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§ 4.9 CHARITABLE PLEDGESwhich the charitable donee, having acquired the option, exercises it. 90 Anotherillustration of this is a funding agreement, under which a person commits in writingto make multiple contributions to a charitable organization over a statedperiod, for purposes such as general operations or endowment: The charitablecontribution arises in each year of actual payment. 91As one court case reflects, however, a charitable pledge can arise in otherways. A trustee of a small college and his colleagues were concerned about thelong-term financial viability of the institution. He wanted to substantially augmentthe college’s endowment fund. To that end, he caused a company (ofwhich he was the president) to issue (in 1981) to the college a zero-coupon original-issuediscount bond, with a term of 50 years and a $20 million face amount,payable upon maturity in 2031 (unless the bond was retired early). The purchaseprice of the bond was $23,066 (representing the 1981 present value of $20 million,payable in 50 years, discounted semi-annually using a 14 percent annualinterest rate). The company was obligated to maintain a sinking fund sufficientto retire the bond at full maturity; it had the option to retire the bond at a discountafter July 1986. The president of the company personally arranged for contributionsto the school to cover the purchase price of the bond.The company is on the accrual basis of accounting. The total interest that isto accrue over the term of the bond (the original issue discount) is $19,976,934.One-fiftieth of the total discount is $399,539. That amount is what the companyannually transferred to the sinking fund and deducted as interest accrued onindebtedness. 92 The mechanics of this transaction were dynamic. The accruedinterest would have been taxable to a commercial taxpayer; the college, however,being tax-exempt, was excused from this tax liability. In 2031, it will receive$20 million for a 1981 outlay of $23,066. The company could have retired thebond as early as August 1, 1986; the retirement payment would have been$45,377, with the company enjoying about $2 million in tax deductions. (Even ifthe IRS recaptured a tax deficiency attributable to the company’s deductions forinterest accrued but not paid, the company would have had the use of thatmoney to invest in the meantime.) The IRS asserted, however, and a courtagreed, that the transaction lacked a business purpose other than tax avoidance,and disallowed the deductions. 93 The court concluded that the bond was a legitimateindebtedness for tax purposes and that the transaction had some economicsubstance for the company. The court made an evaluation of thecompany’s motive for the transaction and found that it was (other than tax benefits)a means to provide the college with an investment that would substantiallyenhance its endowment. The court wrote that this motive, “while admirable, iswholly unlike the economically self-interested purpose that taxpayers mustdemonstrate.” 94Thus, in the absence of any other economic, commercial, or business purposefor the bond transaction, the court found that it lacked the requisite independent90 E.g., Priv. Ltr. Rul. 200202034.91 E.g., Priv. Ltr. Rul. 200241044.92 IRC § 163(a).93 Peerless Indus., Inc. v. United States, 94-1 U.S.T.C. 50,043 (E.D. Pa. 1994).94 Id. at 83,174. 143