Paul L. Caron

Tuesday, May 31, 2022

Lesson From The Tax Court: The Sharp Corners Of The §170 Substantiation Requirements

Camp (2021)The sainted Justice Holmes once wrote:  “Men must turn square corners when they deal with the Government.”  It is no accident that Justice Holmes wrote that in a tax case.  Rock Island R.R. v. United States, 254 U.S. 141, 143 (1920).  Of all the corners in all the laws governing citizen interaction with government, tax laws contain some of the squarest.  This is a lesson we’ve seen before.  See Lesson From The Tax Court: The Structure Of Substantiation Requirements of §170, TaxProf Blog (Sept. 24, 2018).  But I think it’s a lesson worth repeating: the substantiation rules in §170 contain some very sharp corners.  The lesson is important for high-end donations such as the one in today’s case.  And it is not just a lesson for taxpayers, but also for charities.

In Martha L. Albrecht v. Commissioner, T.C. Memo. 2022-53 (May 25, 2022) (Judge Greaves), the taxpayer made a very large donation to a museum and claimed a §170 charitable donation deduction on her return.  The IRS said that the 5-page document memorializing the gift did not meet the statutory substantiation requirements for such a gift.  The Tax Court agreed.  Thus, no §170 deduction.  Details below the fold.

Law: Navigating the Sharp Corners of §170 Substantiation
Section 170 permits taxpayers to deduct certain contributions made to charitable organizations.  Section 170(f) contains the main rules for taxpayer to follow to substantiate their deduction.  Congress has historically been concerned about two potential abuses.  First, taxpayers might overvalue donations, especially when the donations are property.  You see that concern, for example, in the rules for donations of vehicles.  §170(f)(12).  Second, Congress has been concerned that taxpayers might buy stuff from a charity and claim the purchase price as a deduction. While taxpayers can certainly buy stuff from charities, a purchase does not qualify as a contribution under §170(c).  Only amounts paid in excess of the fair market value of what taxpayers receive counts as a gift.  Treas. Reg. 301.170A-1(h).  That concern is addressed in  §170(f)(8).

One reason why courts apply the §170(f)(8) substantiation requirements so strictly is because so few returns are audited and the system depends on taxpayers and their tax advisors to comply.  Thus, the “deterrence value of section 170(f)(8)'s total denial of a deduction [for failure to substantiate] comports with the effective administration of a self-assessment and self-reporting system.”  Addis v. Commissioner, 374 F.3d 881, 887 (9th Cir. 2004).

One way to understand the substantiation requirements is to see how they address both these concerns.  I find it convenient to bucket the §170 substantiation requirements according to the size of the claimed deductions: less than $250; between $250-$500; over $500 but less than $5,000; over $5,000.

(1) Small Donations: Adequate Records
For contributions of less than $250, taxpayers must keep adequate records to substantiate the contribution.  If the contribution is money, the records must show name of the charity, the date of the contribution, and the amount of the contribution.  §170(f)(17).  If the contribution is property, the records must also show the location of the donation and a reasonable description of the property donated.  Treas. Reg. 1.170A-13(b)(1).

Receipts are preferred but not required if the taxpayer’s records are otherwise adequate.  For example, cancelled checks can substantiate a monetary donation if the check shows the required information.  Treas. Reg. 1.170-13(a)(1)(i).  Donations of property at drive-by drop boxes can also qualify, but are particularly problematic because substantiation depends on the taxpayer keeping adequate records, which means something more than adequate. The regulations say the “adequate records” determination is a very facts-and-circumstances determination, so not having receipts really leaves it up to what the narrowed gimlet eyes of the auditor sees as "adequate."

Bottom line: Taxpayers who do not obtain receipts take a risk because they must depend on their records being solid.

(2) Medium Donations: Records Plus Receipts
For contribution of $250 or more, taxpayers must keep adequate records as above, but now must obtain a receipt, called a Contemporaneous Written Acknowledgement (CWA).  §170(f)(8).  To create a valid CWA, the taxpayer and charity must turn several square corners, most of which are found in §170(f)(8).

First, a CWA must specify the amount of cash donated, or give a description of property donated.  §170(f)(8)(B). For property, the receipt does not have to state any value and, if fact, doing so does little good.  Establishing value is on the taxpayer.  My practice is to list the items, snap a pic of them, then assign values using thrift store prices or eBay sold prices (for the larger items).  I print all that out, staple it to my donation receipt, and stuff it in the file.

Second, a CWA must say whether the charity provided any goods or services in consideration for the donation, either in whole or in part.  §170(f)(8)(B)(ii).  I call this the “magic language” requirement.  It is arguably the squarest corner to turn.  I want my CWA to make an explicit statement, something like “No goods or services were given in exchange for this donation.”  Notice that the requirement, however, does not permit silence; the CWA must declare whether or not something was given for the donation.

