Donating Eyeglasses

Some tax cases take near forever to wrap-up.

I am looking at a case involving tax year 2008; it was decided in April, 2020. It involves over $300 grand in taxes and penalties.

Let’s set it up.

A.  Take an accounting firm with offices in Cerritos, California and Kansas City, Missouri.

B.   Through them the taxpayers (Campbell) learned of a donation program involving Lions in Sight. The program was rather straightforward.

a.    A company (ZD Products) consolidates eyeglass frames (let’s say approximately 170,000).

b.   The company breaks down that number into lots (let’s say approximately 3,400 frames).

c.    It then sells the lots for approximately $50 grand each.

d.   If you buy a lot, you are advised to wait a year before doing anything. Not to fear, they will take care of your lot for you.

e.    After a year you donate the lot to Lions in Sight.

                                             i.     This is prearranged.

                                           ii.     Lions in Sight is affiliated with the Lions Club International. Its mission is to collect and provide used eyeglasses for use worldwide and to provide eye care assistance to the needy and low-income. In truth, it sounds like a fine charity.

f.     You will get a bright shiny appraisal saying that your donation was worth approximately $225 grand.

It sounds like the program ran well. In 2007 Lions in Sight had so many frames in storage that they requested ZD Products to store a sizeable new donation until 2008, when they could free up space.

Nice problem to have.

The IRS became aware and did not care for this at all. No surprise: one puts in $50 grand and – a year and a day later – gets a donation worth $225 grand.  Quick math tells me that someone with a tax rate over 23% comes out ahead.

What do we have? Someone takes a good cause (the Lions Club), stirs in a for-profit party (both the company selling the eyeglasses and the company organizing the deal), and has a sacerdote (the appraiser) bless the bona fides. Everybody wins; well, everybody but the IRS.   

We have seen something similar to this with conservation easements. Take a good cause – say preserve a wetland … or just green space. Bring in the marketers, attorneys and valuation experts. Stick the property into an LLC; sell interests in the LLC; donate the LLC interests to who-knows-who and – voila – instant big bucks tax deduction for someone who was never really that interested in wetlands or green space to begin with.

I have a question for you. Why do you think that the IRS has so many rules concerning donations? You know them: you need a receipt; past a certain dollar limit you need a letter from the charity; past another dollar limit you need an appraisal; somewhere in there you have a form attached to your tax return just for the donation.

Tripwires.

Let me give you one.

If you need an appraisal, then the appraisal has to be for what you actually donated.

Bear with me.

This story started off with approximately 170,000 eyeglass frames. They are of varying sizes, styles, quality and value. An appraisal is done on the mother lode.

Break the lode into lots of approximately 3,400.

Donate the lots.

The appraisal was done on the 170,000.

You need an appraisal on your 3,400.

You do not have this. Best you have is 34/1,700 of an appraisal.

But it is virtually impossible that each lot will be the same. There are too many combinations of styles, sizes, designers, costs and whatnot.  Just taking a percentage (34/1,700) is not good enough – not for this purpose.

You have no appraisal.

You have no deduction.

Tripwire.

The case for the home gamers is Campbell v Commissioner.

Can A Land Fill Make A Charitable Donation?

I have a client on extension for their individual tax return. They donated real estate last year. I am waiting on an appraisal and a signed Form 8283 before sending in the return.  

Charitable contributions have become a “gotcha” area for the IRS. The rules border on the insane. Does it make sense to you that I need a letter from the charity for donations over $250 even if I have a cancelled check? The IRS will accept a cancelled check as proof of a travel expense or of a child-care payment, but not for proof of a donation. Fail to follow their rules and you may lose the deduction altogether.

Sure enough, someone thought they followed the rules. Let’s go through the story of Boone Operations.

Boone Operations owned a landfill (Speedway). Right next to them, the city of Tucson (Arizona) also owned a landfill (Tucson). Both were surrounded by commercial and residential development. 

