Case Law Update

December 2018—U.S. Tax Court on Qualified Appraisals and Gill v. Gill, Minnesota’s Supreme Court Rules on the Status of Earn-Outs in Dissolution Cases

The U.S. Tax Court issued two valuation memorandums in September and October 2018. Each memorandum serves as a reminder of the importance of attaching a qualified appraisal. The issue in Presley v. Commissioner, T.C. Memo. 2018-171 (October 15, 2018) was whether petitioners were entitled to charitable deductions claimed in 2010 relating to land improvements paid before 2010 that benefitted a religious charity. We cite pertinent portions of this decision since it involves tax planning and the importance of documenting contemplated transactions before gifts are made, not after-the-fact. The issue in Chrem v. Commissioner, T.C. Memo. 2018-164 (September 26, 2018) was whether to grant summary judgment to taxpayers or the Commissioner in connection with gifts of closely held shares made to a charity following a stock sale; here, taxpayers did not attach a qualified appraisal to their returns. Last, we highlight the recent Minnesota Supreme Court case of Gill v. Gill, where the Court decided whether a contingent earn-out was marital or non-marital property.

[su_pullquote align=”right”]Resources:

Industry Standards and Ethics

Current Update in Valuations

Introduction to Matrimonial Litigation

The Good, Bad, and Wealthy—Top Five Financial Issues in High Net–Worth Divorces

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The U.S. Tax Court issued two valuation memorandums in September and October 2018. Each memorandum serves as a reminder of the importance of attaching a qualified appraisal. The issue in Presley v. Commissioner, T.C. Memo. 2018-171 (October 15, 2018) was whether petitioners were entitled to charitable deductions claimed in 2010 relating to land improvements paid before 2010 that benefitted a religious charity. We cite pertinent portions of this decision since it involves tax planning and the importance of documenting contemplated transactions before gifts are made, not after-the-fact. The issue in Chrem v. Commissioner, T.C. Memo. 2018-164 (September 26, 2018) was whether to grant summary judgment to taxpayers or the Commissioner in connection with gifts of closely held shares made to a charity following a stock sale; here, taxpayers did not attach a qualified appraisal to their returns. Last, we highlight the recent Minnesota Supreme Court case of Gill v. Gill, where the Court decided whether a contingent earn-out was marital or non-marital property.

1. Presley v. Commissioner, T.C. Memo. 2018-171 (October 15, 2018)

Facts: On October 30, 1997, the Presleys, Rob Moritz (Mr. Moritz), who was Mr. Presley’s brother-in-law, and Bertha Coffin (Ms. Coffin), who was a friend of the Presleys, incorporated Presley Family Ministries, Inc. (PFM), as a nonprofit corporation under the laws of the State of Oklahoma. Pursuant to its articles of incorporation, PFM had various powers and authority, including the power and authority “[t]o earnestly seek and promote the unity of God’s people and churches in a Scriptural manner of Godly love, respect, and faithful voluntary cooperation with liberty.” At all relevant times, including during 2010 and 2012, Mr. Presley was the pastor and primary spiritual leader of PFM.

Petitioners formed a farm and leased land they owned to the newly formed entity that ostensibly would grow fruit and those profits would be used to support missions. Petitioners expended a considerable amount improving the land and claimed a charitable deduction. Petitioners also donated their residence to PFM; petitioners were the major PFM donors and board members for the years in question.

On July 7, 2016, respondent issued a notice of deficiency to petitioners for their taxable years 2010 and 2012 (notice). In the notice, respondent determined for petitioners’ taxable year 2010 to disallow the respective claimed charitable contribution deductions of $107,364 for the required land improvement expenses, and $3,000 for the donated tractor/mower. In the notice, respondent further determined for petitioners’ taxable year 2012 to disallow the claimed noncash charitable contribution deduction of $235,422 for petitioners’ residence.

In the notice, respondent also determined that petitioners are liable for each of their taxable years 2010 and 2012 for the accuracy-related penalty under section 6662(a).

