March 11, 2023

Heckerling Institute Summary – Part 2

As discussed in last month’s blog, the Heckerling Institute on Estate Planning is a five-day long program which takes place in Orlando, Florida. In our prior blog, we discussed the Secure 2.0 Act and the new Corporate Transparency Act of 2021. This month, we will discuss estate planning for the middle rich and some interesting recent court cases.

Middle rich is commonly defined as the group of people who are in the highest 5% to 10% of the population in wealth. These individuals are unlikely to have an estate tax issue as the federal transfer tax exemption amount is now $12,920,000 per person (almost $26,000,000 for married couples) and Florida does not impose a state level estate/death/inheritance tax. The middle rich tend to be more concerned about income taxes, basis adjustment for income tax purposes, asset protection and probate avoidance. Common topics of discussion among these clients are pre-nuptial agreements for children and grand-children, annual gift tax exclusion gifts, how to maintain a step-up in basis on assets at death, charitable giving issues, asset freeze techniques, business succession planning, retirement account planning, disability planning, inflation issues, and end of life decision making. It would be impossible to cover all of these topics in this one blog post. Therefore, consider the following questions:

  1. Are you aware of what your basis is for income tax purposes in all of your major holdings, including real estate?
  2. Which assets do you own that are most likely to increase in value the quickest?
  3. Are you using the annual gift tax exclusion (currently $17,000 per person, per year) to reduce your estate?
  4. Do you have an annual plan for charitable giving?
  5. Are you maximizing the charitable use of distributions from a retirement account?
  6. Have you discussed with your children/grandchildren the idea of a pre-nuptial agreement before marriage to protect inheritances and gifts?
  7. Are your affairs in order in the event that you become disabled?
  8. Does your family know what to do with your body when you pass (do you wish to be buried or cremated)?

If any of the above questions are too difficult for you to answer, it would be a good idea to come and visit us.

The following are some recent court cases that have the possibility of impacting some of our clients, especially those with charitable intentions:

Insufficient substantiations case where the taxpayer loses are common. In Chancellor v. Commissioner, T.C. Memo. 2021-50 (May 4, 2021), the taxpayer deducted $6,500 on her tax returns, claiming that she contributed $6,000 to her church, and spent another $500 directly on volunteer work for her church. However, she provided no documentation whatsoever to substantiate these contributions, and the IRS subsequently denied all of these deductions. The denial was upheld by the court because, although cash gifts are usually more easily substantiated with evidence, a taxpayer claiming such a deduction is still required by law to provide either: (1) a bank record/written communication from the receiving charity with that charity’s name, the date on which they received the donation, and the amount of the donation, or (2) some other reliable, written records showing those same three pieces of information, as noted in Section 170(f)(17); Reg. ‘1.170A-13(a). Because the taxpayer provided none of this information, her deductions were rightfully denied by the IRS.

According to the IRS, you cannot deduct charitable contributions made to private individuals. In Scholz v. Comm’r of Internal Revenue, No. 20743-19S, 2022 WL 1001555 (T.C. April 4, 2022), Suzanne M. Scholz made several cash and non-cash charitable contributions, claiming $9,731 in total deductions. She reported $5,290 of cash donations made to various charitable organizations, and $4,441 in non-cash deductions, including a used 2006 Chevrolet car, food, clothing, and other household items that she donated to individuals in her community. The car was reported to have a fair market value of $1,000 and the remaining $3,441 worth of food/clothing/household goods were given directly to private individuals in need. Of the total $9,731 she claimed, the IRS disallowed any deduction for $6,586 of it. $2,645 was allowed of cash gifts to charity and $500 of noncash charitable gifts related to the donation of the car. In order to claim a deduction for a charitable contribution, a taxpayer must satisfy both statutory and regulatory substantiation requirements that depend on different factors, such as the size of the donation and whether it is cash or property being contributed. The court emphasized that all charitable contributions must be made to government entities or corporations, trusts, community chests, funds, or foundations for the specific purposes that are listed in Section 179(c). The $6,586 that the IRS did not allow her to deduct included the entire $3,441 worth of noncash contributions that she gave directly to homeless people and students in need. The taxpayer’s contributions to private individuals are considered a private gift and are not deductible under section 170 because they are not given to or for the use of a charitable organization as defined in section 170. As for the allowed cash gift deductions, the taxpayer only provided evidence for $2,645 of the $5,290 reported cash donations. Therefore, she is only entitled to deductions for the properly reported donations in the amount of $2,645. As for the deduction on the car, the IRS only allowed $500 of the reported $1,000 because the taxpayer did not provide the required evidence needed under Treas. Ref ‘1.70A-13(b)(1), to claim a deduction for a charitable contribution of property.

Proper appraisals have become so important in recent years but there are still taxpayers and tax professionals that feel the rules do not apply to them. In the case of Pankratz v. Commissioner, T.C. Memo 2021-26, the taxpayer donated land and a conference center built on the land to a religious organization. The taxpayer hired an appraiser, but the appraiser turned down the job as it was too complex. The appraiser then explained the complex issues to the taxpayer. Rather than hire another appraiser, the taxpayer based his deduction solely on the price he paid for the property and the price of the improvements. The same taxpayer, a year earlier, donated $2,000,000 worth of oil and gas projects to a local church and took the deduction based on his tax basis in the investment. Once again, the taxpayer failed to obtain a qualified appraisal, or any appraisal. The court felt sympathetic towards the taxpayer, though it completely denied both deductions and added numerous penalties. The taxpayer’s argument that he relied upon the advice of bookkeepers, Realtors, and other financial professionals did not sway the court in abating the penalties. The fact that the taxpayer was a self-made multi-millionaire also did not help when arguing to the court that he acted upon the reliance of professionals in filing the returns.

Let us finish with an amusing case – Mann v. United States, 984 F.3d 317 (4th Cir. Jan. 6, 2021). Linda Mann owned a house that she wanted to donate to a public charity that employs disadvantaged people to help de-construct properties by salvaging the property’s building materials, furniture and other fixtures. Mann had the house appraised at its greatest potential for profit, which valued the entire house at $675,000. A second appraisal valued the house at $313,353, assuming that the house was to be conveyed to the charity for training purposes and that the charity would sell any salvaged materials. The Manns deducted $675,000 for gifting their house based on the first appraisal, $24,206 for the new value of all the personal property left in the house (not depreciated values), and another $11,500 for their cash donations to the charity. The IRS proceeded to deny every single one of Mann’s deductions, including Mann’s effort to amend the deduction all the way down to $313,353. The court found that the Manns never actually transferred the whole interest in the property to the charity, because the Manns failed to record the deed actually transferring the house out of their ownership. Instead, the donation granted the charity a license to train/salvage out of the home. Unfortunately for the Manns, a license is a non-deductible partial interest. Moreover, even if they had properly transferred the whole interest in the property, the appraisals were not properly conducted/qualified, because the house was valued based on the resale value of the building materials despite the conditions of the charity’s training program being inconsistent with being able to salvage all these materials. Furthermore, the appraisal failed to provide adequate documentation and method for valuing the home’s furniture etc., nor did the appraisal follow the proper guidelines on depreciation by 42%. Rather, the appraisal valued the materials at their new value. The court did, however, grant summary judgment for the Manns regarding their cash donations of $11,500 being properly deductible.

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