Setting Up A Museum

Have you ever wondered why and how there are so many private art museums in the United States: The Brant Foundation, The Broad, The Warehouse?

Let’s posit the obvious immediately: wealthy people with philanthropic objectives.

This however is a tax blog, meaning there is a tax hook to the discussion.

Let’s go through it.

We already know that the tax Code allows a deduction for charitable contributions made to a domestic corporation or trust that is organized and operated exclusively for charitable purposes.  There are additional restrictions: no part of the earnings can inure to the benefit of a private individual, for example.

Got it: charitable and no sneak-arounds on the need to be charitable.

How much is the deduction?

Ah, here is where the magic happens. If you give cash, then the deduction is easy: it is the amount of cash given, less benefits received in return (if any).

What if you give noncash? Like a baseball card collection, for example.

Now we have to look at the type of charity.

How many types of charities are there?

Charities are also known as 501(c)(3)s, but there several types of (c)(3)s:

·      Those that are publicly supported

·      Those that are supported by gifts, dues, and fees

·      The supporting organization

·      The nonoperating private foundation

·      The operating private foundation

What happens is that the certain noncash contributions do not mix will with certain types of (c)(3)s. The combination that we are concerned with is:

 

·      Capital gain property (other than qualified stock), and

·      The nonoperating private foundation

 Let’s talk definitions for a moment.

 

·      What is capital gain property?

 

Property that would have generated a long-term capital gain had it been sold for fair market value. Say that you bought $25,000 of Apple stock in 1997, for example, when it traded at 25 cents per share.

 

By the way, that Apple stock would also be an example of “qualified stock.”

 

·      What is not capital gain property?

The easiest example would be inventory to a business: think Krogers and groceries. A sneaky one would be property that would otherwise be capital gain property except that you have not owned it long enough to qualify for long-term capital gains treatment.

 

·      What is a nonoperating private foundation?

 

The classic is a family foundation. Say that CTG sells this blog for a fortune, and I set up the CTG Family Trust. Every year around Thanksgiving and through Christmas the CTG family reviews and decides how much to contribute to various and sundry charitable causes.  Mind you, we do not operate any programs or activities ourselves. No sir, all we do is write checks to charities that do operate programs and activities.

Why do noncash contributions not mix well with nonoperating foundations?

Because the contribution deduction will be limited (except for qualified stock) to one’s cost (referred to as “basis”) in the noncash property.

So?

Say that I own art. I own a lot of art. The art has appreciated ridiculously since I bought it because the artist has been “discovered.” My cost (or “basis”) in the art is pennies on the dollar.

My kids are not interested in the art. Even if they were interested, let’s say that I am way over the combined estate and gift tax exemption amount. I would owe gift tax (if I transfer while I am alive) or estate tax (if I transfer upon my death). The estate & gift tax rate is 40% and is not to be ignored.

I am instead thinking about donating the art. It would be sweet if I could also keep “some” control over the art once I am gone. 

I talk to my tax advisor. He/she tells me about that unfortunate rule about art and nonoperating foundations.

I ask my tax advisor for an alternate strategy.

Enter the operating foundation.

Take a private foundation. Slap an operating program into it.

Can you guess an example of an operating program?

Yep, an art museum.

I set-up the Galactic Command Family Museum, donate the art and score a major charitable contribution deduction.

What is the museum’s operating program?

You got it: displaying the art.

Let’s be frank: we are talking about an extremely high-end tax technique. Some consider this to be a tax loophole, albeit a loophole with discernable societal benefits.

Can it be abused? Of course.

How? What if the Galactic Command Family Museum’s public hours are between 3:30 and 5 p.m. on the last Wednesday of April in leap years? What if the entrance is behind a fake door on an unnumbered floor in a building without obvious ingress or egress? What if a third of the art collection is hanging on the walls of the CTG family business offices?

That is a bit extreme, but you get the drift.

One last point about the deduction if this technique is done correctly. Let’s use the flowing example:

                  The art is worth             $10,000,000

                  I paid                            $          1,000

We already know that I get a $10,000,000 charitable deduction.

However, what becomes of the appreciation in the art – that is, the $9,999,000 over what I paid for it? Does that get taxed to me, to the museum, to anybody?

Nope.

Another IRA-As-A-Business Story Gone Wrong

 

I am not a fan.

