Taxpayer, IRS Battle Regarding Whether Gift Was a Valid Charitable Contribution or Impermissible Sham

Allied Paper Corporation Stock Certificate A short-lived partnership’s attempt to claim a $33 million deduction for the donation of stock to a university hit a snag when the Internal Revenue Service declared the whole thing a sham and sought to disqualify the donation from eligibility for the charitable donation deduction. Despite the taxpayer’s arguments to the contrary, the US Tax Court concluded that a transaction’s economic substance, or lack thereof, did bear upon a charitable donation’s qualification for the deduction.

A little more than two years after forming it, RERI Holdings I’s partners dissolved the entity. During its brief existence, however, RERI did manage to make what its partners characterized as a $33 million donation to the University of Michigan, which the partnership claimed on its 2003 federal income tax return. The donation in question was 100% of the shares of H.W. Hawthorne Holdings, LLC, the parent of a company that owned a web hosting facility in Hawthorne, California. The partnership arrived at its donation amount based upon an appraiser’s assessment of the property’s investment value.

The IRS balked at the deduction, though, claiming the donation in question was worth closer to $3.9 million than $33 million. Additionally, the IRS contended that RERI’s very creation was a sham lacking any economic substance and designed as a tax dodge. As a result, the partnership should be allowed no deduction at all, the IRS concluded. The taxpayers requested that the Tax Court enter summary judgment in their favor, arguing that the IRS’s allegation of an economic sham was not a valid argument. The court disagreed, pointing out that an economic sham exists when “a transaction … actually occurred … that exploits a feature of the Internal Revenue Code.”

A sham arrangement could invalidate a charitable donation under Section 170 in certain circumstances. The court cited a 1993 case, Torney v. Commissioner, that shot down a charitable donation deduction because the taxpayer never controlled the asset donated and never benefited from owning that asset. In that case, a man with controlling interest in a corporation issued shares of stock to several taxpayers, and then suggested that the taxpayers donate those shares of stock to charitable organizations that the man supported. Based upon those facts, the court concluded that the donation lacked economic substance.

If the IRS were to secure the proper evidence, the RERI donation could suffer the same fate, so the IRS was entitled to continue pursuing its case against RERI. The court did, however, warn the IRS that it would have to make a clear showing about the gift itself and why it was ineligible for the deduction, rather than focusing solely on the facts surrounding RERI’s acquisition of the interest in the LLC. “[G]ifts to charity need have no economic substance beyond the mere fact of the gift.”

Ultimately, rulings like the RERI decision highlight the fact that simply giving a charitable donation is not always enough to yield a tax deduction, especially if the donor is a business entity. To ensure your donation satisfies the tax code and regulations, contact the experienced tax attorneys at Samuel C. Berger, P.C. and CPAs at S.C. Berger, P.C. They can provide you with top-quality advice regarding your charitable donation and deduction. To consult our attorneys and CPAs, contact us online or call (201) 587-1500 or (212) 380-8117.

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