assignment of income and gifts

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To determine if the sale of inherited property is taxable, you must first determine your basis in the property. The basis of property inherited from a decedent is generally one of the following:

• The fair market value (FMV) of the property on the date of the decedent's death (whether or not the executor of the estate files an estate tax return ( Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return) ).
• The FMV of the property on the alternate valuation date, but only if the executor of the estate files an estate tax return (Form 706) and elects to use the alternate valuation on that return. See the Instructions for Form 706 .

For information on the FMV of inherited property on the date of the decedent’s death, contact the executor of the decedent’s estate. In 2015, Congress passed a law that, in certain circumstances, requires the recipient’s basis in certain inherited property to be consistent with the value of the property as finally determined for Federal estate tax purposes. If you receive a Schedule A to Form 8971 from an executor of an estate or other person required to file an estate tax return, you may be required to report a basis consistent with the estate tax value of the property. 

Check  What's new - Estate and gift tax  for updates on final rules being promulgated to implement the new law.

If you or your spouse gave the property to the decedent within one year before the decedent's death, see Publication 551, Basis of Assets .

Report the sale on Schedule D (Form 1040), Capital Gains and Losses and on Form 8949, Sales and Other Dispositions of Capital Assets :

• If you sell the property for more than your basis, you have a taxable gain.
• For information on how to report the sale on Schedule D, see Publication 550, Investment Income and Expenses .

Under the law passed by Congress in 2015, an accuracy-related penalty may apply if an individual reporting the sale of certain inherited property uses a basis in excess of that property’s final value for Federal estate tax purposes. Again, check What's new - Estate and gift tax for updates on final rules being promulgated to implement the new law.

What is “Assignment of Income” Under the Tax Law?

Gross income is taxed to the individual who earns it or to owner of property that generates the income. Under the so-called “assignment of income doctrine,” a taxpayer may not avoid tax by assigning the right to income to another.

Specifically, the assignment of income doctrine holds that a taxpayer who earns income from services that the taxpayer performs or property that the taxpayer owns generally cannot avoid liability for tax on that income by assigning it to another person or entity. The doctrine is frequently applied to assignments to creditors, controlled entities, family trusts and charities.

A taxpayer cannot, for tax purposes, assign income that has already accrued from property the taxpayer owns. This aspect of the assignment of income doctrine is often applied to interest, dividends, rents, royalties, and trust income. And, under the same rationale, an assignment of an interest in a lottery ticket is effective only if it occurs before the ticket is ascertained to be a winning ticket.

However, a taxpayer can shift liability for capital gains on property not yet sold by making a bona fide gift of the underlying property. In that case, the donee of a gift of securities takes the “carryover” basis of the donor.  

For example, shares now valued at $50 gifted to a donee in which the donor has a tax basis of $10, would yield a taxable gain to the donee of its eventual sale price less the $10 carryover basis. The donor escapes income tax on any of the appreciation.

For guidance on this issue, please contact our professionals at 315.242.1120 or [email protected] .

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Recognizing when the IRS can reallocate income

• C Corporation Income Taxation
• IRS Practice & Procedure

Transactions between related parties come under close scrutiny by the IRS because they are not always conducted at arm's length. If the amounts involved in the transaction do not represent fair market values, the IRS can change the characteristics of the transaction to reflect its actual nature.

The IRS may attempt to reallocate income between a closely held corporation and its shareholders based on several sets of rules, including the following:

• Assignment-of-income rules that have been developed through the courts;
• The allocation-of-income theory of Sec. 482; and
• The rules for allocation of income between a personal service corporation and its employee-owners of Sec. 269A.

Income reallocation under the assignment - of - income doctrine is dependent on determining who earns or controls the income. Justice Oliver Wendell Holmes made the classic statement of the assignment - of - income doctrine when he stated that the Supreme Court would not recognize for income tax purposes an "arrangement by which the fruits are attributed to a different tree from that on which they grew" ( Lucas v. Earl , 281 U.S. 111, 115 (1930)).

Reallocation under Sec. 482 is used to prevent tax evasion or to more clearly reflect income when two or more entities are controlled by the same interests. Note the use of the word "or" in the preceding sentence. The Code empowers the IRS to allocate income even if tax evasion is not present if the allocation will more clearly reflect the income of the controlled interests. The intent of these provisions is to place the controlled entity in the same position as if it were not controlled so that the income of the controlled entity is clearly reflected (Regs. Sec. 1. 482 - 1 (a)) .

Example 1. Performing services for another group member:   Corporations P and S are members of the same controlled group. S asks P to have its financial staff perform an analysis to determine S' s borrowing needs. P does not charge S for this service. Under Sec. 482, the IRS could adjust each corporation's taxable income to reflect an arm's - length charge by P for the services it provided to S .

Under Sec. 269A(a), the IRS has the authority to allocate income, deductions, credits, exclusions, and other items between a personal service corporation (PSC) and its employee - owners if:

• The PSC performs substantially all of its services for or on behalf of another corporation, partnership, or other entity; and
• The PSC was formed or used for the principal purpose of avoiding or evading federal income tax by reducing the income or securing the benefit of any expense, deduction, credit, exclusion, or other item for any employee-owner that would not otherwise be available.

A PSC will not be considered to have been formed or availed of for the principal purpose of avoiding or evading federal income taxes if a safe harbor is met. The safe harbor applies if the employee - owner's federal income tax liability is not reduced by more than the lesser of (1) $2,500 or (2) 10% of the federal income tax liability of the employee - owner that would have resulted if the employee - owner personally performed the services (Prop. Regs. Sec. 1. 269A - 1 (c)).

For purposes of this rule, a PSC is a corporation, the principal activity of which is the performance of personal services when those services are substantially performed by employee - owners (Sec. 269A(b)(1)). An employee - owner is any employee who owns on any day during the tax year more than 10% of the PSC's outstanding stock. As with many related - party provisions, the Sec. 318 stock attribution rules (with modifications) apply in determining stock ownership (Sec. 269A(b)(2)).

Example 2. Reallocation of income: H forms M Corp., which is a PSC. A few months later, he transfers shares of stock of an unrelated corporation to M . The following year, M receives dividends from the unrelated corporation and claims the Sec. 243(a) 50% dividend exclusion. The IRS may reallocate the dividend income from M to H if the principal purpose of the transfer of the unrelated stock to M was to use the 50% dividend exclusion under Sec. 243. However, the amounts to reallocate to H must exceed the safe - harbor amounts.

These rules usually apply when an individual performs personal services for an employer that does not offer tax - advantaged employee benefits (such as a qualified retirement plan and other employee fringe benefits). In those situations, the individual may set up a 100%- owned C corporation that contracts with the employer. The employer then pays the corporation. The individual functions as the employee of the corporation, and the corporation sets up tax - advantaged fringe benefit programs. The individual generally is able to "zero out" the income of the corporation with payments for salary and fringe benefits.

Despite the significant authority that Sec. 269A grants to the IRS, there is little evidence of the IRS or the courts using this statute. In a 1987 private letter ruling, the IRS held that a one - owner , one - employee medical corporation did not violate the statute, even though it retained only nominal amounts of taxable income, and the corporate structure allowed the individual to achieve a significant pension plan deduction. These facts were not sufficient to establish a principal purpose of tax avoidance (IRS Letter Ruling 8737001). In Sargent , 929 F.2d 1252 (8th Cir. 1991), the Eighth Circuit indicated a lack of interest in applying Sec. 269A because, in that case, the court felt the PSC had been set up for other legitimate reasons.    

This case study has been adapted from PPC's Tax Planning Guide — Closely Held Corporations , 31st Edition (March 2018), by Albert L. Grasso, R. Barry Johnson, and Lewis A. Siegel. Published by Thomson Reuters/Tax & Accounting, Carrollton, Texas, 2018 (800-431-9025; tax.thomsonreuters.com ).

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EMPLOYEE BENEFITS & PENSIONS

The 2022 act affected a wide array of retirement fund and pension plan provisions. This article highlights many of the most noteworthy ones, along with relevant IRS guidance and congressional plans for technical corrections.

Make A Payment

Hoensheid: assignment of income and gift substantiation.

It is fairly common to make charitable gifts of property prior to a sale transaction. Often, those gifts are of real property or closely-held business interests. This is for good reason. Structured properly, not only do donors generally receive a charitable income tax deduction equal to the fair market value of the donated property, they also avoid any capital gains on the sale of that property. [1] The double benefit of both avoiding capital gain and receiving a full fair market value deduction can be quite powerful. [2]

As stated above, however, the gift must be structured properly in order to obtain these benefits. Two of the important areas in this regard are: (1) avoidance of an assignment of income; and (2) proper gift substantiation. We have previously written about cases where these issues have arisen. [3]   A recent Tax Court opinion once again addresses these issues, [4] this time possibly contradicting IRS guidance [5] and a previous binding opinion of the full Tax Court. [6]

Commercial Steel Treating Corp. (“CTSC”) was owned by three brothers. After one of the brothers announced his plans to retire in the Fall of 2014, the three brothers decided to solicit bids for a sale of the company. In so doing, they engaged a financial advisory firm which began the process in early 2015.

Once that process started, the following sequence of events unfolded:

• April 1, 2015: HCI Equity Partners (“HCI”) submitted a draft Letter of Intent (“LOI”) to acquire CTSC.
• Mid April 2015: Mr. Hoensheid, one of the owner/brothers and the taxpayer in this case, begins discussing the possibility of establishing a donor advised fund (“DAF”) to make a charitable contribution of CTSC stock prior to the anticipated sale to take advantage of the type of planning described above (i.e. double benefit of fair market value charitable deduction and avoidance of capital gains on the donated shares).
• April 16, 2015: Mr. Hoensheid’s attorney emailed that “the transfer would have to take place before there is a definitive agreement in place.” [7]
• April 23, 2015: LOI between HCI and CTSC was executed.
• May 22, 2015: CTSC executed an Affidavit of Acquired Person for the Federal Trade Commission representing that CTSC had “a good faith intention of completing the transaction.”
• Valuation date of CTSC submitted in substantiation of charitable deduction.
• Hoensheid emailed his attorney that “I do not want to transfer the stock until we are 99% sure we are closing.”
• Shareholders and Directors meetings ratifying sale of all stock of CTSC to HCI.
• CTSC submitted to the Michigan Department of Licensing and Regulatory Affairs an amendment to its Articles of Incorporation per request from HCI.
• Stock Purchase Agreement submitted by Mr. Hoensheid’s attorney to Fidelity Charitable for execution (dated effective June 15, 2015).
• Shareholders approve Mr. Hoensheid’s transfer of an unspecified number of CTSC shares to Fidelity.
• June 12, 2015: HCI’s investment committee and managing partners approved acquisition of CTSC.
• HCI formed a new Delaware corporation to serve as the acquirer of CTSC.
• Hoensheid sends an email that he is “not totally sure of the shares being transferred to the charitable fund yet.”
• July 7: CTSC determined to distribute payments to employees pursuant to a Change of Control Bonus Plan and almost all remaining cash to its shareholders.
• Email from Mr. Hoensheid’s financial advisor that “it looks like Scott has arrived at 1380 shares.”
• Hoensheid delivered the stock certificate transferring shares in CTSC to his attorney.
• Revised draft Stock Purchase Agreement circulated with missing date upon which Mr. Hoensheid transferred shares to Fidelity Charitable.
• CTSC paid bonuses to employees under Change of Control Bonus plan.
• Redline draft of Stock Purchase Agreement circulated indicating acceptance of all substantive changes.
• Printout list of CTSC shareholders indicating gift to Fidelity Charitable from Mr. Hoensheid on July 10, 2015.
• PDF stock certificate submitted by email to Fidelity Charitable showing the stock transfer from Mr. Hoensheid to Fidelity Charitable.
• July 14: CTSC distributed almost all remaining cash to its shareholders.
• July 15, 2015: Transaction closing and funding.

There was some dispute between the taxpayers and the IRS about the date of the charitable gift. The taxpayers argued the stock was gifted on July 10, 2015, the date upon which Mr. Hoensheid decided to transfer 1380 shares of CTSC to Fidelity Charitable, executed a stock certificate to that effect, and delivered the stock certificate to his attorney. However, the IRS argued, and the Tax Court agreed, that the transfer did not occur until July 13, 2015. The reason was that, citing to Michigan law [8] , there was no deliver of the gift to the charity until the PDF stock certificate was sent [9] and no acceptance of the gift until Fidelity Charitable’s email on July 13, 2015, acknowledging same. [10] As a result, for purposes of the tax dispute, July 13, 2015, was the date of the charitable donation.

Assignment of Income

The assignment of income doctrine recognizes income as taxed “to those who earn or otherwise create the right to receive it.” [11] Particularly in the charitable donation context, a donor will be deemed “to have effectively realized income and then assigned that income to another when the donor has an already fixed or vested right to the unpaid income.” [12] This analysis looks “to the realities and substance of the underlying transaction, rather than to formalities or hypothetical possibilities.” [13] The form of a charitable donation will not be respected if the donor does not: (1) give the appreciated property away absolutely and divest of title (2) before the property gives rise to income by way of a sale. [14]

Before analyzing Mr. Hoensheid’s donation through the relevant tests for assignment of income, the Tax Court addressed arguments raised by Mr. Hoensheid regarding existing guidance. In addition to other sources, this is particularly important in citing to Rev. Rul. 78-197 and Rauenhorst [15] . In Rev. Rul. 78-197 the IRS acquiesced in the Palmer [16] decision where a donor transferred shares in a closely-held corporation he controlled to a private foundation he also controlled, followed by a redemption of those shares by the corporation. The IRS argued the substance of the transaction was a redemption followed by a cash contribution since the taxpayer had a “prearranged plan” of redeeming the shares at the time of the contribution. After the Tax Court ruled in favor of the taxpayer, the IRS issued Rev. Rul. 78-197 stating that “the Service will treat the proceeds of a redemption of stock under facts similar to those in Palmer as income to the donor only if the donee is legally bound, or can be compelled by the corporation to surrender the shares for redemption ” (emphasis added). Certainly, regardless of any other facts, there was nothing to legally compel a closing of the sale of CTSC stock to HCI, or otherwise compel such closing, at the date of Mr. Hoensheid’s charitable gift.

