The Bankruptcy Code and Charitable Contributions

Millions of Americans support charitable and religious organizations with financial gifts every year. For some time, Congress has articulated a public policy in favor of charitable giving. The best known example is the charitable income tax deduction, which has been around since the War Revenue Act of 1917. This public policy also led to the adoption of the Religious Liberty and Charitable Donation Act of 1998 and a follow-on Religious Liberty and Charitable Donation Clarification Act of 2006. Prior to these acts, a bankruptcy debtor's ability to continue charitable giving in and around bankruptcy was limited, and charitable organizations were sometimes sued by bankruptcy trustees to return gifts to be redistributed to creditors. This post briefly discusses the current protections in the bankruptcy code.

In chapter 7, the debtor's past patten of charitable giving is broadly excluded by section 707(b)(1) from a court's considerations when ruling on a motion to dismiss under section 707, including motions to dismiss related to the 707(b)(2) means test. The exclusion is implemented as a deduction for continued charitable giving on the official form B22A calculation of disposable income for chapter 7 means testing. In chapter 13, charitable contributions also receive special treatment. Section 1325(b)(2)(A)(ii) provides that debtors may deduct from disposable income available to creditors reasonably necessary charitable contributions in an amount not to exceed 15 percent of gross income. These provisions cause the bankruptcy process to respect an individual debtor's choice to give to charity.

Two sections of the code work together to protect past charitable contributions from being undone by a bankruptcy trustee for redistribution to creditors. Section 548(a)(2) excludes transfers of charitable contributions from the scope of the constructive fraudulent transfer statute, as long the contribution does not exceed 15 percent of gross income in the contribution year or is otherwise consistent with the debtor's past practices. This exclusion is important, as the 548(a)(1)(B) constructive fraudulent transfer statute can be invoked on showing of insolvency and lack of reasonably equivalent value, and such equivalence is nebulous for charitable gifts. Furthermore, section 544(b)(2) provides that non-bankruptcy federal and state law causes of action to avoid a transfer of a charitable contribution are preempted by the filing of a bankruptcy case, and are therefore unavailable to a trustee. The effect of these two code sections is to leave only actual fraud under 548(a)(1)(A) as a grounds to undo a charitable gift as a fraudulent transfer. Therefore, while a debtor cannot give money to charity for the purpose of keeping it from creditors, he or she can otherwise make normal gifts which can stand up through bankruptcy.

The Bankruptcy Code borrows from the Internal Revenue Code the definition of charitable contribution, with the qualification that the contribution must be cash or a financial instrument. This definitional borrowing ensures substantial overlap between tax-deductible charitable contributions and those qualifying for special bankruptcy treatment. A debtor's history of giving as represented on prior tax returns is important information for substantiating a pattern of charitable giving.

An example recent case applying the chapter 13 charitable contribution deduction is In re Gamble, No. 11-80131 (Bankr. M.D.N.C. June 15, 2011) (Aron, J.), http://scholar.google.com/scholar_case?case=12069299268505610186.