U.S. Tax Court Opinions
T.C. Memo. 2023-34
Estate of Scott M. Hoensheid v. Commissioner
United States Tax Court
T.C. Memo. 2023-34
ESTATE OF SCOTT M. HOENSHEID, DECEASED, ANNE M.
HOENSHEID, PERSONAL REPRESENTATIVE,
AND ANNE M. HOENSHEID,
Petitioners v.
COMMISSIONER OF INTERNAL REVENUE,
Respondent
—————
Docket No. 18606-19. Filed March 15, 2023.
—————
Steven S. Brown, William Gibbs Sullivan, and Adam M. Ansari, for petitioners.
Megan E. Heinz, Alexandra E. Nicholaides, and Lauren M. Simasko, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
NEGA, Judge: This case is before the Court on a Petition filed in response to a statutory notice of deficiency issued to petitioners for the tax year 2015. It involves the contribution of appreciated shares of stock in a closely held corporation to a charitable organization that administers donor-advised funds for tax-exempt purposes under section 501(c)(3).1 The contribution was made near contemporaneously with the 1 Unless otherwise indicated, all statutory references are to the Internal Revenue Code (Code), Title 26 U.S.C., in effect at all relevant times, all regulation references are to the Code of Federal Regulations, Title 26 (Treas. Reg.), in effect at all relevant times, and all Rule references are to the Tax Court Rules of Practice and Procedure.
Served 03/15/23
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[*2] selling of those shares to a third party. After concessions,2 the issues for decision are (1) whether and when petitioners made a valid contribution of the shares of stock; (2) whether petitioners had unreported capital gain income due to their right to proceeds from the sale of those shares becoming fixed before the gift; (3) whether petitioners are entitled to a charitable contribution deduction; and
(4) whether petitioners are liable for an accuracy-related penalty under section 6662(a) with respect to an underpayment of tax.
# FINDINGS OF FACT
Some of the facts have been stipulated and are so found. The Stipulations of Facts and the attached Exhibits are incorporated herein by this reference. Petitioners resided in Michigan when their Petition was timely filed.
# I. Commercial Steel Treating Corp. (CSTC)
CSTC was founded in 1927 by Ralph Hoensheid (Mr. Hoensheid) and members of the Hoensheid family. CSTC has historically engaged in the business of heat-treating metal fasteners for use in automobiles and other commercial vehicles. Mr. Hoensheid’s son, Merle, later established a separate manufacturing facility in order to provide engineered coatings for fasteners, which was incorporated as a subsidiary of CSTC, named Curtis Metal Finishing Co. The ownership of CSTC remained in the family, and as of January 1, 2015, CSTC was owned by Mr. Hoensheid’s grandchildren Scott Hoensheid (petitioner) and his two brothers Craig P. Hoensheid and Kurt L. Hoensheid (two brothers) with each holding an equal one-third share of the outstanding stock. As of June 11, 2015, petitioner, his two brothers, Jack R. Howard, and William A. Penner made up the board of directors of CSTC.
# II. Fidelity Charitable
Fidelity Charitable Gift Fund (Fidelity Charitable) is a tax- exempt charitable organization under section 501(c)(3). Fidelity Charitable is primarily engaged in administering donor-advised funds as a sponsoring organization. Under Fidelity Charitable’s donoradvised fund program, donors can establish a giving account with Fidelity Charitable by completing and submitting a donor application 2 Respondent has conceded that petitioners are not liable for a penalty under section 6662(a) with respect to the underpayment determined in the notice of deficiency resulting from a disallowed charitable contribution deduction.
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[*3] and making an irrevocable cash or noncash asset contribution.
After a giving account is established and a contribution made, donors have retained advisory privileges over three things: (1) how to invest the funds, (2) which public charities will receive grants, and (3) the timeline for making grants, subject to some minimum activity requirements.
Fidelity Charitable typically requires proof of transfer in the form of a stock certificate and formal acceptance by Fidelity Charitable to complete a contribution of shares of a privately held corporation that issues stock certificates. The general policy of Fidelity Charitable is to liquidate noncash contributed assets as quickly as possible after contribution.
# III. The Transaction & Contribution
In the fall of 2014 Kurt informed petitioner and Craig of his intention to retire from CSTC. Petitioner and Craig did not want CSTC to incur debt to finance a redemption of Kurt’s 33% interest in CSTC, so they instead decided to pursue a potential sale of CSTC.3 As of December 12, 2014, CSTC had established an amended Change in Control Bonus Plan, which granted certain employees a potential right to bonus compensation in the event of a change in control of CSTC, such as a transfer of more than 80% of CSTC’s stock to third parties.
In the end, CSTC chose to engage FINNEA Group as its financial adviser in connection with a sale of CSTC. FINNEA Group is a sell-side investment banking firm. Brian Dragon, senior managing director of FINNEA was the main collaborator for CSTC and petitioner. Both petitioner and Mr. Dragon considered $80 million to be a fair target price for CSTC. Thus, the engagement letter executed by petitioner on behalf of CSTC stated that CSTC would pay FINNEA a fee of 1% of the ultimate transaction’s value up to $80 million and 5% of the ultimate transaction’s value over $80 million. The engagement letter, however, did not include any mention of appraisal or valuation services in connection with the transaction.
In early 2015 FINNEA began soliciting bids for CSTC and received several letters of intent to purchase the company from interested private equity firms. HCI Equity Partners (HCI), a Washington, D.C. based private equity firm which focuses in part on acquiring companies in the automotive industry, was one of the 3 Two other brothers, Mark Hoensheid and Ralph Hoensheid, had retired from CSTC in previous years.
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[*4] interested parties. On April 1, 2015, HCI submitted a letter of intent to acquire CSTC for total consideration of $92 million.
Meanwhile, in mid-April 2015, petitioner began discussing the prospect of establishing a Fidelity Charitable donor-advised fund to make a presale charitable contribution of some of his CSTC stock with his wealth advisers, Richard Balamucki and Casey Bear, and Andrea Kanski, his longtime tax and estate planning attorney at Clark Hill PLC.
On April 16, 2015, Ms. Kanski emailed John Hensien, a corporate attorney at Clark Hill and CSTC’s merger and acquisition partner. In the email, Ms. Kanski mentioned that petitioner was considering donating some of his CSTC stock to charity “to avoid some capital gains” and noted that “the transfer would have to take place before there is a definitive agreement in place.” Ms. Kanski also requested that Mr.
Hensien inquire as to FINNEA’s capability to prepare a qualified appraisal to establish the value of the charitable gift; “since they have the numbers, it would seem to be the most efficient method.” On April 20, 2015, after discussions with representatives of Fidelity Charitable, Mr. Balamucki emailed petitioner and Ms. Kanski to inform them that Fidelity Charitable had brought up a “concept called the ‘anticipatory assignment of income’ which makes the timing of the gift very important.” Mr. Balamucki added that “it must be a completed gift before any purchase agreement is executed or else the IRS can come back and try and impose the capital gains tax on the gift.” Fidelity Charitable provided petitioners’ wealth advisers with a Letter of Understanding to be executed in advance of the gift. On April 21, 2015,
Ms. Kanski responded to Mr. Balamucki and petitioner, stating that “the deadline to assign the stock to a donor advised fund is prior to execution of the definitive purchase agreement” and suggesting that they “gather the forms and documents from Fidelity so we’re ready to go and the paperwork is done well before the signing of the definitive purchase agreement.” Petitioner responded in an email to Ms. Kanski with the following:
Anne and I have agreed that we want to put 3.5MM in the fund, but I would rather wait as long as possible to pull the trigger. If we do it and the sale does not go through, I guess my brothers could own more stock than I and I am not sure if it can be reversed. I have not definitively given Richard a number. Please know this and help us plan accordingly.
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[*5] On April 23, HCI, CSTC, petitioner, and his two brothers executed a nonbinding letter of intent,4 establishing the parties’ mutual interest in HCI’s acquisition of CSTC for total consideration of $107 million. The letter of intent did not include any breakup fee provision to compensate HCI if the transaction was not finalized. After the execution of the letter of intent, HCI began the process of conducting due diligence into CSTC’s business and financial operations.
In mid-May counsel for HCI and CSTC began negotiating a contribution and stock purchase agreement based on the terms of the letter of intent. Ms. Kanski was not involved in the drafting process but was provided with copies of each draft and was kept up to date on the progress of the negotiations. On May 21, 2015, Ms. Kanski noted in an email to Messrs. Balamucki and Bear and petitioner: “We now have a draft purchase and sale agreement; do you have the information from Fidelity for my review?” Petitioner responded that he had not yet signed the Letter of Understanding document provided by Fidelity Charitable;
Ms. Kanski replied that she “want[ed] to make sure that nothing slips and all of your advisors are on the same page so that there are no issues with the charitable deduction.” On May 22, pursuant to 16 C.F.R.