In Palmer , the Tax Court held that certain charitable gifts made after a redemption of stock was “imminent” did not constitute an assignment of income. In Rauenhorst , the Tax Court noted that the IRS attempted to “devise a ‘bright-line’ test which focuses on the donee’s control over the disposition of the appreciated property” by adopting Rev. Rul. 78-197. Although Revenue Rulings do not bind the Tax Court, they do bind the IRS. When there was an LOI, but no binding obligation to sell, therefore, the IRS was precluded in Rauenhorst from arguing there as an assignment of income when the facts in the case were not distinguishable from those in Rev. Rul. 78-197. The facts in Rauenhorst bear similarities to those in Hoensheid . In Rauenhorst , there was a signed LOI, a resolution authorizing executing an agreement of sale, and a valuation report indicating there was little chance the transaction would not close.

However, in Rauenhorst , and cited in Hoensheid , the Tax Court noted “we have indicated our reluctance to elevate the question of donee control to a talisman for resolving anticipatory assignment of income” and that the donee’s power to reverse the transaction is “only one factor to be considered in ascertaining the ‘realities and substance’ of the transaction.” In Rauenhorst and Hoensheid , the Tax Court stated that “the ultimate question is whether the transferor, considering the reality and substance of all the circumstances, had a fixed right to income in property at the time of the transfer.” [17] As such, notwithstanding that the Tax Court in Rauenhorst held the IRS to its position in Rev. Rul. 78-197, the court stated that “in the appropriate case we could disregard a ruling or rulings as inconsistent with our interpretation of the law.” As such, while Hoensheid could be seen as inconsistent with Rauenhorst , it also could be seen as consistent insofar as the Tax Court kept the door open for the Hoensheid result in the opinion it issued in Rauenhorst . [18]

In making that determination the Tax Court in Hoensheid looked at factors including: (1) “any legal obligation to sell by the donee”, (2) “the actions already taken by the parties to effect the transaction”, (3) “the remaining unresolved transactional contingencies”, and (4) “the status of the corporate formalities required to finalize the transaction.”

Applying these factors, while conceding that there was no obligation of Fidelity Charitable to sell shares at the time of contribution, the Tax Court found there to be an assignment of income. The court cited to the number of acts which had taken place at the time of the donation which rendered the transaction a “foregone conclusion.” Relevant facts included that, on the date of the charitable donation, corporate formalities of approving the transaction had occurred, bonuses payable to employees resulting from the transaction had been paid, dividends had been paid to such an extent that CTSC no longer remained a viable going concern, and all substantive terms of the transaction had been fully negotiated. Ultimately, the court stated that, by July 13, 2015, “the transaction had simply ‘proceeded too far down the road to enable petitioners to escape taxation on the gain attributable to the donated shares.’”

Substantiation

Although the scope of this writing is to address the concept of anticipatory assignment of income and the Hoensheid opinion, particularly as it relates to prior authorities and guidance, it is important to note the substantiation issues which ultimately cost the taxpayers any charitable deduction. Even finding an assignment of income, the taxpayers would be entitled to charitable donation equal to the fair market value of the shares gifted. They merely would be forced to recognized their share of gain from the sale transaction. However, having failed to satisfy the charitable donation substantiation requirements, the taxpayers lost the deduction in full.

Relevant in Hoensheid , gifts of property of more than $500,000 require taxpayers to obtain a qualified appraisal from a qualified appraiser to attach to the taxpayer’s income tax return for the year of the gift. [19] Although the scope of what constitutes a “qualified appraisal” from a “qualified appraiser” is beyond the scope of this writing, in Hoensheid , the taxpayer failed primarily as a result of obtaining an appraisal from someone unqualified to render valuations for purposes of substantiating charitable gifts.

The Tax Court notes that the requirement for the appraiser to be qualified is “the most important requirement” of the regulations. [20] The appraiser in Hoensheid only infrequently performed valuations, did not hold himself out as an appraiser, and held no certifications from any professional appraiser organization. Based on these and other factors, it was clear that the appraiser in Hoensheid was not a “qualified appraiser” as contemplated by the applicable statute and regulations. By all accounts, he was used because he charged no fee for the valuation, instead offering to perform the valuation under the fees paid to the financial advisory firm handling the sale transaction which is where he was employed. In addition to the appraiser lacking the proper qualifications, the valuation report contained a number of deficiencies which rendered it not to constitute a “qualified appraisal” either. One of such problems was using a June 1, 2015, valuation date when intervening events between that date and the date of the gift, including the substantial bonus and dividend distributions, should have caused the value of CSTC to materially change.

Although “substantial compliance” can be sufficient in satisfying regulatory substantiation requirements [21] , the Tax Court found that Mr. Hoensheid failed to substantially comply due to his failure to engage a qualified professional to complete the valuation along with the numerous errors could not be concluded to satisfy the requirements of substantial compliance. However, as a silver lining, in avoiding a 20% underpayment penalty [22] , Mr. Hoensheid was held to have reasonably relied on his attorney’s advice that the deadline for the charitable donation was the date a definitive agreement is executed.

Here, Mr. Hoensheid made a couple of fatal choices. First, he chose to wait until the transaction was 99% sure to close before making the charitable gift. Second, he cut corners by using a free and unqualified appraiser rather than simply paying for a qualified valuation professional. Sure, Mr. Hoensheid’s professional advisors led him to believe he may have had until the closing (the date the purchase agreement would be signed) in order to make the gift. Further, his attorney may have been justified in believing that to constitute the law given Rauenhorst and Rev. Rul. 78-197. However, his own attorney said “any tax lawyer worth [her] fees would not have recommended that a donor make a gift of appreciated stock” so close to the closing.

It is understandable that taxpayers desire to wait until they are confident a sale will close before donating equity interests. We encounter that frequently. There is no clear, bright-line date on which the tests as discussed in Hoensheid may apply (as opposed to Rauenhorst and Rev. Rul. 78-197). As such, taxpayers and their planners should look to the timeline in this case and the Tax Court’s discussion in determining when to make charitable gifts in anticipation of a sale. In many cases, closing and purchase agreement execution occur simultaneously as opposed to transactions where a purchase agreement is signed with a number of contingencies and before much of the due diligence or other pre-closing details have been finalized. Extra care is likely needed when there is a contemporaneous execution and closing, as in  Hoensheid . While no legally binding document may have been executed, the deal may be a “foregone conclusion” at some point along the spectrum.

Of course, beyond the assignment of income issues, we continue to see taxpayers trip up on charitable gift substantiation. [23] Sometimes it is a mere mistake; other times taxpayers try to cut corners and/or save money by not engaging the proper professionals. When large gifts are being made, real value is being donated. The donor will never get those funds back and the costs of complying with the substantiation requirements is typically much less than the value of the deduction, especially when gifts are made in advance of a liquidity event.

[1] This presumes a donation of long-term capital gain property to a public charity, generally subject to a limitation on the deduction of 30% of the donor’s adjusted gross income. IRC § 170(b)(1)(C).

[2] As an example, a top bracket taxpayer (37% ordinary income tax bracket and 20% capital gains bracket) who donates a $1 million asset with a $200,000 cost basis stands to obtain both an $1M income tax deduction for a benefit of $370,000 and also avoid $800,000 of capital gains for a benefit of $160,000, yielding a combined tax benefit of $530,000. This means the true cost of the $1 million charitable gift was only $470,000. The savings may be more to the extent the net investment income tax and/or state income tax applies.

[3] Allen, Charles J., “IRS Continues Aggressive Stance on Charitable Contributions,” Oct. 23, 2018, https://esapllc.com/chrem-case/ ; and Sage, Joshua W., “Gifting Appreciated Stock Before Redemption – Dickinson,” Oct. 6, 2020, https://www.esapllc.com/dickinson-redemption2020/ .

[4] Estate of Scott Hoensheid, et ux. v. Commissioner , T.C. Memo 2023-34.

[5] Rev. Rul. 78-197.

[6] Rauenhorst v. Commissioner , 119 T.C. 157 (2002).

[7] These statements were repeated in an email from the taxpayer’s financial advisor on April 20, 2015, and the taxpayer’s attorney on April 21, 2015.

[8] Michigan law requires a showing of: (1) donor intent to make a gift; (2) actual or constructive delivery of the subject matter of the gift; and (3) donee acceptance. See Davidson v. Bugbee , 575 N.W.2d 574, 576 (Mich. Ct. App. 1997).

[9] Although the stock ledger showing an earlier transfer date could have possibly substantiated delivery, that printout was dated July 13, 2015, meaning the Tax Court could not determine an earlier date upon which CTSC acknowledged the transfer.

[10] Again, here, there were communications with Fidelity Charitable showing a July 11, 2015, transfer date but the documentary proof provided to the Tax Court by the taxpayers bore a July 15, 2015, date rather than a production of the earlier original. As such, absent proper proof, the Tax Court could not conclude a July 11, 2015, acceptance date occurred.

[11] Helvering v. Horst , 311 U.C. 112, 119 (1940).

[12] Cold Metal Process Co. v. Commissioner , 247 F.2d 864, 872-73 (6th Cir. 1957).

[13] Jones v. U.S. , 531 F.2d 1343, 1345 (6th Cir. 1976); and Allen v. Commissioner , 66 T.C. 340, 346 (1976).

[14] Humacid Co. v. Commissioner , 42 T.C. 894, 913 (1964).

[15] See supra Note 6.

[16] Palmer v. Commissioner , 62 T.C. 684 (1974),

[17] Citing Ferguson v. Commissioner , 108 T.C. 244 (1997).

[18] Note also the Ninth Circuit’s opinion in Ferguson v. Commissioner , 174 F.3d 997 (9th Cir. 1999), whereby assignment of income was found where a threshold of a tender of 85% of corporate shares was required prior to any binding obligations to sell when only more than 50% had been transferred at the time of the gift, the court finding there was enough “momentum” to the transaction to make the merger “most unlikely” to fail. This extension of the assignment of income doctrine was specifically refused to be followed by the U.S. District Court in Keefer v. U.S. , 2022 WL 2473369, particularly given that the case was appealable to the Fifth Circuit Court of Appeals.

[19] IRC §170(f)(11)(D) and (E), and Treas. Reg. § 1.170A-13.

[20] Citing Mohamed v. Commissioner , T.C. Memo 2012-152.

[21] We have discussed substantial compliance in other writings including, Gray Edmondson, “RERI Revisited on Appeal, $33M Deduction Denial Upheld,” June 5, 2019, https://esapllc.com/reri-appeal/ ; and Devin Mills, “Private Jet Deduction Fails for Lack of Substantiation,” July 26, 2022, https://esapllc.com/izen-jet-2022/ .

[22] IRC § 6662 based on any underpayment of tax required to be shown on a return that is attributable to negligence, disregard of rules or regulations, or a substantial understatement of income tax.

[23] For a recent article discussing charitable gift substantiation, including substantial compliance, see Sholk, Steven H., “A Guide to the Substantiation Rules for Deductible Charitable Contributions,” 137 J. Tax’n 03 (Dec. 2022).

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• Frost Brown Todd

Section 1202 Planning: When Might the Assignment of Income Doctrine Apply to a Gift of QSBS?

Jan 26, 2022

Categories:

Blogs Qualified Small Business Stock (QSBS) Tax Law Defined™ Blog

Scott W. Dolson

Section 1202 allows taxpayers to exclude gain on the sale of QSBS if all eligibility requirements are met.  Section 1202 also places a cap on the amount of gain that a stockholder is entitled to exclude with respect to a single issuer’s stock. [i]   A taxpayer has at least a $10 million per-issuer gain exclusion, but some taxpayer’s expected gain exceeds that cap.  In our article Maximizing the Section 1202 Gain Exclusion Amount , we discussed planning techniques for increasing, and in some cases multiplying, the $10 million gain exclusion cap through gifting QSBS to other taxpayers. [ii]  Increased awareness of this planning technique has contributed to a flurry of stockholders seeking last-minute tax planning help.  This article looks at whether you can “multiply” Section 1202’s gain exclusion by gifting qualified small business stock (QSBS) when a sale transaction is imminent.

This is one in a series of articles and blogs addressing planning issues relating to QSBS and the workings of Sections 1202 and 1045.  During the past several years, there has been an increase in the use of C corporations as the start-up entity of choice.  Much of this interest can be attributed to the reduction in the corporate rate from 35% to 21%, but savvy founders and investors have also focused on qualifying for Section 1202’s generous gain exclusion.  Recently proposed tax legislation sought to curb Section 1202’s benefits, but that legislation, along with the balance of President Biden’s Build Back Better bill, is currently stalled in Congress.

The Benefits of Gifting QSBS

Section 1202(h)(1) provides that if a stockholder gifts QSBS, the recipient of the gift is treated as “(A) having acquired such stock in the same manner as the transferor, and (B) having held such stock during any continuous period immediately preceding the transfer during which it was held (or treated as held under this subsection by the transferor.”  This statute literally allows a holder of $100 million of QSBS to gift $10 million worth to each of nine friends, with the result that the holder and his nine friends each having the right to claim a separate $10 million gain exclusion.  Under Section 1202, a taxpayer with $20 million in expected gain upon the sale of founder QSBS can increase the overall tax savings from approximately $2.4 million (based on no Federal income tax on $10 million of QSBS gain) to $4.8 million (based on no Federal income tax on $20 million of QSBS gain) by gifting $10 million worth of QSBS to friends and family. [iii]

A reasonable question to ask is whether it is ever too late to make a gift of QSBS for wealth transfer or Section 1202 gain exclusion cap planning?  What about when a sale process is looming but hasn’t yet commenced?  Is it too late to make a gift when a nonbinding letter of intent to sell the company has been signed?   What about the situation where a binding agreement has been signed but there are various closing conditions remaining to be satisfied, perhaps including shareholder approval?  Finally, is it too late to make a gift when a definitive agreement has been signed and all material conditions to closing have been satisfied?

