The substantiation rules for the charitable deduction are detailed and essentially unforgiving. While “substantial compliance”1 might be argued successfully as a last resort, it comes at the cost of time as well as legal and accounting fees. Given the unpredictability of prevailing against an Internal Revenue Service challenge with a substantial compliance argument, the best practice is total compliance. Professional advisors are at risk for malpractice lawsuits due to noncompliance because the tax savings lost often are six or seven figures.
While the charitable documentation rules under Internal Revenue Code Section 170(f) jeopardize deductions based on nitpicky errors, there are a number of parties to a gift with unity of interest to “get things right.” During the planning phase of a gift, practitioners should begin thinking about what will be needed for an IRC-compliant documentation. The compliance phase of completing the tax return is the last chance to catch errors. Charitable organizations have a duty to assist with the documentation. At a minimum, their outside legal counsel should annually be reviewing institutional protocols for the providing of receipts of complicated, illiquid cash assets.
The recently decided cases of Albrecht v. Commissioner2 and Keefer v. United States3 show how either poorly drafted or multiple gift agreements can fail the contemporaneous written acknowledgment (CWA) requirement.
Key Requirements
Let’s briefly review the requirements. For any contribution of $250 or more, IRC Section 170(f)(8)(A) requires that the donor obtain from the charity, and maintain in the donor’s files, a CWA. The CWA must include: (1) the amount of cash and a description (but not value) of any property other than cash contributed; (2) whether the charity provided any goods or services in consideration, in whole or in part, for any such property; and (3) a description and good faith estimate of the value of any such goods or services.4 Furthermore, the donor must receive the CWA from the charity on or before the earlier of the date the taxpayer files their return or the due date for filing such return.5 Contributions to a donor-advised fund (DAF) must be under its “exclusive legal control” per Section 170(f)(18)(B). Interestingly, a CWA isn’t required to take any particular form, but the requirement that it be obtained “is a strict one.”6
Albrecht
Albrecht v. Comm’r7 illustrates the fatal complications of documenting a charitable transfer through multiple legal instruments, specifically a 5-page deed of gift (deed) and a gift agreement (agreement). The donor transferred over 100 pieces of Native American jewelry and artifacts (property) to a museum.
The first page of the deed read in part that the donor “hereby donates the material described below to the Wheelwright Museum of the American Indian under the terms stated in the Conditions Governing Gifts to the Wheelwright Museum of the American Indian.”8 Immediately following this clause was the heading “Description of Material: See Attached List.”9 The first page also included the museum’s logo, petitioner’s address and her donor identification number, as well as the signatures of petitioner and a museum official. The next page of the deed was titled “Conditions Governing Gifts to the Wheelwright Museum of the American Indian,” noting conditions governing gifts to the museum. One of these conditions stipulated in relevant part that “the donation is unconditional and irrevocable; that all rights, titles and interests held by the donor in the property are included in the donation, unless otherwise stated in the Gift Agreement.”10 The remaining three pages of the deed listed items of donated property. Despite the “Gift Agreement” referenced on the deed’s second page, no such agreement was included with the deed. Nor did the Wheelwright Museum provide the donor with any further written documentation concerning the donation.
The issue before the Tax Court was whether the written acknowledgment met the CWA requirements within the meaning of Section 170(f)(8)(B). The Tax Court denied the deduction in full because the CWA hadn’t been received from the charity on or before the earlier of the date the taxpayer filed the return or the due date for filing that return. While acknowledging the CWA requirements are “strict” ones, the Tax Court denied the deduction. The deed didn’t specify whether any goods or services were provided in exchange for the donation. Additionally, the deed referred to an agreement creating an ambiguity as to whether there were additional terms and conditions overriding the deed. That agreement not only lacked a statement of whether goods or services were provided but also failed the CWA requirement. The Tax Court specifically rejected the donor’s argument that the separate agreement created a presumption that the deed alone satisfied the substantiation requirement. Although the donor may have been in “substantial compliance,” the enumerated requirements of Section 170(f)(8) weren’t met.
Safer Course of Action
The safer course of action would have been for the donor to place all terms of the agreement in a single legal document specifying not only whether any rights were retained but also whether goods and services were provided to the donor in exchange for the gift.11 Izen v. Comm’r12 noted that a deed of gift can serve as a de facto CWA. However, a donor may not deduct the contribution if the donation acknowledgment fails to meet these strict demands.13
Donors who insist on a deed and agreement should include a statement in each that no goods and services were provided by the charity. The donor should also state which document represents the terms of the entire understanding. Alternatively, the donor should invoke the merger doctrine so both agreements are treated as a single document. Of course, the merged agreement needs to be carefully analyzed to be sure there are no inconsistencies. The donor can’t rely on the charity to recognize the potential for the ambiguities created by two agreements. However, the charity should consider at least alerting the donor of the possibility of confusion.
