On January 6, 2020, the Tax Court issued a Memorandum Opinion in the case of Loube v. Commissioner (T.C. Memo. 2020-3). The issues presented in Loube v. Commissioner were whether the petitioners had complied with § 155 of the Deficit Reduction Act of 1984 (DEFRA) with respect to the appraisal that they obtained regarding charitable deductions claimed on their return; and if not, whether the petitioners were in substantial compliance with DEFRA.
Charitable Contributions, Generally in Loube v. Commissioner
The deductibility of a charitable contribution depends on the donor-taxpayer meeting several conditions, which conditions are determined by the size and type of contribution. The larger the contribution, the more stringent the documentation and substantiation that is needed. See IRC § 170(a)(1). With respect to non-cash donations, the amount of the contribution is generally equal to the fair market value of the property at the time of contribution. See Treas. Reg. § 1.170A-1(c)(1). Determining the FMV, however, is the factor that taxpayers so often fail to meet, as is the case in Loube.
Are You (Compliant with) DEFRA?
In 1984, Congress passed the Deficit Reduction Act of 1984 (DEFRA), Pub. L. No. 98-369, 98 Stat. at 691. Section 155(a) of DEFRA authorized (and required) the Treasury to prescribe regulations implementing substantiation requirements for noncash charitable contributions in excess of $5,000, which substantiation necessarily would require “qualified appraisals” of the donated property. See DEFRA, § 155(a); IRC § 170(f)(11)(c). The Treasury’s authority to promulgate regulations related to charitable donations is further set forth in IRC § 170(a)(1).
In response to DEFRA, the Treasury promulgated Treasury Regulation § 1.170A-13(c), which codifies the qualified appraisal requirement by setting out the information required to be included as a part of the substantiation for the property donation. The appraisal must be prepared by a qualified appraiser and a complete (and compliant) appraisal summary must be attached to the return on which the taxpayer first claims a deduction for the contribution. See DEFRA, § 155(a)(1)(B); Treas. Reg. § 1.170A-13(c)(2); Treas. Reg. § 1.170A-13(c)(4).
A compliant qualified appraisal summary must include, among other information, a description of the property in sufficient detail to ascertain that the property that was appraised is the property that was contributed, the manner of acquisition, the date of acquisition of the property by the donor. Most critically, the summary must set out the cost or other basis of the property. Treas. Reg. § 1.170A-13(c)(4)(ii)(B), (D), (E). The “appraisal summary” is a summary of a qualified appraisal which must be made on a Form 8283, and that form must be attached to the return. Treas. Reg. 1.170A-13(c)(4)(i)(A). The regulations could not be any clearer about the requirements, but compliance with the enumerated steps hamstrings ever so many taxpayers.
Understanding that they were asking a lot of taxpayers, the Treasury Regulations even provides an escape hatch. Although the failure to meet all of the required elements of an appraisal summary will generally result in the disallowance of the charitable deduction, if a taxpayer can demonstrate reasonable cause for its inability to provide the information relating to the manner of acquisition or even the actual basis of the contributed property, this failure may not be absolutely fatal to the deduction. Treas. Reg. 1.170A-13(c)(4)(iv)(C)(1). “An appropriate explanation” of reasonable cause must be attached to the appraisal summary, which means that in any event, an appraisal summary must be provided and attached to the return, even if it is not 100% complete or compliant. Failure to include a complete summary, or a partial summary and a reasonable cause statement is, in the regulations’ estimation a failure to substantiate the deduction. “Strict compliance” includes compliance with the reasonable cause requirement, which is, in and of itself, less than full compliance with the regulatory requirements…and yet, the taxpayers in Loube couldn’t even be bothered to get this part right.
Tax Court Concludes no Strict Compliance in Loube v. Commissioner
The Tax Court concluded that the petitioners failed to strictly comply with § 155 of DEFRA and the regulations thereunder because they failed to provide, among other information, the basis and the acquisition date of the contributed property on the appraisal summary. They also failed to attach a reasonable cause statement explaining their inability to provide such information.
“But we tried really hard,” the taxpayers pleaded to the Tax Court. “We ‘substantially complied’ with DEFRA; isn’t that enough?”
“Not good enough!” replied the Tax Court cracking its whip to punctuate its swift condemnation.