Although neither Section 1202 nor any other tax authorities interpreting Section 1202 address whether there are any exceptions to Section 1202’s favorable treatment of gifts based on the timing of the gift, the IRS is not without potential weapons in its arsenal.

Application of the Assignment of Income Doctrine

If QSBS is gifted in close proximity to a sale, the IRS might claim that the donor stockholder was making an anticipatory assignment of income. [iv]

As first enunciated by the Supreme Court in 1930, the anticipatory assignment of income doctrine holds that income is taxable to the person who earns it, and that such taxes cannot be avoided through “arrangement[s] by which the fruits are attributed to a different tree from that on which they grew.” [v]   Many assignment of income cases involve stock gifted to charities immediately before a prearranged stock sale, coupled with the donor claiming a charitable deduction for full fair market value of the gifted stock.

In Revenue Ruling 78-197, the IRS concluded in the context of a charitable contribution coupled with a prearranged redemption that the assignment of income doctrine would apply only if the donee is legally bound, or can be compelled by the corporation, to surrender shares for redemption. [vi]  In the aftermath of this ruling, the Tax Court has refused to adopt a bright line test but has generally followed the ruling’s reasoning.  For example, in Estate of Applestein v. Commissioner , the taxpayer gifted to custodial accounts for his children stock in a corporation that had entered into a merger agreement with another corporation. Prior to the gift, the merger agreement was approved by the stockholders of both corporations.  Although the gift occurred before the closing of the merger transaction, the Tax Court held that the “right to the merger proceeds had virtually ripened prior to the transfer and that the transfer of the stock constituted a transfer of the merger proceeds rather than an interest in a viable corporation.” [vii]   In contrast, in Rauenhorst v. Commissioner , the Tax Court concluded that a nonbinding letter of intent would not support the IRS’ assignment of income argument because the stockholder at the time of making the gift was not legally bound nor compelled to sell his equity. [viii]

In Ferguson v. Commissioner , the Tax Court focused on whether the percentage of shares tendered pursuant to a tender offer was the functional equivalent of stockholder approval of a merger transaction, which the court viewed as converting an interest in a viable corporation to the right to receive cash before the gifting of stock to charities. [ix]   The Tax Court concluded that there was an anticipatory assignment of income in spite of the fact that there remained certain contingencies before the sale would be finalized.  The Tax Court rejected the taxpayer’s argument that the application of the assignment of income doctrine should be conditioned on the occurrence of a formal stockholder vote, noting that the reality and substance of the particular events under consideration should determine tax consequences.

Guidelines for Last-Minute Gifts

Based on the guidelines established by Revenue Ruling 78-197 and the cases discussed above, the IRS should be unsuccessful if it asserts an assignment of income argument in a situation where the gift of QSBS is made prior to the signing of a definitive sale agreement, even if the company has entered into a nonbinding letter of intent.  The IRS’ position should further weakened with the passage of time between the making of a gift and the entering into of a definitive sale agreement.  In contrast, the IRS should have a stronger argument if the gift is made after the company enters into a binding sale agreement.  And the IRS’ position should be stronger still if the gift of QSBS is made after satisfaction of most or all material closing conditions, and in particular after stockholder approval.  Stockholders should be mindful of Tax Court’s comment that the reality and substance of events determines tax consequences, and that it will often be a nuanced set of facts that ultimately determines whether the IRS would be successful arguing for application of the assignment of income doctrine.

Transfers of QSBS Incident to Divorce

The general guidelines discussed above may not apply to transfers of QSBS between former spouses “incident to divorce” that are governed by Section 1041.  Section 1041(b)(1) confirms that a transfer incident to divorce will be treated as a gift for Section 1202 purposes.  Private Letter Ruling 9046004 addressed the situation where stock was transferred incident to a divorce and the corporation immediately redeemed the stock.  In that ruling, the IRS commented that “under section 1041, Congress gave taxpayers a mechanism for determining which of the two spouses will pay the tax upon the ultimate disposition of the asset.  The spouses are thus free to negotiate between themselves whether the ‘owner’ spouse will first sell the asset, recognize the gain or loss, and then transfer to the transferee spouse the proceeds from the sale, or whether the owner spouse will first transfer the asset to the transferee spouse who will then recognize gain or loss upon its subsequent sale.”  Thus, while there are some tax cases where the assignment of income doctrine has been successfully asserted by the IRS in connection with transfers between spouses incident to divorce, Section 1041 and tax authorities interpreting its application do provide divorcing taxpayers an additional argument against application of the doctrine, perhaps even where the end result might be a multiplication of Section 1202’s gain exclusion.

More Resources 

In spite of the potential for extraordinary tax savings, many experienced tax advisors are not familiar with QSBS planning. Venture capitalists, founders and investors who want to learn more about QSBS planning opportunities are directed to several articles on the Frost Brown Todd website:

• Planning for the Potential Reduction in Section 1202’s Gain Exclusion
• Section 1202 Qualification Checklist and Planning Pointers
• A Roadmap for Obtaining (and not Losing) the Benefits of Section 1202 Stock
• Maximizing the Section 1202 Gain Exclusion Amount
• Advanced Section 1045 Planning
• Recapitalizations Involving Qualified Small Business Stock
• Section 1202 and S Corporations
• The 21% Corporate Rate Breathes New Life into IRC § 1202
• View all QSBS Resources

Contact  Scott Dolson  or  Melanie McCoy  (QSBS estate and trust planning) if you want to discuss any QSBS issues by telephone or video conference.

[i] References to “Section” are to sections of the Internal Revenue Code.

[ii] The planning technique of gifting QSBS recently came under heavy criticism in an article written by two investigative reporters.  See Jesse Drucker and Maureen Farrell, The Peanut Butter Secret: A Lavish Tax Dodge for the Ultrawealthy.  New York Times , December 28, 2021.

[iii] But in our opinion, in order to avoid a definite grey area in Section 1202 law, the donee should not be the stockholder’s spouse.  The universe of donees includes nongrantor trusts, including Delaware and Nevada asset protection trusts.

[iv] This article assumes that the holder of the stock doesn’t have sufficient tax basis in the QSBS to take advantage of the 10X gain exclusion cap – for example, the stock might be founder shares with a basis of .0001 per share.

[v]   Lucas v. Earl , 281 U.S. 111 (1930).  The US Supreme Court later summarized the assignment of income doctrine as follows:  “A person cannot escape taxation by anticipatory assignments, however skillfully devised, where the right to receive income has vested.”  Harrison v. Schaffner , 312 U.S. 579, 582 (1941).

[vi] Revenue Ruling 78-197, 1978-1 CB 83.

[vii] Estate of Applestein v. Commissioner , 80 T.C. 331, 346 (1983).

[viii] Gerald A. Rauenhorst v. Commissioner , 119 T.C. 157 (2002).

[ix] Ferguson v. Commissioner , 108 T.C. 244 (1997).

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Tax Alert | Tax Court Guidance on Charitable Contributions and Assignment of Income

February 26, 2024

Today is the first of two alerts dealing with the Estate of Hoensheid v. Commissioner of Internal Revenue, T.C. Memo 2023-34 (2023). In this, the first, the standard for determining whether a taxpayer has made an anticipatory assignment of income is discussed. The judicially created anticipatory assignment of income doctrine recognizes that income is taxed to those who earn or otherwise create the right to receive it and that it cannot be assigned or gifted away.

Hoensheid involves a common fact pattern. The taxpayer was one of three owners of a closely held business, wishing to both sell and to contribute part or all of the proceeds to a tax-exempt charity or donor advised fund, the assignee. If properly structured, the owner receives a charitable deduction equal to the fair market value of the contributed property and the built-in gain on the investment is taxed to the charity. In order to do so, the owner must contribute the ownership interest (in this case 1380 shares of stock) to the charity, but when? Like most owners, the taxpayer in Hoensheid wanted to wait as long as possible before making the actual contribution. During the course of the negotiations concerning the sale, the taxpayer was advised that the contribution had to be completed before any purchase agreement was executed. This is referred to the binding agreement test and has its origin in Rev. Rul. 78-197. If you contribute before the purchase agreement is signed, no anticipatory assignment. If you contribute after the purchase agreement is signed, anticipatory assignment. It provides a bright line for taxpayers. But is it that simple?

The Tax Court first analyzed the requirements under state law to determine when the gift was completed. It concluded the gift took place on July 13, 2015, two days before the signing of the SPA on July 15, 2015, seemingly within the bright line test of Rev. Rul. 78-197. The Tax Court agreed that the gift occurred before the sale and that the charity was not obligated to sell at the time of the gift, but that although the donee’s legal obligation to sell is significant to the assignment of income analysis, it was only one factor.

In short, there is no bright line but there are multiple factors in an assignment of income analysis of a fact pattern. Instead, the ultimate question is whether the transferor, considering the reality and substance of all the circumstances, had a fixed right to income in the property at the time of transfer. If the sale was virtually certain to occur, the anticipatory assignment of income doctrine is satisfied and the taxpayer, not the charity, is taxed on the sales proceeds from the charity’s sale.

In this case, the relevant factors in determining whether the sale of shares was virtually certain to occur include:

• Any legal obligation to sell by the donee.
• The actions already taken by the parties to effect the transaction.
• The remaining unresolved transactional contingencies.
• The status of the corporate formalities required to finalize the transactions.

With regard to the first factor, the Tax Court held that there was no proof of any obligation of the charity to sell the shares, either formal or informal. This was a favorable factor for the taxpayer.

With regard to the second factor, the Tax Court found that there were bonus and shareholder distributions made before the SPA was executed. This factor indicates that the income was earned at an earlier point in time.

With regard to the third factor, the Tax Court found that there were major transactional contingencies (environmental obligations) but that they had been resolved before the SPA was executed. This factor indicates that the income was earned at an earlier point in time.

With regard to the fourth factor, the Tax Court found that after the SPA was executed there were only ministerial actions remaining. This factor indicates that the income was earned at an earlier point in time.

The tax court, based on the various factors mentioned above, determined that the income or gain from the sale was earned at an earlier point in time, resulting in the taxpayer being treated as the seller of the shares of stock purportedly gifted to the charity.

In summary, as the Tax Court found, to avoid an anticipatory assignment of income on the contribution of appreciated shares of stock followed by a sale of the donee, a donor must bear at least some risk at the time of contribution that the sale will not close. The bright line of Rev. Rul. 78-187 was a factor but compliance with that alone did not provide a safe harbor. Other factors needed to be considered to determine if the gain was earned before the sale and taxable to the donor.

If you are the owner of a closely held business and are contemplating a charitable gift of a portion of your ownership interest, do not hesitate to contact either David Ritter, Stuart Gladstone, Bob Kosicki, or Cheryl Ritter for guidance in dealing with the multiple factors set forth in the anticipatory assignment of income doctrine.

For more information or assistance, please contact:

David J. Ritter, Esq. , Member and Chair, Tax Practice , at [email protected] or 973-403-3117

Stuart M. Gladstone, Esq. , Member, Tax Practice , at [email protected] or 973-403-3109

Robert A. Kosicki, Esq. , Counsel, Tax Practice , at [email protected] or 973-403-3122

Cheryl L. Ritter, Esq. , Counsel, Tax Practice , at [email protected] or 973-364-8307

About Brach Eichler LLC

Brach Eichler LLC is a full-service law firm based in Roseland, NJ. With over 80 attorneys, the firm is focused in the following practice areas: Healthcare Law; Real Estate; Litigation; Trusts and Estates; Corporate Transactions & Financial Services; Personal Injury; Criminal Defense and Government Investigations; Labor and Employment; Environmental and Land Use; Family Law Services; Patent, Intellectual Property & Information Technology; Real Estate Tax Appeals; Tax; and Cannabis Law. Brach Eichler attorneys have been recognized by clients and peers alike in The Best Lawyers in America©, Chambers USA, and New Jersey Super Lawyers. For more information, visit www.bracheichler.com .

This alert is intended for informational and discussion purposes only. The information contained in this alert is not intended to provide, and does not constitute legal advice or establish the attorney/client relationship by way of any information contained herein. Brach Eichler LLC does not guarantee the accuracy, completeness, usefulness or adequacy of any information contained herein. Readers are advised to consult with a qualified attorney concerning the specifics of a particular situation.

David J. Ritter

Member Tax, Corporate Transactions & Financial Services, Trusts and Estates

973.403.3117 · 973.618.5517 Fax

Stuart M. Gladstone

Member Trusts and Estates, Corporate Transactions & Financial Services, Tax

973.403.3109 · 973.618.5509 Fax

Robert A. Kosicki

Counsel Corporate Transactions & Financial Services, Family Law Services, Patent, Intellectual Property & IT, Tax, Trusts and Estates

973.403.3122 · 973.618.5522 Fax

Cheryl L. Ritter

Counsel Tax, Trusts and Estates

973.364.8307 · 973.618.5508 Fax

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ASSIGNMENT OF INCOME DOCTRINE – SECTION 61 INTERNAL REVENUE CODE – J. RONALD JACKSON

I don’t want to pay tax on this income, assignment of income doctrine.

