Washington Hotline – May 12, 2015


Washington Hotline

IRS Employees Who Evade Taxes

The Treasury Inspector General for Tax Administration (TIGTA) published a report on April 14 that showed IRS employees were failing to pay taxes. Over a period of 10 years, there were 1,580 employees who willfully refused to pay taxes.

From this group 620 (39%) were terminated, resigned or retired. The remaining 960 (61%) received penalties. The IRS Commissioner allowed their penalty to be reduced to a suspension, reprimand or counseling.

The IRS officially defended the agency. The IRS responded, “It is important to note that the IRS has a more than 99% tax compliance rate, the highest of any major federal agency.” Under the Restructuring and Reform Act of 1998 (RRA 98), the IRS must terminate employees who willfully refuse to pay taxes. However, the IRS Commissioner may reduce the penalties. TIGTA observed that the IRS Commissioner was not documenting the reasons for the penalty reductions.

As a result of the TIGTA report, the IRS Commissioner agreed that there would be a higher level of documentation. It also acknowledged that the detailed TIGTA review of 34 cases discovered “willful overstatement of expenses, claiming the First-Time Home Buyer Tax Credit without buying a home, and repeated failure to timely file federal tax returns.”

Senate Finance Committee Chairman Orrin Hatch (R-UT) expressed outrage over the serious violations and chastised the IRS for its failure to take action. Hatch stated, “Unfortunately, as today’s report shows, the IRS has often failed to maintain that standard, and has instead allowed employees with serious tax violations to go about their business as usual. Even worse, the agency appears to have rewarded some of them with cash bonuses, promotions and paid time off. This is unacceptable – American taxpayers deserve better.”

House Ways and Means Oversight Sub Committee Chairman Peter Roskam (R-IL) echoed the Hatch concerns. He responded, “The agency acted with impunity, purposefully refusing to fire a majority of employees who violated tax law, including some repeat offenders with other documented misconduct issues.”

Bargain Sale Deduction Valid

In Bob R. Davis et ux. v. Commissioner; T.C. Memo (6 May 2015), the Tax Court approved a majority of a $2.1 million charitable deduction involving a bargain sale of undeveloped land to a nonprofit retirement center.

Bob and Erin Davis owned multiple properties in Waco, Texas. They also were active with charitable organizations in the region. At a dinner sponsored by a Waco bank, Davis met Donald Keith Perry, President of the Sears Methodist Retirement System, Inc. (SMRS) and the Sears Methodist Foundation.

In 2004, following Davis’s acquisition of several parcels of undeveloped land near Waco, Perry proposed Davis gift to SMRS land needed for a new retirement center. Davis and Perry entered into negotiations for a transfer of approximately 63 acres of land.

Perry indicated that SMRS was willing to pay $2 million for the land. Davis gave tentative approval to the transfer. He expected an appraised value of $4.1 million to produce a gift amount of $2.1 million on the bargain sale. Davis also requested an additional agreement that SMRS would provide retirement housing for his mother as part of the bargain sale.

In 2005, Davis provided the required Phase One Environmental Impact Survey. On September 9, 2005, Davis deeded the property to SMRS for a payment of $2 million. Because there were differences on the memorandum of understanding with respect to the care of Davis’s mother, that agreement was not signed.

Davis secured the services of appraiser Bruce Cresson II. Based on comparable properties, Cresson valued the parcel at $4.1 million. The charitable deduction of $2.1 million was reported by Davis on tax returns for 2005, 2006 and 2007.

The IRS denied the charitable deduction. It claimed that there was no deduction because there was no charitable intent by Davis and there was not the required contemporaneous written acknowledgement of the gift. Finally, IRS appraiser Donald L. Ward determined that the fair market value on date of the deed was below the $2 million payment and therefore the gift had zero charitable value.

The Tax Court noted that Cresson was a very experienced appraiser. While the IRS claimed that he did not “properly reflect adjustments for (1) time, (2) location, (3) traffic count, and (4) river/trees,” the court rejected the first three IRS claims and determined an adjustment was appropriate for number (4).