§ 803.5(b), petitioner executed a notarized Affidavit of Acquired Person on behalf of CSTC, representing that CSTC had “a good faith intention of completing the transaction.” On June 1, Mr. Bear emailed to Kurt Chisholm, a representative of Fidelity Charitable, a Letter of Understanding signed by petitioner which described the planned donation as being of shares of CSTC stock but did not specify the number of shares. The terms and conditions of that Letter of Understanding stated inter alia that (1) “As holder of the Asset, Fidelity Charitable is not and will not be under any obligation to redeem, sell, or otherwise transfer the asset” and (2) “No contribution is complete until formally accepted by Fidelity Charitable.” Furthermore on June 1, 2015, petitioner emailed Ms. Kanski requesting that she prepare a shareholder consent agreement allowing him to transfer a portion of his stock to Fidelity Charitable.5 In the email, petitioner reiterated to Ms. Kanski that “I do not want to transfer the stock until we are 99% sure we are closing.” 4 The letter of intent was binding on the parties with respect to confidentiality and a 60-day exclusivity period for negotiations.
5 Petitioner and his two brothers were parties to a Buy-Sell Agreement that restricted their ability to dispose of their shares of CSTC stock.
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[*6] On June 11, 2015, CSTC held its annual shareholders meeting, at which petitioner and his two brothers were present and unanimously approved petitioner’s request for “ratification of the sale of all outstanding stock of Commercial Steel Treating Corporation to HCI.” As part of that approval, petitioner and his two brothers “acknowledge[d] that they have been involved throughout the process, understand and accept all terms associated with the transaction;” the minutes also noted that “a formal Consent Resolution authorizing the recapitalization will be developed as part of the closing documents” and “will be distributed for all Board members [sic] signature.” Craig and Kurt also unanimously approved petitioner’s request to be able to transfer a portion of his stock to Fidelity Charitable and executed a Consent to Assignment agreement to that effect. The Consent to Assignment agreement had a blank space for the parties to specify the number of shares and stated that the consent governed “only the number of shares identified above.” However, that field was left blank and not filled in on June 11, when the parties signed the agreement, nor on June 15, 2015, when petitioner emailed a copy of the signed agreement to Ms. Kanski.6 Immediately following the shareholder meeting, CSTC held a board meeting. The directors unanimously approved petitioner’s request to be able to transfer a portion of his shares to Fidelity Charitable. The directors also unanimously approved a resolution to dissolve CSTC’s Incentive Compensation Plan for executives and to distribute all remaining balances “prior to the recapitalization of the corporation.” At some point after the June 11, 2015, board meeting, petitioner had a stock certificate partially prepared for the eventual transfer to Fidelity Charitable. Petitioner kept the incomplete stock certificate on his office desk until July 9 or 10, 2015, when he dropped it off at Ms. Kanski’s office.
On June 12, 2015, HCI’s Investment Committee and managing partners unanimously approved the acquisition of CSTC, subject to completion of their financial and business due diligence. On June 30, consultants hired by HCI completed and delivered a due diligence report 6 During the examination of petitioners’ 2015 return, Ms. Kanski produced to the examining revenue agent a copy of the Consent to Assignment agreement, with a number of “1380” shares hand-written onto the blank line. At trial petitioner confirmed his handwriting inserting the number of shares and testified that he had prepared and signed the agreement on June 11, 2015, before his two brothers signed it.
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[*7] addressing potential environmental liability issues arising out of CSTC’s existing facilities.
Negotiations between CSTC and HCI began to gather steam. On July 1, HCI’s counsel prepared a revised draft of the Contribution and Stock Purchase Agreement. This draft, dated July 1, 2015, included a new, partially blank recital (share contribution provision) stating in relevant part: “On June 2015, Scott M. Hoenshied [sic] transferred . . . shares of Common Stock to … ” Furthermore, on July 1, HCI prepared and circulated the initial draft of the Minority Stock Purchase Agreement for a purchase of shares from Fidelity Charitable. The draft Minority Stock Purchase Agreement included a clause appointing petitioner as seller’s representative with authority to, inter alia,
(1) accept delivery of, on behalf of the Seller [Fidelity Charitable], all such documents as may be deemed . . . to be appropriate to consummate this Agreement;” and (2) “to endorse and to deliver on behalf of the Seller [Fidelity Charitable], certificates representing the Shares.” Counsel for CSTC forwarded the draft to petitioner with this message: “Attached is the initial draft of the purchase agreement for the shares you have/intend to gift.” On July 6, 2015, HCI caused the organization of a Delaware corporation, CSTC Holdings, Inc., for the purpose of acquiring shares of
CSTC. That same day petitioner emailed Messrs. Bear, Balamucki, and Hensien and Ms. Kanski, circulating the draft Minority Stock Purchase Agreement and stating inter alia: “We are not totally sure of the shares being transferred to the charitable fund yet” and “[h]opefully, and based on the closing documents, we will have a much better handle on this come Wednesday or Thursday of this week.” Petitioner added: “Once we know the share values, I am confident Andrea will execute the stock assignment as required.” The next day, July 7, petitioner emailed Mr.
Bear to inform him that CSTC would “sweep the cash from the company prior to closing and distribute it to the brothers.” That same day, Mr.
Bear emailed Mr. Chisholm and Ryan Boland, Fidelity Charitable’ s vice president for national corporate and executive giving. In the email Mr.
Bear noted that he was “concerned” with the clause in the Minority Stock Purchase Agreement appointing petitioner as seller’s representative for Fidelity Charitable; Mr. Bear suggested that the clause instead appoint one of CSTC’s corporate attorneys as seller’s representative. Also on July 7, petitioner executed an amendment to CSTC’s Change in Control Bonus Plan, specifying that the impending sale to HCI would constitute a change in control and thus trigger bonus payments to key employees.
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[*8] On July 9, 2015, CSTC prepared a revised draft of the Contribution and Stock Purchase Agreement. In this revised draft, counsel for CSTC had partially filled in the recital relating to the gift transfer to read in relevant part: “On July . . . 2015, [petitioner] transferred 1,380 shares of Common Stock to The Fidelity Investments Charitable Gift Fund.” Furthermore, the revised draft added that one of the conditions precedent to the obligations of the buyer was that “[t]he Fidelity Investments Charitable Gift Fund shall have executed and delivered to HCI and the Buyer the Minority Stock Purchase Agreement.”7 In a reply to Mr. Bear’s email the same day, Mr. Boland agreed that “[o]ne of the corporate attorneys would be a much better fit, from our perspective.” Later that same day, Mr. Bear informed Mr. Boland in an email that “it looks like Scott has arrived at 1380 shares—which will come out to about $3,000,000” and that Mr. Bear would “have the stock certificate shortly.” Petitioner in a subsequent email to Messrs.
Bear and Balamucki noted that “Andrea is completing the Stock transfer of 1380 shares to the Charitable account” and requested his account number from Fidelity Charitable. Mr. Bear then forwarded the email to Messrs. Boland and Chisholm and requested the account number. Mr. Chisholm replied to Mr. Bear the following morning, Friday, July 10, noting that “it appears as though Scott does not yet have a Giving Account created with us” and providing a link to the account setup process on Fidelity Charitable’s website. Later that day, petitioner set up an online giving account with Fidelity Charitable.
Additionally, on July 10, 2015, HCI prepared a revised draft of the Contribution and Stock Purchase Agreement. Nevertheless, the share contribution provision was still missing a specific date when petitioner transferred the shares to Fidelity Charitable. However, this draft update did propose to resolve the environmental liability issue by including a provision by which the sellers would indemnify HCI and CSTC Holdings for any damages arising out of matters or liabilities identified in the environmental due diligence report.8 The 7 The July 9, 2015, draft also proposed to resolve issues relating to the postclosing bonus and equity participation plans of CSTC and the postclosing treatment of any excess real property.
8 The draft also accepted CSTC’s proposed addition of provisions addressing the postclosing bonus and equity participation plans and the postclosing treatment of excess real property, with minor changes.
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[*9] environmental indemnification provision was the primary substantive addition made in the July 10 draft.