By:  J Ronald “Ron” Jackson, MBA, CPA

Under federal income tax law gross income is taxed to the person who earns it or to the owner of property that generates the income. It is not uncommon for a high tax bracket taxpayer to want to shift income to a lower tax bracket family member in order to save on taxes and the income stay within the family unit. Alternatively, one who has appreciated stock or other type of property that he knows will be sold in the near future may wish to save on income taxes by gifting a portion of the property to a lower tax bracket family member who will report the sale at his or her lower income tax bracket. Alternatively, the individual may want a double benefit by gifting the appreciated property to a qualified charity thereby gaining a charitable income tax deduction for the value of the contributed property and being relieved of paying income taxes on the gain from the sale of the gifted property. This shifting of income, if permitted for income tax purposes, may provide considerable income tax savings.

The assignment of income doctrine was developed from court decisions which decided the issues, including the various methods employed in attempting to determine who earned the income. There was a time during the World War II years and thereafter, until around 1963, that the top income tax brackets could be as high as 91% – 93%. In addition to family members, the issues often arose when a high bracket taxpayer would make a gift of property (often the issues were gifts of appreciated stock that were to be sold shortly) to a qualified charity. The taxpayer would then take a charitable income tax deduction and not report the gain as he no longer owned the stock when sold. This shifting of income to a lower bracket taxpayer could have large savings in taxes for the high bracket taxpayer.

A simple example of income earned and taxed to the one who earns the income is when one works for weekly wages. The work week ends on Friday but the actual paycheck is not delivered until the following Wednesday. The wages are earned, for income tax purposes, at the end of the week (Friday). If the individual tells his employer to pay the earned wages to the individual’s mother, and the employer did that, the wages would still be taxed for federal income tax purposes to the individual since he earned the wages. The fact he may have made a gift of his earned wages does not change the income tax treatment as his employer has to include the earned wages on the individual’s W-2 form.

The above is a simple illustration of the doctrine that one who earns the income has to pay income tax on the wages. Let’s look at another situation. Suppose Perry, an individual taxpayer, owns all of the stock ownership in a very successful corporation (Company A) that he has run for many years. Perry is approached by the owners of another corporation (Company B) with an interest in purchasing Perry’s stock ownership in Company A. Negotiations have progressed and a total value has been tentatively negotiated of $5,000,000.00. The actual contract is still to be finalized and there are some remaining details to settle. Perry believes it will be finalized and signed within a reasonably short time. Perry, who is in a very high federal income tax bracket and who is a very civic-minded individual, has been told of the benefit of donating appreciated property to charity. Perry contacts the local Community Foundation and arranges to create the Perry Charitable Fund through the Community Foundation. The charitable fund will provide donations to his church and to other qualified charities that Perry usually supports. Perry then donates fifteen percent of his stock ownership, valued at $750,000.00 to the Community Foundation. Later after negotiations are completed, all of Company A’s stock is sold to Company B for the negotiated price of $5,000,000.00. Perry is happy. He has made a substantial profit from his years of work, made a donation to his favorite charity for which he plans to take a charitable income tax deduction, and will only have to report and pay income tax at capital gain rates on 85% of his stock as he has given 15% away.

Perry files his income tax return for the year and reports his taxable gain on the sale of his 85% ownership interest in Company A. About one year later Perry is audited by the IRS. The IRS agent questions why he did not report gain on the 15% of stock given to the Foundation. Perry replies that he did not own the stock as it was gifted to the charity before the date of the sale. The IRS auditor states that Perry should pay income tax on the gain on the stock given to the Community Foundation since it appears to have been a “done deal” before Perry gave the stock away and for that reason Perry owes income tax on all of the stock. Perry argues that no contracts were signed until weeks after the gift and that the deal could have fallen through at any time before signed by all parties. Perry disagreed with the audit. His tax dispute is now pending before the United States Tax Court. How will the court decide?

Section 61 of the Internal Revenue Code provides that gross income means all income earned from whatever source derived, and then lists several examples such as wages, services rendered, gains from the sales of property, and several other examples. In 1930, the U. S. Supreme Court summarized when addressing who earned income that “The fruits cannot be attributed to a different tree from that on which they grew.” Lucas v. Earl, 281 U.S. 111 (1930). This in effect clarified that gross income is to be taxed to the one that earns it and led to the fact that one cannot avoid paying income tax on earned income by gifting the property that created the income when it has been earned on or before the gift. An example would be when a corporation declares a dividend payable say on November 1st to stockholders of record on October 10th. A stockholder who owned the stock on October 10th is the one who has earned the income even if he or she sells or assigns their stock between October 10th and November 1st. The dividend is taxed to the owner on October 10, the date the dividend was declared.

In Perry’s case he argues that the negotiations were not complete when he made his gift, and that Company B could have backed out of the deal. When the court decides it will consider the stage of the negotiations, whether Company B had the financial backing to complete the deal, whether any contracts or preliminary statements of intent were prepared for review, and how long was the interval between the tentative agreement and the actual sale will all be considered. Situations like these happen from time to time. When the issue arises, it should be discussed in advance of the transaction, if possible, with your legal tax advisors who should be well versed in this area of tax law. One should be aware of the assignment of income doctrine in situations where it could apply in connection with his/her estate planning. What if this had been a publicly traded company?

If you have questions regarding   Assignment of Income Doctrine   and would like to discuss these issues, please contact Cody Walls, MBA, CPA at Denton Law Firm at 270-450-8253.

THIS ARTICLE IS DESIGNED TO PROVIDE GENERAL INFORMATION PREPARED BY THE PROFESSIONALS AT DENTON LAW FIRM, PLLC IN REGARD TO THE SUBJECT MATTER COVERED. IT IS PROVIDED WITH THE UNDERSTANDING THAT THE AUTHOR IS NOT ENGAGED IN RENDERING LEGAL, ACCOUNTING, OR OTHER PROFESSIONAL SERVICE. ALTHOUGH PREPARED BY PROFESSIONALS, THESE MATERIALS SHOULD NOT BE UTILIZED AS A SUBSTITUTE FOR PROFESSIONAL SERVICE IN SPECIFIC SITUATIONS. IF LEGAL ADVICE OR OTHER EXPERT ASSISTANCE IS REQUIRED, THE SERVICE OF A PROFESSIONAL SHOULD BE SOUGHT.

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• TAX MATTERS

Appreciated stock donation not treated as a taxable redemption

The tax court holds that taxpayers made an absolute gift..

• Individual Income Taxation

The Tax Court granted summary judgment to a married couple, ruling that the IRS improperly recharacterized their charitable donations of stock as taxable redemptions. The court held the couple made an absolute gift in each tax year at issue, and although the charity soon after redeemed the stock, the court respected the form of the transaction.

Facts:  Jon and Helen Dickinson claimed a charitable contribution deduction on their joint federal income tax returns for 2013 through 2015, due to a contribution each year by Jon Dickinson of appreciated stock in his employer, Geosyntec Consultants Inc. (GCI), a privately held company, to Fidelity Investments Charitable Gift Fund, a Sec. 501(c)(3) tax-exempt organization. Dickinson was GCI’s CFO.

GCI’s board of directors authorized shareholders to donate GCI shares to Fidelity in written consent actions in 2013 and 2014, stating that Fidelity’s donor-advised fund program required Fidelity “to immediately liquidate the donated stock” and that the charity “promptly tenders the donated stock to the issuer for cash.” The board also authorized donations in 2015.

GCI confirmed in letters to Fidelity the recording of Fidelity’s new ownership of the shares. Dickinson signed a letter of understanding to Fidelity regarding each stock donation, stating that the stock was “exclusively owned and controlled by Fidelity.” Fidelity sent confirmation letters stating that it had “exclusive legal control over the contributed asset.” Fidelity redeemed the GCI shares for cash shortly after each donation.

The IRS issued a notice of deficiency, asserting that the Dickinsons were liable for tax on the redemption of the donated GCI shares and a penalty under Sec. 6662(a) for each year. The Service contended the donations should be treated in substance as taxable redemptions of the shares for cash by Dickinson, followed by donations of the cash to Fidelity.

The Dickinsons petitioned the Tax Court for a redetermination of the deficiencies and penalties and moved for summary judgment.

Issue:  Generally, pursuant to Sec. 170 and Regs. Sec. 1.170A-1(c)(1), a taxpayer may deduct the fair market value of appreciated property donated to a qualified charity without recognizing the gain in the property.

In  Humacid Co. , 42 T.C. 894, 913 (1964), the Tax Court stated: “The law with respect to gifts of appreciated property is well established. A gift of appreciated property does not result in income to the donor so long as [1] he gives the property away absolutely and parts with title thereto [2] before the property gives rise to income by way of a sale.” 

The issue before the court was whether the form of Dickinson’s donations of GCI stock should be respected as meeting the requirements in  Humacid Co. , or recharacterized as taxable redemptions resulting in income to the Dickinsons.

Holding:  The Tax Court held that the form of the stock donations should be respected, as both prongs of  Humacid Co.  were satisfied, and granted the taxpayers summary judgment.

Regarding the first prong, the court held that Dickinson transferred all his rights in the shares to Fidelity, based on GCI’s letters to Fidelity confirming the transfer of ownership in the shares, Fidelity’s letters to the Dickinsons stating it had “exclusive legal control” over the donated stock, and the letters of understanding. Thus, Dickinson made an absolute gift.

The Tax Court analyzed the second prong under the assignment-of-income doctrine. This provides that a taxpayer cannot avoid taxation by assigning a right to income to another. The court stated: “Where a donee redeems shares shortly after a donation, the assignment of income doctrine applies only if the redemption was practically certain to occur at the time of the gift, and would have occurred whether the shareholder made the gift or not.”

The Tax Court noted that in  Palmer , 62 T.C. 684 (1974), it held there was no assignment of income where there was not yet a vote for a redemption at the time of a stock donation, even though the vote was anticipated. Similarly, the court reasoned that “the redemption in this case was not a fait accompli at the time of the gift” and held Dickinson did not avoid income due to the redemption by donating the GCI shares. Thus, the court respected the form of the transaction.

The Tax Court did not apply Rev. Rul. 78-197, in which the IRS ruled that it “will treat the proceeds as income to the donor under facts similar to those in the  Palmer  decision only if the donee is legally bound, or can be compelled by the [issuing] corporation, to surrender the shares for redemption.” The court noted that it has not adopted the revenue ruling, and furthermore, the IRS did not allege that Dickinson had a fixed right to redemption income at the time of the donation.

• Dickinson , T.C. Memo. 2020-128

—  By Mark Aquilio, CPA, J.D., LL.M. , professor of accounting and taxation, St. John’s University, Queens, N.Y.

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Taxable Income

This page includes information that addresses many of the common questions received by Corporate Tax, Compliance, and Payroll about the taxability of various income components. Where applicable, we feature references to supporting documentation from the IRS and other resources.

Assignment of Income

Income earned is generally taxable to the payee at the time payments are made available to them.  

The assignment of income doctrine provides that an individual who assigns  their  right to receive income ,  rather than receiving the income directly, retains the tax liability associated with that income. Under this doctrine, an individual is not allowed to shift the taxation of income by making a gift or gratuitous transfer of income to another individual or organization, including the University. The assignment of income doctrine is summarized in IRS Revenue Ruling 69-102.  

Travel Meal Reimbursement

In order for  travel meal reimbursements to be excludable from wages, employees must be traveling away from their tax home on their employer’s business. The tax home encompasses the general area of the taxpayer’s place of business. Traveling “away from home” means:  

• Employee must be traveling away from the general tax home area substantially longer than an ordinary day’s work, and  
• Employee needs to obtain substantial sleep or rest to meet the demands of the work while away from home.  

The IRS does  not  specifically define sleep or rest , but  the Tax Courts have determined that sleep or rest is one that requires the securing of lodging.   

References:  

• U.S. v.  Correll , Barry v. Commissioner, Unger v. Commissioner  Thunstedt , T.C memo 2013-280 and Rehman, T.C. Memo 2013-71.  
• IRC §1.62(a)(2), Rev. Ruling 75-170, Rev. Ruling 75-432.
• See Publication 463, Travel, Entertainment, Gift, and Car Expenses; Publication 5137 Fringe Benefit Guide.  

Business Use of Home

Please refer to  this   PD F  Flowchart    

Commuting Expense

The costs of commuting to and from work are not deductible,  neither  as trade or business expenses or as expenses incurred in the production of income. Instead, they are nondeductible personal expenses. The cost of commuting to and from work is not deductible even if it is essential to the taxpayer’s pursuit of business activities that  they  have  their  car with  them  at work, or even if the taxpayer is on call and thus must have access to speedy and reliable transportation to  their  place of employment.  

Compensation Assigned to Charity

A taxpayer generally ca nno t avoid the tax on compensation paid for services  they  perform by having the amounts given directly to charity.   ( Primm, T., (1933) 28 BTA 13. )  

If a person renders services to a third party for the benefit of a charitable organization, any amount paid under an agreement or understanding to the charity by the third party for those services is income to the person performing the services. It does  no t matter if the commitment to pay the earnings directly to the charity is made before the services are rendered.  ( 14 Reg § 1.61-2(c ) ;  Rev  Rul  58-495, 1958-2 CB 27 )  

Dues Paid to Charitable Organizations

Membership dues paid to charitable organizations or other qualifying professional organizations  are not  deductible as charitable contributions if by reason of such membership, the taxpayer receives benefits or privileges, such as publications, the use of a library, free or reduced admissions to concerts, lectures, etc.  

M any cultural organizations  ( e.g. tax-exempt museums and symphonies )  also solicit “sustaining” and similar members who pay much higher dues for the privilege of being known as benefactors of the organization. Where such dues have a dual character because of the great discrepancy between payments and benefits,  the  IRS will give due consideration to the possible separation on a uniform basis of that portion of the total payment that may properly be treated as a charitable contribution.  

Employee Gifts and Awards

The University of Pennsylvania recognizes the services of its employees while complying with federal, state, local, and or other sponsor guidelines. The University of Pennsylvania establishes cost-effective practices that are consistently applied.