The result in Albrecht is all the more disappointing to the donor as the charity in fact didn’t provide any goods or services. The lack of the language eliminated the income tax deduction.
Keefer
At first blush, the taxpayers seemed to have received a compliant CWA, which read:
Thank you for your donation to The Pi Foundation, Inc. of a 4.00% interest in Burbank HHG Hotel, LP. The Pi Foundation, Inc., is a 501(c)(3) nonprofit organization. Your contribution is tax-deductible to the extent allowed by law. No goods or services were provided in exchange for your generous financial donation. Please keep this page for your records.14
So what happened to upend the deduction?
The Keefers brought a charitable deduction-based refund claim, seeking a deduction for an assignment that they made to a foundation of a partial interest in a partnership that held hotel property for the purpose of establishing a DAF (the Pi Foundation). This assignment occurred at the time of a pending hotel sale to a third party. The district court determined that the donation was actually anticipatory assignment of income. Although the pending hotel sale agreement didn’t itself render the donation an anticipatory assignment of income, the denial of the deduction did result from the taxpayers making their assignment subject to oral agreement, in which they effectively carved out a portion of the subject partnership interest before making the donation. In effect, the charity wasn’t receiving a 4% partnership interest but its share of the sales net after cash had been made to the pre-gift partners.
Even if there were no anticipatory assignment of income, the Keefers’ deduction claim failed under Section 170(f) because they didn’t obtain a CWA that met the requirements of Sections 170(f)(8) and 170(f)(18). Although they did obtain initial and contemporaneous documents, those referred to an intended donation.
Notwithstanding the receipt of another letter properly acknowledging donation,15 that letter didn’t also state that charity had “exclusive legal control” of contributed assets as required by Section 170(f)(18)(B) for contributions regarding DAFs.
The court in the end found the Keefers lacked a statutorily compliant CWA. It did entertain whether the DAF packet and an acknowledgment letter could create a CWA. The Keefers might have had a better chance of winning had one of the agreements had a merger clause. But the court found the packet can’t supplement an acknowledgment letter. In so finding, the court didn’t consider whether the packet established that the Pi Foundation had exclusive legal control over the donated property.
Instead, because the acknowledgment letter alone contained nothing to prove exclusive legal control by the Pi Foundation, the court concluded that Section 170(f)(18) wasn’t satisfied.
Thus, the substantiation failed the strict compliance test.
Other Penalties
If the loss of a large charitable deduction weren’t enough motivation to walk the straight and narrow road to deductibility, there’s also the risk of courts imposing negligence, accuracy-related penalties and even fraud.16 While the rules for substantiating a deduction are among the least interesting related to gift planning, don’t let noncompliance generate interest from the IRS. The price of failure is not only severe but also rarely with an opportunity for correction after the return has been filed.
Endnotes
1. Treasury Regulations Section 1.170A-13 describes the recording and return requirements for charitable contributions. The doctrine of substantial compliance, however, doesn’t excuse noncompliance with the strict substantiation requirements of Internal Revenue Code Section 170(f)(8)(B) regarding the content of the written acknowledgment. See French v. Commissioner, 111 T.C.M. (CCH) 1241 (2016).
2. Albrecht v. Comm’r, T.C. Memo. 2022-53 (May 25, 2022).
3. Keefer v. United States, 130 A.F.T.R.2d 2022-5002 (D.C. Texas 2022).
4. See IRC Section 170(f)(8)(B); 15 W. 17th St. LLC v. Comm’r, 147 T.C. 557, 563 (2016); Treas. Regs. Section 1.170A-13(f)(2).
5. See Section 170(f)(8)(C).
6. 15 W. 17th St. LLC, supra note 4.
7. Supra note 2.
8. Ibid., at p. 2.
9. Ibid.
10. Ibid.
11. Ibid., at p. 4.
12. Izen v. Comm’r, 148 T.C. 71, 78 [*4] (2017).
13. See supra note 6, at p. 562.
14. Supra note 3, at p. 6.
15. Ibid., at p. 7.
16. The penalties for fraud, accuracy and negligence are imposed by IRC Sections 6663, 6662A and 6013, respectively.