Tuesday December 5, 2023
Stress-Free Tax Filing Tips
1. Good Records — Taxpayers should gather all of their records. A key to easy tax filing is maintaining good records. These records enable taxpayers to take appropriate deductions and credits.
2. Use IRS.gov — The IRS website, IRS.gov, is available around-the-clock. It is the fastest way to benefit from assistance. You can use IRS.gov to file your tax return, pay taxes, receive information about your returns or find answers to many different tax questions. The IRS Services Guide on this website explains the best ways to obtain assistance from the IRS.
3. Helpful Online Tools — IRS.gov includes a wealth of helpful tools. If you have tax questions, use the Interactive Tax Assistant to obtain quick answers. The IRS has upgraded this tool and it generally provides the same answers that would be available over the phone.
4. Reputable Preparer — Over half of taxpayers use a CPA, attorney, enrolled agent or other preparer. You can go to IRS.gov/chooseataxpro and find many qualified preparers. The IRS Directory of Federal Tax Return Preparers also lists professionals and their credentials for filing returns.
5. File Electronic Returns — The IRS Free File program will help you calculate your earned income tax credit, child and dependent care credit and recovery rebate credit. Online software, MilTax, is available for members of the military and certain Department of Defense veterans. There are also limited Free File options available in Spanish.
6. Direct Deposit — By filing an electronic return and choosing direct deposit, you can ensure both an accurate tax return and a rapid refund.
7. Report All Income — Income from all sources is taxable. This includes your IRS Forms W-2, Wage and Tax Statements, IRS Forms 1099, “gig economy” income, tips and other income. All income from any source must be reported. This is true even if you do not receive a formal statement for that income.
8. Unemployment Benefits — If you received unemployment benefits, these amounts are reportable as taxable income on your IRS Form 1040.
9. Review to Avoid Errors — Take extra time to review your tax return. Any taxpayer should understand the basic income, deductions and tax amounts. It is important that you file a complete and accurate return. Your electronic filing is generally the most accurate way to eliminate clerical or math errors. Check to make certain all names and Social Security numbers are correct. You also must recheck your bank account and routing numbers for direct deposit of your refund.
DAF Best Practices for CWAs
In Estate of Scott M. Hoensheid et al. v. Commissioner; No. 18606-19; T.C. Memo. 2023-34, the Tax Court stated the requirements for a donor advised fund (DAF) contemporaneous written acknowledgement (CWA). See Section 170(f)(8)(B). The CWA must be received by the taxpayer prior to the date the tax return is filed or the due date (with extensions) of the relevant tax return, whichever is earlier. Section 170(f)(18)(B) specifies an additional requirement for DAFs. A CWA for a DAF must state that the donee "has exclusive legal control over the assets contributed."
There is a strict interpretation of the CWA requirements and substantial compliance does not "excuse defects in a CWA." Therefore, the Fidelity Charitable DAF receipt for a gift of 1,380 shares of CSTC stock was required to include two statements: one states that no goods or services were transferred in return for the gift and a second that the nonprofit has exclusive legal control over the assets contributed. Because the Fidelity CWA included both statements, it was deemed sufficient.
Many DAF custodians include the "no goods or services" statement in the CWA and the "exclusive legal control" statement resides in the DAF agreement. While the Tax Court may be willing to permit this, it is poor donor relations to require your DAF major donor to go to Tax Court to qualify for a charitable deduction.
A best practice for DAF custodians is to be certain that CWAs includes the "no goods or services" statement and the "exclusive legal control" statement. Fidelity Charitable and other large DAF custodians are following this best practice. While nonprofits could send the "no goods or services" statement CWA to regular donors and the "no goods or services" and "exclusive legal control" statement CWA to DAF donors, there are often staff changes at nonprofits. To avoid staff errors in the CWAs, it may be a best practice for DAF custodians to send CWAs containing both disclosures to all donors.
Editor's Note: Many midsized nonprofits with DAFs are not following the best practice with the longer (and now required by the Tax Court) CWA. Major DAF donors may move to the larger DAF custodians that are using the longer CWA.
Ripened Gain Before Gift and Failed Appraisal
In Estate of Scott M. Hoensheid et al. v. Commissioner; No. 18606-19; T.C. Memo. 2023-34, the Tax Court determined the taxpayer transferred stock to a donor advised fund after the transaction was virtually certain and the gain had ripened. There was no bypass of capital gain on the gift and the taxpayer did not receive a charitable deduction because the appraisal and appraiser failed to meet the requirements.
Commercial Steel Treating Corporation (CSTC) was founded by the grandfather of taxpayer Scott M. Hoensheid. In 2015, CSTC was owned one third by Scott and one third each by his brothers, Craig and Kurt Hoensheid.
Kurt planned to retire and the brothers decided to place CSTC up for sale. They engaged the FINNEA Group as investment adviser. Brian Dragon was Senior Managing Director of FINNEA and assisted in the transaction. After soliciting bids, HCI Equity Partners (HCI) indicated it would be willing to purchase CSTC for $92 million. After further negotiations, all parties agreed on a sale price of $107 million.