On occasion the University or an individual department, school, or center will recognize employees for outstanding work-related achievement, a significant contribution, or a major milestone such as a promotion or retirement.  

When these occasions arise, we are reminded that:   

• Federally sponsored funds should never be used to charge employee gifts, morale building events, or celebratory/work related achievement events;   
• Departmental funds may be used at the discretion of the department within the criteria of this policy and the departmental budget.   

The following guidelines have been developed according to the IRS regulations concerning gifts and awards to employees.  

This policy does not cover ordinary business expenses in the promotion of employee morale. Examples of such business expenses are: occasional business lunches and office gatherings. Nor does this policy cover performance-based awards or bonuses, which are generally taxable to the recipient and are processed through Payroll.  

This policy is not applicable to prizes/awards given for established student events.   

Furthermore, this policy does not preclude individual faculty or staff members from giving personal gifts to their colleagues provided University funds are not used for this purpose. Such personal gifts will not be reported as taxable income to the recipient.   

General Guidelines

It is not appropriate to spend any University funds in recognition of employees for  non-work-related  achievement or events such as birthdays, holidays (Christmas, Hanukkah, Kwanza, etc.) weddings, baby showers, housewarming, etc.   

Gifts and awards received by employees are taxable and must be reported as additional earnings if their value exceeds the following thresholds:   

• The IRS considers gift certificates, gift cards, or any savings bond to be a cash equivalent even if the property or service acquired with the gift certificate would normally be excludable.
• Gifts and awards of tangible personal property to employees are “de  minimis ” when they are awarded infrequently and are not greater than $100. 
• These awards may not be made within the employee’s first five years of service or more frequently than every five years.  

All taxable gifts and awards will be net of Federal, State, City, and FICA payroll taxes. In other words, the total expense charged to the departmental funding source will equal the specified award amount; however the amount received by the employee will be net of the applicable taxes withheld.  

Work-related Achievement Award Guidelines

Recognition may take the form of celebratory events such as a department-wide luncheon, dinner, or party. Appropriate circumstances for such recognition include:  

• To mark achievement of a major departmental goal;   
• To honor an employee in connection with a work-related employee recognition program;   
• To honor an employee who is leaving the University or department;   
• To honor a retiree (other than University wide recognition programs).  

These costs should be treated consistent with the University’s general business expense guidelines.   

Recognition may also be in the form of a gift. Appropriate circumstances for recognition by gifts include:   

• To honor an employee for achievement of a work-related goal or objective (non-bonus);   
• To honor a long-service employee, outside of a University-wide recognition program;   
• To honor an employee departing the University or department.   

What May Not be Charged

Celebratory events and gifts to honor an individual for personal reasons (e.g., wedding, baby shower, birthday, housewarming, holiday, etc.) may not be charged to University funds. Personal funds should be used to pay for these and other kinds of staff parties and for gifts for such events.   

Flowers:  The University will not pay or reimburse for payment of flowers, other than flowers of nominal cost sent upon the hospitalization of an employee or a death in the employee’s family.   

Holiday Cards:  The University will not pay or reimburse for payment of holiday cards for interoffice mailing. External mailings are allowable for purposes such as alumni and donor relations.   

Taxability of Awards to Employees  

If you have any questions or concerns, please contact us at  [email protected] .

Graduate Stipends

Graduate students and the staff who support them should review the resources below to better understand the taxability of their graduate stipends.  

• Graduate Stipend s  – Tax Withholding  
• Guide to Graduate Student Appointments
• Guide to Post-Doctoral Appointments

Reimbursement of Sabbatical Expenses

The IRS would allow sabbatical expenses to be reimbursed if: 1.)  It  is for research purposes; 2.) The  the  research is in the employee’s field of study; and 3.) The  the research cannot be performed elsewhere. As long as the three criteria are met, taxability should not be an issue for reimbursement of the travel expenses, regardless of a salary or no salary. If all three criteria are met, send the reimbursement to Travel.  

In order to be prepared for an audit, a document stating the following needs to be included with the travel receipts:   

• The University requires the employee to conduct the research (to prove that the research is not for personal reasons)   
• What is the purpose of conducting the research and how will it benefit the  University of Pennsylvania
• A statement that the research is in the employee’s field of study 
• Why the research is being conducted at a location other than the  University   of Pennsylvania

The Tax Reform Act repeal ed  the employee deduction and income exclusion for moving expenses. Therefore, reimbursement of qualifying moving expenses reimbursed in 2018 and forward  are  recognized as taxable income for the employee. No longer can qualified relocation expenses be reimbursed tax-free. The request for relocation reimbursement must be made through payroll as an additional pay.  

Student Prizes

Taxation of student prizes  .

Cash, gift certificates, and other cash equivalents are taxable income to students regardless of value. The giving of these items as prizes is strongly discouraged.  

Contest Prizes  

Scholarship prizes won in a contest are not scholarships or fellowships if you do not have to use the prizes for your education. If you can use the prize for any purpose, the entire amount is taxable.  

Taxable Scholarships and Fellowships  

If you received a scholarship or fellowship, all or part of it may be taxable, even if you did not receive a Form W-2. Generally, the entire amount is taxable if you are not a candidate for a degree.  

If you are a candidate for a degree, you generally can exclude from income that part of the grant used for t uition and fees required for enrollment or attendance, or f ees, books, supplies, and equipment required for your courses.  

You cannot exclude from income any part of the grant used for other purposes, such as room and board.  

Prizes and Awards  

Prizes and awards are amounts received primarily in recognition of religious, charitable, scientific, educational, artistic, literary, civic achievement, or as the result of entering a contest. All prizes and awards (with the exception of qualified scholarships) are includible in gross income (Code Sec. 74 (a); Reg. § 1.74-1(b)) unless all of the following conditions are met:  

• The recipient was selected without any action on his or her part to enter the contest.  
• The recipient is not required to render substantial future services as a condition to receive the prize or award.  
• The prize or award is transferred by the payer to a government unit or tax-exempt charitable organization as designated by the recipient.  

All three of the above conditions must be met in order to exempt the prize from taxation.  

IRS Reporting Requirements  

For U.S. and resident alien students, all prizes in the amount of $600 or greater must be reported by the University to the IRS on form 1099-MISC. It is the responsibility of all prize recipients, regardless of the amount of the prize, to report the taxable prize received to the IRS on their personal income tax returns.  

For non-resident alien students, the University is required to withhold 30% tax on the full amount of the prize unless the individual is exempt from taxation under a tax treaty. Contact Corporate Tax, Compliance, and Payroll at [email protected] or Room 308 Franklin Building (between 10 am and 2 pm) to determine treaty eligibility. The prize amount will be reported to the IRS and to the student on form 1042-S.  

Department Reporting Responsibilities  

For prizes of $600 or more issued to U.S. students and resident alien students, the following documentation must be forwarded to Accounts Payable:  

• The student name and address 
• A W-9 with the student’s social security number 
• Value of the prize 

For all prizes issued to non-resident alien students, the following documentation must be forwarded to Accounts Payable:  

• University of Pennsylvania Foreign National Information Form
• A copy of the student’s I-94 Card, Visa, Passport, and I-20 / DS 2019 or I-797 

Note: If the non-resident alien student is an employee of the University, only the student’s name, address, and prize value is required to be forwarded to Accounts Payable.  

It is important to inform the recipients of the income tax consequences of their winnings. Even in situations where the University is not required to report winnings, the recipients are responsible for reporting such payments on their individual tax returns.  

The University is not in the position to offer specific tax advice. It is recommended that the student consult with a tax professional.  

For more information

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The Assignment of Income Doctrine

Tax Court ruling of special interest to church treasurers.

Ferguson v. Commissioner, 108 T.C. 244 (1997)

Background. Donors occasionally attempt to “assign” their right to receive income to a church, assuming that they are avoiding any receipt of taxable income.

Example. Rev. T is senior pastor of First Church. He conducts a service at Second Church, and is offered compensation of $500. Rev. T refuses to accept any compensation, and asks the pastor of Second Church to put the $500 in the church’s building fund. Rev. T, and the treasurer at Second Church, assume that there is no income to report. Unfortunately, they may be wrong.

The United States Supreme Court addressed this issue in a landmark ruling in 1940. Helvering v. Horst, 311 U.S. 112 (1940). The Horst case addressed the question of whether or not a father could avoid taxation on bond interest coupons that he transferred to his son prior to the maturity date. The Supreme Court ruled that the father had to pay tax on the interest income even though he assigned all of his interest in the income to his son. It observed: “The power to dispose of income is the equivalent of ownership of it. The exercise of that power to procure the payment of income to another is the enjoyment and hence the realization of the income by him who exercises it.” The Supreme Court reached the same conclusion in two other landmark cases. Helvering v. Eubank, 311 U.S. 122 (1940), Lucas v. Earl, 281 U.S. 111 (1930).

Example. A taxpayer earned an honorarium of $2,500 for speaking at a convention. He requested that the honorarium be distributed to a college. This request was honored, and the taxpayer assumed that he did not have to report the $2,500 as taxable income since he never received it. The IRS ruled that the taxpayer should have reported the $2,500 as taxable income. It noted that “the amount of the honorarium transferred to the educational institution at the taxpayer’s request … is includible in the taxpayer’s gross income [for tax purposes]. However, the taxpayer is entitled to a charitable contribution deduction ….” The IRS further noted that “the Supreme Court of the United States has held that a taxpayer who assigns or transfers compensation for personal services to another individual or entity fails to be relieved of federal income tax liability, regardless of the motivation behind the transfer” (citing the Horst case discussed above). Revenue Ruling 79 121.

A recent Tax Court ruling. The Tax Court has issued an important ruling addressing the assignment of income to a church. Don owned several shares of stock in Company A. On July 28, Company A agreed to merge with Company B. Pursuant to the merger agreement, Company B offered to purchase all outstanding shares of Company A for $22.50 per share (an 1,100% increase over book value). On August 15, Don informed his stockbroker that he wanted to donate 30,000 shares of Company A to his church. On September 8 Don deposited 30,000 shares in his brokerage account and on September 9 signed an authorization directing his broker to transfer the shares to his church. A few days later the church issued Don a receipt acknowledging the contribution. The receipt listed the “date of donation” as September 9. The church sold all of the shares to Company B for $22.50 per share. Don claimed a charitable contribution deduction for $675,000 (30,000 shares at $22.50 per share). He did not report any taxable income in connection with the transaction..

The IRS audited Don, and conceded that a gift of stock had been made to the church. It insisted, however, that Don should have reported the “gain” in the value of his stock that was transferred to the church. Not so, said Don. After all, he never realized or “enjoyed” the gain, but rather transferred the shares to the church to enjoy.

The IRS asserted that Don had a legal right to redeem his Company A shares at $22.50 per share at the time he transferred the shares to the church. As a result, Don had “assigned income” to the church, and could not avoid being taxed on it.

The Tax Court agreed with the IRS. It began its opinion by addressing the date of Don’s gift. Did the gift to the church occur before he had a legal right to receive $22.50 per share for his Company A stock? If so, there was no income that had been assigned and no tax to be paid. Or, did Don’s gift occur after he had a legal right to receive $22.50 per share? If so, Don had “assigned income” to the church and he would have to pay tax on the gain. The court concluded that Don’s gift occurred after he had a legal right to receive $22.50 per share. It quoted the following income tax regulation addressing the timing of gifts of stock:

Ordinarily, a contribution is made at the time delivery is effected …. If a taxpayer unconditionally delivers or mails a properly endorsed stock certificate to a charitable donee or the donee’s agent, the gift is completed on the date of delivery or, if such certificate is received in the ordinary course of the mails, on the date of mailing. If the donor delivers the stock certificate to his bank or broker as the donor’s agent, or to the issuing corporation or its agent, for transfer into the name of the donee, the gift is completed on the date the stock is transferred on the books of the corporation.

The critical issue was whether Don’s broker was acting as Don’s agent or the church’s agent in handling the transaction. The court concluded that the broker had acted as Don’s agent. The broker “facilitated” Don’s gift of stock to the church, and was acting on the basis of Don’s instructions. The court concluded:

[Don has] failed to persuade us that depositing stock in his brokerage account with instructions to [the stockbroker] to transfer some of the stock to the [church] constituted the unconditional delivery of stock to a charitable donee’s agent …. [Don] has failed to persuade us that depositing stock in [his] brokerage account with instructions to [his stockbroker] to transfer some of the stock to the [church] constituted the unconditional delivery of stock to a charitable donee’s agent pursuant to [the regulations] …. Based on the circumstances surrounding the gift … we believe that [the stockbroker] acted as [Don’s] agent in the transfer of the stock and that [he] relinquished control of the stock on September 9 when the letters of authorization were executed, and we so find. The gift to the [church], therefore, was complete on September 9.

The court concluded that on the date of the gift (September 9) Don had a legal right to receive $22.50 per share for all his shares of Company A, and therefore his gift to the church was a fully taxable “assignment of income.” The court observed:

It is a well-established principle of the tax law that the person who earns or otherwise creates the right to receive income is taxed. When ]the right to income has matured at the time of a transfer of property, the transferor will be taxed despite the technical transfer of that property …. An examination of the cases that discuss the anticipatory assignment of income doctrine reveals settled principles. A transfer of property that is a fixed right to income does not shift the incidence of taxation to the transferee …. [T]he ultimate question is whether the transferor, considering the reality and substance of all the circumstances, had a fixed right to income in the property at the time of transfer.

The court concluded that Don did have a “fixed right to income” at the time he donated the 30,000 shares to his church. According to the terms of the merger agreement between Company A and Company B, each outstanding share of Company A was “converted” into a right to receive $22.50 per share in cash. In essence, the stock in Company A “was converted from an interest in a viable corporation to a fixed right to receive cash.”