We are talking about using your IRA to start or own a business. We are not talking about buying stock in Tesla or Microsoft; rather we are talking about opening a car dealership or rock-climbing facility with monies originating in your retirement account. The area even has its own lingo – ROBS (Rollover for Business Start Ups), for example - of which we have spoken before.

Can it be done correctly and safely?

Probably.

What are the odds that it will not be done – or subsequently maintained - correctly?

I would say astronomical.

For the average person there are simply too many pitfalls.

Let’s look at the Ball case. It is not a standard ROBS, and it presents yet another way how using an IRA in this manner can blow up.

During 2012 Mr Ball had JP Morgan Chase (the custodian of his SEP-IRA) distribute money.

COMMENT: You have to be careful. The custodian can send the money to another IRA. You do not want to receive the money personally.

Mr Ball initiated disbursements requests indicating that each withdrawal was an early disbursement ….

         COMMENT: No!!!

He further instructed Chase to transfer the monies to a checking account he had opened in the name of a Nevada limited liability company.

         COMMENT: That LLC better be owned by the SEP-IRA.

Mr Ball was the sole owner of the LLC.

         COMMENT: We are watching suicide here.

Mr Ball had the LLC loan the funds for a couple of real estate deals. He made a profit, which were deposited back into the LLC.

At year-end Chase issued Forms 1099 showing $209,600 of distributions to Mr Ball.

         COMMENT: Well, that is literally what happened.

Mr Ball did not report the $209,600 on his tax return.

COMMENT: He wouldn’t have to, had he done it correctly.  

The IRS computers caught this and sent out a notice of tax due.

COMMENT: All is not lost. There is a fallback position. As long as the $209,600 was transferred back into an IRA withing 60 days, Mr Ball is OK.

ADDITIONAL COMMENT: BTW, if you go the 60-day route – and I discourage it – it is not unusual to receive an IRS notice. The IRS does not necessarily know that you rolled the money back into an IRA within the 60-day window.

This matter wound up in Tax Court. Mr Ball had an uphill climb. Why? Let’s go through some of technicalities of an IRA.

(1) An IRA is a trust account. That means it requires a trustee. The trustee is responsible for the assets in the IRA.

Chase was the trustee. Guess what Chase did not know about? The LLC owned by Mr Ball himself.

Know what else Chase did not know about? The real estate loans made by the LLC upon receipt of funds from Chase.

If Chase was the trustee for the LLC, it had to be among the worst trustees ever. 

(2)  Assets owned by the IRA should be named or titled in the name of the IRA.

Who owned the LLC?

Not the IRA.

Mr Ball’s back was to the wall. What argument did he have?

Answer: Mr Ball argued that the LLC was an “agent” of his IRA.

The Tax Court did not see an “agency” relationship. The reason: if the principal did not know there was an agent, then there was no agency.

Mr Ball took monies out of an IRA and put it somewhere that was not an IRA. Once that happened, there was no restriction on what he could do with the money. Granted, he put the profits back into the LLC wanna-be-IRA, but he was not required to. The technical term for this is “taxable income.”

And – in the spirit of bayoneting the dead – the Court also upheld a substantial underpayment penalty.

Worst. Case. Scenario.

Is there something Mr Ball could have done?

Yes: Find a trustee that would allow nontraditional assets in the IRA. Transfer the retirement funds from Chase to the new trustee. Request the new trustee to open an LLC. Present the real estate loans to the new trustee as investment options for the LLC and with a recommendation to invest. The new trustee – presumably more comfortable with nontraditional investments – would accept the recommendation and make the loans.

Note however that everything I described would take place within the protective wrapper of the IRA-trust.

Why do I disapprove of these arrangements?

Because – in my experience – almost no one gets it right. The only reason we do not have more horror stories like this is because the IRS has not had the resources to chase down these deals. Perhaps some day they will, and the results will probably not be pretty. Then again, chasing down IRA monies in a backdrop of social security bankruptcy might draw the disapproval of Congress.

Our case this time was Ball v Commissioner, TC Memo 2020-152.

