It is fairly common to make charitable gifts of property prior to a sale transaction. Often, those gifts are of real property or closely-held business interests. This is for good reason. Structured properly, not only do donors generally receive a charitable income tax deduction equal to the fair market value of the donated property, they also avoid any capital gains on the sale of that property. The double benefit of both avoiding capital gain and receiving a full fair market value deduction can be quite powerful.
As stated above, however, the gift must be structured properly in order to obtain these benefits. Two of the important areas in this regard are: (1) avoidance of an assignment of income; and (2) proper gift substantiation. We have previously written about cases where these issues have arisen. A recent Tax Court opinion once again addresses these issues, this time possibly contradicting IRS guidance and a previous binding opinion of the full Tax Court.
Commercial Steel Treating Corp. (“CTSC”) was owned by three brothers. After one of the brothers announced his plans to retire in the Fall of 2014, the three brothers decided to solicit bids for a sale of the company. In so doing, they engaged a financial advisory firm which began the process in early 2015.
Once that process started, the following sequence of events unfolded:
- April 1, 2015: HCI Equity Partners (“HCI”) submitted a draft Letter of Intent (“LOI”) to acquire CTSC.
- Mid April 2015: Mr. Hoensheid, one of the owner/brothers and the taxpayer in this case, begins discussing the possibility of establishing a donor advised fund (“DAF”) to make a charitable contribution of CTSC stock prior to the anticipated sale to take advantage of the type of planning described above (i.e. double benefit of fair market value charitable deduction and avoidance of capital gains on the donated shares).
- April 16, 2015: Mr. Hoensheid’s attorney emailed that “the transfer would have to take place before there is a definitive agreement in place.”
- April 23, 2015: LOI between HCI and CTSC was executed.
- May 22, 2015: CTSC executed an Affidavit of Acquired Person for the Federal Trade Commission representing that CTSC had “a good faith intention of completing the transaction.”
- June 1, 2015:
- Valuation date of CTSC submitted in substantiation of charitable deduction.
- Hoensheid emailed his attorney that “I do not want to transfer the stock until we are 99% sure we are closing.”
- June 11, 2015:
- Shareholders and Directors meetings ratifying sale of all stock of CTSC to HCI.
- CTSC submitted to the Michigan Department of Licensing and Regulatory Affairs an amendment to its Articles of Incorporation per request from HCI.
- Stock Purchase Agreement submitted by Mr. Hoensheid’s attorney to Fidelity Charitable for execution (dated effective June 15, 2015).
- Shareholders approve Mr. Hoensheid’s transfer of an unspecified number of CTSC shares to Fidelity.
- June 12, 2015: HCI’s investment committee and managing partners approved acquisition of CTSC.
- July 6, 2015:
- HCI formed a new Delaware corporation to serve as the acquirer of CTSC.
- Hoensheid sends an email that he is “not totally sure of the shares being transferred to the charitable fund yet.”
- July 7: CTSC determined to distribute payments to employees pursuant to a Change of Control Bonus Plan and almost all remaining cash to its shareholders.
- July 9-10, 2015:
- Email from Mr. Hoensheid’s financial advisor that “it looks like Scott has arrived at 1380 shares.”
- Hoensheid delivered the stock certificate transferring shares in CTSC to his attorney.
- Revised draft Stock Purchase Agreement circulated with missing date upon which Mr. Hoensheid transferred shares to Fidelity Charitable.
- CTSC paid bonuses to employees under Change of Control Bonus plan.
- July 13, 2015:
- Redline draft of Stock Purchase Agreement circulated indicating acceptance of all substantive changes.
- Printout list of CTSC shareholders indicating gift to Fidelity Charitable from Mr. Hoensheid on July 10, 2015.
- PDF stock certificate submitted by email to Fidelity Charitable showing the stock transfer from Mr. Hoensheid to Fidelity Charitable.
- July 14: CTSC distributed almost all remaining cash to its shareholders.
- July 15, 2015: Transaction closing and funding.
There was some dispute between the taxpayers and the IRS about the date of the charitable gift. The taxpayers argued the stock was gifted on July 10, 2015, the date upon which Mr. Hoensheid decided to transfer 1380 shares of CTSC to Fidelity Charitable, executed a stock certificate to that effect, and delivered the stock certificate to his attorney. However, the IRS argued, and the Tax Court agreed, that the transfer did not occur until July 13, 2015. The reason was that, citing to Michigan law, there was no deliver of the gift to the charity until the PDF stock certificate was sent and no acceptance of the gift until Fidelity Charitable’s email on July 13, 2015, acknowledging same. As a result, for purposes of the tax dispute, July 13, 2015, was the date of the charitable donation.