Three significant actions were taken on July 10. First, CSTC paid out employee bonuses totaling $6,102,862 pursuant to its newly amended Change in Control Bonus Plan. Second, CSTC submitted to the Michigan Department of Licensing and Regulatory Affairs an amendment to its Articles of Incorporation, signed by petitioner, which provided for actions requiring a shareholder meeting and vote to be taken upon written consent of the shareholders—a change requested by
HCI. Third, Ms. Kanski forwarded to Mr. Bear the updated draft of the Minority Stock Purchase Agreement dated July 15 and asked Mr. Bear to forward it to Fidelity Charitable for signature; the next morning (Saturday, July 11), Mr. Bear forwarded the email from Fidelity Charitable to Messrs. Boland and Chisholm. In Ms. Kanski’s initial email to Mr. Bear, Ms. Kanski noted that “the closing has been pushed back to Tuesday, at the earliest.” Ms. Kanski also noted that “the definition of seller’s representative will be revised from Scott to Clark Hill.” The draft Minority Stock Purchase Agreement was dated July 13 and included a warranty that Fidelity Charitable “is the record and beneficial owner of and has good and valid title to the Shares, free and clear of any and all Liens.” At 4:38 a.m. on July 13, 2015, the Contribution and Stock Purchase Agreement underwent a redline comparison against the prior revised updated draft on behalf of HCI. This revised draft had already accepted the environmental liability provision into the text. The share contribution provision still did not specify the date on which petitioner transferred the shares to Fidelity Charitable. Later that morning, at 7:56 a.m., Mr. Bear once more emailed Mr. Boland to request signatures from Fidelity Charitable on the Minority Stock Purchase Agreement, as the parties were “hoping to close . . . the next day.” At 9:08 a.m., Mr.
Boland responded: “It is important that we receive the stock certificate before we reach a conclusion on the sale/redemption. Did the stock certificate go out yet?” At 9:13 a.m., Mr. Bear swiftly alerted Ms. Kanski to the problem, informing her that “Fidelity will not sign off on anything until they see the stock certificate. As far as they know, they don’t have any shares to sell.” At Mr. Bear’s request, Ms. Kanski emailed him a PDF stock certificate, which Mr. Bear forwarded by email to Mr. Boland at 9:30 a.m. The stock certificate was numbered 1670, was signed by 10 [*10] petitioner but undated, and stated that 1,380.40 shares of CSTC common stock were owned by Fidelity Charitable.9 At 1:21 p.m., counsel for HCI emailed counsel for CSTC, noting that “I know CSTC will be issuing a certificate to the Gift Fund” and asking whether “the transfer to the gift fund has occurred yet.” At 3:24 p.m., counsel for CSTC responded that “[y]es, the transfer to the Gift Fund has occurred” and attached a printout spreadsheet that purported to list CSTC shareholders, numbers of shares held, and dates of issuance. The relevant page of the printout was dated July 13, 2015, and displayed a disposition entry for certificate No. 1654 with a date of “7/10/2015” and a note stating: “Cancelled: Scott transferred 1,380.50 Fidelity Investments.”10 The printout also displayed an issuance entry for certificate No. 1670 stating that 1,380 shares had been issued to Fidelity Charitable. At 5:22 p.m., Mr. Boland emailed Mr. Bear with an attached signature page, signed by Mr. Boland on behalf of Fidelity Charitable, for the Minority Stock Purchase Agreement. At 6:43 p.m., counsel for CSTC forwarded signature pages for a number of transaction-related documents, including the written consents by the board of CSTC, to petitioner and his two brothers requesting their signatures.
Early on the morning of July 14, Mr. Bear forwarded the signature pages from Fidelity Charitable to Ms. Kanski, who forwarded them to CSTC’s counsel. Later that day, counsel for CSTC circulated a revised draft of the Contribution and Stock Purchase Agreement, which filled in the share contribution provision to specify that petitioner had transferred the shares on July 10, 2015. The final draft made minimal changes to the prior circulated drafts.11 Additionally, on July 14, CSTC made a pro rata distribution, characterized as a dividend, of $4,796,352 to petitioner and his two brothers; Fidelity Charitable did not 9 During the examination of petitioners’ 2015 return, Ms. Kanski produced a copy of a stock certificate stamped “cancelled,” which she received from petitioner that included an additional typewritten date field of June 11, 2015.
10 The fractional amount of .50 appears to have been a clerical error.
11 The primary change was a slight revision to a provision for payment of compensation to the retired brothers Mark and Kurt Hoensheid to cover the cost of their health insurance, specifying that compensation would terminate upon either
(1) the retirees’ becoming eligible for Medicare or (2) a defined liquidity event’s occurring.
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[*11] participate in the distribution. The distribution represented nearly all of the remaining cash within CSTC.
On July 15, HCI, CSTC Holdings, petitioner, and his two brothers executed signatures on a final Contribution and Stock Purchase Agreement, which was approved by CSTC’s shareholders and board that same day. The final agreement included the share contribution provision, which specified that petitioner had transferred 1,380 shares to Fidelity Charitable on “July 10, 2015.” The final agreement provided for petitioner and his two brothers to exchange shares in CSTC for shares in the new CSTC Holdings, in an amount sufficient to constitute 51% ownership of CSTC Holdings. HCI agreed to contribute cash to CSTC Holdings in exchange for shares in a number sufficient to constitute 49% ownership of the common stock of CSTC Holdings.12 CSTC Holdings then agreed to purchase the remainder of the outstanding shares of CSTC owned by petitioner and his two brothers, as well as the 1,380 shares owned by Fidelity Charitable. On July 15, a representative from Clark Hill signed on behalf of Fidelity Charitable a document titled “Irrevocable Stock Power.” The document represented that Fidelity Charitable “does hereby sell, assign and transfer” the 1,380 shares to CSTC Holdings. The document also stated that Fidelity Charitable “does hereby irrevocably constitute and appoint (blank space) as attorney to transfer the said stock on the books of the Corporation with full power of substitution in the premises.” Fidelity Charitable received $2,941,966 in cash proceeds from the sale, which was deposited into petitioners’ giving account.
At closing, petitioners received $21,330,818 in cash, 50,000 shares of CSTC Holdings common stock, and a subordinated promissory note of
$5 million. In October 2015 petitioner and his two brothers received a postclosing distribution of excess working capital from CSTC totaling
$1,093,878. Additionally, in August, October, and November 2016, petitioner and his two brothers received another distribution relating to
CSTC’s 2015 tax refunds.
# IV. The Contribution Confirmation Letter, Tax Return, & Appraisal
On November 18, 2015, Fidelity Charitable sent petitioners a contribution confirmation letter acknowledging a charitable 12 The agreement also provided for HCI to receive shares of nonvoting convertible preferred stock in CSTC Holdings and a subordinated promissory note for $2 million.
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[*12] contribution from them of 1,380.400 shares of CSTC stock.13 The letter indicated, inter alia, that Fidelity Charitable received the shares of CSTC stock on June 11, 2015, and stated that “Fidelity Charitable has exclusive legal control over the contributed asset, and this contribution is irrevocable and cannot be refunded.” The letter further stated that “Fidelity Charitable did not provide any goods or services in exchange for or in consideration of this contribution.” Fidelity Charitable also provided petitioners with a yearend account statement, which reported a received date of June 11, 2015, for the shares of CSTC stock and stated that “[a]ny error must be reported to Fidelity Charitable within 60 days.” On November 30, 2015, petitioner emailed Ms. Kanski, asking:
“What date did we donate the stock to Fidelity Charitable?” He stated that “FINNEA is playing dumb toward providing the appraisal and I have asked Plante Moran.” Several minutes later, petitioner sent a subsequent email to Ms. Kanski: “I think I found it: 6/11/15,” and copying text that appeared to be from Fidelity Charitable’s documentation. On December 18, Ms. Kanski emailed petitioner to inform him that she had asked Mr. Hensien of Clark Hill “to light a fire under FINNEA regarding the appraisal.”
Ms. Kanski supervised the preparation of petitioners’ 2015 federal income tax return and signed the return as the preparer. The return was timely filed with the Internal Revenue Service (IRS) on April 14, 2016. Petitioners did not report any capital gains associated with the sale of the 1,380 shares and claimed a noncash charitable contribution deduction of $3,282,511.
Petitioners attached to their return a Form 8283, Noncash
Charitable Contributions, reporting a contribution of $3,282,511 relating to the 1,380 shares of CSTC stock and a date of contribution of June 11, 2015. The declaration of appraiser section on the Form 8283 13 On July 15, 2015, Fidelity Charitable apparently sent petitioners an initial contribution confirmation letter for the receipt of the shares of CSTC stock. By unsigned letter dated November 18, 2015, Fidelity Charitable informed petitioners that “[d]ue to an error made by one of our contribution representatives, a contribution confirmation dated July 15, 2015 was mailed to you noting the incorrect party for tax deduction purposes.” That letter further stated that “[t]his error has now been corrected,” that “a new confirmation letter has been mailed,” and that petitioners “must disregard the contribution confirmation letter that was previously sent to you, dated July 15, 2015.” Petitioners did not produce a copy of the initial, apparently erroneous, contribution confirmation letter.
