Last week, we got another lesson in the value of proper appraisals of charitable donations. In Chrem v. Comm’r,[1] the initial tax filings failed to comply with the appraisal requirements, but the taxpayer nevertheless argues that “reasonable cause” excuses their failure. And just days prior to the Chrem decision, we got Belair Woods v. Comm’r[2], yet another substantiation-failure case.
Both decisions are on summary judgment motions and the taxpayers survived (barely) to fight another day, but these unhappy tales already serve as cautionary examples. Read on to see what went wrong here.
Belair Woods
The first case involved Belair Woods LLC which owned more than 140 acres of woodland in Georgia. In 2009, Belair entered into a deed of conservation easement with respect to substantially all of this land.
The tax return included both an appraisal (valuing the easement at $4.7 million using the “before and after” method) and Form 8283 (executed by the appraiser and charity). However, the form did not include the basis of the property donated. On audit, the IRS disallowed the entire deduction for that omission, as they also did in RERI[3].
Belair claims that it did comply with the regulatory requirements in this case, either strictly or substantially. The Tax Court disagrees:
- Belair “did not report its cost basis as the regulation requires and as Form 8283 directs. And the explanation Belair attached to that form, far from showing that it was unable to provide this information, simply asserted that the information was not necessary.” With measured understatement, the Court concludes: “Asserting that one may ignore a requirement does not constitute strict compliance with it.”
- Relying on its recent finding in RERI, the Court finds that, particularly in cases where the gap between the basis and the value claimed is large (as was the case here), failure to provide basis (a red flag) is especially inexcusable. Also, this “was not a case of inadvertent omission, but of a conscious election not to supply the required information.” Thus, Belair didn’t substantially comply either.
Congress added a “reasonable cause” defense to the tax code in 2004, too late to help the taxpayer in RERI, but perhaps just what the doctor ordered for Belair? Here, the Court punts and wants a trial for more fact finding. The taxpayer's defense leans heavily on the advice received from counsel. Advice that the IRS “seems to regard as too good to be true." Why, you ask?
The attorney “had reviewed the instructions to Form 8283 and concluded that ‘it should not be necessary to include the basis information … if you attach an explanation to Form 8283 providing a reasonable cause.'” And such reasonable cause “should be that the basis of the property is not taken into consideration when computing the amount of the deduction.”
Oh, really? Is that how it works? We suspect that something was lost in the translation here or, in the alternative, that the appropriate liability carriers have been alerted.
Comtrad Trading: Deal or No Deal?
In Chrem, the taxpayers owned all of the shares in Comtrad Trading, Ltd., a closely held Hong Kong corporation. This corporation did most of its business with another entity, SDI, also controlled by the same shareholders. SDI, a US ‘S’ corporation, was owned almost entirely by its Employee Stock Ownership Plan (ESOP).
In late 2012, SDI proposed to acquire all of Comtrad for $4,500 per share. The ESOP Trustee engaged a well-regarded valuation firm to prepare a fairness opinion, as is standard practice. The appraisal report submitted to the trustee valued the shares in a range from $4,214 to $4,626 per share and concluded the transaction was fair to the ESOP. Two days after the fairness opinion, on December 12, 2012, SDI purchased all of the shares of Comtrad. However, a few days prior to this date, either on December 5 or December 10, the taxpayers had donated about $4 million of shares to a charity.
Under the anticipatory assignment of income doctrine, the IRS determined the taxpayers were liable for tax on their capital gains and, also, disallowed in full all the deductions, with penalties on top. The problems were:
- This was a “done deal” at the date the donation was made, thus the income should be allocated to the taxpayers, not the charity.
- The appraisal report was not submitted with the tax return.
- The report submitted (after the tax return) was not a “qualified appraisal”, even though the appraiser was qualified.
The appraisal is not a qualified appraisal, as defined by the Regulations, because:
- It was not addressed to the taxpayers.
- It did not examine any charitable contributions.
- It did not set forth the date of the contributions.
- It did not include a statement that it was prepared for income tax purposes; in fact, it included language indicating it was prepared for a completely different purpose.
- It valued the wrong thing – the capital stock of Comtrad in its entirety – rather than the actual shares donated.
Petitioners argue that they substantially complied with the requirements, primarily, because the shares were all worth the same in this case (they all sold for $4,500 a few days later) so why does it matter which shares the appraiser valued? In addition, a Form 8283 was signed by the appraiser and submitted with the returns. No harm, no foul.
The Court finds that there’s sufficient dispute remaining about material facts in this case and denies summary judgment. Even for the taxpayers who claimed deductions in excess of $500,000 (where submitting the full appraisal is a requirement), there is enough uncertainty about whether they reasonably relied on their CPA’s advice that the case needs to go to trial.
So the taxpayers live to fight another day. But what an unnecessary fight! Truly another case for the “what were they thinking?” file – and another lesson to take the appraisal requirements seriously when making donations.
Clearly, these taxpayers were motivated by ordinary charitable intent. They do not seem to have been trying to get away with some overly aggressive tax scheme. What would best practice have been in this case? Ordering another appraisal – preferably from another firm than the fairness opinion provider – would have been a trivial expense for a $4 million donation. Another appraisal, valuing the correct shares, would have concluded at a modest discount to the $4,500 valuation, due to the uncertainty remaining in the SDI deal.[4]
Instead, the taxpayers were left with an appraisal that valued the wrong shares, for the wrong purpose, as of the wrong date. And now they’re in the uncomfortable position of having to make two conflicting and, perhaps, ultimately self-defeating arguments:
- That there remained significant risk as of the donation date that the SDI deal wouldn’t close. And yet also;
- That there should be no difference in value between the controlling shares purchased by SDI and the minority shares donated to the charity.
If there is a difference between the two values, then clearly the appraisal won’t be “qualified” because the appraiser valued the wrong thing and, thus, the “no harm, no foul” argument underpinning substantial compliance is unavailing.
Unfortunately, the argument that the value is the same relies on the deal being a certainty, which assists the IRS with their assignment of income position. It will be interesting to see how the Court ultimately resolves this.
What do you think? Your thoughts, comments, agreements, or disagreements are welcome.
ENDNOTES
[1] Marc Chrem et al v. Comm’r TCM 2018-164
[2] Belair Woods LLC et al v. Comm’r TCM 2018-159
[3] RERI Holdings I LLC v. Comm’r 149 TC 1 (2017)
[4] Most appraisers value shares in such situations – either explicitly or implicitly through a small discount – under two possible “state of the world” assumptions: (A) that the deal goes through and (B) that it doesn’t. In the latter scenario, the minority interests being valued are discounted as usual for lack of marketability and lack of control. Weighting the two scenario values provides the ultimate valuation. In the Comtrade case, the ultimate discount would probably have been in the low single-digits, given the facts.