The documentation requirements taxpayers must maintain in order to take a charitable contribution deduction on their tax return have been in place for almost 20 years. They are worth repeating however, as two recent tax court cases have upheld the necessity of following these rules and denied contribution deductions to taxpayers who did not have the necessary documentation.
As a review a donor cannot claim a tax deduction for any single contribution of $250 or more unless the donor obtains a contemporaneous written acknowledgement of the contribution from the recipient organization. Although it is a donors responsibility to obtain a written acknowledgement, charities should be very mindful of these rules because certainly donor relations are at stake if something goes wrong. IRS publication 1771 outlines these requirements.
In a 2012 case, David and Veronda Durden were denied a tax deduction for contributions made to their church because the original acknowledgement letter received from the Church did not clearly stipulate that no goods or services were provided to the donors in exchange for their donation ( TC Memo 2012-140). To correct this problem, the Church issued a second acknowledgement letter with the required statement but it was rejected by the Court because it was not considered to be contemporaneous.
To be considered contemporaneous, the documentation must be obtained on or before the earlier of:
- The date the taxpayer files the original return for the taxable year, or
- The due date ( including extensions ) for filing the original return for the year.
There are rules outlining necessary steps if a non-cash donation of over $5000 is claimed for what is required to take a deduction for non-cash property (real estate, furniture, computer equipment, clothing etc.). The donor is required to file a Form 8283 with their standard return and it must include the signature of a “qualified appraiser” as to the value assigned to the donated property.
The tax court case of Joseph and Shirley Mohamed (TC memo 2012-152) also ruled against the taxpayers (who had taken a deduction of millions of dollars for donated real estate) because they did not properly comply with the rules regarding Form 8283 and did not obtain a qualified appraisal. This case resulted in a really draconian result for the taxpayer who had clearly donated substantially valuable property to their presumably valid charitable remainder trust, yet were denied the deduction due to improper reporting of the gift as far as completing the requirements of IRS Form 8283.
In both of these cases, the Tax Court has sent a strong message that the substantiation rules DO MATTER and failure to follow them closely will result in the loss of a contribution deduction.
The fall-out over the valuation of donated medicine continues with the nonprofit watchdog site, Charity Navigator, landing in the news because of its controversial approach to rating organizations that have changed their values due to adopting more a conservative estimate.
Charity Navigator has decided that instead of punishing organizations that would suffer bad ratings due to a severe drop in revenue based on a more conservative calculation, that they will allow the organizations to file revised financial information for past periods. This would effectively apply the change in value retroactively so that revenue is more comparative.
Opponents to this decision argue that it lets organizations that overstated the value of their donations off the hook and that the excessive balances reported were never supportable under existing accounting rules anyway.
Supporters of the decision say it is a realistic approach to the change in accounting rules.
Organizations that want to file revised financial information have to provide adjusted Form 990 returns, have audit committee sign off, and the revised information must be available on the organization’s website.
Read more about it here.
FASB issued Proposed Accounting Standards Update (ASU) No. EITF-12B, Not-for-Profit Entities (Topic 958): Personnel Services Received from an Affiliate for Which the Affiliate Does Not Seek Compensation (a consensus of the FASB Emerging Issues Task Force). The FASB will be accepting comments on this proposed accounting update until September 20, 2012. The proposed update would modify the current that guidance which indicates that only those contributed services that (1) create or enhance nonfinancial assets or (2) require specialized skills, are provided by individuals possessing those skills, and typically would need to be purchased if not provided by donation should be recognized. In addition, under this accounting update the value of the services would be measured at the cost recognized by the affiliate for the personnel providing those services. For more detail read the full FASB exposure draft.
Frequently nonprofit organizations receive services from a parent or affiliate’s employees or there may be shared administrative support for which the recipient organization doesn’t pay or incur costs. But what do you do to capture the value of the work provided? What is fair value in this case and what qualifies as a “specialized skill” (sidenote: unrelated donated services must qualify as a specialized skill or one that creates or enhances non-financial assets)?