Issues: 1) Whether petitioners are entitled to the claimed charitable deductions. 2) Whether taxpayers are subject to accuracy-related penalties.

Held: Petitioners claims of charitable deductions are denied and accuracy-related penalties apply.

Charitable Deduction Related to PFM Farm

The Court held:

We consider whether petitioners are entitled for their taxable year 2010 to deduct under section 170(a) $107,364 for a claimed charitable contribution to PFM relating to the required land improvement expenses that PFM Farms paid before 2010. In stating that issue, we intentionally use the phrase “relating to” the required land improvement expenses. That is because it is unclear from our review of the record what petitioners are contending Mr. Presley contributed to PFM during 2010 relating to the required land improvement expenses for which they are claiming a deduction under section 170(a). In this regard, we note that certain testimonial evidence (e.g., the respective testimonies of Mr. Presley, Mr. Dryer [attorney for PFM], and Mr. Johnson) and certain documentary evidence (e.g., the October 20, 2010 minutes of PFM’s board that Mr. Dryer drafted, Mr. Dryer’s draft 2010 letter No. 1, PFM’s draft letter No. 2, and PFM’s draft letter No. 3) contain inconsistent (and sometimes internally inconsistent) statements about what Mr. Presley purportedly contributed to PFM during 2010 relating to the required land improvement expenses.

By way of illustration of certain inconsistent (and sometimes internally inconsistent) testimonial evidence, Mr. Presley testified that he informed Mr. Dryer and Mr. Johnson that in 2010 he donated to PFM his wholly owned limited liability company, PFM Farms. Certain testimony of Mr. Dryer is inconsistent.

Even if PFM Farms had paid the required land improvement expenses in 2010, we would find on the record before us that petitioners have failed to carry their burden of establishing that they satisfy section 1.170A-1(g), Income Tax Regs. Pursuant to that regulation, in order for the required land improvement expenses to be deductible under section 170(a), PFM Farms must have incurred them “incident to the rendition of services to” PFM. We have held that in order to be deductible under section 170(a) and section 1.170A-1(g), Income Tax Regs., “unreimbursed expenses must be directly connected with and solely attributable to the rendition of services to a charitable organization.” Van Dusen v. Commissioner, 136 T.C. at 525 (citing Saltzman v. Commissioner, 54 T.C. 722, 724 [1970]).

PFM Farms paid the required land improvement expenses for the purpose of, inter alia, creating the ponds on PFM’s Tulsa property in order to have an irrigation source for PFM Farms’ blueberry farm, which PFM Farms intended to operate for profit on the leased PFM property. On the record before us, even if PFM Farms had paid the required land improvement expenses in 2010, we would find that petitioners have failed to carry their burden of establishing that the required land improvement expenses that PFM Farms paid were directly connected with or solely attributable to the rendition of services to PFM by PFM Farms.

Even if PFM Farms had paid the required land improvement expenses in 2010 and those expenses were directly connected with and solely attributable to the rendition of services to PFM by PFM Farms, we would find on the record before us that petitioners have failed to carry their burden of establishing that they satisfy the substantiation requirements in section 170(f)(8)(A) and (C) and section 1.170A-13(f)(1) and (3), Income Tax Regs. Those authorities, which apply to contributions of $250 or more, required petitioners to substantiate the claimed contribution relating to the required land improvement expenses with a contemporaneous written acknowledgement from PFM. See Van Dusen v. Commissioner, 136 T.C. at 536. In order for the acknowledgement to be considered contemporaneous, the taxpayer must obtain it before the earlier of 1) the date on which the taxpayer files the return claiming the deduction or 2) the due date, including extensions, within which the taxpayer must file the return claiming the deduction. See sec. 170(f)(8)(C); sec. 1.170A-13(f)(3), Income Tax Regs.; see also Van Dusen v. Commissioner, 136 T.C. at 536-537.