Incompetent Employees And IRS Penalties

 

“Taxes are what we pay for civilized society.” Compania General De Tabacos de Filipinas v. Collector, 275 U.S. 87, 100 (1927) (Taft, C.J.). For good reason, there are few lawful justifications for failing to pay one's taxes. Plaintiff All Stacked Up Masonry, Inc. (“All Stacked Up”), a corporation, believes it has such an excuse. It brings this suit to challenge penalties and interest assessed by the Internal Revenue Service (“IRS”) following its failure to file the appropriate payroll tax documents and its failure to timely pay payroll tax liabilities for multiple tax periods.

The above is how the Court decision starts.

Here are the facts from 30,000 feet.

·      The company provides masonry services.

·      The company got into payroll tax issues from 2013 through 2015.

·      The company paid over $95 thousand in penalties and interest.

·      It now wanted that money back. To do so it had to present reasonable cause for how it got into this mess in the first place.

Proving reasonable cause is not easy, as the IRS keeps shrinking the universe of reasonable cause.  An example is an accountant missing a timely extension. There is a case out there called Boyle, and the case divides an accountant’s services into two broad camps:

·      Advice on technical issues, and

·      Stuff a monkey could do.

Let’s say that CTG Galactic Command is planning a corporate reorganization and we blow a step, causing significant tax due. Reliance on us as your advisors will probably constitute reasonable cause, as the transaction under consideration was complex and required specialized expertise. Let’s say however that we fail to extend the corporate return – or we file it two days after its extended due date. Boyle stands for the position that anyone can google when the return was due, meaning that relying on us as your tax advisors to comply with your filing deadline is not reasonable.

As a practitioner, I have very little patience with Boyle. We prepare well over a thousand individual tax returns, not to mention business, nonprofit, payroll, sales tax, paper airplanes and everything in between. Visit this office during the last few days before April 15th, for example, and you can feel the tension like the hum from an electrical transformer. What returns are finished? What returns are only missing an item or two and can hopefully be finished? What returns cannot possibly be finished? Do we have enough information to make an educated guess at tax due? Who is calling the client?  Who is tracking and recording all this to be sure that nothing is overlooked? Why do we do this to ourselves?

Yeah, mistakes happen in practice. Boyle just doesn’t care. Boyle holds practitioners to a standard that the IRS itself cannot rise to. I have several files in my office just waiting, because the IRS DOES NOT KNOW WHAT TO DO. I brought in the Taxpayer Advocate recently because IRS Kansas City botched a client. We filed an amended return in response to a Notice of Deficiency the client did not inform us about. The amended must have appeared as “too much work” to some IRS employee, and we were informed that Kansas City inexplicably closed the file. This act occurred well before but was fortuitously masked by subsequent COVID issues. The after-effects were breathtaking, with lien notices, our requests for releases, telephone calls with IRS attorneys, Collection’s laughable insistence on a payment plan, and – ultimately – a delay on the client’s refinancing. IRS incompetence cumulatively cost me the better part of a day’s work. Considering what I do for a living, that is time and money I cannot get back

I should be able to bill the IRS for wasting my time over stuff a monkey could do.

The Advocate did a good job, by the way.

Let’s get back to All Stacked Up, the company whose payroll issues we were discussing.

The owner fell on ice and suffered significant injuries. This led to the owner relying on an employee for tax compliance. That reliance was misplaced.

·      The first two quarterly payroll returns for 2013 were filed late.

·      The fourth quarter, 2013 return would have been due January 31, 2014. It was not filed until July 13, 2015.

·      None of the 2014 quarterly returns were filed until the summer of 2015.

·      To complete this sound track, the payroll tax deposits were no timelier than the filing of the returns themselves.

Frankly, the company should just have let its CPA firm take care of the matter. Had the firm botched the work this badly, at least the company would have a possible malpractice lawsuit.

The company pleaded reasonable cause. The owner was injured and tried to delegate the tax duties to someone during his absence. Granted, it did not go well, but that does mean that the owner did not try to behave as a prudent business person.

I get the argument. All Stacked Up is not Apple or Microsoft, with acres and acres of lawyers and accountants. They did the best they could with the (clearly limited) resources they had.

The company appealed the penalties. IRS Appeals was willing to compromise – but only a bit. Appeals would abate 16.66% of the penalties and related interest. This presented a tough call: accept the abatement or go for it all.

The company went for it all.