Third, if the charity did give something of value in exchange for the donation, the CWA needs to give a description and good faith estimate of the value of what was given.  §170(f)(8)(B)(iii).  That allows the taxpayer to claim any amount of contribution in excess of the value of what the charity gave.  For example, charities often give donors a “premium” for certain levels of donation.  My practice is to decline the premium.  I really don’t want another coffee mug!

Fourth, the CWA must be “contemporaneous.”  §170(f)(8)(C).  All that means is that it must be obtained by the earlier of (a) when the TP actually files the return or (b) the due date (including any extensions given) for the return. For donations of vehicles, the term is more strictly defined to be with 30 days of the donation.  §170(f)(12)(C).For donations of cash, we’re done.  Cash is always cash and all amounts over $250 are treated the same; there are no further substantiation requirements.

Property donations, however, are a different matter.

(3) Larger Donations: Records, Receipts, Plus More
For property donations that exceed $500, the statute requires taxpayers to obtain all the above substantiation, plus additional information “as the Secretary may require.” §170(f)(11)(B).  The regulations, in turn, punt to sub-regulatory guidance.  They tell taxpayer that to include such information “if required by the return form or its instructions.” Treas.Reg. 1.170A-13(b)(3)(i).  For donations of property taxpayers find those requirements in Form 8283 and its instructions.  Taxpayers must report when and how they acquired the donated property and to report their basis in the property.

For donations of used cars, boats, airplanes, etc., greater than $500, additional substantiation requirements are found in §170(f)(12).  First, the CWA must contain additional information, detailed in paragraph (12)(B).  Second, the CWA must be issued within 30 days of the sale or donation.  Third, the taxpayer must file the CWA with their tax return. §170(f)(12)(A)(i).

(4) Big Donations: Records, Receipts, More, Plus Appraisals.
For donations of property that aggregate more than $5,000, taxpayers must not only obey all of the above substantiation requirements, but they must also obtain a qualified appraisal that supports the value claimed for the donated property. §170(f)(11)(C).  Generally, the taxpayer just has to send in a summary of the appraisal, but if the claimed donation exceeds $500,000 then the taxpayer must attach the appraisal itself.  §170(f)(11).  Lookin’ at you, conservation easements!  See Lesson From The Tax Court: Taxpayer Cannot Cure Reporting Error During Audit, TaxProf Blog (Mar. 2, 2020).

Finally, for property donations greater than $5,000 the taxpayer must also seemingly obtain the signature of an authorized official of the charity on the Form 8283 itself.  I explained my reservations about the legality of this requirement in Lesson From The Tax Court: The Structure Of Substantiation Requirements of §170, TaxProf Blog (Sept. 24, 2018).

(5) The Aggravating Aggregation Rules
For property donations above the $500 and $5,000 thresholds, the statute applies these substantiation requirements not only to individual and discrete donations of personalty but to aggregate donations of “similar items of property” to “1 or more” charity. 170(f)(11)(F).  Treas. Reg. 1.170A-13(c)(7)(iii) tells you that “similar items of property” mean property of the same generic category or type and lists a bunch of categories.  These dollar thresholds are not adjusted for inflation, which makes them increasingly aggravating at time goes by.

In contrast, for cash donations, taxpayers may, but need not, aggregate or obtain a CWA.  Treas. Reg. 301.170A-13(f)(1) provides that “Separate contributions of less than $250 are not subject to the requirements of section 170(f)(8), regardless of whether the sum of the contributions made by a taxpayer to a donee organization during a taxable year equals $250 or more.”  Thus, a taxpayer who donates $100/week to their church must substantiate with adequate records but need not obtain a CWA.  But a taxpayer who donates $400/month needs a CWA.  Yes, that’s aggravating.  Just call me cranky.  But not as cranky as Ms. Albrecht after she reads Judge Greave’s opinion.  Let’s look.

In 2014, Ms Albrecht was sitting on a large collection of Native American jewelry and artifacts, collected over her lifetime with her late husband.  She donated approximately 120 pieces from her collection to the Wheelwright Museum, a well-respected and long-established museum in Santa Fe, NM.  You would think that that a donation of that size to an institution of that caliber would be well and properly substantiated.  You would be wrong.

The Albrecht’s donation was substantiated by a 5-page “Deed of Gift.”  Nowhere in those 5 pages did the Deed say whether or not any goods or services were given in exchange for the gift as required by §170(f)(8)(B)(ii).  Nowhere.

On audit, the IRS disallowed the §170 deduction for failure to substantiate.  Ms. Albrecht petitioned the Tax Court.