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[*13] was signed by Brian Dragon as appraiser, and the donee acknowledgment section was signed by a representative of Fidelity Charitable. Attached to the Form 8283 was a document entitled “CSTC Fidelity Gift Fund Valuation,” which purported to be a qualified appraisal that Mr. Dragon prepared with respect to the “CSTC Fidelity Gift Fund.” According to the appraisal, Mr. Dragon determined that the 1,380 shares of CSTC stock had a value of $3,282,511 as of June 11, 2015, which was $340,545 higher than the actual proceeds Fidelity Charitable received from the sale of those shares to HCI on July 15,
- The appraisal included a brief biography of Mr. Dragon (which did not address whether Mr. Dragon had appraisal experience or qualifications), a valuation summary, the Forms 8283 and 8282, Donee Information Return, and a number of transactional documents relating to the acquisition by HCI. The appraisal attached a final version of the Minority Stock Purchase Agreement, which included an amended clause appointing Clark Hill as seller’s representative.
The valuation summary page included three columns with different valuation scenarios. Each valuation started with an enterprise value of $105 million (the total consideration per the Contribution and Stock Purchase Agreement) and then made various adjustments. The first scenario added to the value the amount of capital expenditure reimbursement and subtracted the amount of transaction fees (both of which were accounted for in the transaction with HCI) to arrive at a value of $103,118,311 and thus a proportional value of $2,941,966 (i.e., the actual amount of proceeds received by Fidelity Charitable). The second scenario also added to the value the amount of additional postclosing payments received by petitioner and his two brothers (but not Fidelity Charitable), which related to excess working capital and CSTC’s tax refunds, and subtracted minor adjustments, to arrive at a value of $105,697,329 and thus a proportional value of $3,015,546.
Finally, the third scenario also added to the value $9,357,335 of “Cash & Equivalents,” to arrive at a value of $115,054,664 and thus a proportional value of $3,282,511 (i.e., the claimed appraisal value).
The appraisal report valued the CSTC stock as of June 11 but did not expressly disclose a date of contribution for the shares. The appraisal included a page that listed a number of traditional valuation approaches and quoted from a section of Rev. Rul. 59-60, 1959-1 C.B.
237, that discusses valuation of securities. On the following page the appraisal stated that FINNEA “elected not to contemplate the aforementioned traditional valuation methods in favor of the empirical valuation resulting from its thorough marketing efforts below.” In the 14 [*14] space below, the appraisal contained the scope of services for which FINNEA had been engaged, copied from the text of its letter of engagement with CSTC. The appraisal did not further explain the empirical method used in the appraisal. Neither did it include a statement that it was prepared for federal income tax purposes.
Mr. Dragon had previously performed valuations on a limited basis, including one estate tax valuation, but had not previously prepared an appraisal substantiating a charitable contribution of shares in a closely held corporation. Mr. Dragon did not charge an additional fee for the appraisal in addition to what he and FINNEA had already received as fees in the transaction with HCI; nor did Mr. Dragon and petitioners execute a separate engagement letter for him to perform the appraisal. While petitioners received a quote from a national accounting firm, Plante Moran, to complete an appraisal, they ultimately decided to have Mr. Dragon prepare the report instead.
A Form 8282 was prepared for petitioners. Signed by a representative of Fidelity Charitable, it reported the receipt of petitioners’ entire interest in 1,380.400 shares of CSTC stock on June 11, 2015. A representative of Fidelity Charitable later signed an amended Form 8282, which reflected the receipt of 1,380 shares of CSTC stock from petitioners, rather than 1,380.400.
# V. The Examination & Notice of Deficiency
By letter dated December 19, 2017, petitioners were informed that the Commissioner had selected their 2015 return for examination.
Ms. Kanski represented petitioners during the examination. On December 6, 2018, John Copenhagen, an IRS group manager, electronically signed a Civil Penalty Approval Form approving the assessment of a penalty under section 6662 against petitioners. By letter dated December 6, 2018, respondent proposed to disallow in full petitioners’ charitable contribution deduction and to assess a penalty under section 6662.
On October 9, 2019, respondent issued to petitioners a notice of deficiency, determining a deficiency of $647,489, resulting from the disallowance of the claimed charitable contribution deduction, and a penalty of $129,498 under section 6662(a).
Petitioner’s timely Petition was filed on October 15, 2019. On December 16, 2019, respondent filed an Answer. Respondent’s counsel received approval to request assessment of an additional penalty under 15 [*15] section 6662(a) on February 19, 2020, in an email from, her immediate supervisor at the IRS Office of Chief Counsel. On August 25, 2020, respondent filed an amended Answer, asserting an increased deficiency and an increased section 6662(a) penalty, due to application of the anticipatory assignment of income doctrine.
# OPINION
In general, the Commissioner’s determinations in a notice of deficiency are presumed correct, and the taxpayer bears the burden of proving that those determinations are erroneous. Rule 142(a)(1); Welch v. Helvering, 290 U.S. 111, 115 (1933); Kearns v. Commissioner, 979 F.2d 1176, 1178 (6th Cir. 1992), aff’g T.C. Memo. 1991-320. Moreover, deductions are a matter of legislative grace, and taxpayers must demonstrate their entitlement to the deductions claimed. INDOPCO,
Inc. v. Commissioner, 503 U.S. 79, 84 (1992). However, the Commissioner bears the burden of proof with respect to new matters or increases in deficiency pleaded in his answer. Rule 142(a)(1). In his amended Answer, respondent first asserted an increase in deficiency on the grounds that petitioners made an anticipatory assignment of income of their proceeds from the sale of CSTC shares to HCI. Consequently, the burden is on petitioners only with respect to (1) whether they made a valid gift of shares to Fidelity Charitable and (2) whether they are entitled to a charitable contribution deduction. Respondent bears the burden with respect to whether petitioners realized and recognized gains pursuant to the anticipatory assignment of income doctrine.
The burden of proof on factual issues may be shifted to the Commissioner if the taxpayer introduces “credible evidence” with respect thereto and satisfies recordkeeping and other requirements. See § 7491(a)(1) and (2). Petitioners have not sought to shift the burden with respect to any factual issue.
Gross income means “all income from whatever source derived,” including “[g]ains derived from dealings in property.” § 61(a)(3). In general, a taxpayer must realize and recognize gains on a sale or other disposition of appreciated property. See § 1001(a)–(c). However, a taxpayer typically does not recognize gain when disposing of appreciated property via gift or charitable contribution. See Taft v. Bowers, 278 U.S.
470, 482 (1929); Guest v. Commissioner, 77 T.C. 9, 21 (1981); see also § 1015(a) (providing for carryover basis of gifts). A taxpayer may also generally deduct the fair market value of property contributed to a qualified charitable organization. See § 170(a)(1); Treas. Reg.
16
[*16] § 1.170A-1(c)(1). Contributions of appreciated property are thus tax advantaged compared to cash contributions; when a contribution of property is structured properly, a taxpayer can both avoid paying tax on the unrealized appreciation in the property and deduct the property’s fair market value. See, e.g., Dickinson v. Commissioner, T.C. Memo.
2020-128, at *5. The use of a donor-advised fund further optimizes a contribution by allowing a donor “to get an immediate tax deduction but defer the actual donation of the funds to individual charities until later.” Fairbairn v. Fid. Invs. Charitable Gift Fund, No. 18-cv-04881, 2021 WL 754534, at *2 (N.D. Cal. Feb. 26, 2021).
We apply a two-part test when determining whether to respect the form of a charitable contribution of appreciated property followed by a sale by the donee. The donor must (1) give the appreciated property away absolutely and divest of title (2) “before the property gives rise to income by way of a sale.” Humacid Co. v. Commissioner, 42 T.C. 894, 913 (1964). The first prong incorporates the section 170(c) requirement that the taxpayer make a valid gift14 of property, see Jones v.
Commissioner, 129 T.C. 146, 150 (2007), aff’d, 560 F.3d 1196 (10th Cir.
2009), while the second prong incorporates the anticipatory assignment of income doctrine, see Dickinson, T.C. Memo. 2020-128, at *8.
Accordingly, we first must determine whether petitioners made a valid gift of the CSTC shares to Fidelity Charitable and, if so, on what date the gift was made. We must then determine the tax consequences, including eligibility for a charitable contribution deduction, of any gift by petitioners.