Conclusions. Here are a few principles for church treasurers to consider:

* Charitable contribution reporting. Note that the “assignment of income” doctrine does not bar recognition of a charitable contribution. Both the Tax Court and IRS conceded that Don was eligible for a charitable contribution deduction as a result of his gift of stock.

* Timing of a gift of stock. This case will provide helpful guidance to church treasurers in determining the date of a gift of stock. The income tax regulations (quoted above) contain the following three rules:

(1) Hand delivery. if a donor unconditionally delivers an endorsed stock certificate to a charity or an agent of a charity, the gift is completed on the date of delivery

(2) Mail. if a donor mails an endorsed stock certificate to a charity or an agent of a charity, the gift is completed on the date of mailing

(3) Delivery to an agent. if a donor delivers a stock certificate to his or her bank or stockbroker as the donor’s agent (or to the issuing corporation or its agent) for transfer into the name of a charity, the gift is completed on the date the stock is transferred on the books of the corporation

* Notification of income consequences. While certainly not required, church treasurers may want to inform some donors about the assignment of income doctrine. It often comes as a shock to donors (such as Don) to discover that their charitable contribution is “offset” by the taxable income recognized under the assignment of income doctrine. Assignments of income most often occur in connection with donations of stock rights or compensation for services already performed.

* Gifts of appreciated stock not affected. Many donors give stock that has appreciated in value to their church. Such transactions are not affected by the court’s ruling or by the assignment of income doctrine because the donor ordinarily has no “fixed right to income” at the time of transfer. Don’s case was much different. He had a contractual right to receive $22.50 per share for all of his shares of Company A stock as a result of the merger.

Key point. Persons who donate stock often can deduct the fair market value of the stock as a charitable contribution (there are some important limitations to this rule) and they have no “assigned income” to report.

Example. Jill is employed by a local business. Her company declares a $1,000 Christmas bonus. Jill asks her supervisor to send the bonus directly to her church. The supervisor does so. The church treasurer should be aware of the following: (1) Jill will be taxed on the bonus under the assignment of income doctrine. The church treasurer may want to point this out to Jill, although this is not required. There is no need for the church to report this income, or issue Jill a W-2 or 1099. (2) Jill should be given credit for a charitable contribution in the amount of the bonus. Since the bonus was in excess of $250 the receipt issued by the church should comply with the charitable contribution substantiation rules that apply to contributions of $250 or more.

This content is designed to provide accurate and authoritative information in regard to the subject matter covered. It is sold with the understanding that the publisher is not engaged in rendering legal, accounting, or other professional service. If legal advice or other expert assistance is required, the services of a competent professional person should be sought. "From a Declaration of Principles jointly adopted by a Committee of the American Bar Association and a Committee of Publishers and Associations." Due to the nature of the U.S. legal system, laws and regulations constantly change. The editors encourage readers to carefully search the site for all content related to the topic of interest and consult qualified local counsel to verify the status of specific statutes, laws, regulations, and precedential court holdings.

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Tax Court in Brief | Estate of Hoenshied v. Commissioner | Anticipatory Assignment of Income, Charitable Contribution Deduction, and Qualified Appraisals

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The Tax Court in Brief – April 3rd – April 7th, 2023

Freeman Law ’s “ The Tax Court in Brief ” covers every substantive Tax Court opinion, providing a weekly brief of its decisions in clear, concise prose.

For a link to our podcast covering the Tax Court in Brief, download  here  or check out other episodes of  The Freeman Law Project .

Tax Litigation:  The Week of April 3rd, 2022, through April 7th, 2023

Estate of Hoenshied v. Comm’r, T.C. Memo. 2023-34 | March 15, 2023 | Nega, J. | Dkt. No. 18606-19

Summary: In this 49-page opinion the Tax Court addresses a deficiency arising from the charitable contribution of appreciated shares of stock in a closely held corporation to a charitable organization that administers donor-advised funds for tax-exempt purposes under section 501(c)(3). The contribution in issue was made near contemporaneously with the selling of those shares to a third party. The timeline (truncated heavily for this blog) is as follows:

On June 11, 2015, the shareholders of the corporation in issue unanimously ratified the sale of all outstanding stock of the corporation. Immediately following the shareholder meeting, the corporation’s board of directors unanimously approved Petitioner’s request to be able to transfer a portion of his shares to Fidelity Charitable Gift Fund, a tax-exempt charitable organization under section 501(c)(3). Thereafter, the corporation and the purchaser of shares continued drafting and revising the Contribution and Stock Purchase Agreement.

On July 13, 2015, Fidelity Charitable first received a stock certificate from Petitioner.

On July 14, 2015, the Contribution and Stock Purchase Agreement was revised to specify that Petitioner contributed shares to Fidelity Charitable on July 10, 2015, and on July 15, 2015, the Contribution and Stock Purchase Agreement was signed and the transaction was funded.

Fidelity Charitable, having provided an Irrevocable Stock Power as part of the transaction, received $2,941,966 in cash proceeds from the sale, which was deposited in Petitioner’s donor-advised fund giving account.

On November 18, 2015, Fidelity Charitable sent Petitioner a contribution confirmation letter acknowledging a charitable contribution of the corporate shares and indicating that Fidelity Charitable received the shares on June 11, 2015.

In its 2015 tax return, Petitioner did not report any capital gains on the shares contributed to Fidelity Charitable but claimed a noncash charitable contribution deduction of $3,282,511. In support of the claimed deduction, a Form 8283 was attached to the return.

Petitioner’s 2015 tax return was selected for examination. The IRS issued to Petitioners a notice of deficiency, determining a deficiency of $647,489, resulting from the disallowance of the claimed charitable contribution deduction, and a penalty of $129,498 under section 6662(a).

Key Issues:

• Whether and when Petitioners made a valid contribution of the shares of stock?
• Whether Petitioners had unreported capital gain income due to their right to proceeds from the sale of those shares becoming fixed before the gift?
• Whether Petitioners are entitled to a charitable contribution deduction?
• Whether Petitioners are liable for an accuracy-related penalty under section 6662(a) with respect to an underpayment of tax?

Primary Holdings:

(1) Petitioners failed to establish that any of the elements of a valid gift was present on June 11, 2015. No evidence was presented to credibly identify a specific action taken on June 11 that placed the shares within Fidelity Charitable’s dominion and control. Instead, the valid gift of shares was made by effecting delivery of a PDF of the certificate to Fidelity Charitable on July 13.

(2) Yes. None of the unresolved contingencies remaining on July 13, 2015 were substantial enough to have posed even a small risk of the overall transaction’s failing to close. Thus, Petitioners, through the doctrine of anticipatory assignment of income, had capital gains on the sale of the 1,380 appreciated shares of stock, even though Fidelity Charitable received the proceeds from that sale.

(3) No, Petitioners failed to show that the charitable contribution met the qualified appraisal requirements of section 170. The appraiser was not shown to be qualified, per regulations, at trial or in the appraisal itself, and the appraisal did not substantially comply with the regulatory requirements. “The failure to include a description of such experience in the appraisal was a substantive defect. . . . Petitioners’ failure to satisfy multiple substantive requirements of the regulations, paired with the appraisal’s other more minor defects, precludes them from establishing substantial compliance.” In addition, Petitioners failed to establish reasonable cause for failing to comply with the appraisal requirements “because petitioner knew or should have known that the date of contribution (and thus the date of valuation) was incorrect.” Thus, the IRS’s determination to disallow the charitable contribution deduction is sustained.

(4) No. While Petitioners did not have reasonable cause for their failure to comply with the qualified appraisal requirement, their liability for an accuracy-related penalty was a separate analysis, and the IRS did not carry the burden of proof. Petitioners did not follow their professional’s advice to have the paperwork for the contribution ready to go “well before the signing of the definitive purchase agreement.” But, Petitioners adhered to the literal thrust of the advice given: that “execution of the definitive purchase agreement” was the firm deadline to contribute the shares and avoid capital gains (even if that proved to be incorrect advice under the circumstances).

Key Points of Law:

Gross Income. Gross income means “all income from whatever source derived,” including “[g]ains derived from dealings in property.” 26 U.S.C. § 61(a)(3). In general, a taxpayer must realize and recognize gains on a sale or other disposition of appreciated property. See id. at § 1001(a)–(c). However, a taxpayer typically does not recognize gain when disposing of appreciated property via gift or charitable contribution. See Taft v. Bowers , 278 U.S. 470, 482 (1929); see also 26 U.S.C. § 1015(a) (providing for carryover basis of gifts). A taxpayer may also generally deduct the fair market value of property contributed to a qualified charitable organization. See 26 U.S.C. § 170(a)(1); Treas. Reg. 16 § 1.170A-1(c)(1). Contributions of appreciated property are thus tax advantaged compared to cash contributions; when a contribution of property is structured properly, a taxpayer can both avoid paying tax on the unrealized appreciation in the property and deduct the property’s fair market value. See, e.g. , Dickinson v. Commissioner , T.C. Memo. 2020-128, at *5.

Donor-Advised Fund. The use of a donor-advised fund further optimizes a contribution by allowing a donor “to get an immediate tax deduction but defer the actual donation of the funds to individual charities until later.” Fairbairn v. Fid. Invs. Charitable Gift Fund , No. 18-cv-04881, 2021 WL 754534, at *2 (N.D. Cal. Feb. 26, 2021).

Two-Part Test to Determine Charitable Contribution of Appreciated Property Followed by Sale by Donee. The donor must (1) give the appreciated property away absolutely and divest of title (2) “before the property gives rise to income by way of a sale.” Humacid Co. v. Commissioner , 42 T.C. 894, 913 (1964).

Valid Gift of Shares of Stock. “Ordinarily, a contribution is made at the time delivery is effected.” Treas. Reg. § 1.170A-1(b). “If a taxpayer unconditionally delivers or mails a properly endorsed stock certificate to a charitable donee or the donee’s agent, the gift is completed on the date of delivery.” Id. However, the regulations do not define what constitutes delivery, and the Tax Court evaluates applicable state law for the threshold determination of whether donors have divested themselves of their property rights via gift. See, e.g. , United States v. Nat’l Bank of Com. , 472 U.S. 713, 722 (1985). In determining the validity of a gift, Michigan law, for example (and as applied in Estate of Hoensheid ), requires a showing of (1) donor intent to make a gift; (2) actual or constructive delivery of the subject matter of the gift; and (3) donee acceptance. See Davidson v. Bugbee , 575 N.W.2d 574, 576 (Mich. Ct. App. 1997).

Present Intent. The determination of a party’s subjective intent is necessarily a highly fact-bound issue. When deciding such an issue, the Tax Court must determine “whether a witness’s testimony is credible based on objective facts, the reasonableness of the testimony, the consistency of statements made by the witness, and the demeanor of the witness.” Ebert v. Commissioner , T.C. Memo. 2015-5, at *5–6. If contradicted by the objective facts in the record, the Tax Court will not “accept the self-serving testimony of [the taxpayer] . . . as gospel.” Tokarski v. Commissioner , 87 T.C. 74, 77 (1986).

Delivery. Under Michigan law, the delivery requirement generally contemplates an “open and visible change of possession” of the donated property. Shepard v. Shepard , 129 N.W. 201, 208 (Mich. 1910). Manually providing tangible property to the donee is the classic form of delivery. Manually providing to the donee a stock certificate that represents intangible shares of stock is traditionally sufficient delivery. The determination of what constitutes delivery is context-specific and depends upon the “nature of the subject-matter of the gift” and the “situation and circumstances of the parties.” Shepard , 129 N.W. at 208. Constructive delivery may be effected where property is delivered into the possession of another on behalf of the donee. See, e.g. , In re Van Wormer’s Estate , 238 N.W. 210, 212 (Mich. 1931). Whether constructive or actual, delivery “must be unconditional and must place the property within the dominion and control of the donee” and “beyond the power of recall by the donor.” In re Casey Estate , 856 N.W.2d 556, 563 (Mich. Ct. App. 2014). If constructive or actual delivery of the gift property occurs, its later retention by the donor is not sufficient to defeat the gift. See Estate of Morris v. Morris , No. 336304, 2018 WL 2024582, at *5 (Mich. Ct. App. May 1, 2018).

Delivery of Shares. Retention of stock certificates by donor’s attorney may preclude a valid gift. Also, a determination of no valid gift may occur where the taxpayer instructs a custodian of corporate books to prepare stock certificates but remained undecided about ultimate gift. In some jurisdictions, transfer of shares on the books of the corporation can, in certain circumstances, constitute delivery of an inter vivos gift of shares. See, e.g. , Wilmington Tr. Co. v. Gen. Motors Corp. , 51 A.2d 584, 594 (Del. Ch. 1947); Chi. Title & Tr. Co. v. Ward , 163 N.E. 319, 322 (Ill. 1928); Brewster v. Brewster , 114 A.2d 53, 57 (Md. 1955). The U.S. Court of Appeals for the Sixth Circuit has stated that transfer on the books of a corporation constitutes delivery of shares of stock, apparently as a matter of federal common law. See Lawton v. Commissioner , 164 F.2d 380, 384 (6th Cir. 1947), rev’g 6 T.C. 1093 (1946); Bardach v. Commissioner , 90 F.2d 323, 326 (6th Cir. 1937), rev’g 32 B.T.A. 517 (1935); Marshall v. Commissioner , 57 F.2d 633, 634 (6th Cir. 1932), aff’g in part, rev’g in part 19 B.T.A. 1260 (1930). The transfers on the books of the corporation were bolstered by other objective actions that evidenced a change in possession and thus a gift. See Jolly’s Motor Livery Co. v. Commissioner , T.C. Memo. 1957-231, 16 T.C.M. (CCH) 1048, 1073.