The Emerging issues Task Force (EITF)’s job is to hash out those insidious little details that are left in grey territory by the FASB. They began discussing this topic in March which I helpfully translated into dramatic narrative here. Or, you can read all about it in their own words here. They go through possible scenarios and discuss if changes should be retrospective. At their June meeting, EITF reached what is referred to as “consensuses-for exposure” which is to say they agreed on an approach and now the FASB needs to chime in.
What was agreed upon was this: The recipient organization should record donated service revenue and expense for all work done on their behalf by an affiliate’s employees at cost. Retrospective application is optional. Early adoption is permitted.
The Tax Court recently denied a taxpayer’s large charitable contribution deduction for donated real estate valued at $18.5 Million. The Court denied the deduction because the taxpayer did not have the proper substantiation of the value under the tax code rules. The Court acknowledged the taxpayer did make the donation and also stated that the property’s value was probably greater than the amount the taxpayer was claiming. (TC Memo 2012-152)
In order to take charitable deductions of more than $5,000 worth of noncash property, there are very strict substantiation rules that must be followed. Among the rules is the requirement for the taxpayer to obtain a qualified appraisal for any noncash single item or grouping of items donated and valued by the taxpayer at over $5,000.
If you are a nonprofit 501(c)(3) receiving noncash donations, or a taxpayer who wishes to donate such items and take the charitable deduction applicable, we strongly advise you talk to your nonprofit tax specialist early in the process to make sure the taxpayer meets all the substantiation requirements so the desired tax deduction can be taken.
The Protagonist: Affiliated nonprofits with separate governance.
The Game: Shared employees.
At Stake: Do you recognize contributed services if employees for Player A work for Player B, although Player A pays their compensation and Player B doesn’t have to reimburse Player A? Does Player B recognize contributed services and at what cost?
Deep in the Codification, Player B knows that paragraph 958-605-25-16 says that such services should be recognized if they create or enhance nonfinancial assets, or they require specialized skills that would typically need to be purchased. BUT! If Player A and Player B are affiliated, is it fair for Player B to recognize contributed service revenue? Should it be at fair value or cost? TWIST!
The jury is split because there are conflicting points of view. The tension is palpable.
One view is that ALL services that are regularly performed by employees of an affiliated entity – whether or not they qualify under Paragraph 958-605-25-16 – should be recognized by Player B as contributed service revenue and associated expense at the known cost to Player A. Put it all on the table. Show your resources. Show what your true costs are.
Opponents to this view observe that it’s possible the fair value of the services received might not be the same as the known costs. Services qualified under Paragraph 958-605-25-16 should be recognized at fair value and non-qualifying services should be recorded at cost, according to the opposition. The argument against this mixed-measurement proposal is that it’s going to get complex and overly burdensome.
Rogue players are suggesting it should all hang on whether Player B controls and directs the services performed or if Player A controls them.
The only thing they can all agree on is that there should be no extensive additional disclosures and no retroactive application requirements (although it would be an option).
The Cliff-hanger: They haven’t decided anything. We will stay on the edge of our seats as they duke it out and when they alert us that they’ve come to some decision. Only then will we know the impact on the players.
To read it yourself, go here.
Canadian charity, Escarpment Biosphere Foundation, has had its charity status revoked by the Canadian government based on claims that the organization has functioned as a tax shelter for companies in Canada, Europe, and the U.S.
The organization claims it never violated tax law but has closed its doors due to the expense of defending itself against the accusation over the last four years. The group valued the medicine it distributed as worth $300 million but obtained no independent verification of the value. The medicine was never in the possession of the foundation, instead being funneled through other Canadian charities to be distributed.
The foundation’s website states that the medicines distributed saved over 90,000 lives and treated more than 90 million people. Therein lie the true victims. Whether or not the group intentionally functioned as a tax shelter or not, the over-valuing of its donated medicine became its downfall. The Canadian tax agency put it succinctly, “The organization’s original purposes, those for the protection and preservation of the environment, have been modified and sidetracked to promote a tax-shelter gifting arrangement.” As will happen in the nonprofit sector, the next group will step in to fill the need. One hopes that they learn from others’ mistakes and will not be similarly sidetracked.
Read more about the issue here.
The IRS has released its list of the Dirty Dozen Tax Scams to watch for when preparing and filing returns for 2011. “Illegal scams can lead to significant penalties and interest and possible criminal prosecution,” according to the IRS website. The list is published as a way of increasing public awareness and cautioning people to be on the look-out.
