In Mohamed, the Tax Court denied a substantial charitable deduction, in full, because the taxpayers failed to follow the regulations in making donations to a Charitable Remainder Trust.
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The Mohameds (Taxpayers) donated real estate to charity, but did not properly report the transaction. The IRS subsequently denied the charitable deduction. This dispute eventually proceeded to the Tax Court.
Taxpayers made the donations in 2003 and 2004 through a charitable remainder trust (CRUT). A CRUT provides a taxpayer with an immediate deduction for the donation, while retaining the right to receive income from the donation for a term of up to 20 years. Thereafter, the donated property, the corpus of the trust, passes to charity.
Taxpayer’s CRUT was designed to provide this immediate deduction for donated real estate. Taxpayer planned to receive income for life from the CRUT and for the corpus to pass to several worthy charitable organizations.
Taxpayers complete their 2003 and 2004 returns themselves. They found the pertinent form confusing. The Tax Court agreed the form was unclear. Taxpayers therefore failed to obtain a third party appraisal of the properties and instead made their own best estimate – which was later found to be quite accurate.
The IRS audited the returns and found a deficiently, claiming that the Taxpayers overstated the value of the donated real estate. Even after the properties were valued by an appraiser and sold by the trust for more than the deduction claimed by Taxpayers, the Commissioner continued to assert the properties where overvalued. The Service then realized Taxpayers had incorrectly completed the relevant forms and moved for summary judgment.
The Code provides that charitable deductions must conform to the regulations. 170(a)(1). With respect to the Taxpayer’s donation, the code requires that: (1) a qualified appraisal must be obtained; (2) the appraisal summary must be attached to the return; and (3) records of the appraisal must be maintained by the taxpayer. 1.170A-13(c)(2)(i)(A)-(C).
The qualified appraisal must be made no more than 60 days before the donation and before the return is filed. 1.170A-13(c)(3)(i). A qualified appraiser cannot be the taxpayer/donor. 1.170A-13(c)(5)(iv)(A), (C). Taxpayers clearly were not qualified appraisers.
The appraisal statement, which is to be attached to the return, also must include a laundry list of information. 1.170A-13(c)(4)(ii). Taxpayers failed this requirement as well.
The Tax Court easily concluded that the Taxpayers did not comply with the regulations. Moreover, the Court would not find the regulations invalid because Congress clearly delegated authority to flesh out the statutes to the Service and the regulations the Service developed where not arbitrary and capricious
The Court also declined to find Taxpayers substantially complied with the regulations. Lastly, the Court declined to rule in favor of the Taxpayer due to the genuinely confusing forms since the forms are not authoritative sources of tax law. The Tax Court denied the deductions.
To its credit, the Tax Court concluded the opinion by admitting the result of its decision was harsh. However, the decision was palatable to the Court because Congress conveyed specific concern regarding the intentional misvaluing of property. The Court would not allow a sympathetic case undermine the rules.
We have to agree with the Court this was a harsh result. Given the facts known to us, the Mohameds do not seem to be taxpayers aggressively manipulating valuations. However, since valuations are quite subjective and very malleable there is a significant opportunity for abuse, which is often seized upon. Congress’s concern and the regulatory response are appropriate. The Court found itself in a difficult situation: ignore the law or be unfair to the Mohameds. Either decision was justifiable, yet problematic.
We hope in the future, the Service can find a way to work with taxpayers to avoid such Catch-22s. The law undermined both when it is ignored and when it reaches an unfair result. The tax law is already subject to much public contempt. More contempt will only make compliance more difficult all involved.
I hope this helps you help others.
Robert S. Keebler, CPA, MST, AEP
Cites: Mohamed v. Commissioner.Docket Nos. 13947-07, 12882-08. (5/29/2012)