Assignment of Income
The assignment of income doctrine recognizes income as taxed “to those who earn or otherwise create the right to receive it.” Particularly in the charitable donation context, a donor will be deemed “to have effectively realized income and then assigned that income to another when the donor has an already fixed or vested right to the unpaid income.” This analysis looks “to the realities and substance of the underlying transaction, rather than to formalities or hypothetical possibilities.” The form of a charitable donation will not be respected if the donor does not: (1) give the appreciated property away absolutely and divest of title (2) before the property gives rise to income by way of a sale.
Before analyzing Mr. Hoensheid’s donation through the relevant tests for assignment of income, the Tax Court addressed arguments raised by Mr. Hoensheid regarding existing guidance. In addition to other sources, this is particularly important in citing to Rev. Rul. 78-197 and Rauenhorst. In Rev. Rul. 78-197 the IRS acquiesced in the Palmer decision where a donor transferred shares in a closely-held corporation he controlled to a private foundation he also controlled, followed by a redemption of those shares by the corporation. The IRS argued the substance of the transaction was a redemption followed by a cash contribution since the taxpayer had a “prearranged plan” of redeeming the shares at the time of the contribution. After the Tax Court ruled in favor of the taxpayer, the IRS issued Rev. Rul. 78-197 stating that “the Service will treat the proceeds of a redemption of stock under facts similar to those in Palmer as income to the donor only if the donee is legally bound, or can be compelled by the corporation to surrender the shares for redemption” (emphasis added). Certainly, regardless of any other facts, there was nothing to legally compel a closing of the sale of CTSC stock to HCI, or otherwise compel such closing, at the date of Mr. Hoensheid’s charitable gift.
In Palmer, the Tax Court held that certain charitable gifts made after a redemption of stock was “imminent” did not constitute an assignment of income. In Rauenhorst, the Tax Court noted that the IRS attempted to “devise a ‘bright-line’ test which focuses on the donee’s control over the disposition of the appreciated property” by adopting Rev. Rul. 78-197. Although Revenue Rulings do not bind the Tax Court, they do bind the IRS. When there was an LOI, but no binding obligation to sell, therefore, the IRS was precluded in Rauenhorst from arguing there as an assignment of income when the facts in the case were not distinguishable from those in Rev. Rul. 78-197. The facts in Rauenhorst bear similarities to those in Hoensheid. In Rauenhorst, there was a signed LOI, a resolution authorizing executing an agreement of sale, and a valuation report indicating there was little chance the transaction would not close.
However, in Rauenhorst, and cited in Hoensheid, the Tax Court noted “we have indicated our reluctance to elevate the question of donee control to a talisman for resolving anticipatory assignment of income” and that the donee’s power to reverse the transaction is “only one factor to be considered in ascertaining the ‘realities and substance’ of the transaction.” In Rauenhorst and Hoensheid, the Tax Court stated that “the ultimate question is whether the transferor, considering the reality and substance of all the circumstances, had a fixed right to income in property at the time of the transfer.” As such, notwithstanding that the Tax Court in Rauenhorst held the IRS to its position in Rev. Rul. 78-197, the court stated that “in the appropriate case we could disregard a ruling or rulings as inconsistent with our interpretation of the law.” As such, while Hoensheid could be seen as inconsistent with Rauenhorst, it also could be seen as consistent insofar as the Tax Court kept the door open for the Hoensheid result in the opinion it issued in Rauenhorst.
In making that determination the Tax Court in Hoensheid looked at factors including: (1) “any legal obligation to sell by the donee”, (2) “the actions already taken by the parties to effect the transaction”, (3) “the remaining unresolved transactional contingencies”, and (4) “the status of the corporate formalities required to finalize the transaction.”
