Reasonable Cause & Reporting Charitable Donations

The IRS is tasked with enforcing our tax laws. The task should be to ensure “substantial compliance” by taxpayers. But all too often the audit process is nothing more than the IRS examining a handful of go-to-adjustment issues.

These go-to-adjustment issues involve tax laws that Congress passed that leave room for interpretation. These issues often involve activities and the law asks what activities a taxpayer engaged in to qualify for a tax deduction or credit. The law for these issues may hint at a level of detailed recordkeeping that really can’t ever be complied with. Congress usually notes these deficiencies by saying that the Treasury is to issue regulations to clarify. Sometimes the Treasury does this and other times it does not. Even when it does, the regulations raise more questions than they provide answers.

This leaves IRS auditors with an easy job. IRS auditors can simply pull returns that have these tax deductions or credits, write up adjustments for them, repeat the process over and over, and then go back and point to their statistics to show a job well done. Hobby losses, passive losses, charitable deductions, etc. all fall into this category of go-to-adjustment issues.

This brings us to the Schweizer v. Commissioner, T.C. Memo. 2022-102 case. The case concerns a charitable deduction and the rules that can allow the deduction even when the strict reporting requirements are not followed.

Facts & Procedural History

This case involves artwork the taxpayer donated to a museum. The taxpayer and his CPA requested a statement of value from the IRS Art Appraisal Services. The IRS Art Appraisal Services did not respond timely to the submission. Thus, the taxpayer had to file a tax return without the benefit of the advance agreement with the IRS on the value of his art.

The taxpayer filed his tax return with a partially completed Form 8283 that reported a $600,000 fair market value for the art he had donated. The form did not provide information about the history of the art and the taxpayer did not sign the form. The tax return also did not include a valuation report as required for gifts of property in excess of $500,000.

The taxpayer had previously submitted a one-and-a-half-page appraisal to the IRS as part of his earlier request to the IRS Art Appraisal Services. As explained below, the taxpayer apparently believed that this information was already in the IRS’s possession and therefore he did not have to submit it again with his tax return.

The IRS audited the taxpayer’s return and determined that the artwork was worth $250,000. Litigation ensued in the U.S. Tax Court. The IRS filed a motion for summary judgment asking the court to deny the charitable deduction as the taxpayer failed to file a complete Form 8283 and failed to attach the required valuation report. The IRS ruled in the IRS’s favor on the IRS’s motion and set the question of reasonable cause for trial.

The court had to determine whether the reasonable cause exception found in Sec. 170 applied to excuse the failure to meet the technical filing requirements for charitable contributions.

About Charitable Gifts of Property

Section 170 sets out the rules for taking charitable deductions. Generally, they allow a charitable deduction for gifts of cash or property.

When it comes to gifts of property, there are a number of rules that one has to comply with. These rules are found in Treas. Reg. § 1.170A-1. These regulations say that a taxpayer has to obtain a qualified appraisal for property that is in excess of $5,000. The appraisal has to be obtained prior to the time the tax return is filed that reports the charitable deduction.

Section 170 itself says that the taxpayer has to attach a qualified appraisal to his tax return if the gift is of property in excess of $500,000.

The regulations say that a qualified appraisal is an appraisal document that:

1. Relates to an appraisal that is made not earlier than 60 days prior to the date of contribution of the appraised property nor later than the due date for the return.
2. Is prepared, signed, and dated by a qualified appraiser.
3. Includes the information required by the regulations, such as a description of the property, the date donated, etc.
4. Does not involve an appraisal fee prohibited, such as contingent fees.

Section 170 goes on to say that failure to provide this information results in no charitable deduction, but that these requirements can be excused for reasonable cause.

Reasonable Cause for Charitable Deduction Reporting

The court stated its view that reasonable cause is akin to reasonable cause that is often cited as a defense against tax penalties. The court cited its prior court cases saying that the rules in the penalty provisions define what is reasonable cause for purposes of Section 170. We’ll come back to this point below.

Those who read this site will recall the numerous instances where we address the reasonable cause defense for penalties. There is a whole body of law that applies these rules to various fact patterns. One common fact pattern is the reliance on a tax advisor. This can be reasonable cause for penalties if the taxpayer can show that the tax advisor was competent, the tax advisor had the required information, and the tax advisor gave tax advice. The court in this case found that there was no evidence that the tax advisor actually provided advice. The court concluded, based on the evidence presented, that the tax advisor just prepared tax returns and did not provide advice.

Turning back to the assumption that reasonable cause as defined in the penalty defense rules applies, one could also argue that even if that is true, the fact patterns are different for Section 170 and, therefore, the new fact patterns qualify. For example, providing information to the IRS Art Appraisal Service before filing a return could suffice. Hiring an appraiser before filing the return, even if they are not fully qualified, could suffice. Or even relying on the appraisal provided by the appraiser, could suffice. It would seem that the court could adopt the reasonable cause defense concepts from the penalty cases, but adapt them to more than the constrained factual situations presented by the penalty cases. The court chose not to do that in this case.

The Takeaway

The IRS has a track record of auditing and disallowing charitable deductions. Those who donate property to charity need to comply with the substantiation and reporting rules. As this case shows, taxpayers who cannot fully comply with the reporting rules should take steps to document their attempts to comply. The taxpayer’s documentation efforts may include creating correspondence and an audit trail long before the tax return is filed. Relying on the IRS Art Appraisal Service to do its work on a timely basis is insufficient. That this function of the IRS (which is carried out by volunteers) fails to do its job timely is no excuse, apparently.