The record contains the following three different purported acknowledgement letters from PFM that were addressed to PFM Farms: Mr. Dryer’s draft 2010 letter No. 1, PFM’s draft letter No. 2, and PFM’s draft letter No. 3. None of those letters are dated. Although the copy of each of those letters that is in the record is signed by Mr. Douglas, 55 petitioners have failed to carry their burden of establishing that Mr. Douglas in fact signed Mr. Dryer’s draft 2010 letter No. 1, PFM’s draft letter No. 2, and/or PFM’s draft letter No. 3. Even if the record had established that Mr. Douglas signed one or more of those letters, petitioners have failed to carry their burden of establishing when he signed any of them and sent any of them to PFM Farms, Mr. Presley, and/or petitioners. On the record before us, even if PFM Farms had paid the required land improvement expenses in 2010 and those expenses were directly connected with and solely attributable to the rendition of services to PFM by PFM Farms, we would find that petitioners have failed to carry their burden of establishing that they satisfy the substantiation requirements in section 170(f)(8)(A) and (C) and section 1.170A-13(f)(1) and (3), Income Tax Regs.

Even if PFM Farms had paid the required land improvement expenses in 2010, those expenses were directly connected with and solely attributable to the rendition of services to PFM, and Mr. Dryer’s draft 2010 letter No. 1, PFM’s draft letter No. 2, and/or PFM’s draft letter No. 3 had been signed by Mr. Douglas and had been sent to PFM within the time prescribed in section 170(f)(8)(C) and section 1.170A-13(f)(3), Income Tax Regs., we would find on the record before us that petitioners have failed to carry their burden of establishing that they satisfy the substantiation requirements in section 170(f)(8)(B)(ii) and (iii) and section 1.170A-13(f)(2)(ii) and (iii), Income Tax Regs. Section 1.170A-13(f)(2)(ii), Income Tax Regs., which was promulgated under section 170(f)(8)(B)(ii), requires a donee organization to indicate in a contemporaneous written acknowledgement “whether or not the donee organization provides any goods or services in consideration, in whole or part, for any of the cash or other property transferred to the donee organization.” Where the donee organization provides any goods or services, section 170(f)(8)(B)(iii) and section 1.170A-13(f)(2)(iii), Income Tax Regs., require the donee organization to indicate in the contemporaneous written acknowledgement “a description and good faith estimate of the value of those goods or services”.

Where the acknowledgement incorrectly states that “[n]o goods or services were provided for the donation”, that donor acknowledgement fails to satisfy the substantiation requirements in section 170(f)(8)(B)(ii) and (iii) and section 1.170A-13(f)(2)(ii) and (iii), Income Tax Regs. See Viralam v. Commissioner, 136 T.C. 151, 171 (2011). The following language appeared in each of the purported acknowledgement letters (i.e., Mr. Dryer’s draft 2010 letter No. 1, PFM’s draft letter No. 2, and PFM’s draft letter No. 3): “No goods or services were provided for the contributions given.” We have found that PFM Farms paid the required land improvement expenses, inter alia, to create the ponds on an area of PFM’s Tulsa property other than the leased PFM property as a source of irrigation for PFM Farms’ blueberry farm, which PFM Farms intended to operate for profit on that leased property. On the record before us, we find that PFM Farms expected to benefit financially from the required land improvement expenses that it paid by establishing and operating PFM Farms’ blueberry farm with the intention of making a profit. On that record, even if PFM Farms had paid the required land improvement expenses in 2010, those expenses were directly connected with and solely attributable to the rendition of service to PFM, and Mr. Dryer’s draft 2010 letter No. 1, PFM’s draft letter No. 2, and/or PFM’s draft letter No. 3 had been signed by Mr. Douglas and had been sent to PFM within the time prescribed by section 170(f)(8)(C) and section 1.170A-13(f)(3), Income Tax Regs., we would find that petitioners have failed to carry their burden of establishing that they satisfy the substantiation requirements in section 170(f)(8)(B)(ii) and (iii) and section 1.170 A-13(f)(2)(ii) and (iii), Income Tax Regs.

Based upon our examination of the entire record before us, we find that petitioners have failed to carry their burden of establishing that they are entitled for their taxable year 2010 to deduct under section 170(a) $107,364 of the required land improvement expenses that PFM Farms paid before 2010.