Applying these factors, while conceding that there was no obligation of Fidelity Charitable to sell shares at the time of contribution, the Tax Court found there to be an assignment of income. The court cited to the number of acts which had taken place at the time of the donation which rendered the transaction a “foregone conclusion.” Relevant facts included that, on the date of the charitable donation, corporate formalities of approving the transaction had occurred, bonuses payable to employees resulting from the transaction had been paid, dividends had been paid to such an extent that CTSC no longer remained a viable going concern, and all substantive terms of the transaction had been fully negotiated. Ultimately, the court stated that, by July 13, 2015, “the transaction had simply ‘proceeded too far down the road to enable petitioners to escape taxation on the gain attributable to the donated shares.’”
Although the scope of this writing is to address the concept of anticipatory assignment of income and the Hoensheid opinion, particularly as it relates to prior authorities and guidance, it is important to note the substantiation issues which ultimately cost the taxpayers any charitable deduction. Even finding an assignment of income, the taxpayers would be entitled to charitable donation equal to the fair market value of the shares gifted. They merely would be forced to recognized their share of gain from the sale transaction. However, having failed to satisfy the charitable donation substantiation requirements, the taxpayers lost the deduction in full.
Relevant in Hoensheid, gifts of property of more than $500,000 require taxpayers to obtain a qualified appraisal from a qualified appraiser to attach to the taxpayer’s income tax return for the year of the gift. Although the scope of what constitutes a “qualified appraisal” from a “qualified appraiser” is beyond the scope of this writing, in Hoensheid, the taxpayer failed primarily as a result of obtaining an appraisal from someone unqualified to render valuations for purposes of substantiating charitable gifts.
The Tax Court notes that the requirement for the appraiser to be qualified is “the most important requirement” of the regulations. The appraiser in Hoensheid only infrequently performed valuations, did not hold himself out as an appraiser, and held no certifications from any professional appraiser organization. Based on these and other factors, it was clear that the appraiser in Hoensheid was not a “qualified appraiser” as contemplated by the applicable statute and regulations. By all accounts, he was used because he charged no fee for the valuation, instead offering to perform the valuation under the fees paid to the financial advisory firm handling the sale transaction which is where he was employed. In addition to the appraiser lacking the proper qualifications, the valuation report contained a number of deficiencies which rendered it not to constitute a “qualified appraisal” either. One of such problems was using a June 1, 2015, valuation date when intervening events between that date and the date of the gift, including the substantial bonus and dividend distributions, should have caused the value of CSTC to materially change.
Although “substantial compliance” can be sufficient in satisfying regulatory substantiation requirements, the Tax Court found that Mr. Hoensheid failed to substantially comply due to his failure to engage a qualified professional to complete the valuation along with the numerous errors could not be concluded to satisfy the requirements of substantial compliance. However, as a silver lining, in avoiding a 20% underpayment penalty, Mr. Hoensheid was held to have reasonably relied on his attorney’s advice that the deadline for the charitable donation was the date a definitive agreement is executed.
Here, Mr. Hoensheid made a couple of fatal choices. First, he chose to wait until the transaction was 99% sure to close before making the charitable gift. Second, he cut corners by using a free and unqualified appraiser rather than simply paying for a qualified valuation professional. Sure, Mr. Hoensheid’s professional advisors led him to believe he may have had until the closing (the date the purchase agreement would be signed) in order to make the gift. Further, his attorney may have been justified in believing that to constitute the law given Rauenhorst and Rev. Rul. 78-197. However, his own attorney said “any tax lawyer worth [her] fees would not have recommended that a donor make a gift of appreciated stock” so close to the closing.
It is understandable that taxpayers desire to wait until they are confident a sale will close before donating equity interests. We encounter that frequently. There is no clear, bright-line date on which the tests as discussed in Hoensheid may apply (as opposed to Rauenhorst and Rev. Rul. 78-197). As such, taxpayers and their planners should look to the timeline in this case and the Tax Court’s discussion in determining when to make charitable gifts in anticipation of a sale. In many cases, closing and purchase agreement execution occur simultaneously as opposed to transactions where a purchase agreement is signed with a number of contingencies and before much of the due diligence or other pre-closing details have been finalized. Extra care is likely needed when there is a contemporaneous execution and closing, as in Hoensheid. While no legally binding document may have been executed, the deal may be a “foregone conclusion” at some point along the spectrum.
Of course, beyond the assignment of income issues, we continue to see taxpayers trip up on charitable gift substantiation. Sometimes it is a mere mistake; other times taxpayers try to cut corners and/or save money by not engaging the proper professionals. When large gifts are being made, real value is being donated. The donor will never get those funds back and the costs of complying with the substantiation requirements is typically much less than the value of the deduction, especially when gifts are made in advance of a liquidity event.