Here is the Court:

Applying Boyle to this case, it is clear as a matter of law that retention of an employee or software to prepare and remit tax filings, make required deposits, and tender payments cannot, in itself, constitute “reasonable cause” for All Stacked Up’s failure to satisfy those tax obligations. The employee’s failures are All Stacked Up’s failures, no matter how prudent the delegation of those duties may have been.”

And there is full Boyle: we don’t care about your problems and you doing your best with the resources available. Your standard is perfection, and do not ask whether we hold ourselves to the same standard.

I wonder if that employee is still there.

I mean the one at IRS Kansas City.

Our case this time was All Stacked Up v U.S., 2020 PTC 340 (Fed Cl 2020).

A Puff Piece

 

Although we do not condone her inconsistency, we find it is merely puffery in an attempt to obtain new employment and of no significance here.”

There is a word one rarely sees in tax cases: puffery.

Puffery is an exaggeration. It approaches a lie but stops short, and presumably no “reasonable” person would believe what is being said or take it literally. The distinction matters if one’s puffery can be used against them as a statement of fact.

Let’s look at the Robinson case.

Mr Robinson had a lawn care business. Beverly Robinson had a job at Georgia Pacific, but in 2007 she started working at the lawn care business. She did the billing. She was also listed on the business checking account, but she never wrote checks.

She must have been the face of the business through, as for 2007 through 2009 most of the Forms 1099 to the business were sent in her name.

In 2010 the marriage went south. Mr Robinson moved out, and Beverly’s dad chipped-in to pay the mortgage on her house. Needless to say, she was not working at the company with all that going on.

In 2011 they filed a joint tax return for 2010. The return showed tax due of approximately $43 grand. She must have separated hard from the business, as no Forms 1099 were issued to her; all the Forms 1099 were issued to him.

COMMENT: I do not understand filing a joint tax return with someone you are likely to divorce. In Beverly’s defense, though, she did not realize that she had an option. They hired a tax preparer (likely because of the business), but the preparer never explained that the option to file separately existed.

In 2011 she was telling the IRS that they could not pay the 2010 tax debt. She also asked about innocent spouse status.

In 2012 they file a joint 2011 tax return. She was working again at another Georgia Pacific facility and had tax withholdings. The IRS took her withholdings and applied them to the 2010 tax year.

COMMENT: That is how it works.

In 2013 Beverly needed to find a new job. She uploaded her resume on a jobseeker website. She listed her Georgia Pacific gig. She also listed Robinson Lawn Care and embellished her duties, especially glossing over the fact that she no longer worked there.

In 2013 Mr Robinson somehow forced his way back into her house. She called the police and was told that they could not evict him since the two were still married.

In October, 2013 she filed a petition for dissolution of marriage.

About time. The year before Mr Robinson had fathered a child with another woman. In 2013 he started paying her child support.

The divorce became final in 2014. Mr Robinson agreed to assume the 2010 tax due.

Riiiight.

In 2015 she files for innocent spouse because of that 2010 tax debt and the IRS continuing to take her refunds.

The IRS turned down her request.

One of the requirements is that the tax liability for which the spouse is seeking relief belong to the “nonrequesting” spouse. In this case, the nonrequesting spouse was Mr Robinson.

He testified that he had moved out of the house in 2013. Oh, he also remembered Beverly working in the business in 2010.

Not good.

The IRS looked at certain Florida registrations that showed her name through 2014.

They also pointed out that she was a signatory on the business checking account.

Then they looked at her resume on that jobseeker website.

The Court was having none of it.

As for Mr Robinson:

Throughout the trial Mr. Robinson’s testimony was relatively inconsistent, and we give it little value.”

As for the registrations:

Although petitioner is listed as the registered owner of Robinson Lawn Care from December 1998 to December 2014, we find the reason for her filing the fictitious name--that her former husband worked during the day--is a sufficient explanation for why she is listed instead of Mr. Robinson. Moreover, she did not sign any State filings in 2010 or thereafter.

As for the checking account:

Similarly we find that petitioner’s name on the business account is not persuasive support for respondent’s position as Mr. Robinson had control of that account and she never wrote checks on it.

The Court pointed out that none of the 2010 Forms 1099 were made out to her, in clear contrast to prior tax years.

We saw above the Court’s comment on her puffery.

It was clear who the Court believed – and did not believe.