# III. Charitable Contribution Deduction
We have concluded that petitioners did make a valid gift, and although we have determined that gift to be an assignment of income, petitioners may nevertheless be entitled to a charitable contribution deduction under section 170. Section 170(a)(1) allows as a deduction any charitable contribution (as defined in subsection (c)) payment of which is made within the taxable year. “A charitable contribution is a gift of property to a charitable organization made with charitable intent and without the receipt or expectation of receipt of adequate consideration.” Palmolive Bldg. Invs., LLC v. Commissioner, 149 T.C.
380, 389 (2017) (citing Hernandez v. Commissioner, 490 U.S. 680, 690 (1989)). Section 170(f)(8)(A) provides that “[n]o deduction shall be allowed . . . for any contribution of $250 or more unless the taxpayer substantiates the contribution by a contemporaneous written acknowledgement of the contribution by the donee organization that meets the requirements of subparagraph (B).” For contributions of property in excess of $500,000, the taxpayer must also attach to the 35 [*35] return a “qualified appraisal” prepared in accordance with generally accepted appraisal standards. § 170(f)(11)(D) and (E).
Here, the contributed CSTC shares had a value in excess of $500,000, and petitioners were thus required to substantiate their claimed deduction with both a contemporaneous written acknowledgement (CWA) and a qualified appraisal. Respondent asserts that petitioners have failed to satisfy both requirements and thus are not entitled to a charitable contribution deduction for the gift of the CSTC shares to Fidelity Charitable.
A. CWA
A CWA must include, inter alia, the amount of cash and a description of any property contributed. § 170(f)(8)(B). A CWA is contemporaneous if obtained by the taxpayer before the earlier of either
(1) the date the relevant tax return was filed or (2) the due date of the relevant tax return. § 170(f)(8)(C). Section 170(f)(18)(B) adds a specific requirement for donor-advised funds that any CWA include a statement that the donee “has exclusive legal control over the assets contributed.” We construe the requirements of section 170(f)(8)(B) strictly and do not apply the doctrine of substantial compliance to excuse defects in a CWA.
See 15 W. 17th St. LLC v. Commissioner, 147 T.C. 557, 562 (2016). The contribution confirmation letter issued by Fidelity Charitable was contemporaneous, acknowledged receipt of 1,380.400 shares of CSTC stock, and contained the applicable statements required by the statute, including the “exclusive legal control” statement.
Respondent argues that the contribution confirmation letter failed to satisfy section 170(f)(8)(B) because it described petitioners’ contribution as shares of stock rather than cash. Respondent’s argument conflates the issues in this case. As a matter of state law, we have held that petitioners made a valid gift of CSTC shares to Fidelity Charitable. However, for federal income tax purposes, we have classified those shares as carrying a fixed right to income as of July 13, 2015, such that petitioners effectively realized and recognized gains before transfer. That second holding does not disturb our conclusion that petitioners made a valid gift of stock. See Commissioner v. Tower, 327 U.S. 280, 287–88 (1946) (citing Lucas v. Earl, 281 U.S. at 114–15) (distinguishing between gift of stock’s validity under state law and its treatment for federal tax purposes); see also Vercio v. Commissioner, 73 T.C. 1246, 1253 (1980) (observing that anticipatory assignments of 36 [*36] income “are not recognized as dispositive for Federal income tax purposes despite their validity under applicable State law”).
We construe the section 170(f)(8)(B) requirement that a CWA include a description of the “property” contributed in the light of the settled principle that the Code “creates no property rights but merely attaches consequences, federally defined, to rights created under state law.” Nat’l Bank of Com., 472 U.S. at 722 (quoting United States v. Bess, 357 U.S. 51, 55 (1958)). While the ultimate question of “whether a statelaw right constitutes ‘property’ or ‘rights to property’ is a matter of federal law,” id. at 727, the answer to that question “largely depends upon state law,” see United States v. Craft, 535 U.S. 274, 278 (2002); see also Patel v. Commissioner, 138 T.C. 395, 403–04 (2012) (applying state law as to whether contributed property was a partial interest for purposes of section 170(f)(3)). We do not interpret section 170(f)(8)(B) to require that a donee ascertain and correctly describe a contributed property interest in accordance with how that interest should be classified for federal tax law purposes. It is sufficient here that the CWA provided by Fidelity Charitable described the contributed property as shares of stock. We conclude that the CWA issued by Fidelity Charitable satisfied the requirements of section 170(f)(8)(B).
B. Qualified Appraisal
In the early 1980s Congress was made aware of significant abuse of section 170 stemming from overvaluation of property contributed to charities. See Abusive Tax Shelters: Hearing Before the S. Subcomm. On Oversight of the Internal Revenue Serv. of the S. Comm. on Fin., 98th
Cong. 71 (1983) (statement of Robert G. Woodward, Acting Tax Legis.
Couns., Dep’t of Treasury) (“We are very concerned with the problem of the widespread abuse of the charitable contribution provision.”); id. at 151 (statement of M. Bernard Aidinoff, Chairman, Section of Tax’n of
Am. Bar Ass’n) (“Inflating the value of assets has been a particular abuse in the charitable area, and I have got to say that it is an abuse engaged in by ordinary taxpayers.”); Staff of J. Comm. on Tax’n, 98th Cong., Background on Tax Shelters, JCS-29-83, at 34 (J. Comm. Print
- (detailing high volume of charitable contribution deduction audits and noting difficulty for IRS in detecting instances of excessive deductions at the administrative level). Congress responded by enacting new substantiation requirements, in order to assist the IRS in detecting overvalued contributions and to deter taxpayers from playing the “audit lottery.” See Staff of S. Comm. on Fin., Explanation of Provisions Approved by the Committee on March 21, 1984, S. Prt. 98-169 (Vol. I), 37 [*37] at 444–45 (S. Comm. Print 1984); H.R. Rep. No. 98-861, at 998
(1984) (Conf. Rep.), as reprinted in 1984-3 C.B. (Vol. 2) 1, 252; see also Staff of J. Comm. on Tax’n, General Explanation of the Revenue Provisions of the Deficit Reduction Act of 1984, JCS-41-84, at 504
(J. Comm. Print 1984) (describing new substantiation requirements as intended to be “more effective in deterring taxpayers from inflating claimed deductions than relying solely on the uncertainties of the audit process and on penalties”). In particular, Congress added an off-Code provision directing the Secretary of the Treasury to promulgate regulations requiring taxpayers to obtain and attach to their returns a “qualified appraisal” when claiming deductions for charitable contributions of property exceeding certain dollar amounts. See Deficit Reduction Act of 1984 (DEFRA), Pub. L. No. 98-369, § 155(a), 98 Stat.
494, 691–93. In DEFRA, Congress defined a qualified appraisal as an appraisal prepared by a qualified appraiser that included certain enumerated information and “such additional information as the Secretary prescribes in such regulations.” Id. § 155(a)(4), 98 Stat. at
- Temporary regulations swiftly followed, see Temp. Treas. Reg.
§ 1.170A-13T (1984), setting out extensive requirements with respect to what constituted a qualified appraisal; final regulations were later issued with similarly extensive requirements, see Treas. Reg.
§ 1.170A-13.
Twenty years later, Congress amended section 170 to codify a qualified appraisal requirement. See § 170(f)(11) (as amended by American Jobs Creation Act of 2004, Pub. L. No. 108-357, § 883, 118
Stat. 1418, 1631–32); H.R. Rep. No. 108-755, at 746 (2004) (Conf. Rep.), as reprinted in 2004 U.S.C.C.A.N. 1341, 1784. Two years after that, Congress again acted in response to publicized reports of questionable appraisal practices, amending section 170 to enumerate requirements for an individual to be a qualified appraiser. See Pension Protection Act of 2006, Pub. L. No. 109-280, § 1219(b)(1), 120 Stat. 780, 1084–85; Staff of J. Comm. on Tax’n, 109th Cong., General Explanation of Tax Legislation Enacted in the 109th Cong., JCS-1-07, at 606 (J. Comm.
Print 2007).
Section 170(f)(11)(A)(i) now provides that “no deduction shall be allowed . . . for any contribution of property for which a deduction of more than $500 is claimed unless such person meets the requirements of subparagraphs (B), (C), and (D), as the case may be.” Subparagraph
(D) is the relevant one here, requiring that, for contributions for which a deduction in excess of $500,000 is claimed, the taxpayer attach a 38 [*38] qualified appraisal to the return. Section 170(f)(11)(E)(i) provides that a qualified appraisal means, with respect to any property, an appraisal of such property which—
(I) is treated for purposes of this paragraph as a qualified appraisal under regulations or other guidance prescribed by the Secretary, and
(II) is conducted by a qualified appraiser in accordance with generally accepted appraisal standards and any regulations or other guidance prescribed under subclause (I).