 This presumes a donation of long-term capital gain property to a public charity, generally subject to a limitation on the deduction of 30% of the donor’s adjusted gross income. IRC § 170(b)(1)(C).
 As an example, a top bracket taxpayer (37% ordinary income tax bracket and 20% capital gains bracket) who donates a $1 million asset with a $200,000 cost basis stands to obtain both an $1M income tax deduction for a benefit of $370,000 and also avoid $800,000 of capital gains for a benefit of $160,000, yielding a combined tax benefit of $530,000. This means the true cost of the $1 million charitable gift was only $470,000. The savings may be more to the extent the net investment income tax and/or state income tax applies.
 Allen, Charles J., “IRS Continues Aggressive Stance on Charitable Contributions,” Oct. 23, 2018, https://esapllc.com/chrem-case/; and Sage, Joshua W., “Gifting Appreciated Stock Before Redemption – Dickinson,” Oct. 6, 2020, https://www.esapllc.com/dickinson-redemption2020/.
 Estate of Scott Hoensheid, et ux. v. Commissioner, T.C. Memo 2023-34.
 Rev. Rul. 78-197.
 Rauenhorst v. Commissioner, 119 T.C. 157 (2002).
 These statements were repeated in an email from the taxpayer’s financial advisor on April 20, 2015, and the taxpayer’s attorney on April 21, 2015.
 Michigan law requires a showing of: (1) donor intent to make a gift; (2) actual or constructive delivery of the subject matter of the gift; and (3) donee acceptance. See Davidson v. Bugbee, 575 N.W.2d 574, 576 (Mich. Ct. App. 1997).
 Although the stock ledger showing an earlier transfer date could have possibly substantiated delivery, that printout was dated July 13, 2015, meaning the Tax Court could not determine an earlier date upon which CTSC acknowledged the transfer.
 Again, here, there were communications with Fidelity Charitable showing a July 11, 2015, transfer date but the documentary proof provided to the Tax Court by the taxpayers bore a July 15, 2015, date rather than a production of the earlier original. As such, absent proper proof, the Tax Court could not conclude a July 11, 2015, acceptance date occurred.
 Helvering v. Horst, 311 U.C. 112, 119 (1940).
 Cold Metal Process Co. v. Commissioner, 247 F.2d 864, 872-73 (6th Cir. 1957).
 Jones v. U.S., 531 F.2d 1343, 1345 (6th Cir. 1976); and Allen v. Commissioner, 66 T.C. 340, 346 (1976).
 Humacid Co. v. Commissioner, 42 T.C. 894, 913 (1964).
 See supra Note 6.
 Palmer v. Commissioner, 62 T.C. 684 (1974),
 Citing Ferguson v. Commissioner, 108 T.C. 244 (1997).
 Note also the Ninth Circuit’s opinion in Ferguson v. Commissioner, 174 F.3d 997 (9th Cir. 1999), whereby assignment of income was found where a threshold of a tender of 85% of corporate shares was required prior to any binding obligations to sell when only more than 50% had been transferred at the time of the gift, the court finding there was enough “momentum” to the transaction to make the merger “most unlikely” to fail. This extension of the assignment of income doctrine was specifically refused to be followed by the U.S. District Court in Keefer v. U.S., 2022 WL 2473369, particularly given that the case was appealable to the Fifth Circuit Court of Appeals.
 IRC §170(f)(11)(D) and (E), and Treas. Reg. § 1.170A-13.
 Citing Mohamed v. Commissioner, T.C. Memo 2012-152.
 We have discussed substantial compliance in other writings including, Gray Edmondson, “RERI Revisited on Appeal, $33M Deduction Denial Upheld,” June 5, 2019, https://esapllc.com/reri-appeal/; and Devin Mills, “Private Jet Deduction Fails for Lack of Substantiation,” July 26, 2022, https://esapllc.com/izen-jet-2022/.
 IRC § 6662 based on any underpayment of tax required to be shown on a return that is attributable to negligence, disregard of rules or regulations, or a substantial understatement of income tax.
 For a recent article discussing charitable gift substantiation, including substantial compliance, see Sholk, Steven H., “A Guide to the Substantiation Rules for Deductible Charitable Contributions,” 137 J. Tax’n 03 (Dec. 2022).