Trends & Developments - October 2012 - Substantial Compliance Is Usually Insufficient to Obtain Charitable Deductions
The Internal Revenue Code allows a deduction for charitable contributions, which gives charitably inclined taxpayers the ability to, in effect, have the U.S. Treasury fund part of their charitable contributions by reducing those taxpayers’ tax liability. Charitable contribution deductions are allowed for both the regular tax computation, the alternative minimum tax computation and many state tax computations. However, as recent court decisions make clear, in the absence of compliance with specific procedures and requirements, a taxpayer can lose the tax benefit of his or her charitable contributions.
For example, in the recent case of Mohamed, Sr. v. Commissioner, TC Memo 2012-152 (5/29/2012), the taxpayers gave very valuable real estate (worth over $15million) to charitable entities but did not achieve any tax deduction, even though the value of the property was not in question, the property was validly transferred, and the recipients were qualified charitable entities. The taxpayer had prepared his own tax returns and had included significant information about the property he donated. However, he did not properly complete a Form 8283, Noncash Charitable Contributions, nor fully comply with the relevant Treasury Regulations requiring certain substantiation in order to obtain a charitable deduction. Those regulations require that this type of donation be substantiated by a qualified appraisal and that a fully completed appraisal summary be attached to the return (or included on the Form 8283). A qualified appraisal must be made no more than 60 days before the date of the donation and no later than the due date of the return on which the deduction is claimed. It must be made by an independent appraiser. The required appraisal summary must include the following:
- the name and Social Security Number of the donor;
- a description of the property;
- a brief summary of the overall physical condition of the property;
- the manner and date of the donor’s acquisition of the property;
- the cost or other basis of the property;
- the name, address, and taxpayer identification number of the charitable entity (the donee);
- the date the donee received the property;
- a statement about whether the contribution involved a bargain sale;
- the name, address, and taxpayer identification number of the qualified appraiser;
- the appraised fair market value of the property;
- a declaration by the appraiser that s/he is an appraiser, with sufficient qualifications to make the appraisal, and not a person unable to provide a qualified appraisal (i.e., that s/he meets the tests for independence); and
- a statement by the appraiser that the fee charged was not prohibited, and that the appraiser has not been barred from presenting appraisals to the Internal Revenue Service.
Since the taxpayers had not complied with the substantiation requirements, they attempted to have the Treasury Regulations invalidated and/or rely on a doctrine of “substantial compliance” because their tax returns included much of the information that would have been in a qualified appraisal. The Tax Court ruled against the taxpayers on both of these issues and denied any charitable deduction.
Another recent Tax Court decision shows that even a deduction for a cash contribution to a bona fide charity can be denied for a failure to comply with the statutory and regulatory requirements. In David P. Durden v. Commissioner, TC Memo 2012-140 (5/17/2012), the taxpayers had made various contributions by cash and check to their church during 2007, most of which exceeded $250. They were able to produce cancelled checks for most of the contributions and they obtained a letter from the church dated January 10, 2008, which acknowledged that the taxpayers made contributions during 2007 totaling $22,171. However, upon examination of the taxpayers’ return, the Internal Revenue Service noted that the letter from the church did not contain a statement relating to whether any goods or services were provided in consideration for the contributions. The taxpayers obtained a second letter from the church dated June 21, 2009, that contained a statement that no goods or services were provided to the taxpayers in exchange for their contributions.
Section 170(f)(8)(A) of the Internal Revenue Code states: “No deduction shall be allowed…for any contribution of $250 or more unless the taxpayer substantiates the contribution by a contemporaneous written acknowledgment of the contribution by the donee organization that meets the requirements of subparagraph (B).” For donations of money, the donee’s written acknowledgement must state the amount contributed, indicate whether any goods or services were provided, in whole or in part, by the donee organization for the contribution, and provide a good faith estimate of the value of any such goods or services. The written acknowledgment is considered contemporaneous if it is obtained on or before the earlier of (1) the date the taxpayer files the original return for the year of the contribution or (2) the due date (including extensions) for filing of that return. Since the second acknowledgment letter from the church was issued after this time period, the court disregarded it. Moreover, because the first letter did not contain the language required by the Treasury Regulations, the court denied the charitable deduction.
Given this trend requiring strict compliance with the rules for obtaining a charitable deduction, it is very important to comply fully and make sure that your tax returns contain the proper information. While it seems harsh to deny a deduction for contributions that have certainly been made, this is an area where you should dot your “I’s” and cross your “T’s.”