The regulations in turn provide that a qualified appraisal is an appraisal document that, inter alia, (1) “[r]elates to an appraisal that is made” no earlier than 60 days before the date of contribution and (2) is “prepared, signed, and dated by a qualified appraiser.” Treas. Reg.
§ 1.170A-13(c)(3)(i). Treasury Regulation § 1.170A-13(c)(3)(ii) requires that a qualified appraisal itself include, inter alia:
(1) “[a] description of the property in sufficient detail for a person who is not generally familiar with the type of property to ascertain that the property that was appraised is the property that was (or will be) contributed;”
(2) “[t]he date (or expected date) of contribution to the donee;”
(3) “[t]he name, address, and . . . identifying number of the qualified appraiser;”
(4) “[t]he qualifications of the qualified appraiser;”
(5) “a statement that the appraisal was prepared for income tax purposes;”
(6) “[t]he date (or dates) on which the property was appraised;”
(7) “[t]he appraised fair market value . . . of the property on the date (or expected date) of contribution;” and
(8) the method of and specific basis for the valuation.
39
[*39] Turning back to the statute, section 170(f)(11)(E)(ii) provides that a “qualified appraiser” is an individual who
(I) has earned an appraisal designation from a recognized professional appraiser organization or has otherwise met minimum education and experience requirements set forth in regulations,
(II) regularly performs appraisals for which the individual receives compensation, and
(III) meets such other requirements as may be prescribed . . . in regulations or other guidance.
An appraiser must also demonstrate “verifiable education and experience in valuing the type of property subject to the appraisal.” Id. cl. (iii)(I). The regulations add that the appraiser must include in the appraisal summary a declaration that he or she (1) “either holds himself or herself out to the public as an appraiser or performs appraisals on a regular basis;” (2) is “qualified to make appraisals of the type of property being valued;” (3) is not an excluded person specified in paragraph (c)(5)(iv) of the regulation; and (4) understands the consequences of a “false or fraudulent overstatement” of the property’s value. Treas. Reg.
§ 1.170A-13(c)(5)(i). Finally, the regulations prohibit a fee arrangement for a qualified appraisal “based, in effect, on a percentage . . . of the appraised value of the property.” Id. subpara. (6)(i).
Respondent contends that petitioners’ appraisal is not a qualified appraisal because it (1) did not include the statement that it was prepared for federal income tax purposes; (2) included the incorrect date of June 11 as the date of contribution; (3) included a premature date of appraisal; (4) did not sufficiently describe the method for the valuation;
(5) was not signed by Mr. Dragon or anyone from FINNEA; (6) did not include Mr. Dragon’s qualifications as an appraiser; (7) did not describe the property in sufficient detail; and (8) did not include an explanation of the specific basis for the valuation. Aside from petitioners’ alreadyrejected claim that the June 11 date of contribution was correct, petitioners do not meaningfully dispute that their appraisal had at least some defects. As a consequence, petitioners do not argue that they strictly complied with the qualified appraisal requirement. Instead, they rely on the doctrine of substantial compliance and the statutory reasonable cause defense to excuse any defects.
40
- Substantial Compliance
We have previously held that the qualified appraisal requirements are directory, rather than mandatory, as the requirements “do not relate to the substance or essence of whether or not a charitable contribution was actually made.” See Bond v. Commissioner, 100 T.C.
32, 41 (1993). We thus may apply the doctrine of substantial compliance to excuse a failure to strictly comply with the qualified appraisal requirements. See id. As demonstrated by the relevant legislative history, the purpose of the qualified appraisal requirements is “to provide the IRS with information sufficient to evaluate claimed deductions and assist it in detecting overvaluations of donated property.” Costello v. Commissioner, T.C. Memo. 2015-87, at *17; see Cave Buttes, LLC v. Commissioner, 147 T.C. 338, 349–50 (2016);
Hendrix v. United States, No. 2:09-CV-132, 2010 WL 2900391, at *6 (S.D. Ohio July 21, 2010) (“[T]he purpose of the qualified appraisal is to ‘show the work’ so as to obviate the injection of unfounded guessing into the tax scheme.”). Accordingly, if the appraisal discloses sufficient information for the Commissioner to evaluate the reliability and accuracy of a valuation, we may deem the requirements satisfied. Bond, 100 T.C. at 41–42; see Hewitt v. Commissioner, 109 T.C. 258, 265 & n.10
(1997) (describing substantial compliance as applicable where the taxpayer has “provided most of the information required” or made omissions “solely through inadvertence”), aff’d, 166 F.3d 332 (4th Cir.
1998). Substantial compliance allows for minor or technical defects but does not excuse taxpayers from the requirement to disclose information that goes to the “essential requirements of the governing statute.” Estate of Evenchik v. Commissioner, T.C. Memo. 2013-34, at *12 (quoting Estate of Clause v. Commissioner, 122 T.C. 115, 122 (2004)).
We thus generally decline to apply substantial compliance where a taxpayer’s appraisal either (1) fails to meet substantive requirements in the regulations or (2) omits entire categories of required information.
See Costello, T.C. Memo. 2015-87, at *24; see also Alli v. Commissioner, T.C. Memo. 2014-15, at *54 (observing that substantial compliance “should not be liberally applied”).
Petitioners’ appraisal is deficient with respect to several key substantive requirements. We start with Mr. Dragon’s status as an appraiser. We have previously described the requirement that an appraiser be qualified as the “most important requirement” of the regulations. Mohamed v. Commissioner, T.C. Memo. 2012-152, 2012 WL 1937555, at *4. Respondent argues that Mr. Dragon was not a qualified appraiser, asserting that Mr. Dragon performed valuations [*40]
41
[*41] infrequently, did not hold himself out as an appraiser, and has no certifications from a professional appraiser organization.24 Petitioners counter that Mr. Dragon was qualified because he has prepared “dozens of business valuations” over the course of his 20+ year career as an investment banker, including some valuations of closely held automotive businesses.
Mr. Dragon’s mere familiarity with the type of property being valued does not by itself make him qualified. See, e.g., Brannan Sand & Gravel Co. v. Commissioner, T.C. Memo. 2020-76, at *9–10, *15 (finding that attorney’s familiarity with type of property being valued and awareness of typical asking price was insufficient to satisfy qualified appraiser requirement). Mr. Dragon does not have appraisal certifications and does not hold himself out as an appraiser. We found
Mr. Dragon’s own words at trial about his appraisal experience to be particularly instructive. Mr. Dragon testified that he conducted valuations “briefly” and only “on a limited basis” before starting at FINNEA in 2014—the year before the appraisal. Mr. Dragon also testified that he now performs (presumably gratis) business valuations for prospective clients “once or twice a year” in order to solicit their business for FINNEA. We find Mr. Dragon’s uncontroverted testimony sufficient to establish that he does not “regularly perform[] appraisals for which [he] receives compensation.” See § 170(f)(11)(E)(ii)(II).
Petitioners have failed to show that Mr. Dragon was a qualified appraiser.
We have previously described the requirement that an appraiser be qualified as one of the substantive requirements of the regulations.
See Alli, T.C. Memo. 2014-15, at *56–57 (“[O]btaining an appraisal from a nonqualified appraiser does not constitute substantial compliance.”) Absent an appraisal prepared by a qualified appraiser, the Commissioner cannot effectively verify whether a reported charitable contribution has been properly valued. See Mohamed v. Commissioner, 24 Respondent also argues that Mr. Dragon is precluded under the fee arrangement rule in Treasury Regulation § 1.170A-13(c)(6)(i) from serving as a qualified appraiser because of the value-based fee he and FINNEA received from CSTC for effecting the transaction with HCI: 1% of the transaction’s value up to $80 million and 5% of the transaction’s value over $80 million. By its plain terms, the fee arrangement rule is limited to fees that are effectively based on an appraised value (i.e., where the appraiser is incentivized to inflate a valuation in order to receive a higher fee); there was no such fee in this case, and we do not understand the rule to apply to a fee, like the one Mr. Dragon received, that is based on actual value received in a separate arm’s-length transaction.
42
[*42] 2012 WL 1937555, at *7–8. We find that consideration to be heightened in the context of valuing a minority interest in a closely held family corporation, which often presents difficult questions for even an experienced appraiser. See, e.g., Rabenhorst v. Commissioner, T.C.
Memo. 1996-92, 1996 WL 86215, at *2. We thus conclude that in engaging a nonqualified appraiser, petitioners failed to demonstrate substantial compliance.