Scott had indicated to his attorney, Andrea Kanski, that he was interested in creating a donor advised fund with Fidelity Charitable. Ms. Kanski stated to Scott, "the deadline to assign the stock to a donor advised fund is prior to execution of the definitive purchase agreement." Scott responded, "I would rather wait as long as possible to pull the trigger."
Prior to the gift, family wealth adviser, Casey Bear, emailed a Letter of Understanding to Fidelity Charitable representative, Kurt Chisholm. The letter indicated that Fidelity Charitable "is not and will not be under any obligation to redeem, sell, or otherwise transfer the asset."
On June 11, 2015, CSTC held a shareholders meeting and the three brothers approved the "ratification of the sale of all outstanding stock of Commercial Steel Treating Corporation to HCI." They also accepted the request of Scott to transfer part of his stock to Fidelity Charitable.
Scott had a partially prepared certificate but had not yet finalized the number of shares. The brothers agreed that CSTC would also "sweep the cash from the company prior to closing and distribute it to the brothers."
After discussions with Fidelity Charitable, Scott decided to give 1,380 shares with approximate value of $3 million to the donor advised fund. On July 10, 2015, CSTC paid approximately $6.1 million in bonuses to key employees under a Change in Control Bonus Plan. On July 13, there was an acceptance of the stock gift by Fidelity Charitable. On July 14, 2015, CSTC distributed $4.8 million to the three brothers. On July 15, the law firm of Attorney Kanski signed an "Irrevocable Stock Power" for the 1,380 shares transferred to Fidelity Charitable.
Attorney Kanski assisted in preparation of the 2015 federal income tax return. An appraisal and IRS Form 8283 Noncash Charitable Contributions reported a gift of $3,282,511, which was $340,545 higher than the net proceeds transferred to Fidelity Charitable.
The appraisal was prepared by FINNEA Director Brian Dragon. He had not previously performed valuations for IRS purposes, with the exception of one estate tax return. He had experience in valuing companies for acquisition purposes. Scott was offered an opportunity to obtain an appraisal from accounting firm Plante Moran, but he chose the FINNEA appraisal.
The IRS audited the tax return of Scott, denied the deduction and assessed a deficiency of $647,489 and a Section 6662(a) penalty of $129,498.
There were three primary issues in the court opinion. First, was there an assignment of income because the gain had ripened? Second, did the contemporaneous written acknowledgment meet the requirements? Third, were the appraiser and appraisal qualified?
A gift of appreciated asset will bypass the gain if there is not an assignment of income. However, the donor must transfer title prior to the ripening of gain.
Scott testified at trial that his intention existed at the June 11 stockholders meeting to make a gift of 1,380 shares. However, the documents that established this number did not exist until July 9 or July 10. Therefore, there was no actual or constructive delivery prior to July 11 or July 12. There was a July 13 email and PDF of the stock certificate sent from financial adviser Bear to Fidelity Charitable. The Tax Court determined that based on this strong documentary evidence, the actual date for the gift and acceptance of the 1,380 shares by Fidelity Charitable was July 13, 2015.
The right to avoid taxation is available if there is not a vested or fixed right to receive income at the time of the transfer. See Rauenhorst v. Commissioner, 119 T.C. 157, 173 (2002); Ferguson v. Commissioner, 174 F.3d 997 (1999). It is possible a gift transfer does not obligate the nonprofit to sell. In Dickinson v. Commissioner, T.C. Memo. 2020-128, an individual made multiple share transfers to Fidelity Charitable and the shares were subsequently redeemed by the corporation. Because the redemption "was not a fait accompli at the time of the gift," the taxpayer was not subject to the "practically certain to occur" realization event. This principle also was relevant in Rauenhorst. Rauenhorst stated that while the courts are not subject to Rev. Rul. 78-197, 1978-1 C.B.83, the Commissioner is precluded from arguing against the IRS position on prearranged sales.
In Ferguson, the shareholders had approved the sale and the gain had ripened, but in Rauenhorst there still was uncertainty as to the sale and the gain had not ripened. The key issues in prearranged sale cases are whether there is a legal obligation to sell by the donee, actions have already been taken by the parties to effect the transaction and any remaining unresolved transactional contingencies.
The first issue was whether Fidelity Charitable had an obligation to sell. The Letter of Understanding expressly disclaimed such obligation and therefore the IRS had not established there was an obligation by Fidelity Charitable to sell. However, the second question was whether the actions taken by CSTC Directors had caused the transaction to be virtually certain. Because the cash in the company of $6.1 million was distributed to employees through bonuses on July 10 and CSTC had decided to make the distribution of $4.8 million to the three brothers, the decision was essentially made to sell CSTC. The Tax Court noted, "We consider it highly improbable that petitioner and his two brothers would have emptied CSTC of its working capital if the transaction had even a small risk of not consummating." Therefore, the transaction was virtually certain when the 1,380 shares were gifted on July 13.
