Failure to Secure a Timely Appraisal Leads to Denial of Charitable Contribution Deduction
The Tax Court's recent opinion in Hewitt v. Commissioner, 109 T.C. No. 12 (Oct. 29, 1997), reminds us of the importance of following the procedural requirements of the Treasury regulations as carefully as possible. All the facts and documents in the case were stipulated. In 1990 and 1991, the taxpayers made gifts of non-publicly-traded common stock to charity, which they claimed as deductions on Schedule A of their income tax returns. They also attached to their returns Forms 8283 (Non-Cash Contributions). The fair market values of the charitable gifts claimed by the taxpayers were based on the average per share price at which the stock had traded in bona fide arm's-length transactions at approximately the same time as the gifts. Thus, it was stipulated that the gifts to charity were fairly valued. However, the taxpayers did not obtain a qualified appraisal for each gift prior to the filing of each return. The Service allowed the taxpayers' deductions only for the amount of their cost basis for the stock, which was less than 10% of the fair market value.
Section 170 of the Code allows a deduction for a charitable contribution for the fair market value of the donated property at the time of the contribution. The statute also provides that such a deduction is allowable only if "verified under regulations prescribed by the Secretary". The Treasury issued regulations which contain fairly elaborate and detailed provisions concerning the appraisal requirement. They include the requirement that where the property donated consists of non-publicly-traded securities with a fair market value in excess of $10,000, a "qualified appraisal" must be obtained prior to the filing of the first return in which the deduction is claimed. The regulations also require that an appraisal summary be submitted with the return. The appraisal summary requirement is satisfied by completing Section B of Form 8283 and filing the form with the return.
It is clear that the taxpayers had not obtained a qualified appraisal. The Tax Court also found that the Forms 8283 filed did not contain qualified appraisal summaries because they were not signed by a qualified appraiser and did not identify the name of the corporation whose stock was contributed or state the number of shares donated.
The taxpayers argued that literal compliance with the statutory requirement was not necessary, arguing that the reporting requirements of these Regulations were "directory" and not "mandatory" and, therefore, that these reporting requirements could be met by substantial rather than strict compliance. In general, the Tax Court has held that strict compliance with a regulation is required if its requirements relate to the substance or essence of the statute. On the other hand, if the requirements relate to the orderly conduct of business, the regulations are procedural or directory and may be satisfied by substantial compliance.
In a previous case, the Tax Court had held that failure to obtain a separate appraisal report was not fatal to deduction of the gift to charity. Bond v. Commissioner, 100 T.C. 32 (1993). In that case, the Court concluded that the Form 8283 attached to the return, which was signed by a qualified appraiser, satisfied both the requirement of an appraisal summary and of an appraisal report, even though a statement of the qualifications of the appraiser (which is required to be part of a qualified appraisal) was not attached to the appraisal summary. These minor technical flaws were held not to go to the substance or essence of the statutory requirement.
In Hewitt, however, the Tax Court held that having a qualified appraiser conclude that the donated stock had a fair market value equal to the price determined by arm's-length transactions between other shareholders was essential to the substance of statute. The Tax Court's determination of the essence of the statute was not based on anything set forth in Section 170 of the Internal Revenue Code. The Court looked to a non-codified provision of the Tax Reform Act of 1984 (TRA '84), Section 155. This section had its origins in proposed amendments to Section 170 of the Internal Revenue Code which never made it into the Internal Revenue Code. Section 155 of TRA '84 directed the Secretary of the Treasury to prescribe regulations which would require a taxpayer to secure a qualified appraisal for donated property which exceeds certain values, to attach an appraisal summary to the return in which the deduction is first claimed, and to include such additional information on the return as the Secretary prescribes in such regulations.
The Tax Court reasoned that the principal objective of Section 155 was to provide a mechanism whereby the IRS would obtain sufficient return information in support of the claimed valuation of the charitable gift to enable it to deal more effectively with potential overvaluations. The Tax Court apparently rejected the argument that the Forms 8283 filed by the taxpayers with their returns provided sufficient information to fulfill this essential statutory objective. It is unclear why omitting the name and signature of the appraiser, the name of the privately-held company whose shares were donated, and the number of shares was detrimental to enabling the IRS to deal with potential overvaluation. How would this information help the IRS determine whether to audit the return for possible overvaluations? Most likely, the omission of the information actually caused the IRS to audit the taxpayers' returns. It appears the essence of the statute is to require an unrelated third-party expert to be part of the valuation process in order to enhance the integrity of the process. No such third-party was involved in Hewitt.
The sticking point here is another question that the Tax Court did not address directly: Whether the requirement of the Regulations that an appraisal report be obtained prior to the filing of the first return which claimed a charitable gift goes to the substance or the essence of the statute? Although not addressed directly, by implication, the Tax Court answers this question in the affirmative.
Several observations are in order: First, the IRS allowed the taxpayers deductions for their basis in the gifted stock. However, there appears to be no statutory authority for allowing any amount as a deduction in light of the failure to secure the required appraisal.
Second, a 20% penalty was proposed by the IRS, but was dropped before trial. Although the grounds for the penalty are not set forth in the opinion, presumably it was an overvaluation penalty. Even though the taxpayers had fairly valued the gifts to charity, because most of the deductions were disallowed, albeit for a procedural omission, the Service might well have succeeded in imposing this penalty. It would seem that the Service was being generous by allowing deductions for the cost-basis and not imposing a penalty.
Third, although the substantial compliance argument may succeed in some cases (see, e.g., Bond), strict compliance with the terms of the regulations is recommended. Thus, a taxpayer should not file a tax return claiming a deduction for a charitable contribution which requires a qualified appraisal unless that appraisal is in hand before the return is filed and a properly completed appraisal summary, signed by the qualified appraiser, is attached to the return. If you don't have the required appraisal, request an extension of time to file your return. Alternatively, file the return without claiming a deduction for the charitable gift and then file an amended return with Form 8283 attached after you have obtained the qualified appraisal.
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