Next, leaving aside the separate issue of whether Mr. Dragon was actually qualified, the appraisal itself failed to sufficiently describe any of Mr. Dragon’s relevant qualifications and valuation experience. See Treas. Reg. § 1.170A-13(c)(3)(ii)(F). Mr. Dragon’s biography provided no information relevant to his valuation experience and described only general corporate finance experience and his business school education.
As noted above, Mr. Dragon testified at trial that he did have some limited experience in valuation before the appraisal at issue. The failure to include a description of such experience in the appraisal was a substantive defect. We have previously described the qualifications requirement as important because it “provide[s] necessary context permitting the IRS to evaluate a claimed deduction.” Alli, T.C. Memo.
2014-15, at *35 (first citing Hendrix, 2010 WL 2900391, at *5 (“Without, for example, the appraiser’s education and background information, it would be difficult if not impossible to gauge the reliability of an appraisal that forms the foundation of a deduction.”); and then citing Bruzewicz v. United States, 604 F. Supp. 2d 1197, 1205 (N.D. Ill. 2009) (describing qualifications requirement as providing IRS with ability to “determine whether the valuation in an appraisal report is competent and credible evidence”)). The absence of Mr. Dragon’s relevant qualifications further confirms our conclusion that petitioners’ appraisal failed to substantially comply, as the defect deprived the Commissioner of information necessary to evaluate whether the appraisal was reliable.
Lastly, petitioners’ appraisal is substantively deficient in stating an incorrect date of contribution. We have described the date requirement as intended to enable the Commissioner “to compare the appraisal and contribution dates for purposes of isolating fluctuations in the property’s fair market value between those dates.” Rothman v.
Commissioner, T.C. Memo. 2012-163, 2012 WL 2094306, at *15, supplemented and vacated on other grounds, T.C. Memo. 2012-218. An incorrect date of contribution may be excused if it reflects only a minor typographical error. See Friedberg v. Commissioner, T.C. Memo. 2011-238, 2011 WL 4550136, at *10 (finding substantial compliance where date discrepancies were “merely typographical errors”), supplemented 43 [*43] by T.C. Memo. 2013-224. However, omission of the correct date of contribution is generally significant and will weigh against a conclusion of substantial compliance. See, e.g., Presley v. Commissioner, T.C.
Memo. 2018-171, at *78, aff’d, 790 F. App’x 914 (10th Cir. 2019);
Costello, T.C. Memo. 2015-87, at *24–25; Alli, T.C. Memo. 2014-15, at *24; Smith v. Commissioner, T.C. Memo. 2007-368, 2007 WL 4410771, at *18–19, aff’d, 364 F. App’x 317 (9th Cir. 2009).
Petitioners’ reported June 11, 2015, date of contribution was incorrect, and thus the June 11 valuation date was premature by approximately a month. In Cave Buttes, LLC, 147 T.C. at 355, we concluded that a taxpayer’s appraisal was in substantial compliance, despite finding a several-week discrepancy between the actual date of contribution and the date of valuation. That conclusion, however, was conditioned on the fact there was no “significant event that would obviously affect the value of the property in those two or three weeks.”
Id. Here, in contrast, the period between June 11 and July 13, 2015, encompassed CSTC’s initial bonus payouts of approximately $6.1 million, which had a significant effect on the value of the shares. In addition, as we have concluded above, the underlying transaction with HCI became virtually certain to occur in the period after June 11. The significance of these intervening developments is clear in part from the $340,545 discrepancy between the June 11 appraised value and the actual proceeds received by Fidelity Charitable for the shares on July 15. The misreporting of the date of contribution prevented the Commissioner from effectively double-checking the accuracy of the appraised value—a concern that relates to the “essential requirements of the governing statute” and thus further confirms that petitioners cannot demonstrate substantial compliance. See Estate of Evenchik, T.C. Memo. 2013-34, at *12.
This is not the rare case “where a taxpayer does all that is reasonably possible, but nonetheless fails to comply with the specific requirements of a provision.” Durden v. Commissioner, T.C. Memo.
2012-140, 103 T.C.M. (CCH) 1762, 1763 (citing Samueli v.
Commissioner, 132 T.C. 336, 345 (2009)). Petitioners’ failure to satisfy multiple substantive requirements of the regulations, paired with the appraisal’s other more minor defects, precludes them from establishing substantial compliance.
44
- Reasonable Cause
Although petitioners are unable to establish substantial compliance, their defective appraisal may nevertheless be excused if petitioners had reasonable cause for their noncompliance. Taxpayers who fail to comply with the qualified appraisal requirements may still be entitled to charitable contribution deductions if they show that their noncompliance is “due to reasonable cause and not to willful neglect.” § 170(f)(11)(A)(ii)(II). We have construed the reasonable cause defense in section 170(f)(11)(A)(ii)(II) similarly to the defense applicable to numerous other Code provisions that prescribe penalties and additions to tax. See § 6664(c)(1); see also Chrem, T.C. Memo. 2018-164, at *18– 19; Crimi v. Commissioner, T.C. Memo. 2013-51, at *98–99. Reasonable cause thus requires that a taxpayer “have exercised ordinary business care and prudence as to the challenged item.” Crimi, T.C. Memo. 2013-51, at *99 (citing United States v. Boyle, 469 U.S. 241 (1985)). To show reasonable cause due to reliance on a professional adviser, we generally require that a taxpayer show (1) that their adviser was a competent professional with sufficient expertise to justify reliance; (2) that the taxpayer provided the adviser necessary and accurate information; and
(3) that the taxpayer actually relied in good faith on the adviser’s judgment. See Neonatology Assocs., P.A. v. Commissioner, 115 T.C. 43, 99 (2000), aff’d, 299 F.3d 221 (3d Cir. 2002).
Respondent argues that petitioners cannot show reliance in good faith, because petitioner—not Ms. Kanski—made the decision to have
Mr. Dragon perform the appraisal without verifying that he was sufficiently qualified. Respondent suggests that petitioner’s decision to have Mr. Dragon perform the appraisal, despite receiving a quote from a national accounting firm, was largely motivated by the fact that Mr.
Dragon would not charge an additional fee for the work. Petitioners argue that they have satisfied each factor of the Neonatology test with respect to the defective appraisal. Petitioners argue that Ms. Kanski was closely involved in reviewing the appraisal, meeting with Mr.
Dragon, and advising petitioners that the appraisal met the statutory and regulatory requirements.
Petitioners have established that Ms. Kanski was competent and professionally experienced in tax and estate planning issues. See 106
Ltd. v. Commissioner, 136 T.C. 67, 77 (2011) (finding taxpayer’s longtime personal attorney and return preparers to be adequately competent professionals with respect to taxpayer), aff’d, 684 F.3d 84 (D.C. Cir. 2012). In addition, Ms. Kanski was involved both in reviewing [*44]
45
[*45] drafts of the transactional documents and in the ongoing discussions with petitioners’ wealth advisers about the contribution.
She thus had the underlying knowledge necessary to procure a qualified appraisal of the shares.
However, Ms. Kanski’s handling of the process does not necessarily insulate petitioners from the consequences of the defective appraisal. See Stough v. Commissioner, 144 T.C. 306, 323 (2015) (“Unconditional reliance on a tax return preparer or C.P.A. does not by itself constitute reasonable reliance in good faith; taxpayers must also exercise ‘[d]iligence and prudence’.” (quoting Estate of Stiel v.
Commissioner, T.C. Memo. 2009-278, 2009 WL 4877742, at *2)).
Petitioner is an experienced and sophisticated businessman. See Treas.
Reg. § 1.6664-4(c)(1) (stating that “[a]ll facts and circumstances must be taken into account in determining whether a taxpayer has reasonably relied in good faith on advice” and that “the taxpayer’s education, sophistication and business experience will be relevant”). Petitioner made a business decision to have CSTC’s transactional adviser conduct the appraisal gratis, rather than engage a national accounting firm on a paid basis. Given Mr. Dragon’s admittedly limited experience and unfamiliarity with the qualified appraisal process, such a decision did not demonstrate ordinary business care and prudence. See, e.g., Webster v. Commissioner, T.C. Memo. 1992-538, 1992 WL 220112, at *4 (describing taxpayer’s decision to engage unqualified adviser as “not a technical matter, but one calling for ordinary human wisdom and careful deliberation”). Petitioners have not provided credible evidence, aside from self-serving uncorroborated testimony, that they reasonably relied upon Ms. Kanski’s judgment in proceeding with that unwise course of action.25 In addition, petitioner’s close involvement in the contribution and transaction requires us to cast a skeptical eye to his claim that he relied in good faith on Ms. Kanski as to the appraisal’s incorrect date of contribution. The record firmly establishes that petitioner did not transfer the shares to Fidelity Charitable on June 11. The transactional 25 We do not ignore Ms. Kanski’s email of April 16, in which she asked Mr.
