Business Owners: Failure to Substantiate Donations Can Be Costly

Charitable donations can provide businesses with significant tax savings. But for gifts over a certain amount, they must obtain a contemporaneous written acknowledgement of their donations to qualify for a charitable contribution deduction. Failing to do so can prove costly. An S corporation learned that lesson the hard way when the IRS and the U.S. Tax Court denied its $5.22 million deduction for a bargain sale of land to a town in New York (Braen v. Commissioner, T.C. Memo. 2023-85, July 11, 2023).

IRS Rejects Charitable Deduction

The S corporation was a family-owned mining company. In 1998, the company bought a 505-acre parcel of land in a town in New York for $3.5 million. They'd planned to develop it into a granite quarry.

For 25 years prior to the purchase, the property had been zoned as "planned industrial." Quarrying was prohibited by law in the town, so the town would need to amend its zoning laws to permit such activity. The company also needed several other governmental permits and approvals to establish a quarry on the land.

Years of delays and disputes with both the town and the state ensued, including litigation over a 2004 zoning amendment by the town that changed the property's zoning to "low-density rural residential." As part of a 2010 settlement of the zoning lawsuit, the town purchased about 425 acres of the property for $5.25 million and rezoned the remainder to its earlier industrial designation.

On its 2010 tax reporting, the company treated the transaction as a bargain sale that had generated a charitable contribution of $5.22 million. Members of the S corporation claimed proportionate shares of the contribution as deductions on their respective federal tax returns. The IRS disallowed these deductions in full. The family turned to the Tax Court for relief.

Tax Court Agrees

The court initially found that the deduction was invalid because the company's valuation of the contribution didn't account for the benefit it received from the change in the zoning designation. But it also ruled that the deduction would be barred regardless because of a "fatal defect" in the company's contemporaneous written acknowledgement.

The company had submitted an acknowledgement letter from the town's attorney. However, it didn't identify the zoning change as consideration that the company received or provide a good faith valuation of it, as required by law. Rather, the letter stated that the company didn't receive "any goods or services, in whole or in part" as consideration other than the $5.25 million.

The family argued that the letter's reference to the settlement, including the case number, sufficed to satisfy the substantiation requirements. The court found that the IRS wasn't required to look beyond the written acknowledgement when, on its face, the acknowledgement didn't provide the mandated information. Even if the reference to the settlement was sufficient to identify the rezoning as consideration, neither the attorney's letter nor the settlement agreement included the requisite good faith valuation.

IRS Substantiation Requirements

Donors generally must substantiate any monetary or noncash contribution valued at $250 or more. Specifically, they must obtain a contemporaneous written acknowledgment from the donee organization before claiming a charitable deduction on their federal income tax returns. Additional substantiation requirements may apply to noncash contributions, such as qualified appraisals.

A contemporaneous written statement generally must contain the following:

• The name of the organization,
• The amount of any monetary contribution,
• A description (but not value) of any property other than cash contributed,
• A statement that no goods or services were provided by the organization in consideration for the contribution, if that was the case, and
• A description and good faith estimate of the fair market value (FMV) of any goods or services provided in consideration for the contribution.

An organization may provide a separate acknowledgement for each single contribution valued at $250 or more or one acknowledgment (for example, an annual summary) to substantiate several contributions of $250 or more. The IRS doesn't have a standard acknowledgement form. Donors shouldn't submit written acknowledgements with their tax returns, but they hold on to the acknowledgement in case they have to substantiate contributions in the future.

Written acknowledgements are considered "contemporaneous" if received by the donor on or before the earlier of:

• The date when the donor files its federal income tax return for the year of the contribution, or
• The due date, including extensions, of such return.

In other words, the S corporation in Braen couldn't amend its tax return with a proper written acknowledgement because the contemporaneous deadline had already expired.

Important: For donations of goods and services—which includes property—the contemporaneous written acknowledgement also must include a good faith estimate of the FMV of the donation from the recipient organization. The donor's deduction generally is limited to the contribution's FMV, less the FMV of any goods or services the donor receives from the organization in exchange.

More than a Technicality

The failure to obtain a contemporaneous written acknowledgement of a business donation with all the required information could lead to a much heftier tax bill than expected or budgeted for. Contact your SSB tax advisor to help ensure you satisfy all the requirements for your charitable contribution deduction on a timely basis and don't forfeit the tax benefits.

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