The Internal Revenue Service and the courts have been very active this year in the charitable arena. There have been informal reports of increased audit activity by the IRS, and the public record shows a sample outcome of those audits. The authorities have denied tax benefits to donors who mostly had the best of intentions, but were missing some key component required for deductibility or tax-exempt status. In the interest of avoiding problems for you and your clients, here's a survey of some frequent problem areas.

Payments to Individuals

If a charitable organization is to make payments to individuals in need, the individuals must constitute a charitable class, the benefits must be provided on a non-discriminatory basis and records must be retained to prove that those standards have been met. Fundraising for payment of medical expenses for individuals in need, while admirable, is a private purpose that will lead to revocation of the exemption.¹

Public Benefit Required

To be tax-exempt, an organization has to provide solely a public benefit; any private benefit must be incidental to the public benefit. The IRS recently revoked the exemption of a volunteer organization after finding that the “volunteers” were actually earning money for their children's extracurricular activities at their school.²

Inconsistencies

Speaking of revocations, the IRS regularly reviews the websites of charities during the audit process. Inconsistencies between what's reported on tax returns and applications for exempt status and what's visible on the Internet, brochures and other public sources can lead to revocation — if the materials promise benefits to donors, insiders or others that are inconsistent with tax-exempt status.³ The IRS also reviews the websites of organizations applying for exemption, as well as those who are being audited.⁴

Missing Documentation

The courts haven't been any more forgiving than the IRS. In one instance, the DiDonatos transferred land rights valued at $1.87 million to a governmental agency. But they failed to obtain the required acknowledgment letter and failed to attach a completed Form 8283 to their return, so they lost the entire deduction.⁵ In another real estate donation case, a partnership lost its $6.57 million deduction for its donation of a façade easement and development rights.⁶ The partnership's agreement with its mortgage lender failed to deal properly with the disposition of insurance proceeds, should something happen to the building. The Tax Court held, following its holding last year in Kaufman I,⁷ that the failure to properly provide for the proportionate allocation of potential insurance proceeds between the charity holding the easement and the lender was fatal to the partnership's deduction. Another partnership failed to obtain a qualified appraisal and therefore lost almost 99 percent of its charitable deduction for its donation of a conservation easement.⁸ In yet another instance, the Schrimshers fared no better with their easement: they failed to obtain the proper paperwork from the Alabama Historical Commission to support their donation of a façade easement and were denied any deduction.⁹

The news isn't universally bad for façade and other easement donors, however. For example, Dorothy Jean Simmons lost over 60 percent of her deduction for the donation of two façade easements, but she was allowed the remainder of the deduction on appeal. The Tax Court, not satisfied with either her appraisals or those of the IRS, applied its own judgment and determined a value reduction for the easements of 5 percent of the value of each property (her appraisals had calculated 11 percent and 13 percent reductions). The District Court upheld that decision.¹⁰

To the extent that the taxpayers have the required receipts and acknowledgement letters, courts have allowed a deduction for cash contributions. Bridgett Jeanette Bell and Jan Elizabeth Van Dusen were each allowed to deduct their out-of-pocket expenses only to the extent that they had the proper documentation.¹¹ However, there are at least a half-dozen cases so far in 2011 in which all tax benefits have been denied for stated contributions because the taxpayers have been unable to substantiate them when called upon by the IRS and the courts.

Pay Attention to the Details

The IRS has found that audits of charitable organizations and deductions are a productive way to apply their resources. Applying for tax-exempt status? Be sure that your activities, application and website are all in accord with one another and with the standards for charitable activities. Donors and their advisors should pay close attention to the requirements for acknowledgement letters and appraisals.¹² Donors and potential donors of façade easements and other conservation donations should review the recent cases as well as the regulations.¹³ Miss a step, and you risk losing the tax benefit as well as suffering public embarrassment.

— This publication contains general information only and Deloitte is not, by means of this publication, rendering accounting, business, financial, investment, legal, tax, or other professional advice or services. This publication is not a substitute for such professional advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified professional advisor. Deloitte, its affiliates and related entities, shall not be responsible for any loss sustained by any person who relies on this publication.

Endnotes

1. Private Letter Ruling 201128037 (April 20, 2011).
2. PLR 201130012 (April 18, 2011).
3. PLR 201128031 (April 19, 2011), PLR 201130018 (May 3, 2011), PLR 201130010 (May 4, 2011), PLR 201039042 (March 5, 2011), PLR 201039046 (May 14, 2007) (released Oct. 1, 2010).
4. Form 1023 Application for Recognition of Exempt Status, Question 9.a.
5. DiDonato v. Commissioner, T.C. Memo. 2011-153 (June 29, 2011).
6. 1982 East, LLC v. Comm'r, T.C. Memo. 2011-84 (April 12, 2011).
7. Kaufman v. Comm'r, 134 T.C. 182 (2010).
8. Boltar, L.L.C v. Comm'r, 136 T.C. No. 14 (April. 5, 2011).
9. Schrimsher v. Comm'r, T.C. Memo. 2011-71 (March 28, 2011).
10. Comm'r v Simmons, D.C. Circuit Court of Appeals, 2011-2 U.S.T.C. par. 50,469, (June 21, 2011).
11. Bridgett Jeanette Bell v. Comm'r, T.C. Summary Opinion 2011-54 (April 18, 2011) and Van Dusen v. Comm'r, 136 T.C. No. 25 (June 2, 2011).
12. Treasury Regulations Section 1.170A-13.
13. Treas. Regs. Section 170A-14.