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Tax Court Disallows a $33 Million Charitable Donation Deduction Because Taxpayer Did Not Sufficiently Fill Out Form

Serving as a vivid reminder that it is vital that a taxpayer comply strictly and completely with the charitable deduction regulations, the Tax Court recently denied a $33 million charitable deduction in its entirety and imposed a gross valuation misstatement penalty because the taxpayer did not properly fill out Form 8283.

In Reri Holdings I, LLC v. Commissioner, 149 T.C. 1 (2017), a partnership donated an interest in a piece of property to the University of Michigan.  The donor retained an appraiser who assigned a fair market value of $33 million to the donation.  The taxpayer prepared a Form 8283 appraisal summary and included the form with its return.  The form indicated that the donor had acquired the donated interest through a purchase but did not include an amount for the donor’s “cost or other adjusted basis.”  Importantly, the Court does not state whether the taxpayer also attached the appraisal report prepared by the appraiser.

The Tax Court denied the entire deduction solely because the Form 8283 did not list the donor’s cost basis. According to the court, Congress prescribed strict substantiation requirements when claiming a charitable deduction over certain amounts in order “to alert the Commissioner to potential overvaluations of contributed property and thus deter taxpayers from claiming excessive deductions.”  A failure to comply with these requirements will result in a denial of the deduction, even if the amount of the deduction is correct.

A taxpayer can sometimes avoid this draconian result if it substantially complies with the regulations. Critically, a taxpayer does not do so if it fails to provide sufficient information to alert the IRS to a potential overvaluation.

That is precisely what the court determined happen here. By failing to list the adjusted cost basis of the property, as required by Treas. Reg. § 170A-13(c)(4)(ii)(E), the taxpayer did not comply with the regulations.  Omitting the cost basis “prevented the appraisal summary from achieving its intended purpose,” as “[t]he significant disparity between the claimed fair market value and the price [the taxpayer] paid to acquire [the property] just 17 months before it assigned [the property] to the University, had it been disclosed, would have alerted [the IRS] to a potential overvaluation of [the property].”  As such, the taxpayer did not substantially comply with the regulations and justified denying the entire deduction ab initio.

The Tax Court also imposed a 40% gross overvaluation penalty on the taxpayer. After finding the fair market value of the donation was only approximately $3 million, subjecting the taxpayer to the penalty, the court rejected the taxpayer’s reasonable cause defense.  Even though it had an appraisal, the court held that “a taxpayer must do more than simply accept the result of a qualified appraisal” and rejected, as immaterial, the taxpayer’s evidence of a second earlier appraisal that appeared to conform to the one prepared for the return.

Though not the subject of this litigation, it is important to note that there may be consequences to the appraiser, as well. With a judicial determination that the value claimed was grossly overstated, the appraiser may be subject to, among other things, a penalty pursuant to I.R.C. § 6695A.  If the IRS imposes a penalty on the appraiser, the IRS’s Office of Professional Responsibility (OPR) may also take action, see Circular 230 § 10.60, and can reprimand or even disqualify the appraiser.

If you have any questions about this post or about how to ensure that you comply with the substantiation requirements before donating property, please contact Jeff Erney at Jeffry.Erney@dentons.com or Peter Anthony at peter.anthony@dentons.com

Another Instance Where Relying on a Tax Expert Does Not Excuse Penalties Imposed On A Taxpayer

Although it seems reasonable for a taxpayer to assume that by soliciting the advice or services of a tax expert the taxpayer would be insulated from any tax penalties stemming from a mistake made by the tax expert, unfortunately, case law does not always support that assumption.  Specifically, the Ninth Circuit recently ruled that a taxpayer was liable for a penalty for filing a late estate tax return even though the taxpayer relied on a certified public accountant (CPA), who incorrectly advised him about the extended filing deadline.  See Knappe v. United States, 713 F.3d 1164 (9th Cir. 2013).

In Knappe, the taxpayer was named as the executor of an estate.  Because the taxpayer had no prior experience serving as an executor or filing an estate tax return, the taxpayer enlisted the help of a CPA.  The CPA correctly informed the taxpayer that the deadline for filing the estate tax return was nine months after the decedent’s date of death.  In need of additional time to prepare the return, the taxpayer sought advice from the CPA about requesting an extension of the filing deadline from the IRS.  The CPA mistakenly told the taxpayer that he could obtain a 12-month extension of both the filing and payment deadlines.  Acting on the erroneous advice, the taxpayer filed the estate tax return several months late and the IRS assessed a 20% late filing penalty, amounting to $196,414.60.

The taxpayer argued that his reliance on the CPA constituted “ordinary business care and prudence” such that the taxpayer had an apt defense to the penalty—the failure was due to reasonable cause and not due to willful neglect.  The Ninth Circuit, however, disagreed.

The Ninth Circuit addressed the familiar Supreme Court case, Boyle, which involved a taxpayer who delegated the task of filing a tax return to an expert, only to have the expert file the return late.  Boyle v. United States, 469 U.S. 241 (1985).  In contrast to Boyle, the taxpayer here did not delegate the task of filing the return to an expert.  Rather, the taxpayer personally filed the return after the actual deadline, but within the time that the CPA erroneously told him was available.  In fact, the Supreme Court in Boyle expressly declined to address the precise question posed in Knappe.

In Boyle, the Supreme Court drew a sharp distinction between substantive tax advice, on which taxpayers may reasonably rely, and non-substantive tax advice, on which taxpayers may not rely.  The Supreme Court explained that determining the filing date for a tax return is a non-substantive matter.  Although determining the date for a filing extension is different from simply determining a filing deadline, the Ninth Circuit found that it was not different enough.  That is, similar to the question of the determining the filing deadline of a tax return, the question of when the estate tax return was due once an extension had been obtained is also a non-substantive question.  Accordingly, the Ninth Circuit concluded that the taxpayer did not exercise ordinary business care and prudence when he relied on the CPA’s advice regarding the extended deadline.

Interestingly, the Ninth Circuit cited another tax case that treated the question of whether multiple filing extensions were available to the taxpayer as a substantive question, thus, absolving the taxpayer of tax penalties.  It seems there’s a very fine line separating substantive tax advice from non-substantive tax advice.