Claimed Deduction for Machinery and Equipment

The return submitted by taxpayers failed to provide meaningful details and the court rejected taxpayers claim that they reasonably relied upon their CPA’s advice. The Court held:

On the record before us, we find that petitioners have failed to carry their burden of establishing that their failure to satisfy certain charitable contribution deduction substantiation requirements that apply to their claimed charitable contribution deduction of $3,000 for the tractor/mower in question is due to reasonable cause and not to willful neglect within the meaning of section 170(f)(11)(A)(ii)(II).

Donation of Primary Residence

The Court here focused on the date the valuation was submitted, rather than the control argument raised by the Service. This reading is instructive to CPAs and valuation professionals hired well-after the fact:

As we understand petitioners’ position, it is the valuation date, i.e., the date as of which the property is valued, to which section 1.170A-13(c)(3)(i)(A), Income Tax Regs., is referring in requiring that the appraisal document “[r]elate[] to an appraisal that is made not earlier than 60 days prior to the date of contribution…nor later than the date specified in paragraph (c)(3)(iv)(B) of this section[1.170A-13] (c)”. We reject petitioners’ bizarre reading of section 1.170A13(c)(3)(i)(A), Income Tax Regs. An appraisal is made when an appraisal document is final and is signed and dated by the appraiser. It is not made on the date as of which the appraiser is determining the fair market value of the property that he is asked to appraise. On December 5, 2013, Mr. Scott signed the appraisal report in which he appraised the fair market value of petitioners’ residence as of May 10, 2012. In Mr. Scott’s December 5, 2013 appraisal report, Mr. Scott indicated that the date of that report was December 5, 2013, the same date on which he signed it.

On the record before us, we find that Mr. Scott’s December 5, 2013 appraisal report was made on December 5, 2013. The due date, including extensions, for the filing of petitioners’ 2012 return was October 15, 2013. On the record before us, we find that Mr. Scott’s December 5, 2013 appraisal report did not “relate[] to an appraisal that is made not earlier than 60 days prior to the date of contribution of…[petitioners’ residence] nor later than [October 15, 2013] the date specified in” section 1.170A-13(c)(3)(iv)(B), Income Tax Regs. On the record before us, we find that the requirement in section 1.170A-13(c)(3)(i)(A), Income Tax Regs., is not satisfied.

In order to constitute a qualified appraisal, Mr. Scott’s December 5, 2013 appraisal report also was required to “include[] the information required by paragraph (c)(3)(ii) [of section 1.170A-13]”. Petitioners completely ignore the requirement in section 1.170A-13(c)(3)(ii)(C), Income Tax Regs. (quoted above), that a qualified appraisal include “the date…of contribution to the donee”. Mr. Scott’s December 5, 2013 appraisal report contained no information with respect to petitioners’ transfer to PFM on April 30, 2012, of legal title to petitioners’ residence. On the record before us, we find that the requirement in section 1.170A13(c)(3)(ii)(C), Income Tax Regs., is not satisfied.

Petitioners also completely ignore the requirement in section 1.170A13(c)(3)(ii)(D), Income Tax Regs. (quoted above), that a qualified appraisal include “[t]he terms of any agreement or understanding entered into (or expected to be entered into) by or on behalf of the donor or donee that relates to the use…of the property contributed”. From the time they transferred legal title to petitioners’ residence to PFM until at least December 5, 2013, the date of Mr. Scott’s December 5, 2013 appraisal report, petitioners continued to live in petitioners’ residence and to pay all utility bills and did not pay any rent to PFM for the right to live in that residence. Nonetheless, Mr. Scott’s December 5, 2013 appraisal report contained no information with respect to that arrangement. On the record before us, we find that the requirement in section 1.170A-13(c)(3)(ii)(D), Income Tax Regs., is not satisfied.

This 103-page decision is available to QuickRead readers here.