Tucson must have been a mess. The flare in its collection system kept going out and water kept collecting because of poor drainage. Tucson stopped accepted waste materials, but there were issues closing the place down. The neighbors howled; hearings were held. Douglas Kennedy (Kennedy), Boone’s owner, was concerned that Tucson was going to drag him down. He offered to help. In 1996 the two parties were happy and holding hands. Boone agreed to:

·        Share the cost of an interim gas system

·        Negotiate a permanent gas system

·        Cooperate to extend Boone’s aquifer permit to Tucson

You also had the following text in an agreement the attorneys drew up:

6.  Acceptable Waste Fill and Soil Fill

[Boone] agrees to provide [Tucson] with, and [Tucson] agrees to accept, acceptable waste fill and soil.

6.1 Placement of Acceptable Waste Fill

Boone shall, at no cost to [Tucson], fill the *** with acceptable waste to the approved final grades.

Seems clear: Boone will provide waste fill.

The promising relationship between Boone and Tucson soon soured:

·        6/99 - Boone places waste on Tucson to comply with agreement

·        10/99 – the Department of Solid Waste Management wants to know why Boone placed waste on Tucson

·        11/99 – Tucson wants Boone to remove the waste  

·         03/00 – Boone sues Tucson for $20 million

·        04/01 – Tucson provides Boone a settlement offer

·        09/01  -  Tucson files civil and criminal charges

·        04/02 – Boone files with the Superior Court

Shame. They seemed like such a nice couple.

Anyway, in December 2002, they settle. Tucson agreed to a number of things, including (a) paying $450,000 for Boone to construct drainage, (b) helping with easements and (c) releasing Boone and Mr. Kennedy from lawsuits.

And then the magic words:

8.1 Prior Contribution.  [Tucson] acknowledges that as of the date of the Settlement Memorandum, it had accepted Boone’s charitable contribution of 95,000 cubic yards of Acceptable Fill.

8.2 Future Contribution.  Boone agrees to make another charitable contribution of an additional 105,000 cubic yards of Acceptable Fill.

To the uninitiated, it appears that Boone has made a contribution of 200,000 cubic yards of Acceptable Fill to Tucson, don’t you think?

Boone files tax returns showing a donation of $449,000 for one year and $706,000 for another.

The IRS disallows the deductions. It has two arguments:

           

(1)  Boone failed to obtain contemporaneous written acknowledgement.

(2)  Boone received significant cash and noncash consideration and failed to prove that the value of the fill provided exceeded the consideration received.

The IRS argued that a written acknowledgement must include the following magic words:

·        The amount of cash and a description (but not value) of any property other than cash contributed.

·        Whether the donee organization provided any goods or services in consideration, in whole or part, for any property described.

·        A description and good faith estimate of the value of any goods and services received, or, if such goods and services consist solely of intangible religious benefits, a statement to that effect.

What does Boone have? The Settlement Agreement from December 2002. Without the magic words, however, Boone does not have “written acknowledgement.”  Since the donation was over $250, no deduction is allowed without written acknowledgement.

The Court then went on the argument (2). It went through the appraisal process in painstaking detail. There appear to have been significant errors in the appraiser’s calculations, for example, leading to an overvaluation of the donated fill. The Court also pointed out that Boone and Mr. Kennedy were released from a potential lawsuit. That release could have a value. If so, should that value be taken into account?

I question why the Court did this. The Court had already disallowed the deduction for lack of written acknowledgement. Why keep going?

My thinking? The Court expects a challenge on issue [1], and it thinks it could be reversed by a superior court. The Court therefore kept going, reasoning that if was reversed on issue [1] it would be sustained on [2].

You know how this turned out: the Tax Court disallowed the charitable deductions under both arguments.

COMMENT: Please do not mess with IRS in this area. If you are thinking about a significant donation of anything other than cash, please call your tax advisor first.  Get your papers lined up and do not play “gotcha” with the IRS.

Taxpayer Loses Charitable Deduction for Lack of Appraisal

Joseph Mohamed seems a good sort. He and his wife live in Sacramento, California. He is a successful real estate professional. In 1998 they formed the Joseph Mohamed Sr. and Shirley M. Mohamed Charitable Remainder Unitrust II. Tax pros call this a “CRUT.”

