Tax Court in Brief | Lim v. Comm’r | Disallowance of Charitable Contribution Deduction for Lack of Qualified Appraisal; Reasonable Cause Exception

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Tax Litigation:  The Week of January 23rd, 2022, through January 27th, 2023

Lim v. Comm’r, T.C. Memo. 2023-11| January 23, 2023 | Lauber, J. | Dkt. No. 14015-20

Summary:  This case involves taxpayers, Calvin Lim and Helen Chu (together, “Petitioners”) federal income tax liabilities for 2016 and 2017 with respect to a disallowed charitable contribution deduction.

“The Ultimate Tax, Estate, and Charitable Plan.” During 2016 and 2017, Petitioners were the sole shareholders of Integra Capital Group, Inc. (Integra), an S corporation. In December 2016, Michael L. Meyer, an attorney, made a presentation to Petitioners he called “The Ultimate Plan: the Ultimate Tax, Estate and Charitable Plan.” That same day Petitioners executed an engagement agreement with Mr. Meyer. He agreed to form a “Charitable Limited Liability Company” (CLLC) as a charitable giving vehicle. He agreed to create documents that would transfer assets to the CLLC, to create documents that would transfer CLLC units to a charity, and to supply an appraisal supporting the valuation claimed for the gift. He also agreed to represent Petitioners before the IRS and the Tax Court if the tax return on which Petitioners reported the gift was selected by the IRS for examination. Mr. Meyer’s fee would be the greater of $25,000 or a percentage of the “deductible amount” of assets. The assets transferred to the CLLC would consist of five promissory notes with total face amount of $2,008,500.

The Charitable LLC. That same day Mr. Meyer created ABC Foundation Legacy, LLC (ABC), as the CLLC. ABC was a single-member LLC incorporated in Indiana. On December 30, 2016, Petitioners and Integra executed an agreement prepared by Mr. Meyer (ABC agreement). The ABC agreement named Petitioners as ABC’s managers, Integra as ABC’s single member, and Mr. Meyer as its registered agent. Attached to the ABC agreement were the five promissory notes. Each note was dated December 31, 2016. By these notes Petitioner (wife), as payor, promised to pay ABC a total of $2,008,500 in seven years. Petitioner (wife) signed each note as payor, and both Petitioners signed each note (on behalf of ABC) as payees.

Charitable Donation. The charitable recipient was to be the Indiana Endowment Foundation, Inc. (Foundation). The Foundation was an Indiana corporation incorporated in 2016 and Mr. Meyer was listed as the Foundation’s registered agent. The Foundation was recognized by the IRS as a section 501(c)(3) organization. Petitioners asserted that Integra, ABC’s single member, donated “units” of ABC to the Foundation. But Petitioners failed to supply evidence to establish that any property was actually transferred to the Foundation. They offered no explanation as to when or how these “units” were created or what physical form they took. Petitioners claimed the donation was acknowledged via a letter from Indiana Endowment Foundation dated January 1, 2017.

Purported Acknowledgment Letter. The January 1, 2017 provided as follows: “We received your non-cash donation of one thousand (1,000) units in C&H FAMILY LLC in 2016. Indiana Endowment Foundation, Inc., provided no goods or services to you in exchange for your contribution. Please allow this letter to serve as official receipt of your unrestricted gift of 1000 units received in 2016. Your support is greatly appreciated.” The letter did not refer to the units of ABC that were donated. Rather, it referred to 1,000 units of “C&H Family LLC,” which did not exist during 2016 or on January 1, 2017.

Mr. Meyer’s Invoice and Purported Appraisal. On January 4, 2017, Mr. Meyer issued an invoice to Petitioners calculating his fee as $84,000. He also submitted an appraisal. At that time, the only assets allegedly possessed by ABC were the five promissory notes, showing ABC as the payee. According to the Tax Court, Mr. Meyer’s appraisal had the legalistic form of an appraisal but none of the substance. The appraisal was addressed to Integra, the alleged donor. It stated (incorrectly) that ABC has “one (1) Manager,” then stated that the “Manager of the LLC is Helen Chu and Calvin Lim.” It asserted that “LLC interests” were donated to the Foundation in 2016, but it failed to specify how many ABC units were donated. The appraisal recited that ABC’s only assets were promissory notes, but the appraisal did not value the notes or give consideration to their due date. The appraisal assumed that the Foundation owned 100% of the ABC units on the valuation date, but it applied a discount for lack of control in determining the value of those units. Mr. Meyer opined that the deductible value of ABC units allegedly donated to the Foundation on December 31, 2016, was $1,608,808. Mr. Meyer attached a one-page “certification” stating that his compensation as preparer “[was] not contingent on an action or event resulting from the analysis, opinions, or conclusions in, or the use of, this report.” He averred that he had no “present or prospective interest or bias with respect to the parties involved”. He attached a curriculum vitae stating that he was a certified public accountant (CPA), a certified valuation analyst (CVA), and a licensed attorney in Kentucky at that time.

