempt income for purposes of section 265(a)(1), courts have looked to
whether the expenses were “intended to be covered” by tax-exempt income or whether
the expenses would not exist “but for” the tax-exempt income. See Induni v.
Commissioner, 990 F.2d 53 (1993); Dalan v. Commissioner, T.C. Memo. 1988-106.
Similarly, Rev. Rul. 83-3 disallows expenses under section 265(a)(1) that were incurred
for the purpose of earning or otherwise producing tax-exempt income and expenses
that were incurred in carrying out the specific purpose to which the tax-exempt income
is earmarked. 1983-1 C.B. 72, modified by Rev. Rul. 87-32, 1987-1 C.B. 131.

In order to establish that a “contribution or gift” has been made under section 170, a
taxpayer must show a voluntary and irrevocable transfer of ownership of money or
property without the receipt of adequate consideration or a substantial return benefit.
See United States v. American Bar Endowment, 477 U.S. 105, 116 (1986); see also
Transamerica Corp. v. United States, 902 F.2d 1540 (Fed. Cir. 1990); Singer Co. v.
United States, 449 F.2d 413 (Ct. Cl. 1971). In determining whether a taxpayer has
POSTU-102382-20                             3

made a contribution without the expectation of any return benefit or quid pro quo, the
“external features of the transaction in question” are examined. Hernandez v.
Commissioner, 490 U.S. 680, 690 (1989). In addition, the taxpayer is required to have
charitable intent in making the contribution. See American Bar Endowment, 477 U.S. at
118.

A charitable contribution is, by its nature, not allocable to any source of income, but
instead arises from a donor’s charitable intent to voluntarily transfer money or property
without receiving any benefit in return. Consequently, section 265(a)(1) may not be
applied to disallow Organization’s charitable contribution deduction claimed in
computing UBTI under section 512(a)(1).

This advice applies only under the facts and circumstances described herein.

Pursuant to section 6110(k)(3) of the Code, this document may not be used or cited as
precedent. Please call (202) 317-7005 if you have any further questions.