While identity theft and phishing top the listing, of particular interest are these two items:
- Abuse of Charitable Organizations and Deductions, and
- Misuse of Trusts
Intentional abuse of 501(c)(3) organizations includes: arrangements that improperly shield income or assets; attempts to maintain control over donated assets or the income from donated assets; over-valuing non-cash assets; arrangements to buy back the donated asset at a time and price set by the donor; and inaccurate appraisals.
Misuse of trusts include: questionable deductions of personal expenses, and promises of reduced income, estate, and/or gift tax.
IRS personnel have witnessed an increase in the abuse and misuse of these entities. Organizations should be aware of the possible motives behind some donor objectives and strive to not be complicit in such activities. Penalties and the damage to the organization’s reputation might not be worth whatever temporary benefit received.
See the full listing here.
As previously discussed, the valuation of donated medication has been coming under intense scrutiny of late, with Food for the Hungry landing in the news and garnering a hefty federal penalty in the process. It should be noted that at this time, Food for the Hungry maintains it has done nothing wrong. At issue is the method by which nonprofits ascribe worth to donated drugs – some of which may have a “donative intent” in the form of steep discounts on purchase price.
Many nonprofits are re-assessing their valuations with the results being a drastic change, in some cases what was previously valued at $10.64 per pill adjusted down to $1.54 per pill. The impact of decreasing the value of the donation is a significant drop in income. The watchdog group, Charity Navigator is taking a closer look at the potential fall-out for organizations in this position.
Charity Navigator gives rankings to charitable organizations based on their financial health, accountability, and transparency. Typically, an organization with sizeable decreases in revenue get points taken off but in this case, the group is trying to determine if that’s a fair assessment or if these organizations deserve special consideration. The group is soliciting feedback from humanitarian membership groups, gauging the interest in giving the organizations a chance to file restated financials for the past four years, using the reassessed pill values, thereby not having to show a sudden drop in income for the current year.
Arguments are being made for and against allowing the amended reporting. One argument against it being that it would be difficult for an auditor to reassess the fair value four years back. Others note that it wouldn’t be fair to organizations that hadn’t hyper-inflated their medical donation values in the first place. Those arguing in favor are likely the same parties that have needed to make the valuation adjustments.
In an IRS report that Forbes qualifies as “blistering”, Food for the Hungry, an Arizona based nonprofit, is accused of valuing the donation of deworming medicine at an estimated 81,000% above market costs.
The methods for valuing donated medical supplies have been getting increased scrutiny, as noted in an article last month in Forbes, but this is the first time a charity is facing a possible federal penalty of $50,000 for an inaccurate tax return.
The temptation to value donated supplies at above market cost is certainly high. One might argue that it is difficult to nail down a market, and a donation of an asset is offset with an expense so it generates no net income, but it can make a charity look more robust than it is, thereby attracting and keeping donors. Increasing donated supplies decreases the fundraising ratio and makes the organization look more efficient. In fact, the IRS stated in its report on the investigation that the intent of the over-valuation was to “mislead the public in order to raise more funds.”
There are sources for Average Wholesale Price (AWP) of pharmaceuticals such as Red Book (TM) and First Data Bank. The problem is that these sources rely on wholesalers to report their average costs and some are delinquent, meaning there is a possibility that the AWP might not really include the most up to date information.
Over-stating donated pharmaceuticals has caused at least one organization to get cut from the Forbes 200 listing, according to the Senior Editor, William P. Barrett, at Forbes. Barrett also notes what may be an even more scathing condemnation from the IRS in regards to Food for the Hungry, which is that they concluded the charity actually bought the pills and did not receive them as donated. In other words, one would assume that in no way, shape, or form should it be counted as revenue at all, much less massively overstated revenue. However, there is a grey territory of “donative intent” whereby the purchase price of the drug paid by the charity is considerably lower than the price a consumer would pay.
Food for the Hungry rejects the accusation, claiming what other organizations also involved with the deworming medicine have, that they stated values “in accordance with then-prevalent tax law and generally accepted accounting principles. ” In the meanwhile, they have gone from valuing the pills at $16.25 per pill to $1.54 per pill.
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