Ann Jackson Family Foundation v. C.I.R.

• Decision Date: 04 February 1994
• Docket Number: No. 92-70211,92-70211
• Parties: -1023, 62 USLW 2494, 94-1 USTC P 50,068 The ANN JACKSON FAMILY FOUNDATION, Petitioner-Appellee, v. COMMISSIONER INTERNAL REVENUE SERVICE, Respondent-Appellant.
• Court: U.S. Court of Appeals — Ninth Circuit

Page 917

15 F.3d 917

73 A.F.T.R.2d 94-1023, 62 USLW 2494, 94-1

USTC P 50,068

The ANN JACKSON FAMILY FOUNDATION, Petitioner-Appellee, v. COMMISSIONER INTERNAL REVENUE SERVICE, Respondent-Appellant.

No. 92-70211.

United States Court of Appeals Ninth Circuit.

Argued and Submitted Aug. 12, 1993.

Decided Feb. 4, 1994.

Robert W. Wood, Bancroft & McAlister, San Francisco, California, for petitioner-appellee.

Joan I. Oppenheimer, Tax Division, United States Department of Justice, Washington, D.C., for the respondent-appellant.

Appeal from a Decision of the United States Tax Court.

Before: REINHARDT and LEAVY, Circuit Judges, and MERHIGE, ^* District Judge.

LEAVY, Circuit Judge:

In this case we are called upon to decide whether the Tax Court erred by invalidating a federal income tax regulation on the ground that it was inconsistent with its governing statute. For the reasons which follow, we affirm that decision.

FACTS AND PRIOR PROCEEDINGS

In December 1978 Ann Gavit Jackson ("Jackson") established The Ann Jackson Family Foundation ("Foundation"), a private, non-operating, tax-exempt entity whose sole function was and is to award grants to charitable organizations. In order to fund the Foundation, Jackson created The Ann Jackson Family Charitable Trust ("Trust") in February 1979. The Trust, a split-interest charitable lead trust, ¹ was funded by an initial contribution from Jackson of $5,000,000, for which donation she took a one-time income tax deduction of $4,164,000. The Trust invested this $5,000,000 from which it distributes to the Foundation an amount equal to 7% of the Trust corpus, or some $350,000, per year. The Foundation in turn annually donates at least 5% of its income to various charities and invests the undonated portion.

This Trust-Foundation arrangement will expire after twenty years, at which time any funds remaining in the Trust will be paid over to Jackson's heirs. The Foundation will continue in operation, however, based on the assumption that it will have accumulated enough capital from its twenty years of investing the undonated portions of its annual income to be entirely self-sufficient.

In September 1989 the Internal Revenue Service ("IRS") issued a Notice of Deficiency ("Notice") to the Foundation for tax years 1983 through 1989, assessing the Foundation with first tier income tax deficiencies under 26 U.S.C. Sec. 4942(a) ² of $603,651, a second tier income tax deficiency under 26 U.S.C. Sec. 4942(b) ³ of $815,079, and additions to tax (penalties) under 26 U.S.C. Sec. 6651(a)(1) ⁴ of $150,911. Relying on 26 C.F.R. Sec. 53.4942(a)-2, ⁵ the IRS contended that the Trust's original corpus of $5,000,000, and not merely its annual distributions of $350,000, had to be attributed to the Foundation; and, since the Foundation was required by law to donate annually at least 5% of its assets in order to retain its tax-exempt status, see 26 U.S.C. Sec. 4942(e), ⁶ the Foundation was subject to excise taxes because it was not donating an amount equal to at least 5% of $5,000,000. ⁷

The Foundation filed the instant petition with the United States Tax Court ("Tax Court"), arguing that, because the Foundation and Trust were separate and distinct entities, the 5% statutory minimum investment requirement of 26 U.S.C. Sec. 4942(e) applied only to the Foundation's own assets, including the annual $350,000 Trust distribution, but not to the Trust's $5,000,000 original corpus nor to anything else owned or held by the Trust.

The case was tried on stipulated facts. In an opinion authored by Senior Tax Judge Tannenwald, the Tax Court rejected all of the assessed deficiencies and additions to tax, holding that 26 C.F.R. Sec. 53.4942(a)-2(b)(2) was invalid because it was inconsistent with its governing statute, 26 U.S.C. Sec. 4942(e). Judge Tannenwald's decision was reviewed by the full Tax Court and unanimously upheld. ⁸ See The Ann Jackson Family Foundation v. C.I.R., 97 T.C. 534, 1991 WL 231, 243 (1991) ("Family Foundation "). It is from this decision that the IRS has appealed.

ANALYSIS

Standard of Review

Because the underlying facts are not in dispute, the only question before us is one of law. We review the Tax Court's legal conclusions de novo. See Walt Disney, Inc. v. C.I.R., 4 F.3d 735, 738 (9th Cir.1993). ⁹

Discussion

I

The IRS first argues that we should not overturn 26 C.F.R. Sec. 53.4942(a)-2 because it was duly promulgated by the agency charged with applying and interpreting our nation's tax laws and is of long-standing duration. We reject this argument.

