Taxpayers found out the hard way that the documentation rules imposed by the IRS better be followed exactly and to the letter. In Durden, TC Memo, 2012-140, taxpayers claimed a $22,517 charitable contribution for 2007. The IRS disallowed this deduction and the United States Tax Court agreed.
The taxpayers had canceled checks and a letter dated January 10, 2008 from the church confirming this contribution. Seems like that would be enough. Wrong!
The IRS did not accept the church’s acknowledgement because it lacked certain language as required under IRS rules. For a charitable contribution deduction, Section 170(f)(8) of the Internal Revenue Code requires that a monetary contribution of $250 or more must be substantiated by:
- A contemporaneous written acknowledgment,
- That indicates the amount paid by the taxpayer, and
- Whether the organization provided any goods and services in consideration (or in exchange) for the contribution, and if so, a good faith estimate of the value of such goods and services.
The problem for the taxpayers was that the church failed to include part 3 in their January 10, 2008 letter to the taxpayers. They then went back to the church and got a second letter dated January 21, 2009 that revised the first letter by containing the required language under part 3 of this test.
But now the problem was that the revised letter was too late so it could not be considered contemporaneous by the IRS. To be contemporaneous under Section 170(f)(8)(C) of the Internal Revenue Code it must be obtained by the due date of the tax return (here April 15, 2008) plus any extensions or, if earlier, the date the taxpayer files the return. So now the taxpayers flunked part 1 of the test!
You might think that this is pretty harsh since the taxpayer’s really came close here. So did the taxpayers. The taxpayers argued that since they substantially complied they should still get the deduction. The substantial compliance test has been successfully argued where a taxpayer can show that despite strict compliance they have met the essential statutory purpose of such requirement. The court pointed out that the essential statutory purpose of the acknowledgement rules are two-fold:
- Assist taxpayers in determining their deduction, and
- To aid the IRS in processing returns.
The court determined that without a statement from the church that no goods and services were provided, neither of these two essential statutory purposes can be met.
This is a pretty harsh result for the taxpayers, especially since it was clearly the church that failed to provide the requisite language. But the object lessons here are clear.
First, when dealing with charitable contributions you better make sure this language is present, especially in cases where large gifts are involved.
Second, when it comes to taxes attention to details is essential.
Third and finally, complying with the various federal, state and local income taxes is complicated. Having an attention-to-detail minded tax attorney, or tax accountant is greatly recommended and probably essential. With the loss of this large charitable deduction and the cost to bring this matter before the United States Tax Court, the Durdens definitely found this out the hard way.
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Very good article. I am curious to know if the tax return was self prepared.
Judith D. Sherling, CPA, CGMA
Hey Judith. So nice to hear from you. I am not sure that the record reflects this fact. Perhaps if that was the case then it may account for this matter to be terribly mishandled.
Really, really punctilious eh?
Very good Tim. Great word to describe how taxpayers must be when it comes to documentation.
For my readers, punctilious means showing great attention to detail or correct behavior. For example, “The taxpayer was punctilious in providing every piece of documentation to the IRS.”
Some synonyms: meticulous, conscientious, diligent, scrupulous, careful, painstaking, rigorous, perfectionist, methodical, particular, strict.
More synonyms: fussy, fastidious, finicky, pedantic, nitpicking, persnickety. Love this last one!
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Steve, in my opinon this shows lack of common sense from the IRS and the Tax Court. They are punishing the taxpayers for a minor mistake. “Ah ha! Gotcha!” Anyway, it is the society in which we unfortunately live in which no good deed goes unpunished. It is very unfair.
On the other hand your article is spot on. I would like to share it with my clients, but am not sure if I can do so without copyright, etc. infringements. How may I share this with my clients?
John, it does seem heavy handed. But if you read the court ruling carefully it would seem that their reasoning was solid.
As to client sharing, the simplest would be an email with a link to my article. Or if you have a website you could post a small part of the article with a link to the rest of the article.
Let me know if you need my help.
I do not understand why the Durdens went to the trouble and expense of litigating the IRS’s disallowance of the $22,517 deduction for a 2007 donation to a Church when a fairly simple remedy should have been pursued first.
When the Durdens learned that the IRS disallowed the deduction in 2008, instead of getting an ex-post-facto letter from the Church, the Durdens should simply have approached the financial representative of the Church and discussed the problem with that person. The Durdens could have then proposed that the Church refund the $22,517 donation, and, specifically ask them to treat the $22,517 as two gifts, one for $11,258.50 for Mr. Durden and another for $11,258.50 for Mrs. Durden. Under the Internal Revenue Code, the Church, as donor, could have gifted $12,000 or less to each person without tax consquences.
Then, in 2009, the Durdens would then, in effect, start over again by donating the $22,517 and obtaining the required Letter from the Church that would meet the IRC specifications to qualify as an allowable deduction. To my knowledge, there is no rule in the IRC that would not permit the transactions to be completed in this manner.
Although, at first, it may appear that this remedy is a variation of a round-tripping scheme, in which the Church is funding the Durden’s donation, that is not the case. In form and in substance, the first phase of this remedy is that the Durdens are gifting $22,517 to the Church, and the Church is merely gifting back the same amount, but in two checks. That phase of this remedy has no legal connection to the second part, in which the Durdens are simply donating $22,517 to the Church. Of course, this remedy depends upon the faith of Church in the Durdens to actually donate the $22,517 after they receive the Church’s gift to them. But that is the beauty of this remedy because it is existence of that risk that the back-and-forth phase is bona fide gifting.