Hensien to inquire whether FINNEA could perform the appraisal as it “would seem to be the most efficient method.” Ms. Kanski’s preliminary inquiry to a colleague on behalf of petitioners does not speak to whether she ultimately exercised her judgment to advise petitioners that Mr. Dragon was qualified to conduct the appraisal nor to whether petitioners actually relied on that judgment. See, e.g., Pankratz v.
Commissioner, T.C. Memo. 2021-26, at *26. The record is devoid of credible evidence on this point.
46
[*46] documents, petitioner’s contemporaneous emails, and the retention of the undated physical stock certificate strongly suggest that petitioner knew or at least should have known that the shares were not contributed to Fidelity Charitable on June 11. See Treas. Reg. § 1.6664-4(c)(1)(ii) (stating that for reliance to constitute reasonable cause “the advice must not be based upon a representation or assumption which the taxpayer knows, or has reason to know, is unlikely to be true”); see also Exelon Corp. v. Commissioner, 906 F.3d 513, 529 (7th Cir. 2018), aff’g 147 T.C. 230 (2016); Blum v. Commissioner, 737 F.3d 1303, 1318 (10th Cir. 2013), aff’g T.C. Memo. 2012-16. Consequently, we also conclude that petitioners have failed to establish good faith reliance on
Ms. Kanski’s judgment that the appraisal properly reported the required information, because petitioner knew or should have known that the date of contribution (and thus the date of valuation) was incorrect.
We find that petitioners did not have reasonable cause for their failure to procure a qualified appraisal. Consequently, we must sustain respondent’s determination to disallow their charitable contribution deduction.
# IV. Section 6662(a) Penalty
Section 6662(a) and (b)(1) and (2) imposes a 20% penalty on any underpayment of tax required to be show on a return that is attributable to negligence, disregard of rules or regulations, or a substantial understatement of income tax. Negligence includes “any failure to make a reasonable attempt to comply” with the Code, § 6662(c), or a failure “to keep adequate books and records or to substantiate items properly,” Treas. Reg. § 1.6662-3(b)(1). An understatement of income tax is “substantial” if it exceeds the greater of 10% of the tax required to be shown on the return or $5,000. § 6662(d)(1)(A).
Respondent argues that petitioners are liable for a penalty under section 6662(a) on the basis of both negligence and a substantial understatement of income tax. Generally, the Commissioner bears the initial burden of production of establishing via sufficient evidence that a taxpayer is liable for penalties and additions to tax; once this burden is met, the taxpayer must carry the burden of proof with regard to defenses such as reasonable cause. § 7491(c); see Higbee v.
Commissioner, 116 T.C. 438, 446–47 (2001). However, the
Commissioner bears the burden of proof with respect to a new penalty or increase in the amount of a penalty asserted in his answer. See Rader 47 [*47] v. Commissioner, 143 T.C. 376, 389 (2014) (citing Rule 142(a)), aff’d in part, appeal dismissed in part, 616 F. App’x 391 (10th Cir. 2015); see also RERI Holdings I, LLC v. Commissioner, 149 T.C. 1, 38–39 (2017), aff’d sub nom. Blau v. Commissioner, 924 F.3d 1261 (D.C. Cir.
2019).
Respondent has conceded that petitioners are not liable for the section 6662(a) penalty determined in the notice of deficiency, which related to the disallowed charitable contribution deduction. Instead, in his amended Answer, respondent asserted a new section 6662(a) penalty, which relates to his argument that petitioners underreported capital gains because of an anticipatory assignment of income.
Consequently, respondent bears the burden of proving that no affirmative defense, such as reasonable cause, exculpates petitioners from a section 6662(a) penalty. See Full-Circle Staffing, LLC v.
Commissioner, T.C. Memo. 2018-66, at *43, aff’d in part, appeal dismissed in part, 832 F. App’x 854 (5th Cir. 2020).
As part of the burden of production, respondent must satisfy section 6751(b) by producing evidence of written approval of the penalty by an immediate supervisor, made before formal communication of the penalty to petitioners. See Graev v. Commissioner, 149 T.C. 485, 493 (2017), supplementing and overruling in part 147 T.C. 460 (2016); see also Clay v. Commissioner, 152 T.C. 223, 246 (2019), aff’d, 990 F.3d 1296 (11th Cir. 2021). Here, the emailed approval by the immediate supervisor of respondent’s counsel is sufficient to establish compliance with section 6751(b) before formal communication to petitioners of the section 6662(a) penalty. See Estate of Morrissette v. Commissioner, T.C.
Memo. 2021-60, at *119 (“Emails may constitute written supervisory approval.”).
However, section 6664(c)(1) provides that a section 6662 penalty will not be imposed for any portion of an underpayment if the taxpayers show that (1) they had reasonable cause and (2) acted in good faith with respect to that underpayment. A taxpayer’s mere reliance “on an information return or on the advice of a professional tax adviser or an appraiser does not necessarily demonstrate reasonable cause and good faith.” Treas. Reg. § 1.6664-4(b)(1). That reliance must be reasonable, and the taxpayer must act in good faith. Id. In evaluating whether reliance is reasonable, a taxpayer’s “education, sophistication and business experience will be relevant.” Id. para. (c)(1). A taxpayer’s “honest misunderstanding of fact or law that is reasonable in light of all 48 [*48] of the facts and circumstances” may also constitute reasonable cause. Id. para. (b).
While we have held that petitioners did not have reasonable cause for their failure to comply with the qualified appraisal requirement, petitioners’ liability for an accuracy-related penalty presents a separate issue—and one for which respondent bears the burden of proof.
Accordingly, respondent must show that (1) Ms. Kanski was not a competent professional with sufficient expertise to justify reliance;
(2) petitioners failed to provide her with necessary and accurate information; or (3) petitioners did not actually rely in good faith on her judgment. See Neonatology Assocs., P.A., 115 T.C. at 99; see also Full-Circle Staffing, LLC, T.C. Memo. 2018-66, at *43–44.
We have already found that Ms. Kanski was competent and experienced and that she was provided with the necessary details of the transaction and contribution. The record establishes that Ms. Kanski advised petitioners that their deadline to contribute the shares and avoid capital gains was “prior to execution of the definitive purchase agreement.” Petitioner did not follow Ms. Kanski’s supplemental advice to have the paperwork for the contribution ready to go “well before the signing of the definitive purchase agreement.” Petitioner’s statements that he “would rather wait as long as possible to pull the trigger” until he was “99% sure” the sale would close suggest some disregard of his counsel’s advice as to the timing of the contribution. See, e.g., Medieval Attractions N.V. v. Commissioner, T.C. Memo. 1996-455, 1996 WL 583322, at *61 (“[The taxpayers] cannot claim reliance on their advisers’ advice if they failed to follow it.”). However, while petitioners disregarded Ms. Kanski’s cautionary note as to the timing, they did adhere to the literal thrust of her advice: that “execution of the definitive purchase agreement” was the firm deadline to contribute the shares and avoid capital gains. The anticipatory assignment of income issue (and thus the underlying accuracy of Ms. Kanski’s advice) was the subject of contention by the parties in this case. We do not consider the anticipatory assignment of income issue to be so clear cut that petitioner should have known it was unreasonable to rely on Ms. Kanski’s advice.
See Robert L. Peterson Irrevocable Tr. #2, 51 T.C.M. (CCH) at 1321 (finding reasonable cause for accuracy-related penalty where anticipatory assignment of income issue was “vigorously litigated” with “facts going in both directions”). While Ms. Kanski’s advice on an issue of substantive tax law was ultimately incorrect, we conclude that it was reasonable for petitioner to rely on it. See Boyle, 469 U.S. at 251.
49
[*49] Further, respondent has failed to establish any bad faith with respect to petitioners’ reliance on the advice.
We conclude that respondent has failed to establish that petitioners did not have reasonable cause under section 6664(c)(1) for their underpayment of tax. We will not sustain respondent’s determination of a section 6662(a) penalty.
# V. Conclusion
For the foregoing reasons, we hold that (1) petitioners made a valid gift of the CSTC shares on July 13, 2015; (2) petitioners realized and recognized gain because their right to proceeds from the sale became fixed before the gift; (3) petitioners are not entitled to a charitable contribution deduction; and (4) petitioners are not liable for a section 6662(a) penalty. We have considered all of the arguments made and facts presented by the parties in reaching our decision and, to the extent they are not addressed herein, we find them to be moot, irrelevant, or without merit.
To reflect the foregoing,
Decision will be entered under Rule 155.
Source: view the official text
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