2. Chrem v. Commissioner, T.C. Memo. 2018-164 (September 26, 2018)

Facts: Petitioners (along with eight other individuals or couples) owned 100% of the stock of Comtrad Trading, Ltd. (Comtrad), a closely held Hong Kong corporation. A related company proposed to purchase 100% of Comtrad’s stock for $4,500 per share. After Comtrad’s shareholders agreed to tender about 87% of their shares to an ESOP, petitioners donated the balance of their stock to a charitable organization. The acquiring company then completed the acquisition, purchasing the donated stock for $4,500 per share.

On their 2012 Federal income tax returns, petitioners claimed charitable contribution deductions for their gifts, valuing the donated stock at $4,500 per share. In timely notices of deficiency, the Internal Revenue Service (IRS or respondent) determined that petitioners were liable for tax under the assignment of income doctrine on their transfers of stock to the charity. The IRS also determined that petitioners had failed to obtain and (where applicable) attach to their returns “qualified appraisals” of the donated property. See sec. 170(f)(11)(C) and (D).

While petitioners did not attach the appraisal to their returns, each of petitioners’ returns included an “appraisal summary” on Form 8283, Noncash Charitable Contributions. Petitioners relied on the fairness opinion to substantiate their charitable deduction, rather than a separate appraisal. The Court noted that in Part I of these forms, captioned “Information on Donated Property,” petitioners noted the number of Comtrad shares that each had donated. They stated that they had acquired those shares by purchase and supplied their respective cost bases for the donated shares. Gregory Sullivan, the managing director of Empire who had signed the fairness opinion issued to the ESOP trustee (who acquired the majority of Comtrad), signed the “Declaration of Appraiser” on each Form 8283. Saul Wadowski, an officer of JCF, signed the “Donee Acknowledgment” on each form, which listed December 5, 2012, as the date on which JCF had received the donated stock.

The IRS selected all of petitioners’ returns for examination and requested that they supply qualified appraisals to substantiate their claimed deductions. In response, each petitioner supplied a copy of the report that Empire had prepared for the ESOP trustee. The IRS issued notices of deficiency to all petitioners, determining that they were liable for tax under the anticipatory assignment of income doctrine on their transfers of shares to JCF. The IRS also disallowed, in full, the claimed charitable contribution deductions for failure to satisfy the requirements of section 170(f)(11). Finally, the IRS determined that petitioners were liable for 20% accuracy-related penalties under section 6662(a) and, in the alternative, 40% “gross valuation misstatement” penalties under section 6662(h).

Petitioners timely petitioned this Court for redetermination. On February 1, 2017, the Court consolidated the 11 cases for purposes of trial, briefing, and opinion. On March 8, 2018, respondent filed his motion for partial summary judgment. Petitioners filed their cross-motion one week later.

Issues: Whether to grant summary judgment to the Service. Taxpayer/petitioners?

Held: The Court did not enter summary judgment for either party.

The Court reiterated when and why summary judgment is considered and granted. “The purpose of summary judgment is to expedite litigation and avoid costly, time-consuming, and unnecessary trials. Fla. Peach Corp. v. Commissioner, 90 T.C. 678, 681 (1988). Under Rule 121(b), we may grant summary judgment when there is no genuine dispute as to any material fact and a decision may be rendered as a matter of law. Sundstrand Corp. v. Commissioner, 98 T.C. 518, 520 (1992), aff’d, 17 F.3d 965 (7th Cir. 1994). In deciding whether to grant summary judgment, we construe factual materials and inferences drawn from them in the light most favorable to the nonmoving party. Id.; see Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 255 (1986). However, the nonmoving party may not rest upon the mere allegations or denials in his pleadings, but instead must set forth specific facts showing that there is a genuine dispute for trial. Rule 121(d); see Sundstrand Corp., 98 T.C. at 520.”

Here, the Court addressed two concerns: first, whether Empire was a qualified appraiser and prepared a qualified appraisal—the decision discusses timing and content concerns that raised this concern—and second, whether petitioners had reasonable cause for not attaching the appraisal.