The Durdens could still execute this remedy by discussing it with the Church for the tax year ended 2012, for a donation in tax year 2013.
Hey Ralph: Pretty creative way to address this problem. Perhaps they needed you as their accountant.
Here are a couple of points:
The use of annual donee exclusions would not be necessary since the donor church is an exempt entity. They would not be subject to a gift tax.
However, with your 2009 strategy may have succeeded if not questioned by the IRS. The exposure here would be the IRS arguing substance over form; namely, that the gift truly took place in 2008 and any actions taken subsequent do not change this fact. Not sure who would win here, but your strategy would seem to have a better chance of success than what they did.
Musing: Would the church have even entertained this strategem?
In any event, thank you Ralph for your insights and thoughts. Very thought provoking and interesting!
Thanks Steven, enjoy your periodic alerts. When preparing that 2008 tax return claiming a large charitable deduction, do you think the professional advisor should have ask to see the documentation? Do you think there might have been a different result had this case gone through the US District Court instead of the Tax Court?
As to asking for the documentation, tax practitioners go both ways on this; some want to see it; others say it is up to the taxpayers to take of the documentation. However with a $24,000 deduction prudence would seem to dictate looking at that church letter.
As far as the District Court, some think that it is more pro-taxpayer. However, remember the taxpayer needs to pay all the liability and seek a refund claim via that court. But if you read the reasoning of the court closely, they seemed to have gotten it right. Not sure the a District Court judge would have ruled otherwise.
Hello Richard, as Steven so aptly said, some practitioners want to see documentation, others don’t. My personal rule for the past 20 years has always been to retain a copy of the documentation in the client file, as part of the return’s workpapers. It is not a popular position, with either CPA firms or clients. My long term clients have come to expect that from me, and appreciate the peace of mind that a well documented return can bring.
If the client doesn’t provide the documentation, I work with them, going as far as calling the charity to request a duplicate confirmation letter, and assisting the charity with utilizing the proper language, if needed. If a client refuses to provide adequate documentation, I will not report that deduction.
A hard line approach, yes, but if the client is unwilling to cooperate during return prep, it may be difficult for that client to cooperate once a notice has been generated. Any preparer must be aware of the rather stiff preparer penalties. No longer can we rely on a defense that “the return was prepared based on what the client provided.”
Cheryl these are great followups. We as tax practitioners have to be very diligent, conservative and sometimes tough on our tax clients. It is our job to protect them and to set them up in a way that minimizes problems down the road in the event of an tax audit.
Excellent article, Steven, your cautionary tale is right on point. Substantiation of deductions is an area that affects both the taxpayer and the tax preparer, so it is in everyone’s benefit to thoroughly document expenses, and charitable deductions in particular. Higher value, noncash charitable items, particularly artwork, collectibles, and other hard to value items, need a professionally prepared appraisal or valuation report, in addition to an understanding from the charity as to the intended usage and holding period of the gifted item prior to resale by the charity.
Hey Cheryl: Thanks for your kind words. Anywway, these are excellent, very comprehensive compliance details that practitioners and taxpayers should take into account when documentating charitable deductions. Sadly these taxpayers failed to get the advice and guidance needed and paid a very high price indeed.
As a CPA and president of a non-profit, I can certainly appreciate this. We always include the language in item number 3 and indicate the value of any goods or services received by the donor. Thanks for sharing this.
Darren, great to hear from you. Your non-profit is probably in the majority of those organizations that are very serious about these compliance issues. Small churches and small tax exempts may not have in house tax expertise or otherwise understand the tax stakes here. Thus, the problems we see in this current tax case. Thanks again for your input and insight.
This should be plastered on every practitioner’s bulletin board coast to coast. (Also, being a Memorandum decision of the Tax Court, it needs to be given credence). Thanks for posting, Steven.
Hey Tony: I cannot agree more. My job as a tax attorney is to get my clients aware of the detailed requirements involved with taxes. This is why I posted this case as it shows how costly a small mistake can be. These taxpayers not only suffered additional taxes, penalties and interest, but also paid the cost of going to tax court. And they ended up losing the case to boot.
Thanks. Not a surprising result, but always interesting. A lesson to nonprofits to avoid unhappy donors/members..
Hey Martin. Nice to hear from you and thanks for your comments. Yes non-profits need to be very careful in documentation that complies with IRS requirements. They really messed this up for these taxapyers.
Thank you very much, Steve, for bringing this up. I used to look for the donation amount and then move on to the next receipt (especially when I am busy). Now I spend more time looking for the things that the IRS requires.
God bless! Tina
In the article, it says:” To be contemporaneous…it must be obtained by the due date of the tax return”. The other 2 requirements did not mention the date of the contribution.
I checked IRS code section 170(f)(8), it did not mention that the date needs to be included in the acknowledgement either.
I am working on a return with a charitable donation receipt that has no date on it – neither the date of the donation nor the date the letter is written/generated. It met all 3 requirements of the qualified acknowledgement nonetheless.
A letter with no date(s) can be used for any year by mistake. Am I missing something?
Tina, I see your problem but the letter needs to have a date on it. This failure could be equally problematic and your taxpayers could easily find themselves in a Durden situation. So you are not missing something but the taxpayers in question may be missing something really big. Remember this is a tax article about how imperative to have a mindset consumed by attention to details. This is a really good catch on your part and you need to put your clients on notice and try to rectify it in some way or another on a timely basis.
Best to you, Tina.