The Court decided that she was entitled to innocent spouse relief.

She cut it close, though.

Our case this time was Beverly Robinson v Commissioner of Internal Revenue T.C. Memo 2020-134.

FICA Tax On Nonqualified Deferred Compensation

 

One of the accountants brought me what she considered an unusual W-2.

Using accounting slang, Form W-2 box 1 income is the number you include on your income tax return. Box 3 income is the amount on which you paid social security tax.  There often is a difference. A common reason is a 401(k) deferral – you pay social security tax but not income tax on the 401(k) contribution.

She had seen fact pattern that a thousand times. What caught her eye was that the difference between box 1 and box 3 income was much too large to just be a 401(k). 

Enter the world of nonqualified deferred compensation.

What is it?

Let’s analyze the term backwards:

·      It is compensation, meaning that there is (or was) an employment relationship.

·      There is a lag in the payment. It might be that the employee wants the lag; it might be that the employer wants the lag. A common example of the latter is a handcuff: the employee gets a bonus for remaining with the company a while.

·       The arrangement does not meet the requirements of standardized deferred compensation plans, such as a profit-sharing or 401(k) plan. You have one of those and tax Code requires to you include certain things and exclude others. That standardization is what makes the plan “qualified.”

A common type of nonqual (yep, that is what we call it) is a SERP – supplemental executive retirement plan. Get to be a big cheese at a big company (think Proctor & Gamble or FedEx) and you probably have a SERP as part of your compensation package.

I wish I had those problems. Not a big company. Not a big cheese.

Let’s give our mister big cheese a name: Gouda.

Gouda has a nonqual.

The taxation of a nonqual is a bit nonintuitive: the FICA taxation does not necessarily coincide with its income taxation.

Let’s run through an example. Gouda has a SERP. It vests at one point in time- say 5 years from now. It will not however be paid until Gouda retires or otherwise separates from service.

Unless something goes horribly wrong. Gouda does not have income tax until he receives the money. That might be 5 years from now or it might be 20 years.

Makes sense.

The FICA tax is based on a different trigger: when does Gouda have a right to the money?

Think of it like this: when can Gouda sue if the company fails to pay him? That is the moment Gouda “vests” in the SERP. He has a right to the money and – barring the exceptional – he cannot be stripped of this right.

In our example, Gouda vests in 5 years.

Gouda will pay social security and Medicare (that is, FICA) tax in 5 years.

It is what sets up the weird-looking Form W-2. Let’s say the deferred compensation is $100 grand. The accountant is looking at a W-2 where box 3 income is (at least) $100 grand higher than box 1 income (remember: box 1 is income tax and Gouda will not pay income tax until gets the money).

There is even a name for this accounting: the “Special Timing Rule.”

Why does this rule exist?

You know why: the government wants its money - at least some of it.

But if you think about it, the special timing rule can be beneficial to the employee. Say that Gouda is drawing a nice paycheck: $400 grand. The social security wage base for 2020 is $137,700. Gouda is way past paying the full-boat 7.65% FICA tax. He is paying only the Medicare portion of the FICA - which is 1.45%. If the IRS waited until he retired, odds are the Gouda would not be working and would therefore have to pay the full-boat 7.65% (up to the wage limit, whatever that amount is at the time).

Can Gouda get stiffed by the special timing rule?

Oh yes.

Let’s look at the Koopman v United States case.

Mr Koopman retired from United Airlines in 2001. He paid FICA tax (pursuant to the special timing rule) on approximately $415 grand.

In 2002 United Airlines filed for bankruptcy.

It took a few years to shake out, but Mr Koopman finally received approximately $248 grand of what United had promised him.

This being a tax blog, you know there is a tax hook somewhere in there.

Mr Koopman wanted the excess FICA he had paid. He paid FICA on $415 grand but received only $248 grand.

In 2007 Koopman filed a refund claim for that excess FICA.

Does he have a chance?

Mr Koopman lost, but he did not lose because of the general rule or special rule or any of that. He lost for the most basic of tax reasons: one only has 3 years (usually) to amend a return and request a refund. He filed his refund request in 2007 – much more than 3 years after his withholdings in 2001.

Is there something Koopman could have done?

Yes, but he still could not wait until 2007. He would have had to do it by 2004 – the magic three years.