Lesson: Turn ALL The Square Corners
Ms. Albrecht’s 5-page Deed apparently had most of the information required by the statute and regulation for big donations.  The opinion does not tell us how much Ms. Albrecht tried to deduct, but for donating 120 pieces of jewelry and artifacts it’s got to have been greater than $5,000.  Supporting that is the fact that Ms. Albrecht was represented by counsel and would be unlikely to incur that expense to protect a smaller disallowance.

The problem was, again, that the Deed did not recite whether or not the Wheelwright gave Ms. Albrecht anything of value in exchange for her donation.  It was silent.

Ms. Albrecht argued that even though the Deed did not contain the magic language, it substantially complied with the §170(8)(A)(ii) requirement.  Judge Greaves acknowledged that some substantiation requirements can be met by substantial, rather than literal, compliance.  He cites precedent where the Court has looked to the CWA as a whole to determine whether it “effectively states whether any goods or services were provided in the exchange....”  Op. at 4.  And although not cited in the opinion, I expect that Ms. Albrecht relied on Hewitt v. Commissioner, 109 T.C. 258, 265 (1997).  There, the Court distinguished the requirement to obtain a qualified appraisal, which is strict, from the required contents of the appraisal, which may be satisfied by substantial compliance where the taxpayer has "provided most of the information required."  Id.

That would not seem to help her here, however, because she failed to provide what is arguably the most crucial piece of information: whether or not she received anything of value from the charity!  In substantial compliance cases, the Tax Court has explicitly linked the doctrine to the Congressional concerns underlying the substantiation requirement at issue.  Thus, the Court recently wrote: “we have found substantial compliance in cases that involved procedural regulatory requirements where, despite a lack of strict compliance, the taxpayer substantially complied by fulfilling the essential statutory purpose.”  Chiarelli v. Commissioner, T.C. Memo. 2021-27, at 17.  That's not happening here.

It's not clear to me whether Judge Greaves rejects the idea of substantial compliance, or whether he simply does not think Ms. Albrecht substantially complied.  He starts off noting that even though the Deed recites that the donation was unconditional and irrevocable, “the deed does not state whether the Wheelwright Museum provided any goods or services with respect to the donation.” Op. at 4.  That requirement is central to one of the main Congressional concerns about charitable donation deductions: the receipt of something in exchange for the donation.  So that really seems the end of the matter.

Judge Greaves goes on, however, to note that the Deed has a huge equivocation on whether the donation was indeed unconditional.  That inquiry would not be necessary if substantial compliance was off the table.  The Deed provides that “all rights, title and interest held by the donor in the property are included in the donation, unless otherwise stated in the Gift Agreement.”  Op. at 2.  The problem here is that there was no Gift Agreement. “Despite ‘the Gift Agreement’ reference on the second page of the deed, no such agreement was included with the deed, and the Wheelwright Museum did not provide petitioner with any further written documentation concerning the donation.”  Op. at 2.

Whoops.  That omission made it impossible to evaluate whether Ms. Albrecht had substantially complied with the CWA requirements of §170(f)(8).  “When looking exclusively at the deed and considering it as a whole, it leaves open a significant question about whether the parties had entered into a side agreement that included additional, superseding terms.” Op. at 5.

Regardless of the basis for the opinion, the failure by the Wheelwright Museum to give Ms. Albrecht a proper CWA, one that turned all the square corners in §170(f)(8), doomed her deduction.  The government needs to be informed whether taxpayers who make donation are receiving something of value in exchange or not.  That is one of Congress’ central purposes in creating the CWA requirement.  A document that is totally silent on that does not meet that requirement.

Comment:  I see some red herrings in the opinion.  First, the parties apparently argued over whether the Deed would qualify as a CWA if it had an integration clause—you know, a clause that says “this is the entire agreement between the parties...”  I don’t see how that would matter.  The Deed would still have failed to recite whether or not something was given to Ms. Albrecht in exchange for the donation, such as a lifetime pass to the Museum.  Just because the document does not give Ms. Albrecht a legal right to receive something in the future does not mean nothing was actually given!  Second, the parties apparently thought it important that the deed recited the irrevocable nature of the gift.  Again, who cares?  I don’t see how that creates any presumption, much less any substantiation, that no goods or services were given in exchange for the irrevocable gift.  It may go to the valuation the gift, but not to the quid pro quo requirement.

Coda: In 2019 my wife created a 501(c)(3) organization called Earth Day Lubbock.  She’s doing a fantastic job with it, even though COVID cancelled the 2020 and 2021 events and high winds blew away the 2022 event!  And she has secured some donations.  I have told her that her donation thank-you cards and emails should be designed to meet the CWA requirements, regardless of the donor or the amount donated.  I would give that advice to any 501(c)(3).  These may be square corners, but they are not hard ones to turn. 

Bryan Camp is the George H. Mahon Professor of Law at Texas Tech University School of Law.  He invites readers to return each Monday for a new Lesson From The Tax Court.

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