Tax Return. Integra timely filed Form 1120S, U.S. Income Tax Return for an S Corporation, for 2016. Integra attached to its return a copy of Mr. Meyer’s appraisal and Form 8283, Noncash Charitable Contributions, prepared and signed by Mr. Meyer. The Form 8283 described the donated property as “LLC units,” without identifying the entity whose units were being contributed or the number of units contributed. It stated that Integra’s basis in the donated property was $2,008,500—the face amount of the five promissory notes—and incorrectly stated that Integra had acquired the LLC units by “purchase.” It reported the “appraised market value” of the LLC units as $1,608,808. Petitioners reported on Schedule A, Itemized Deductions, a noncash charitable contribution deduction of $1,608,808 passed through to them from Integra. Because that amount exceeded the maximum allowable deduction for 2016, Petitioners claimed a $1,195,073 deduction for 2016 and carried the balance of $415,711 to their 2017 return.

IRS Examination. The IRS selected Petitioners’ 2016 and 2017 returns for examination. The IRS issued Petitioners a notice of deficiency, disallowing the deductions at issue for lack of substantiation. Petitioners timely petitioned this Court for redetermination.

Mr. Meyer’s Other Judicial Matters. In 2018 the Department of Justice filed a complaint against Mr. Meyer, alleging that he promoted the Ultimate Tax Plan as a tax evasion scheme. He settled with the Government and agreed to a permanent injunction. On April 26, 2019, the U.S. District Court for the Southern District of Florida entered a final judgment of permanent injunction against Mr. Meyer, holding that he had engaged in conduct penalizable under section 6700 by promoting the Ultimate Tax Plan. The court permanently enjoined him from, among other things, promoting “the Ultimate Tax Plan or any plan or arrangement that is substantially similar.” The court ordered Mr. Meyer to perform other actions as well in relation to the plan.

Key Issues:

  1. Whether Petitioner’s purported acknowledgement letter was not, as a matter of law, a “contemporaneous written acknowledgement of the contribution” within the meaning of section 170(f)(8)(A)?
  2. Whether Mr. Meyer’s appraisal was not, as a matter of law, a “qualified appraisal” within the meaning of section 170(f)(11)(C)?
  3. Whether Petitioners lacked, as a matter of law, “reasonable cause” for failure to comply with the substantiation requirements of section 170?

Primary Holdings:

  1. No, the IRS was not entitled to summary judgment on that issue. Petitioners produce some evidence (the January 1, 2017 letter) that created a material issue of fact that a jury must determine.
  2. Yes, the appraisal was not a “qualified appraisal” within the meaning of section 170(f)(11)(C). The regulations require, among other things, that “no part of the fee arrangement for a qualified appraisal can be based, in effect, on a percentage (or set of percentages) of the appraised value of the property.” Treas. Reg. § 1.170A-13(c)(6)(i). Mr. Meyer’s fee was a prohibited appraisal fee within the meaning of this regulation.
  3. No, fact issues existed as to whether Petitioners may be entitled to the “reasonable cause” exception for failure to comply with the substantiation requirements of section 170. Petitioners presented sufficient proof that they relied upon professionals in claiming the charitable contribution deduction, and thus, the IRS was not entitled to summary judgment on this issue.

Key Points of Law:

Summary Judgment. The purpose of summary judgment is to expedite litigation and avoid costly, time-consuming, and unnecessary trials. Fla. Peach Corp. v. Commissioner, 90 T.C. 678, 681 (1988). The Tax Court may grant summary judgment regarding an issue as to which there is no genuine dispute of material fact and a decision may be rendered as a matter of law. Rule 121(b). In deciding whether to grant summary judgment, the Court construes factual materials and inferences drawn from them in the light most favorable to the nonmoving party. Bond v. Commissioner, 100 T.C. 32, 36 (1993). Where the moving party properly makes and supports a motion for summary judgment, “an adverse party may not rest upon the mere allegations or denials of such party’s pleading,” but must set forth specific facts, by affidavit or otherwise, showing that there is a genuine dispute for trial. Rule 121(d).