What could he have done?

File a protective refund claim.

I do not believe we have talked before about protective claims. It is a specialized technique, and an accountant can go a career and never file one.

I believe we have a near-future blog topic here. Let me see if I can find a case involving protective claims that you might want to read and I would want to write.

No Shareholder, No S Corporation Election

 Our case this time takes us to Louisville.

There is a nonprofit called the Waterfront Development Corporation (WDC). It has existed since 1986, and its mission is to development, redevelop and revitalize certain industrial areas around the Ohio river downtown. I would probably shy away from getting involved - anticipating unceasing headaches from the city, Jefferson county and the Commonwealth of Kentucky - but I am glad that there are people who will lift that load.

One of those individuals was Clinton Deckard, who wanted to assist WDC financially, and to that effect he formed Waterfront Fashion Week Inc. (WFWI) in 2012. WFWI was going to organize and promote Waterfront Fashion Week – essentially a fundraiser for WDC.

Seems laudable.

Mr Deckard had been advised to form a nonprofit, on the presumption that a nonprofit would encourage people and businesses to contribute. He saw an attorney who organized WFWI as a nonprofit corporation under Kentucky statute.

Unfortunately, Waterfront Fashion Week failed to raise funds; in fact, it lost money. Mr Deckard wound up putting in more than $275,000 of his own money into WFWI to shore up the leaks. There was nothing to contribute to WDC.  What remained was a financial crater-in-the-ground of approximately $300 grand. Whereas WFWI had been organized as a nonprofit for state law purposes, it had not obtained tax-exempt status from the IRS. If it had, Mr Deckard could have gotten a tax-deductible donation for his generosity.

COMMENT: While we use the terms “nonprofit” and “tax-exempt” interchangeably at times, in this instance the technical difference is critical. WFWI was a nonprofit because it was a nonprofit corporation under state law. If it wanted to be tax-exempt, it had to keep going and obtain exempt status from the IRS.  One has to be organized under as a nonprofit for the IRS to consider tax-exempt status, but there also many more requirements.

No doubt Mr Deckard would have just written a check for $275 grand to WDC had he foreseen how this was going to turn out. WDC was tax-exempt, so he could have gotten a tax-deductible donation. As it was, he had ….

…. an idea. He tried something. WFWI had never applied for tax-exempt status with the IRS.

WFWI filed instead for S corporation status. Granted, it filed late, but there are procedures that a knowledgeable tax advisor can use. Mr Deckard signed the election as president of WFWI. An S election requires S corporation tax returns, which it filed. Mind you, the returns were late – the tax advisor would have to face off against near-certain IRS penalties - but it was better than nothing.

Why do this?

An S corporation generally does not pay tax. Rather it passes its income (or deductions) on to its shareholders who then include the income or deductions with their other income and deductions and then pay tax personally on the amalgamation

It was a clever move.

Except ….

Remember that the attorney organized WFWI as a nonprofit corporation under Kentucky statute.

So?

Under Kentucky law, a nonprofit corporation does not have shareholders.

And what does the tax Code require before electing S corporation status?

Mr Deckard has to be a shareholder in the S corporation.

He tried, he really did. He presented a number of arguments that he was the beneficial owner of WFWI, and that beneficial status was sufficient to allow  an S corporation election.

But a shareholder by definition would get to share in the profits or losses of the S corporation. Under Kentucky statute, Mr Deckard could NEVER participate in those profits or losses. Since he could never participate, he could never be a shareholder as intended by the tax Code. There was no shareholder, no S corporation election, no S corporation – none of that.

He struck out.

The sad thing is that it is doubtful whether WFWI needed to have organized as a nonprofit in the first place.

Why do I say that?

If you or I make a donation, we need a tax-exempt organization on the other side. The only way we can get some tax pop is as a donation.

A business has another option.

The payment could just be a trade or business expense.

Say that you have a restaurant downtown (obviously pre-COVID days). You send a check to a charitable event that will fill-up downtown for a good portion of the weekend. Is it a donation? Could be. It could also be just a promotion expense – there are going to be crowds downtown, you are downtown, people have to eat, and you happen to be conveniently located to the crowds. Is that payment more-than-50% promotion or more-than-50-% donation?

I think of generosity when I think of a donation. I think of return-on-investment when I think of promotion or business expenses.

