The U.S. Court of Appeals for the District of Columbia affirmed the Tax Court’s denial of a $33 million charitable deduction in its entirety and imposition of the 40% gross valuation misstatement penalty because it did not fill out Form 8283 correctly. This decision is yet another example of the IRS’s increasingly aggressive position with regards to charitable deductions, pursuing cases where a taxpayer makes what could be seen as a clerical or honest mistake. The decision can be found here.
In 2003, RERI Holdings LLC, donated an interest it had in a web hosting facility in California to the University of Michigan. It claimed a $33 million deduction for the donation which was based on an appraisal conducted by Greenwich Realty Advisors. The appraisal was attached to its return. RERI also filled out Form 8283 for Noncash Charitable Contributions but left blank the space for “Donor’s cost or adjusted basis.” That simple omission proved fatal as the Tax Court disallowed the entire deduction on that basis.
In order to be entitled to claim a deduction for a contribution to a charitable organization, a taxpayer must satisfy certain substantiation requirements. Because these substantiation requirements are designed to assist “the IRS in detecting and deterring inflated valuations,” failing to meet these requirements results in a disallowance of the deduction even if the taxpayer made the donation and the valuation of the donated items was correct. The regulations, however, provide a taxpayer can comply with these requirements if it substantially complies with them.
For this type of contribution, one of those requirements is that the taxpayer file the Form 8283, referred to as an appraisal summary in the regulations, with its return. The Form requires the taxpayer list its cost basis in the donated items, which as noted above, RERI did not include. The Tax Court disallowed the entire deduction on that basis.
On appeal, the D.C. Circuit agreed with the Tax Court. In doing so, it side-stepped the thorny question of how a taxpayer substantial complies with the statute. Instead, it essentially held that a taxpayer’s failure to include cost basis on Form 8283 could never be substantial compliance. This is because failing to include such information may hide from the IRS the fact that there is a substantial discrepancy between the claimed value and the value of the items at acquisition. Armed with that information, the IRS would be alerted “to a potential overvaluation, particularly if the acquisition date, which must also be reported, is not much earlier than the date of the donation.” That is precisely what happened in RERI. The Taxpayer claimed a $33 million donation but the item was only acquired for $3 million 17 months earlier. To the D.C. Circuit, had the taxpayer included that information on its return, it would have alerted the IRS to the potential of an overvaluation.
In affirming the penalty, the D.C. Circuit held that the Tax Court did not clearly err when it determined that the fair market value of the property was only $3 million, not $33 million. As such, the item was grossly missvalued and RERI did not otherwise have reasonable cause for the resultant underpayment of tax.
The key takeaway from this decision is this: A taxpayer is well advised to comply strictly with all the requirements for substantiating a charitable deduction and ensuring that its advisors and appraisers do as well. RERI’s failure to fill in a single box on Form 8283 resulted in it losing any deduction for its donation of an item of substantial value to charity.