The following items are intended to assist you in obtaining a charitable deduction for your charitable donations:
- Make sure the organization qualifies. Charitable contributions must be made to qualified organizations to be deductible. You can ask the organization to verify that is a qualified organization or check IRS Publication 78, Cumulative List of Organizations (available at www.irs.gov).
- If your contribution entitles you to receive merchandise, goods, or services in return – such as admission to a charity banquet or sporting event – deduct only the amount that exceeds the fair market value of the benefit received.
- Keep good records of any contribution you make, regardless of the amount. For any cash contribution, you must maintain a record of the contribution, such as a cancelled check, bank or credit card statement, payroll deduction record or a written statement from the charity containing the date and amount of the contribution and the name of the organization. As indicated above, for any contribution of $250 or more you need more than this type of record. You must have a written acknowledgment from the organization. It must include the amount of cash and say whether the organization provided any goods or services in exchange for the gift. If you donated property, the acknowledgment must include a description of the items and a good faith estimate of their value. If you received solely intangible religious benefits for your contribution, the acknowledgment must so state.
- If you claim a deduction for a contribution of property (other than cash or publicly traded securities) worth more than $5,000, obtain a qualified appraisal. A written appraisal is not required for contributions of non-publicly traded stock with a value of $10,000 or less.
- For noncash items with a value of $500 or more, attach a properly completed Form 8283 (Noncash Charitable Contributions) to your income tax return.
It is generally advantageous to make charitable contributions of appreciated property held by you as a capital asset for more than 12 months (“appreciated long-term capital gain property”). The advantage arises because you are not required to pay capital gains tax on the appreciation, yet you obtain a charitable deduction for the property’s fair market value. Frequently, such contributions are of stock, other securities, art, or real estate. In order to obtain the tax benefit of such a deduction, you must comply with certain rules:
- As mentioned above, you must have held the property for over 12 months.
- If the property is given to a public charity (or an operating private foundation, which is a non-publicly supported organization that devotes most of its earnings to the active conduct of its exempt purposes), the amount deductible in the current year is limited to 30% of your adjusted gross income for that year.
- If the property is given to a non-operating private foundation, the amount deductible in the current year is limited to 20% of your adjusted gross income for that year. Furthermore, a deduction is allowed for a charitable contribution of corporate stock to a non-operating private foundation only if the property is “qualified appreciated stock.” This is stock of a corporation for which market quotations are readily available on an established securities market. It does not include any such stock to the extent that the amount contributed to the private foundation by the donor and members of the donor’s family (when increased by prior contributions) exceeds 10% in value of all the outstanding stock of the corporation.
- For charitable contributions that exceed the 30% or 20% limit, there is a five-year carryover. However, the adjusted gross income limitations can be increased in the following ways:
- If a non-operating private foundation makes qualifying contributions out of its corpus within 2½ months after the end of its taxable year equal to 100% of the contributions it received during that year, the 20% limitation for appreciated capital gain property increases to 30%.
- The 30% limitation for appreciated long-term capital gain property donated to public charities and private operating foundations can be increased to 50% by electing to limit the amount of your contribution to the property's cost. This is only advisable if your contributions would otherwise be limited and it is unlikely that you will benefit from the carryover in the future.
- If you are donating tangible personal property, in order to obtain the property’s full market value as a deduction, the appreciated property must qualify for long-term capital gain treatment had it been sold and the charitable organization must use this property in its exempt function (such as a work of art given to an art museum). Otherwise, the deduction will be limited to the lesser of your tax basis or the property’s fair market value. If the charitable organization disposes of the property within three years, the charitable deduction will be limited to your tax basis, unless the organization certifies to the Internal Revenue Service in writing that the property’s use was, or was intended to be, related to its exempt purpose or function.
- If you are making a charitable contribution of a vehicle valued at over $500, a conservation easement, or other property rights, other requirements must be satisfied and you should consult with your tax advisor before making the contribution.
While the above rules and limitations are somewhat complex, based on recent judicial decisions, a failure to comply with all formalities can cause the loss of your charitable deductions. On the other hand, diligent compliance can achieve the full tax savings provided for your charitable contributions!
Trends & Developments - October 2012 Issue
- Auditing Standards Update: PCAOB Adopts Auditing Standard No. 16, Communications with Audit Committees
- Tax Court: Substantial Compliance Is Usually Insufficient to Obtain Charitable Deductions
- Health Care Update: ICD-10 Implementation Is Coming!
- Firm News