Here, petitioners argued that while it may not have strictly or substantially complied with the regulatory reporting requirements, they argued that the haven in section 170(f)(11)(A)(ii)(II) was available to them. That provision excuses failure to satisfy the reporting requirements discussed above if it is shown that such failure “is due to reasonable cause and not to willful neglect.”  Petitioners allege that their 2012 returns were prepared by an experienced CPA, that they supplied the CPA with the Empire report and all relevant information about the Comtrad stock acquisition, and that the CPA did not direct any of petitioners to include a copy of the Empire report with their returns.

The Court noted that the record “as it stands now, is silent concerning the advice (if any) that the CPA provided petitioners regarding the Empire report and whether they relied in good faith on whatever advice she may have supplied. For these reasons, we conclude that petitioners’ ability to rely on the “reasonable cause” defense of section 170(f)(11)(A)(ii)(II) presents genuine disputes of material fact that are not susceptible to resolution by summary judgment.”

Barring settlement, these cases will need to go to trial on the assignment of income issue and on petitioners’ entitlement to the “reasonable cause” defense. Under these circumstances, the Court deemed it prudent, for two reasons, to deny in their entirety both pending motions for partial summary judgment. First, if petitioners prevail on the “reasonable cause” defense, it will be unnecessary for the Court to decide whether they substantially complied with the appraisal reporting requirements.

Second, there could be some factual overlap between the two sets of issues. During trial of the assignment of income issue, the Court will need to determine (among other things) whether the prospective acquisition of Comtrad’s stock was a mere expectation or a virtual certainty. The resolution of that factual question could affect whether petitioners substantially complied (or had reasonable cause for failing to comply) with the appraisal reporting requirements. That might be so (for example) if petitioners contend that they did not need to get an appraisal at all or were advised that they did not need to get an appraisal because the value of the Comtrad stock was fixed at $4,500 per share by an offer from SDI that was certain to close.

This 26-page decision is readily available to QuickRead readers here.

3. Gill v. Gill, Minnesota Supreme Court, Case No. A16-1421 (October 24, 2018)

Facts: The facts are as follows.

While married to respondent Gretchen Zwakman Gill (Gretchen), appellant Francis Stephen Gill (Stephen) purchased an ownership interest in a company. Stephen later sought a dissolution of marriage. After the district court’s valuation date for marital property but before the dissolution, Stephen and the other owners of the company sold the company and their ownership interests in that company. The purchase agreement gave the company and its owners the right to receive () an up-front payment of $180 million and 2) two potential future earn-out payments, ranging from $0 to $170 million in value.

The parties dispute whether the earn-out payments are marital or nonmarital property. The district court concluded that the earn-out payments are nonmarital property because they are property acquired by a spouse after the valuation date. See Minn. Stat. § 518.003, subd. 3b. The court of appeals reversed. Because the parties’ interest in the company was marital property that was acquired before the valuation date, the consideration for the sale of the company, which occurred before the dissolution and included an amount paid at the time of the sale and a contractual right to receive future amounts, is also marital property.

Issue: Whether future contingent payments in an earn-out are considered marital or non-marital property.

Held: The Minnesota Supreme Court issued a split decision here and held that the earn-out was marital property under Minnesota law. When marital property is sold after the district court’s valuation date but before the dissolution of marriage, and the consideration for the sale is an amount paid at the time of the sale plus the contractual right to receive future amounts, all of the consideration is classified as marital property.

Roberto H Castro, JD, MST, MBA, CVA, CPVA, CMEA, BCMHV, is an appraiser of closely held businesses, machinery, and equipment, and Managing Member of Central Washington Appraisal, Economics & Forensics, LLC. Mr. Castro is also an attorney with a focus on tax, wills and trusts, business law, and succession planning with offices in E. Wenatchee and Chelan, WA. Mr. Castro is also Technical Editor of QuickRead and writes case law columns for The Value Examiner.

Mr. Castro can be contacted at (509) 679-3668 or by e-mail to rcastro@cwa-appraisal.com, rcastro@rcastrolaw.com, or rcastro@cwa-appraisal.com.