What difference does it make? The more-than-50% promotion or business deduction does not require a tax-exempt on the other side. It is a business expense on its own power; it does not need an assist.

I cannot help but suspect that WFWI was primarily recruiting money from Louisville businesses. I also suspect that many if not most would have had a keen interest in downtown development and revitalization. Are we closer to our promotion example or our donation example?

Perhaps Mr Deckard never needed a nonprofit corporation.

The Tax Doctrine Of The Fruit And The Tree

 

I am uncertain what the IRS saw in the case. The facts were very much in the taxpayer’s favor.

The IRS was throwing a penalty flag and asking the Court to call an assignment of income foul.

Let’s talk about it.

The tax concept for assignment-of-income is that a transaction has progressed so far that one has – for all real and practical purposes – realized income. One is just waiting for the check to arrive in the mail.

But what if one gives away the transaction – all, part or whatever – to someone else? Why? Well, one reason is to move the tax to someone else.

A classic case in this area is Helvering v Horst. Horst goes back to old days of coupon bonds, which actually had perforated coupons. One would tear-off a coupon and redeem it to receive an interest check. In this case the father owned the bonds. He tore off the coupons and gave them to his son, who in turn redeemed them and reported the income. Helvering v Horst gave tax practitioners the now-famous analogy of a tree and its fruit. The tree was the bond, and the fruit was the coupon. The Court observed:

… The fruit is not to be attributed to a different tree from that on which it grew.”

The Court decided that the father had income. If he wanted to move the income (the fruit) then he would have to move the bond (the tree).

Jon Dickinson (JD) was the chief financial officer and a shareholder of a Florida engineering firm. Several shareholders – including JD – had requested permission to transfer some of their shares to the Fidelity Charitable Gift Fund (Fidelity). Why did they seek permission? There can be several reasons, but one appears key: it is Fidelity’s policy to immediately liquidate the donated stock. Being a private company, Fidelity could not just sell the shares in the stock market. No, the company would have to buy-back the stock. I presume that JD and the others shareholders wanted some assurance that the company would do so.

JD buttoned-down the donation:

·      The Board approved the transfers to Fidelity.

·      The company confirmed to Fidelity that its books and records reflected Fidelity as the new owner of the shares.

·      JD also sent a letter to Fidelity with each donation indicating that the transferred stock was “exclusively owned and controlled by Fidelity” and that Fidelity “is not and will not be under any obligation to redeem, sell or otherwise transfer” the stock.

·      Fidelity sent a letter to JD after each donation explaining that it had received and thereafter exercised “exclusive legal control over the contributed asset.”

So what did the IRS see here?

The IRS saw Fidelity’s standing policy to liquidate donated stock. As far as the IRS was concerned, the stock had been approved for redemption while JD still owned it. This would trigger Horst – that is, the transaction had progressed so far that JD was an inextricable part. Under the IRS scenario, JD would have a stock redemption – the company would have bought-back the stock from him and not Fidelity – and he would have taxable gain. Granted, JD would also have a donation (because he would have donated the cash from the stock sale to Fidelity), but the tax rules on charitable deductions would increase his income (for the gain) more than the decrease in his income (for the contribution). JD would owe tax.

The Court looked at two key issues:

(1)  Did JD part with the property absolutely and completely?

This one was a quick “yes.” The paperwork was buttoned-up as tight as could be.

(2)  Did JD donate the property before there was a fixed and determinable right to sale?

You can see where the IRS was swinging. All parties knew that Fidelity would redeem the stock; it was Fidelity’s policy. By approving the transfer of shares, the company had – in effect – “locked-in” the redemption while JD still owned the stock. This would trigger assignment-of-income, argued the IRS.

Except that there is a list of cases that look at formalities in situations like this. Fidelity had the right to request redemption – but the redemption had not been approved at the time of donation. While a seemingly gossamer distinction, it is a distinction with tremendous tax weight. Make a sizeable donation but fail to get the magic tax letter from the charity; you will quickly find out how serious the IRS is about formalities. Same thing here. JD and the company had checked all the boxes.

The Court did not see a tree and fruit scenario. There was no assignment of income. JD got his stock donation.

Our case this time was Dickinson v Commissioner, TC Memo 2020-128.