QUESTION: What is a CRUT? This is a special trust involving a charity. You can guess that a purpose of the trust is to make a charitable donation. In a CRUT, an annuity goes to the donor (in this case, Joseph and Shirley) for a period of years. At the expiration of that period, the remainder goes to a charity. In the Mohamed’s case, that period is twenty years. Why would you do that in place of simply donating twenty years out? Because the CRUT allows you to claim the charitable deduction now.

In 2003 and 2004 the Mohameds donated several properties to the CRUT. The properties were worth somewhere between $18 million and $21 million. Joseph Mohamed prepared his own taxes. This means he ran into Form 8283 to report the property donations. He did not read the instructions though, as he did not think he had to. The form seemed straightforward enough.

Form 8283 has several parts. Part 1 Section B required a description of the donated property and “can be completed by the taxpayer and/or appraiser.” It also had the following text:

“If your total art contribution deduction was $20,000 or more you must attach a complete copy of the signed appraisal. See instructions.”  

Mohamed was contributing real estate, not art. He read that to mean that he did not have to attach an appraisal. He did attach all types of statements and documentation to his return, including his own valuation of the real estate.

The return gets audited (who is shocked?). The IRS was displeased that Mohamed had self-valued such a large dollar donation of property. The IRS first goes after the valuation. Makes sense. Mohamed then gets an independent appraisal which shows that the properties are worth more than he claimed.

The IRS then pulls back and realizes something. Regulation 1.170A-13(c) requires the following for donations of this nature and amount:

1.      A qualified appraisal must be made not more than 60 days before the donation and no later than the due date of the return.

2.      It must be signed by a qualified appraiser, who cannot be the donor or person claiming the deduction.

3.      The qualified appraisal must contain defined information, such as a description of the property, its basis and fair market value.

Mohamed had a problem. You see, he did not have a qualified appraisal. That requires an independent appraiser, and he obtained that after the filing of his return. There was of course no signature, as there was no qualified appraisal. While he attached numerous statements to his return, they did not completely address the litany of questions that the IRS wanted in Reg 1.170A-13(c).

The IRS disallowed the donations. Mohamed goes to Tax Court and raises three arguments:

1.      The extreme result indicates that the Regulations are invalid.

2.      The IRS-designed Form 8283 misled him.

3.      He substantially complied with the documentation requirements.

The Court quickly dismissed arguments 1 and 2. It went through an analysis (which we will skip) and concluded that the Regulations were valid and reflected Congressional intent. The IRS, for example, was ordered by Congress to issue Regulations requiring appraisals for donations of property in excess of $5,000. A Regulation that implements Congressional intent is difficult to rule invalid. The Court was sympathetic to argument 2, but it pointed out that the form is not the tax law. The Court even added that “a taxpayer relies on his private interpretation of a tax form at his own risk.”

Now we get to argument 3. What does “substantially comply” mean? There was a previous case (Bond) where the Court found substantial compliance, but succeeding cases have ever compressed the reach of that decision. The Court determined that substantial compliance meant complying with the “essential requirement” of the statute. Problem is, the “essential requirement” of the statute is the need to obtain a qualified appraisal. With that verbal loop, there was no way that Mohamed could substantially comply.

Here is the Court:

We recognize that this result is harsh – a complete denial of charitable deductions to a couple that did not overvalue, and may well have undervalued, their contributions – all reported on forms that even to the Court’s eyes seemed likely to mislead someone who did not read the instructions.”

MY TAKE: I am sympathetic to the Mohameds, but I am also confused. They must have used a tax professional in the past to establish the CRUT. They then make a near-$20 million donation but do not hire a pro to walk it through? It doesn’t make sense to me.

In both Mohamed and Durden there was no question that contributions were made; there were also no question as to the amounts. The taxpayer may have felt comfortable thinking: what are they going to do, put me in jail? No, they won’t put you in jail, but they will take away your charitable deduction. Don’t think that a court will bail you out, as there may be limits to what a court can do.

What is the answer? I would encourage the use of a tax professional if there is even a whiff of a question on your return. I know – it costs money. The problem is that you may not know you have hit a slick spot until after the IRS contacts you. As Mohamed and Durden have shown, that may be too late.