Acceptance. Donee acceptance of a gift is generally “presumed if the gift is beneficial to the donee.” Davidson , 575 N.W.2d at 576.

Anticipatory Assignment of Income. The anticipatory assignment of income doctrine is a longstanding “first principle of income taxation.” Commissioner v. Banks , 543 U.S. 426, 434 (2005). The doctrine recognizes that income is taxed “to those who earn or otherwise create the right to receive it,” Helvering v. Horst , 311 U.S. 112, 119 (1940), and that tax cannot be avoided “by anticipatory arrangements and contracts however skillfully devised,” Lucas v. Earl , 281 U.S. 111, 115 (1930). A person with a fixed right to receive income from property thus cannot avoid taxation by arranging for another to gratuitously take title before the income is received. See Helvering , 311 U.S. at 115–17; Ferguson , 108 T.C. at 259. This principle is applicable, for instance, where a taxpayer gratuitously assigns wage income that the taxpayer has earned but not yet received, or gratuitously transfers a debt instrument carrying accrued but unpaid interest. A donor will be deemed to have effectively realized income and then assigned that income to another when the donor has an already fixed or vested right to the unpaid income. See Cold Metal Process Co. v. Commissioner , 247 F.2d 864, 872–73 (6th Cir. 1957), rev’g 25 T.C. 1333 (1956). The same principle is often applicable where a taxpayer gratuitously transfers shares of stock that are subject to a pending, prenegotiated transaction and thus carry a fixed right to proceeds of the transaction. See Rollins v. United States , 302 F. Supp. 812, 817–18 (W.D. Tex. 1969).

Determining Anticipatory Assignment of Income. In determining whether an anticipatory assignment of income has occurred with respect to a gift of shares of stock, the Tax Court looks to the realities and substance of the underlying transaction, rather than to formalities or hypothetical possibilities. See Jones v. United States , 531 F.2d 1343, 1345 (6th Cir. 1976) (en banc); Allen v. Commissioner , 66 T.C. 340, 346 (1976). In general, a donor’s right to income from shares of stock is fixed if a transaction involving those shares has become “practically certain to occur” by the time of the gift, “despite the remote and hypothetical possibility of abandonment.” Jones , 531 F.2d at 1346. The mere anticipation or expectation of income at the time of the gift does not establish that a donor’s right to income is fixed. The Tax Court looks to several other factors that bear upon whether the sale of shares was virtually certain to occur at the time of a purported gift as part of the same transaction. Relevant factors may include (1) any legal obligation to sell by the donee, (2) the actions already taken by the parties to effect the transaction, (3) the remaining unresolved transactional contingencies, and (4) the status of the corporate formalities required to finalize the transaction.

Corporate Formalities. Also relevant is the status of the corporate formalities necessary for effecting the transaction. See Estate of Applestein , 80 T.C. at 345–46 (finding that taxpayer’s right to sale proceeds from shares had “virtually ripened” upon shareholders’ approval of proposed merger agreement). Under Michigan law, a proposed plan to exchange shares must generally be approved by a majority of the corporation’s shareholders. Formal shareholder approval of a transaction has often proven to be sufficient to demonstrate that a right to income from shares was fixed before a subsequent transfer. However, such approval is not necessary for a right to income to be fixed, when other actions taken establish that a transaction was virtually certain to occur. See Ferguson , 104 T.C. at 262–63.

Charitable Contribution Deduction. Section 170(a)(1) allows as a deduction any charitable contribution (as defined) payment of which is made within the taxable year. “A charitable contribution is a gift of property to a charitable organization made with charitable intent and without the receipt or expectation of receipt of adequate consideration.” Palmolive Bldg. Invs., LLC v. Commissioner , 149 T.C. 380, 389 (2017). Section 170(f)(8)(A) provides that “[n]o deduction shall be allowed . . . for any contribution of $250 or more unless the taxpayer substantiates the contribution by a contemporaneous written acknowledgement of the contribution by the donee organization that meets the requirements of subparagraph (B).” For contributions of property in excess of $500,000, the taxpayer must also attach to the return a “qualified appraisal” prepared in accordance with generally accepted appraisal standards. 26 U.S.C. § 170(f)(11)(D) and (E).

Contemporaneous Written Acknowledgement (“CWA”). A CWA must include, among other things, the amount of cash and a description of any property contributed. 26 U.S.C. § 170(f)(8)(B). A CWA is contemporaneous if obtained by the taxpayer before the earlier of either (1) the date the relevant tax return was filed or (2) the due date of the relevant tax return. Id. at § 170(f)(8)(C). For donor-advised funds, the CWA must include a statement that the donee “has exclusive legal control over the assets contributed.” 26 U.S.C. § 170(f)(18)(B). These requirements are construed strictly and do not apply the doctrine of substantial compliance to excuse defects in a CWA.

Qualified Appraisal for Certain Charitable Contributions. Section 170(f)(11)(A)(i) provides that “no deduction shall be allowed . . . for any contribution of property for which a deduction of more than $500 is claimed unless such person meets the requirements of subparagraphs (B), (C), and (D), as the case may be.” Subparagraph (D) requires that, for contributions for which a deduction in excess of $500,000 is claimed, the taxpayer attach a qualified appraisal to the return. Section 170(f)(11)(E)(i) provides that a qualified appraisal means, with respect to any property, an appraisal of such property which—(I) is treated for purposes of this paragraph as a qualified appraisal under regulations or other guidance prescribed by the Secretary, and (II) is conducted by a qualified appraiser in accordance with generally accepted appraisal standards and any regulations or other guidance prescribed under subclause (I). The regulations provide that a qualified appraisal is an appraisal document that, inter alia, (1) “[r]elates to an appraisal that is made” no earlier than 60 days before the date of contribution and (2) is “prepared, signed, and dated by a qualified appraiser.” Treas. Reg. § 1.170A-13(c)(3)(i).

Qualified Appraisal Must Include: Treasury Regulation § 1.170A-13(c)(3)(ii) requires that a qualified appraisal itself include, inter alia:

(1) “[a] description of the property in sufficient detail for a person who is not generally familiar with the type of property to ascertain that the property that was appraised is the property that was (or will be) contributed;”

(2) “[t]he date (or expected date) of contribution to the donee;”

(3) “[t]he name, address, and . . . identifying number of the qualified appraiser;”

(4) “[t]he qualifications of the qualified appraiser;”

(5) “a statement that the appraisal was prepared for income tax purposes;”

(6) “[t]he date (or dates) on which the property was appraised;”

(7) “[t]he appraised fair market value . . . of the property on the date (or expected date) of contribution;” and

(8) the method of and specific basis for the valuation.

Qualified Appraiser. Section 170(f)(11)(E)(ii) provides that a “qualified appraiser” is an individual who (I) has earned an appraisal designation from a recognized professional appraiser organization or has otherwise met minimum education and experience requirements set forth in regulations, (II) regularly performs appraisals for which the individual receives compensation, and (III) meets such other requirements as may be prescribed . . . in regulations or other guidance. An appraiser must also demonstrate “verifiable education and experience in valuing the type of property subject to the appraisal.” The regulations add that the appraiser must include in the appraisal summary a declaration that he or she (1) “either holds himself or herself out to the public as an appraiser or performs appraisals on a regular basis;” (2) is “qualified to make appraisals of the type of property being valued;” (3) is not an excluded person specified in paragraph (c)(5)(iv) of the regulation; and (4) understands the consequences of a “false or fraudulent overstatement” of the property’s value. Treas. Reg. § 1.170A-13(c)(5)(i). The regulations prohibit a fee arrangement for a qualified appraisal “based, in effect, on a percentage . . . of the appraised value of the property.” Id. at subpara. (6)(i).

Substantial Compliance with Qualified Appraisal Requirements. The qualified appraisal requirements are directory, rather than mandatory, as the requirements “do not relate to the substance or essence of whether or not a charitable contribution was actually made.” See Bond v. Commissioner , 100 T.C. 32, 41 (1993). Thus, the doctrine of substantial compliance may excuse a failure to strictly comply with the qualified appraisal requirements. If the appraisal discloses sufficient information for the IRS to evaluate the reliability and accuracy of a valuation, the Tax Court may deem the requirements satisfied. Bond , 100 T.C. at 41–42. Substantial compliance allows for minor or technical defects but does not excuse taxpayers from the requirement to disclose information that goes to the “essential requirements of the governing statute.” Estate of Evenchik v. Commissioner , T.C. Memo. 2013-34, at *12. The Tax Court generally declines to apply substantial compliance where a taxpayer’s appraisal either (1) fails to meet substantive requirements in the regulations or (2) omits entire categories of required information.

Reasonable Cause to Avoid Denial of Charitable Contribution Deduction. Taxpayers who fail to comply with the qualified appraisal requirements may still be entitled to charitable contribution deductions if they show that their noncompliance is “due to reasonable cause and not to willful neglect.” 26 U.S.C. § 170(f)(11)(A)(ii)(II). This defense is construed similarly to the defense applicable to numerous other Code provisions that prescribe penalties and additions to tax. See id. at § 6664(c)(1). To show reasonable cause due to reliance on a professional adviser, the Tax Court generally requires that a taxpayer show (1) that their adviser was a competent professional with sufficient expertise to justify reliance; (2) that the taxpayer provided the adviser necessary and accurate information; and (3) that the taxpayer actually relied in good faith on the adviser’s judgment. See Neonatology Assocs., P.A. v. Commissioner , 115 T.C. 43, 99 (2000), aff’d , 299 F.3d 221 (3d Cir. 2002).  “Unconditional reliance on a tax return preparer or C.P.A. does not by itself constitute reasonable reliance in good faith; taxpayers must also exercise ‘[d]iligence and prudence’.” See Stough v. Commissioner , 144 T.C. 306, 323 (2015) (quoting Estate of Stiel v. Commissioner, T.C. Memo. 2009-278, 2009 WL 4877742, at *2)).

Section 6662(a) Penalty. Section 6662(a) and (b)(1) and (2) imposes a 20% penalty on any underpayment of tax required to be show on a return that is attributable to negligence, disregard of rules or regulations, or a substantial understatement of income tax. Negligence includes “any failure to make a reasonable attempt to comply” with the Code, 26 U.S.C. § 6662(c), or a failure “to keep adequate books and records or to substantiate items properly,” Treas. Reg. § 1.6662-3(b)(1). An understatement of income tax is “substantial” if it exceeds the greater of 10% of the tax required to be shown on the return or $5,000. 26 U.S.C. § 6662(d)(1)(A). Generally, the IRS bears the initial burden of production of establishing via sufficient evidence that a taxpayer is liable for penalties and additions to tax; once this burden is met, the taxpayer must carry the burden of proof with regard to defenses such as reasonable cause. Id. at § 7491(c); see Higbee v. Commissioner , 116 T.C. 438, 446–47 (2001). The IRS bears the burden of proof with respect to a new penalty or increase in the amount of a penalty asserted in his answer. See Rader v. Commissioner , 143 T.C. 376, 389 (2014); Rule 142(a), aff’d in part, appeal dismissed in part , 616 F. App’x 391 (10th Cir. 2015); see also RERI Holdings I, LLC v. Commissioner , 149 T.C. 1, 38–39 (2017), aff’d sub nom. Blau v. Commissioner , 924 F.3d 1261 (D.C. Cir. 2019). As part of the burden of production, the IRS must satisfy section 6751(b) by producing evidence of written approval of the penalty by an immediate supervisor, made before formal communication of the penalty to the taxpayer.

Reasonable Cause Defense to Section 6662(a) Penalty. A section 6662 penalty will not be imposed for any portion of an underpayment if the taxpayers show that (1) they had reasonable cause and (2) acted in good faith with respect to that underpayment. 26 U.S.C. § 6664(c)(1). A taxpayer’s mere reliance “on an information return or on the advice of a professional tax adviser or an appraiser does not necessarily demonstrate reasonable cause and good faith.” Treas. Reg. § 1.6664-4(b)(1). That reliance must be reasonable, and the taxpayer must act in good faith. In evaluating whether reliance is reasonable, a taxpayer’s “education, sophistication and business experience will be relevant.” Id. para. (c)(1).

Insights: Going forward, this opinion of Estate of Hoenshied v. Commissioner will likely be a go-to source for any practitioner involved in a taxpayer’s proposed transfer of corporate shares (or other property) to a donor-advised fund or other charitable organization as part of a buy-sell transaction that is anywhere close in time to the proposed donation.

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Timing Is Critical for Gift of Appreciated Stock to Avoid Capital Gain From Sale of Company

Business owners contemplating selling their companies often look to their tax advisers for options to reduce the potential tax impact upon sale. One option routinely considered is having the owner contribute a portion of the appreciated stock to a charitable organization before the transaction closes to avoid income taxes on the donated shares. This leads to a critical question: How far in advance of the closing must the charitable contribution occur?

On March 15, 2023, the Tax Court issued an opinion concluding that donating stock two days before closing on a third-party sale transaction was clearly too late to avoid tax. The Tax Court declined to specify a “bright line” deadline for making a donation and instead focused on the substance of the underlying transactions. All in all, these taxpayers paid income taxes on the recognized gain on the shares they no longer owned and didn’t get the charitable tax deduction for failure to meet the strict substantiation rules.

In the Estate of Scott M. Hoensheid, et al. v. Commissioner (T.C. Memo 2023-34), the taxpayers were clear at the outset that they wanted to “wait as long as possible to pull the trigger” on donating shares valued at more than $3 million to charity because they wanted to make sure the sale of the company was going to occur. They were also clear that the purpose for donating was to avoid paying income taxes on any gain associated with the donated shares. To reach these stated goals, the taxpayers worked closely with their tax/estate planning attorney and a financial adviser to structure the stock sale transaction hoping for an $80 million target price and to find a charity that was willing to accept the stock and then participate in the third-party sale transaction without much hassle.