Because the river/trees area was in the U.S. Army Corps of Engineers flood zone, the proposed 30% negative factor by Cresson was reduced to a 15% negative factor recommended by appraiser Ward. With that adjustment, the reduced deduction was approved.

Editor’s Note: A bargain sale is a transfer of property to a nonprofit with payment of an amount less than the fair market value. However, the transfer must be either a fee interest or an undivided interest with all rights to that property included. The side agreement for care of the mother could have created a non-qualified partial interest gift. If there are any additional transfers to the donor, then it is essential to divide the property. There is an undivided transfer for the charitable portion and the balance is sold in exchange for the additional elements. In this transaction, two or three acres could have been allocated to the agreement for care of the mother and the balance of the property would then qualify for the bargain sale to the charitable organization.

Easement Deduction Denied

In David C. Costello et ux. v. Commissioner; T.C. Memo. 2015-87; No. 24995-12 (6 May 2015), the Tax Court denied a charitable easement deduction due to an unqualified appraisal, an unsigned IRS Form 8283 Appraisal Summary and a “quid pro quo” that reduced the conservation easement value to zero.

In 2000, David and Barbara Costello acquired Rose Hill Farm in Howard County, Maryland. By 2006, they had a basis of $1,977,556 in the property.

Howard County created an Agricultural Land Preservation Program (ALTP). Under that law, owners of a farm may sell development rights to a third party. As part of the required sale transaction, the owner of the farm must then grant Howard County a conservation easement that development is no longer permitted on their property.

In January of 2006, the Costellos entered into a contract for sale of sixteen of their seventeen allocated development rights to developer Kennard Warfield. They received an initial down payment of $1.2 million toward the total price of $2.56 million. On October 17, 2006, Howard County approved the transfer and the conservation easement deed was recorded on October 20, 2006.

On July 1, 2007, appraiser Bruce Dumler valued the property as of December 1, 2006. He determined the “before” value with twenty-five potential dwelling units to be $7.69 million. With an “after” value for the farm of $2.1 million, the deduction was $5.59 million. He did not show the reduced value due to Warfield’s $2.56 million payment. Howard County refused to sign IRS Form 8283 and the unsigned form was submitted with IRS Form 1040.

On May 16, 2008, the Costellos filed an amended tax return. Dumler reduced the claimed $5.59 million deduction by the payment to Warfield and the correct amount was now $3.03 million. Howard County also signed Form 8283. The IRS disallowed the conservation easement and assessed penalties.

The Tax Court noted that the IRS deficiency notice claimed a failure to include three specific required elements. There was not “an accurate description of the property contributed; the date of the contribution; and the salient terms of the agreements among the petitioners.”

Therefore, the appraisal was not valid. In addition, the appraisal summary failed to note that Howard County had given the Costellos permission to sell 16 development rights to Warfield. Given the substantial nature of these failures, there was not substantial compliance.

Finally, there was a “quid pro quo.” The sale contract required the Costellos to file a conservation easement. By the time the conservation easement was filed, the owners already had contractually agreed to sell the development rights. Therefore, no remaining value was available to create a conservation easement deduction.

The IRS also assessed a Sec. 6662(a) penalty. Because the taxpayers knew that the initial $5.59 charitable deduction should have been reduced to $3.03 million by the consideration received, the appraisal was not qualified. The later filing did not cure the error and the penalty was applicable.

Applicable Federal Rate of 1.8% for May — Rev. Rul. 2015-8; 2015-17 IRB 1 (17 Apr 2015)

The IRS has announced the Applicable Federal Rate (AFR) for May of 2015. The AFR under Section 7520 for the month of May will be 1.8%. The rates for April of 2.0% or March of 1.8% also may be used. The highest AFR is beneficial for charitable deductions of remainder interests. The lowest AFR is best for lead trusts and life estate reserved agreements. With a gift annuity, if the annuitant desires greater tax-free payments the lowest AFR is preferable. During 2015, pooled income funds in existence less than three tax years must use a 1.2% deemed rate of return. Federal rates are available by clicking here.