The third issue is whether there is an unresolved sale contingency. There were issues of environmental liability and employee compensation. However, on July 13 the other issues had resolved. The transaction in the words of Scott was now "99% sure." Therefore, there were no significant unresolved contingencies.
The basic timeline is a decision on June 11, 2015 by the three brothers to sell CSTC to HCI and a gift of stock on July 13, 2015 at a point when the sale was essentially completed (just two days before final closing). Because the sale was a virtual certainty, the gain had ripened and there was no bypass of gain on the gift of stock to Fidelity Charitable
A charitable contribution deduction over $250 requires a contemporaneous written acknowledgement (CWA). See Section 170(f)(8)(B). The CWA must be received by the taxpayer prior to the date the tax return is filed or the due date (with extensions) of the relevant tax return, whichever is earlier. Section 170(F)(18)(B) specifies an additional requirement for donor advised funds. A CWA for a DAF must include a statement that the donee has "exclusive legal control over the assets contributed." There is a strict interpretation of the CWA requirements and substantial compliance does not "excuse defects in a CWA." Therefore, the requirement was for the Fidelity Charitable receipt for the 1,380 shares of CSTC stock to include both statements representing that "no goods or services" were transferred in return for the gift and the nonprofit has "exclusive legal control over the assets contributed." Because the Fidelity CWA included both statements, it was deemed sufficient.
Section 170(f)(11)(A)(i) states that a qualified appraisal is required for gifts of nonmarketable assets over $5,000 ($10,000 for closely held stock). The appraisal may be made up to 60 days prior to the contribution and must be "prepared, signed, and dated by a qualified appraiser." See Reg. 1.170A-13(c)(3)(i).
The qualified appraisal must describe the property in sufficient detail so the IRS can understand or ascertain the property that has been gifted, list the date of the contribution, include the name, address, and identifying number of the qualified appraiser, describe the qualifications of the appraiser, indicate the appraisal was prepared for income tax purposes, state the date of the appraisal, state the fair market value of the property on the date of the contribution and explain the method and specific basis for the appraisal.
Section 170(f)(11)(E)(ii) indicates a qualified appraiser must have earned an appraisal designation from a recognized professional appraiser organization or has otherwise met minimum education and experience requirements, regularly performs appraisals for compensation, holds himself or herself out to the public as an appraiser, performs appraisals on a regular basis, is qualified to appraise the type of property being valued, is not an excluded person and understands the consequences of a false or fraudulent statement of value.
The IRS contended that Mr. Dragon's appraisal was not a qualified appraisal. The appraisal failed to include the statement that it was prepared for tax purposes, had the wrong date of June 11 as the date of contribution, did not describe the specific method of valuation, was not signed by Mr. Dragon, did not include Dragon's qualifications as an appraiser, did not describe the property in sufficient detail and did not include an explanation of the method for the evaluation. An appraisal may qualify if it meets a substantial compliance standard. However, the number of missing items in the Dragon appraisal do not meet the standard of substantial compliance.
In addition, Mr. Dragon did not hold himself out as an appraiser, had no certification as a professional appraiser and only did appraisals on a very limited basis. He therefore is a nonqualified appraiser. Because both the appraisal and the appraiser failed the requirements, the deduction was denied.
The appraisal exception for reasonable cause was also not applicable. While attorney Kanski was competent and professional, the taxpayer could not claim exclusive reliance on her judgment "because petitioner knew or should have known that the date of contribution (and thus the date of valuation) was incorrect." Therefore, the appraisal does not meet the reasonable cause exception and the charitable deduction was denied.
The IRS had issued a Section 6662(a) penalty and the taxpayer claimed there was a good faith exception for the penalty. The Tax Court determined that the taxpayer did rely on attorney Kanski's advice. Therefore, the Section 6662(a) penalty was not applicable.
The final result is the taxpayer was taxable on the capital gain because the gain had ripened as of the date of the gift and the taxpayer charitable deduction was denied because the both the appraisal and the appraiser failed to meet applicable requirements.
Editor's Note: This is an extensive and thorough opinion. It is likely to be appealed to the Sixth Circuit Court of Appeals. However, it is a very clear case on the difference between making a charitable gift prior to the ripening of gain and the transfer of property after there is a binding agreement or a virtually certain sale. The taxpayer disregarded the advice of both his attorney and the nonprofit.
Applicable Federal Rate of 5.0% for April — Rev. Rul. 2023-6; 2023-14 IRB 1 (15 March 2023)
The IRS has announced the Applicable Federal Rate (AFR) for April of 2023. The AFR under Section 7520 for the month of April is 5.0%. The rates for March of 4.4% or February of 4.6% also may be used. The highest AFR is beneficial for charitable deductions of remainder interests. The lowest AFR is best for lead trusts and life estate reserved agreements. With a gift annuity, if the annuitant desires greater tax-free payments the lowest AFR is preferable. During 2023, pooled income funds in existence less than three tax years must use a 2.2% deemed rate of return.