Substantial Compliance with DEFRA
The Tax Court recognizes the doctrine of substantial compliance. See RERI Holdings I, LLC v. Commissioner, 149 T.C. 1, 15-16 (2017), aff’d sub nom. Blau v. Commissioner, 924 F.3d 1261 (D.C. Cir. 2019). Substantial compliance may bail out the taxpayers where they have provided most of the important information required by the statute or regulations, or the taxpayers’ omissions were made solely through inadvertence. Hewitt v. Commissioner, 109 T.C. 258, 265 & n.10 (1997), aff’d without published opinion, 166 F.3d 332 (4th Cir. 1998); see also Durden v. Commissioner, T.C. Memo. 2012-140.
The key question under the substantial compliance doctrine is whether the taxpayers were compliant with those requirements that relate to the “substance or essence” of the statute at issue, here DEFRA. Bond, 100 T.C. 32, 40-41 (quoting Taylor v. Commissioner, 67 T.C. 1071, 1077 (1977)). If the requirements relate to the substance or essence of the statute, then strict adherence is mandatory. See Dunavant v. Commissioner, 63 T.C. 316, 319-320 (1974). If the requirements are instead procedural or directory, then the requirements may be fulfilled by substantial compliance. RERI Holdings I, LLC, v. Commissioner, 149 T.C. at 15-16. If, however, the element is absolutely essential to the very purpose of the regulation, a taxpayer must always comply with it in order to satisfy the spirit of the regulation. See Bond, 100 T.C. at 41; see also Belair Woods, LLC v. Commissioner, T.C. Memo. 2018-159, at *15-*17.
If this is too complicated for you, as it was for the petitioners, think of it this way: if your three-year-old asks you to make banana pancakes, and you absentmindedly forget the bananas, you’ve still made her pancakes. If you forget the flour, baking soda, milk, oil, and eggs, you have bananas. One of these is substantial compliance, and the other is what the taxpayers in Loube argued. Bananas.
The Tax Court has historically cautioned that the doctrine of substantial compliance is not liberally applied. Costello v. Commissioner, T.C. Memo. 2015-87, at *23 (quoting Alli v. Commissioner, T.C. Memo. 2014-15, at *54)); Kaufman v. Shulman, 687 F.3d 21, 29 (1st Cir. 2012) (court may forgive “minor discrepancies” in the taxpayer’s reporting); Prussner v. United States, 896 F.2d 218, 224 (7th Cir. 1990) (substantial compliance doctrine “should be interpreted narrowly”). Just like it’s tough sledding to convince the three-year-old to eat the banana-less pancakes, it is not easy for taxpayers to convince the Tax Court to stomach failure to strictly comply with the letter of the law. Further, in passing § 155 of DEFRA, Congress intended to tightly regulate the longstanding problem of overvalued property being claimed as charitable deductions. Mohamed v. Commissioner, T.C. Memo. 2012-152.
Bright Line Rule for Substantial Compliance
If the donor/taxpayer provided sufficient information to permit the IRS to evaluate the taxpayer/donor’s reported contributions, i.e., basis, then the pancakes will less often be fed to the willing Labrador under the table. Smith v. Commissioner, T.C. Memo. 2007-368, aff’d, 364 F. App’x 317 (9th Cir. 2009). A taxpayer who fails to disclose cost or adjusted basis on its appraisal summary has failed to substantially comply with Treas. Reg. § 1.170A-13, and you’ll be left scraping pancake of the kitchen window, metaphorically, of course. A taxpayer’s failure to provide the cost or adjusted basis on an appraisal summary is fatal to a taxpayer’s argument of substantial compliance in this context. Smith, T.C. Memo. 2007-368 at *20; Belair Woods, LLC, T.C. Memo. 2018-159 at *15-*20. Basis, like flour, is an absolute requirement. Without it, a charitable deduction is dead in the water. And before you bring up gluten free options, just stop, snowflake. My metaphors do not have time for your almond meal.
IRS Will not Reconstruct Basis for the Taxpayer
In a last-ditch effort, the petitioners argued that the IRS could have gleaned sufficient information from the purchase price and tax information listed in the appraisal to determine the cost or adjusted basis of the property. Politely reminding the taxpayer that the IRS is too damn busy to “glean” anything, the Tax Court pointed out that the entire freaking point of DEFRA’s heightened substantiation requirements was to prevent the IRS from having to do exactly what the petitioners were asking it to do. Belair Woods, LLC, T.C. Memo. 2018-159 at *20. Provide basis to the IRS on the line of Form 8283 that says “basis,” and you’ll be golden…assuming you can substantiate it and haven’t just pulled the number out of the air, or wherever…