Standard of Review. The IRS’s determinations in a notice of deficiency are generally presumed correct. Welch v. Helvering, 290 U.S. 111, 115 (1933). The taxpayer bears the burden of proving entitlement to any deductions claimed and of substantiating the amounts of such deductions. See Rule 142(a).

Section 170 – Charitable Contribution Deduction. Section 170(a)(1) allows as a deduction any charitable contribution made within the taxable year. The amount of the contribution must be “actually paid during the taxable year.” Treas. Reg. § 1.170A-1(a). To show that “payment” of the claimed contribution, a taxpayer must establish that he or she surrendered dominion and control over the property allegedly contributed. See Pollard v. Commissioner, 786 F.2d 1063, 1067 (11th Cir. 1986), aff’g T.C. Memo. 1984-536.If the taxpayer makes a charitable contribution of property other than money, the amount of the contribution is generally equal to the FMV of the property at the time of contribution. See Treas. Reg. § 1.170A-1(c)(1). “A charitable contribution shall be allowable as a deduction only if verified under regulations prescribed by the Secretary.” 26 U.S.C. § 170(a)(1).

Verification of Noncash Charitable Contributions. Extensive regulations govern the verification of noncash charitable contributions. See Treas. Reg. § 1.170A-13. In the case of a contribution of property (other than publicly traded securities) valued in excess of $5,000, the taxpayer must obtain a “qualified appraisal” of the property. 26 U.S.C. § 170(f)(11)(C). The taxpayer must attach to his return “such information regarding such property and such appraisal as the Secretary may require,” which includes a fully completed appraisal summary on Form 8283. Id.; Treas. Reg. § 1.170A-13(c)(2). When a contribution of property is valued in excess of $500,000, the taxpayer must attach a copy of the qualified appraisal to his return. See 26 U.S.C. § 170(f)(11)(D). In the case of a partnership or S corporation, the qualified appraisal requirements “shall be applied at the entity level.” Id.

Qualified Appraisal for Charitable Contribution. An appraisal is “qualified” if it is “conducted by a qualified appraiser in accordance with generally accepted appraisal standards” and meets requirements set forth in “regulations or other guidance prescribed by the Secretary.” 26 U.S.C. § 170(f)(11)(E)(i). An appraisal is “qualified” only if it is “prepared, signed, and dated by a qualified appraiser.” Treas. Reg. § 1.170A-13(c)(3)(i)(B). The regulations specify 11 categories of information that a “qualified appraisal” must include. See id. subdiv. (ii). “[N]o part of the fee arrangement for a qualified appraisal can be based, in effect, on a percentage (or set of percentages) of the appraised value of the property.” Treas. Reg. § 1.170A-13(c)(6)(i); see Alli v. Commissioner, T.C. Memo. 2014-15, 107 T.C.M. (CCH) 1082, 1087 n.14.

Reasonable Cause Exception. Section 170(f)(11)(A)(ii)(II) excuses failure to satisfy the substantiation requirements of section 170, including requirements related to qualified appraisals, if “it is shown that the failure to meet such requirements is due to reasonable cause and not to willful neglect.” This “reasonable cause” defense may enable a taxpayer to avoid disallowance of a charitable contribution deduction. See Belair Woods, LLC v. Commissioner, T.C. Memo. 2018-159, 116 T.C.M. (CCH) 325, 330. The determination of whether a taxpayer acted with reasonable cause and in good faith is made on a case-by-case basis, taking into account all pertinent facts and circumstances. Treas. Reg. § 1.6664-4(b)(1); see Belair Woods, 116 T.C.M (CCH) at 330.

Insights: For an appraisal to be qualified for purposes of a charitable contribution deduction, no part of the fee arrangement for the appraisal can be based, in effect, on a percentage of the appraised value of the property. If an appraisal fails in this regard, the taxpayer may still be excused from the section 170 substantiation requirements, pursuant to section 170(f)(11)(A)(ii)(II). That section excuses failure to satisfy the substantiation requirements of section 170, including requirements related to qualified appraisals. To be entitled to the excuse, the taxpayer must show that the failure to meet the substantiation requirements was due to reasonable cause and not to willful neglect. All pertinent facts and circumstances are considered in this analysis, including whether the taxpayer relied upon professionals in regard to the underlying charitable contribution deduction.