December 6, 2022
Substantiating Charitable Income Tax Deductions – The IRS’ ‘Low Hanging Fruit’
Take-Away: There is a noticeable trend in the U.S. Tax Court of the IRS successfully challenging claimed charitable income tax deductions due to the donor’s failure to substantiate the deduction in accordance with the IRS’s stated instructions. These are cases where a ‘substantial compliance’ with the rules is not enough to preserve a charitable income tax deduction.
Background: Almost weekly these days there are reported Tax Court decisions where the Court has denied an individual’s claim for a federal income tax charitable deduction due to either: (i) not obtaining a qualified appraisal; (ii) failing to file a properly completed Form 8283, Noncash Charitable Contributions; or (iii) not attaching a qualified tax appraisal made by a qualified appraiser to the Form 1040 for which the charitable income tax deduction was claimed. Even with these charitable deduction substantiation failures, it is possible that the donor’s charitable income tax deduction might still be allowed, but only if it is shown by the donor that the failure was due to ‘reasonable cause and not willful neglect on the basis of the donor having received, and reasonably relied upon, advice provide by a tax professional.[IRC 170(f)(11)(A)(ii)(11).] This string of Tax Court decisions make it clear, however, that the donor has a continuing duty to review his/her tax income tax return before signing and filing the return, and that the duty to file accurate tax returns cannot be avoided by shifting that responsibility onto the tax return preparer.
A recent Tax Court decision is a good example of what not to do, and how the donor’s claim that it was the CPA’s responsibility to ‘get the return right’ did not persuade the Tax Court, resulting in the loss of a $600,000 charitable income tax deduction.
Heinrich C. Schweizer v. Commissioner, Tax Court Memo 2022-102
Facts: Heinrich had a long and distinguished career as an African art dealer and collector. He had previously served as the Director of African and Oceanic Art at Sotheby’s from 2006 to 2015. In that position Heinrich’s role was to evaluate African art owned by customers, potential customers, and to estimate the price at which such artwork might sell at auction. In addition, Heinrich worked directly with Sotheby’s appraisal department.
In 2011, Heinrich made a substantial contribution to the Minneapolis Institute of Art; his donation was a ‘Dogon sculpture’ that Heinrich had purchased in Paris for $100,000 in 2003. His gift was made in late December, 2011. In June of 2012, with the assistance of his CPA, Heinrich requested a Statement of Value (SOV) from the IRS’s Art Appraisal Services before he filed his Form 1040. The SOV can be requested by a donor from the IRS in the hope of receiving assurances that the IRS will accept the value as claimed on the donor’s income tax return.[Revenue Procedure 96-15.] Along with the SOV request, Heinrich included a one and a half page ‘appraisal’ of the sculpture by a New York dealer in African art, who valued the sculpture at $600,000. The dealer was not, however, a qualified appraiser, nor was the one-and-a-half page appraisal report a qualified appraisal. This was the only appraisal that the dealer had ever prepared. Also as part of Heinrich’s SOV package was a partially completed Form 8283, which reported a $600,000 value for the sculpture, and it included the dealer’s signature and a signature on behalf of the Institute of Art acknowledging the gift.
Heinrich did not receive a response from the IRS Art Appraisal Services unit before he filed his 2011 income tax return, on which he claimed a $600,000 charitable income tax deduction; since that amount exceeded the maximum allowable charitable income tax deduction for Heinrich, only $406,395 was claimed as the deduction, with the balance of the charitable deduction carried over to the next tax year. The Form 8283 that was filed with the Form 1040 return was missing most of the information that is required to appear on a Form 8283. For example, on the line of the Form that called for a ‘description of donated property’ the words SEE ATTACHED appeared, but no such attachment was included with the return. Other information missing from Form 8283 was: (i) the acquisition date of the sculpture; (ii) the manner of acquisition of the sculpture; or (iii) the current physical description of the sculpture. Nor was any appraisal attached to the income tax return as required by the Tax Code. [IRC 170(f)(11)(D).] On audit, the IRS’s staff appraiser determined that the fair market value of the donated sculpture was $250,000 and a notice of deficiency was issued disallowing any charitable income tax deduction.
Tax Court: The Tax Court upheld the notice of deficiency and denied any charitable income tax deduction. The Court found, among other things, that Heinrich had failed- (i) to obtain a timely qualified appraisal of the sculpture, per Regulation 1.170A-13(c)(3); (ii) to attach to his 2011 Form 1040 an appraisal of any kind, as required for gifts valued in excess of $500,000, per Regulation 170(f)(11)(D); and (iii) to attach to his tax return a fully completed Form 8283 per Regulation 1.170A-13(c)(2)(i)(B). The Court noted that “each of these failures is independently sufficient to warrant a disallowance of the deduction.“
Reasonable Cause: The Tax Court trial was over whether Heinrich had reasonable cause to rely on the CPA who had prepared his Form 1040 for 2011. Heinrich testified, unconvincingly, that his CPA had advised him that there was’ no need to include a complete Form 8283 or an appraisal with the income tax return ‘because the IRS already had it- or the AAS unit’, referring to the documents that were included with the June 2012 submission of the SOV. The CPA denied having given that advice to Heinrich. The Court found that the ‘reasonable cause’ defense requires the donor “to exercise ordinary business care and prudence” and that such a showing includes evidence that Heinrich (i) actually received advice from his CPA and, if he did (ii) that he reasonably relied in good faith upon such advice. The Court found Heinrich’s testimony to be ‘unverified, self-serving, and unreliable. This was based on the CPA’s testimony that he would not have filed an income tax return if he saw that it contained an incomplete Form 8283.
Reliance in Good Faith: Nor was there any credible evidence that Heinrich actually relied upon such advice of his CPA, even if it was given, in good faith. What the Tax Court focused upon was that Heinrich was sophisticated in art transactions, with his numerous years working in the art world and with Sotheby’s appraisal unit. More to the point, Heinrich had previously filed Form 8283 on numerous occasions in the past in connection with his own income tax returns, e.g. $60,000 in 2007, $100,000 in 2009, and $5,000 in 2010; in each instance Heinrich had been required to obtain a qualified appraisal from a qualified appraiser in support of each charitable donation. In short, the Court found that Heinrich was personally familiar with the requirements of Form 8283. The Court concluded that if Heinrich’s testimony was to be believed, that he relied upon the ‘don’t worry’ advice of his CPA, given his background, “such reliance would have exemplified willful blindness.”
In sum, the Tax Court found that Heinrich did not review his 2011 income tax return with any care at all, and if even he did, he could not have reasonably relied on the advice of his CPA that the return’s blatant errors and omissions were immaterial.
Conclusion: Large charitable gifts must be substantiated following many different rules and conditions. Violating any one rule or condition, or not fully completing and timely filing Form 8283 will cause a donor to lose his/her charitable income tax deduction. Substantial compliance with these rules and Regulations is not enough. Nor is relying upon the advice of the tax return preparer if the reliance is not, with hindsight, done in good faith. As the end of the calendar year approaches and the time for large deductible charitable gifts considered, it is important to keep in mind these rules and the fact that the IRS apparently views large charitable gifts as ‘low hanging fruit.’