Interpretive regulations, like the one involved here, are promulgated under the IRS's authority to "prescribe all needful rules and regulations[.]" 26 U.S.C. Sec. 7805(a); Pacific First Fed. Savs. Bank v. C.I.R., 961 F.2d 800, 803 (9th Cir.), cert. denied, --- U.S. ----, 113 S.Ct. 209, 121 L.Ed.2d 150 (1992). Such regulations, however, are entitled to less judicial deference than are those issued pursuant to a specific grant of authority. United States v. Vogel Fertilizer Co., 455 U.S. 16, 24, 102 S.Ct. 821, 827, 70 L.Ed.2d 792 (1982); L & F Int'l Sales Corp. v. United States, 912 F.2d 377, 380 n. 2 (9th Cir.1990); Cameron v. C.I.R., 98 T.C. 123, 125, 1992 WL 17458 (1992). As the Tax Court recently noted,

[A]lthough regulations are entitled to considerable weight, the Secretary may not usurp the authority of Congress by adding restrictions to a statute which are not there. A regulation is not a reasonable statutory interpretation unless it harmonizes with the plain language of the statute, its origin, and its purpose.

Nalle v. C.I.R., 99 T.C. 187, 191, 1992 WL 184967 (1992) (internal citations omitted). Accordingly, the mere fact that the interpretive regulation in the instant appeal was issued by the Secretary of the Treasury some twenty years ago is no argument against either the Tax Court's overturning that regulation or our upholding that ruling if the regulation fails to "implement the congressional mandate in some reasonable manner." Pacific, 961 F.2d at 803 (quoting National Muffler Dealers Ass'n v. United States, 440 U.S. 472, 476, 99 S.Ct. 1304, 1306, 59 L.Ed.2d 519 (1979)).

II

Congress perceived a problem back in 1969 involving tax-motivated investments being made in non-productive assets. In an effort to encourage more income-producing investment, Congress passed the Tax Reform Act of 1969 ("1969 Act"), Pub.L. No. 91-172, 83 Stat. 502 (1969). Section 101(b) of the 1969 Act, since codified (in part) as 26 U.S.C. Sec. 4942, imposes an excise tax on a private foundation's undistributed income, defined as the excess of "distributable amount" over "qualifying distributions". 26 U.S.C. Sec. 4942(c). "Distributable amount" is in turn defined as an amount equal to "the sum of the minimum investment return" (generally pegged at 5% of the fair market value of the foundation's assets) plus certain other items not here relevant. ¹⁰ 26 U.S.C. Sec. 4942(d)(1); Family Foundation, 97 T.C. at 538-39.

In 1971 the Secretary of the Treasury proposed a regulation designed to implement the provisions of section 4942 noted above. That regulation, with some modifications, became 26 C.F.R. Sec. 53.4942(a)-2 two years later.

By 1981 Congress was becoming increasingly concerned about the ravages of inflation and the resultant investment strategies of tax-exempt foundations and trusts. Accordingly, Congress amended 26 U.S.C. Sec. 4942 by way of section 823 of the Economic Recovery Tax Act of 1981 ("ERTA"), Pub.L. No. 97-34, 95 Stat. 351 (1981). That section eliminated the dual distribution requirement of 26 U.S.C. Sec. 4942 by deleting that portion of section 4942 which included the language "or the adjusted gross income (whichever is higher)." By doing so, ERTA Sec. 823 effectively limited the meaning of "distributable amount" to "minimum investment return", i.e., 5% of the fair market value of a foundation's assets, in an effort to encourage fund managers to invest in things offering yields greater than 5%. See Family Foundation, 97 T.C. at 540.

While this change to section 4942 is consistent with the provisions of 26 U.S.C. Sec. 4947 ¹¹ (also part of section 101(b) of the 1969 Act; see Family Foundation, 97 T.C. at 539), it is inconsistent with 26 C.F.R. Sec. 53.4942(a)-2(b)(2), which was never revised to reflect the 1981 change made to 26 U.S.C. Sec. 4942 and its definition of "distributable amount". By placing the amended statute alongside the unrevised regulation, the difference between the two becomes obvious: Under the statute, "distributable amount" is effectively limited to a maximum of 5% of the fair market value of a foundation's own assets, while the regulation defines "distributable amount" as beginning with that same 5%, then adding thereto the income portion of trusts (which the IRS seeks to have here defined as including the Trust's entire corpus). In short, the regulation seeks to include all of the Trust's assets in those of the Foundation. ¹²

We agree with the Tax Court's conclusion that the unrevised regulation and the amended provision of section 4942 cannot be read as being consistent with each other. Were we to adopt the IRS's position, the Trust's original corpus of $5,000,000 would have to be attributed to the Foundation as its property and not that of the Trust. This not only flies in the face of the clear wording of the governing statute, but perverts the Congressional intent exhibited by the 1981 amendment to that statute, as it would force charitable foundations to give away nearly all of their annual investment income without reinvesting enough to allow those foundations to continue in existence.

Under these circumstances we conclude with the Tax Court that the regulation fails to implement the congressional mandate in a reasonable manner. See Pacific, 961 F.2d at 803. Accordingly, the decision appealed from is

AFFIRMED.

* The Honorable Robert R. Merhige, Jr., Senior District Judge for the Eastern District of...