In early 2015, the taxpayers’ financial adviser started soliciting bids for the company and received significant interest from private equity firms. In mid-April 2015, the taxpayers’ tax attorney advised them that “the transfer [to the charity] would have to take place before there is a definitive agreement in place.” Concurrently, the taxpayers began working with Fidelity Investments Charitable Gift Fund, a large tax-exempt organization that serves as a sponsoring organization with regard to establishing donor-advised funds, to accept the donation of company stock. Fidelity Charitable provided a similar warning to the taxpayers that the gift must take place before any purchase agreement is executed to avoid the Internal Revenue Service raising the anticipatory assignment of income doctrine.

Anticipatory Assignment of Income Doctrine

The anticipatory assignment of income doctrine has been around since at least the 1930s. See Lucas v. Earl , 281 U.S. 111 (1930). Under this doctrine, income is taxed “to those who earn or otherwise create the right to receive it.” See Helvering v. Horst , 311 U.S. 112, 119 (1940). The courts have been clear that taxpayers cannot avoid tax by entering into anticipatory arrangements and contracts where a person with a fixed right to receive income from property arranges for another person to gratuitously take title before the income is actually received.

The person who gratuitously takes title usually has a lower effective income tax rate or does not pay tax at all on recognized gains (i.e., many charitable organizations). If the doctrine is triggered, the donor is deemed to have effectively realized the income and then assigned that income to another. This results in the donor paying tax on the income that he or she did not actually receive. For charitable donations, the donor likely is unable to force the charity to rescind the transaction, causing the taxpayer to use personal funds to pay the taxes on the income received by the charity.

Unfortunately, the Tax Court’s ruling in Estate of Hoensheid did not specify a bright line deadline for making a donation to give donors assurance that the anticipatory assignment of income doctrine would not apply. Instead, to determine who has a fixed right to the income, the Tax Court stated that it looks at the realities and substance of the underlying transactions rather than formalities or hypothetical possibilities. Factors considered include (i) the donee’s obligation to sell the shares, (ii) the acts of the parties to effect the sale transactions, (iii) unresolved sale contingencies as of the date of the donation and (iv) corporate formalities necessary to effect the transaction.

In reviewing the substance of the underlying transactions in the Estate of Hoensheid case, the Tax Court found that Fidelity Charitable did not have any obligation to sell the shares, which was a factor in favor of the taxpayers. However, the court was not persuaded by the taxpayers’ arguments that the donation occurred over a month before the transaction closed. Importantly, nine days before the transaction closed, the taxpayers’ attorney indicated that the amount of shares being transferred was unclear and that the stock assignment had not been executed.

In the end, the court concluded that Fidelity Charitable accepted the gift only two days before the stock sale transaction closed when one of the taxpayers’ advisers emailed a copy of the company stock certificate issued in the name of Fidelity Charitable.

As of the date of contribution, the Tax Court opined that there were no unresolved sale contingencies and noted that the shareholders had emptied the company’s working capital by distributing cash to the owners (not including Fidelity Charitable).

Finally, the Tax Court looked at the corporate formalities. While the taxpayers argued that negotiations were ongoing all the way through the closing date of July 15, 2015, the Tax Court said the signing of the definitive purchase agreement on that date was purely ministerial and any decision not to sell as of the date of donation was remote and hypothetical. These facts led to the conclusion that the transaction was “too far down the road to enable [the taxpayers] to escape taxation on the gain attributable to the donated shares.”

When considering the enumerated factors, donors should be very careful to avoid creating an informal, prearranged understanding with the charity that would constitute an obligation for the charity to agree to sell. Additionally, the donor must bear some risk at the time of the contribution that the sale will not close. In the Estate of Hoensheid , the taxpayers sought to eliminate any risk that the sale would not go through, and as a result, the Tax Court agreed with the Internal Revenue Service imposing the anticipatory assignment of income doctrine to force the taxpayers to recognize gain on the contributed shares as a result of the later sale to the private equity firm.

The key takeaways from this case are: (i) waiting until shortly before a purchase agreement is executed significantly increases the risk that the Internal Revenue Service will assert the anticipatory assignment of income doctrine; and (ii) the Internal Revenue Service and the courts will look closely at the transaction documents, intent of the donor, correspondence between the donor and his or her advisers, and the records of the charity to determine the date of the gift and the application of this doctrine.  This does not mean that donors must make such gifts before a transaction is contemplated, or even before a nonbinding letter of intent is executed. This case is simply a cautionary tale to remind taxpayers that the Internal Revenue Service will closely scrutinize donations of stock in advance of a stock sale transaction. Maybe one day the Internal Revenue Service or the courts will provide a “bright line,” but for now caution is key.

Loss of Charitable Deduction

After reaching its conclusion related to the anticipatory assignment of income doctrine, the Tax Court turned to the Internal Revenue Service’s argument that the taxpayers should not be permitted a charitable deduction for the donated shares for failing to comply with the rigid substantiation requirements. For a more complete discussion of these requirements, see McGuireWoods’ Nov. 10, 2022, alert .   As a reminder, when the Internal Revenue Service challenges a charitable deduction on procedural grounds, it is not disputing the fact that a charitable contribution was made.  In fact, the Internal Revenue Service admits that the contribution was made but nonetheless challenges the taxpayers’ ability to claim a tax deduction. 

Here, the Internal Revenue Service argued that the taxpayers failed to engage a qualified appraiser and the appraisal did not satisfy the basic requirements for a qualified appraisal.

A qualified appraiser is someone who has obtained an appraisal designation from a recognized professional organization or otherwise has sufficient education and experience, and who regularly performs appraisals for compensation. The qualified appraisal must include all of the following:

• A description of the contributed property in sufficient detail, including the physical condition of any real or tangible property.
• The valuation effective date. For qualified appraisals prepared before the date of contribution, the valuation effective date must be no earlier than 60 days before the date of contribution and no later than the actual date of contribution. For qualified appraisals prepared after the contribution, the valuation effective date must be the date of contribution.
• The fair market value of the contributed property on the valuation effective date.
• The date or expected date of contribution.
• The terms of any agreement relating to the use, sale or other disposition of the contributed property. This includes any restrictions on the donee’s ability to dispose of the property, any rights to income from the property or rights to vote any contributed securities.
• The name, address and taxpayer identification number of the qualified appraiser or the partnership or employer who employs the qualified appraiser.
• The qualifications of the appraiser, including education and experience.
• A statement that the appraisal was prepared for income tax purposes.
• The method of valuation used (e.g., income approach, market-data approach, replacement-cost-less-depreciation approach) and the specific basis for the valuation (e.g., specific comparable sales, statistical sampling).
• A description of the fee arrangement between the donor and qualified appraiser.
• This declaration: “I understand that my appraisal will be used in connection with a return or claim for refund. I also understand that, if there is a substantial or gross valuation misstatement of the value of the property claimed on the return or claim for refund that is based on my appraisal, I may be subject to a penalty under Section 6695A of the Internal Revenue Code, as well as other applicable penalties. I affirm that I have not been at any time in the three-year period ending on the date of the appraisal barred from presenting evidence or testimony before the Department of Treasury of the Internal Revenue Service pursuant to 31 U.S.C. 330(c).”
• The signature of the qualified appraiser and the appraisal report date. The qualified appraisal must be signed and dated no earlier than 60 days before the date of contribution and no later than the due date for the tax return (including extensions) on which the deduction is claimed.

In Estate of Hoensheid , the taxpayers decided to use the services of their financial adviser that worked on the sales transaction to save the costs of having an outside expert prepare the appraisal. This cost-saving move ended up actually costing the taxpayers their entire $3.3 million claim of a charitable deduction for the donated stock. Because the taxpayers’ financial adviser did not have any appraisal certifications, did not hold himself out as an appraiser, and prepares valuations only once or twice a year in order to solicit business for his financial advisory firm, the Tax Court agreed with the Internal Revenue Service that the taxpayer failed to engage a qualified appraiser.

The Tax Court reviewed the Internal Revenue Service’s arguments that the contents of the appraisal attached to the tax return were deficient. The Tax Court agreed and indicated that the appraisal (i) included the incorrect date of contribution, (ii) did not include the statement that it was prepared for federal income tax purposes, (iii) included a premature date of appraisal, (iv) did not sufficiently describe the method for the valuation, (v) was not signed by the appraiser, (vi) did not include the appraiser’s qualifications as an appraiser, (vii) did not describe the donated property in sufficient detail and (viii) did not include an explanation of the specific basis for the valuation.

While the taxpayers did not dispute that the appraisal had defects, they sought to rely on the “substantial compliance” doctrine to excuse these stringent substantiation requirements. The Tax Court analyzed the substantial compliance argument but rejected it, stating that the appraisal failed with regard to multiple substantive requirements of the applicable regulations. As a result, no deduction for the contribution of shares to Fidelity Charitable was allowed.

Again, it is critical for taxpayers and their advisers to closely review the Treasury regulations that set forth the substantiation requirements to minimize the risk that the Internal Revenue Service challenges a charitable deduction on procedural grounds.

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IRS Applies Special Tax-Benefit Rule to Publicly Traded Stock

Conrad Teitell | Jan 08, 2019

In a recent private letter ruling (PLR 201848005, released Nov. 30, 2018), donors planned to contribute corporate stock regularly traded on a national securities exchange to their private foundation (PF). They represented to the Internal Revenue Service that: the stock was exempt from Securities and Exchange Commission Rule 144 and other SEC rules that would affect marketability; and they wouldn’t take any action that would be subject to insider-trading rules.

General Rules

Before we get to the IRS’ decision on the PLR, let's review some general rules for gifts to PFs (other than private operating foundations [POFs]).

Income tax benefits for gifts to PFs are generally less favorable than those for gifts to public charities. Long-term appreciated securities, real estate and tangible personal property are deductible at cost basis only under Internal Revenue Code Section 170(e)(1)(B)(ii). Gifts of long-term appreciated securities, real estate and related-use tangible personal property to public charities are deductible at fair market value (FMV).

Special rule for pass-through foundations. A deduction for full FMV is allowed when the PF (within two and a half months following the year of receipt) gives an amount equal to all gifts described in the preceding paragraph to churches, schools, hospitals, public charities or POFs. IRC Section 170(b)(1)(D); Section 170(e)(1)(B)(ii); Treasury Regulations Section 1.170A-9(h)(2)(iv). Note. Unless tangible personal property is for a “related use, the deduction is limited to cost basis."

Special rule for certain gifts of publicly traded securities (qualified appreciated stock). A full FMV deduction is allowed for gifts of long-term qualifying publicly traded stock. What’s qualified appreciated stock? Listed securities, of course. The IRS’ definition also includes mutual fund shares if quotations are published daily in readily available newspapers. Treas. Regs. Section 1.170A-13(c)(7)(xi)(A)(3). It also includes securities traded on a national or regional over-the-counter market. Treas. Regs. Section 1.170A-13(c)(7)(xi)(A)(2); PLR 9623018 (March 5, 1996). Gifts of stock subject to SEC Rule 144 restrictions, including volume and resale limitations, may not qualify for FMV deductibility. PLR 9746050 (Aug. 15, 1997). The contributed stock can’t be more than 10 percent of the corporation’s outstanding stock taking into account the current gift and earlier gifts by the donor and family members.

Carryovers for gifts qualifying for FMV deductibility. Excess gifts to PFs may be carried over until exhausted under the applicable deductibility ceiling for up to five years. IRC Section 170(b)(1)(B).

Ordinary income property gifts. As with public charities, gifts of ordinary-income and short-term property to PFs yield a deduction for cost basis or FMV, whichever is lower. Section 170(e)(1)(A).

Ceilings on deductibility for gifts to PFs. Cash and ordinary-income property are deductible up to 30 percent of adjusted gross income (AGI).

Gifts of long-term appreciated property to PFs—including those deductible at FMV under the marketable-securities rule. Deductible up to 20 percent of AGI. Section 170(b)(1)(D).

Carryover. A five-year carryover is allowed for all excess gifts to PFs. Section 170(b)(1)(B). Note. PLR 8824039 (March 21, 1988) (involving a charitable lead trust) suggested that the IRS doesn’t allow a five-year carryover when an excess gift is “for the use of” a PF.

Back to the PLR

Here’s the IRS’ analysis:

• Under Section 170(e)(5)(B), the contributed shares are stock for which, as of the contribution date, market quotations are readily available on an established securities market.

• The donors represented that the contributed shares at all times were held for more than one year. They also represented that, as of the contribution date, the FMV of the contributed shares exceeded the adjusted basis.
• The donors won’t have contributed in aggregate more than 10 percent by value of the corporation stock to the PF when aggregated with prior gifts of the corporation to any private nonoperating foundation.


Based on the information submitted and representations made by the donors, the IRS ruled that, provided the requirements of Section 170 are otherwise satisfied, the shares of stock contributed to PF constitute “qualified appreciated stock” within the meaning of Section 170(e)(B).

IRS’ Caveats

• The PLR is based on the facts and representations submitted by the donors and accompanied by a penalty of perjury statement executed by an appropriate party. It hasn’t verified any of the materials submitted in support of the request for rulings. Verification of the information, representations and other data may be required as part of the examination process.
• Except as expressly provided herein, the IRS neither expresses nor implies an opinion concerning the tax consequences of any aspect of any transaction or item discussed or referenced in this letter:
• whether the contributed shares constitute a “charitable contribution” within the meaning of Section 170(c).

• the assignment of income doctrine. (The stock was held by the donors’ revocable trusts.)
• the excess business holdings within the meaning of IRC Section 4943(c).

• private inurement within the meaning of IRC Section 501(c)(3).

• any issues under Chapter 42 of the Code, affecting PFs.
                                      

© Conrad Teitell 2019. This is not intended as legal, tax, financial or other advice. So check with your advisor on how the rules apply to you.

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