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Why a Physician’s Charitable Contribution was Denied

Setty Gundanna Viralam et ux. v. Commissioner [A Case Model]

By Children’s Home Society of Florida Foundation

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In Setty Gundanna Viralam et ux. v. Commissioner; 136 T.C. No. 8; No. 21355-03 (13 Feb 2011), the Tax Court denied a deduction for a charitable gift to an organization maintaining donor advised funds for doctors. In addition to not receiving the charitable deduction, the doctor was subject to capital gains tax on sale of the stock and an accuracy-related penalty.

Physician Example

Dr. Viralam is a medical practitioner. In 1998, Dr. Viralam sold his 50% interest in a medical practice for $2,262,500, producing a taxable gain of $2,261,750. Dr. Viralam had joined a membership organization of doctors named Xelan. He paid a $975 membership fee for the “Xelan tax reduction plan.”

Xelan Foundation

Based upon promotional materials that promised “a tax reduction” program, Dr. Viralam transferred appreciated stock to the Xelan Foundation (“Foundation”) in 1998. The Foundation indicated that Dr. Viralam could create an account described variously as a “donor advised fund” or “family public charity.” The fund was available for “charitable giving, income tax reduction planning, estate tax reduction, educational funding and future retirement planning.”

The Xelan Foundation had been recognized by the IRS as a public charity and was included in IRS Publication 78. In addition, the Foundation had obtained an opinion letter from the Conner & Winters law firm on deductibility of gifts. In their opinion letter, Conner & Winters suggested that gifts to the Foundation were more likely than not to be deductible. However, the opinion letter declined to issue an opinion on the specific grants or educational programs of the Foundation donor advised funds.

The Gifting Mechanism

Following Dr. Viralam’s gift of stock with fair market value of $262,433 and cost basis of $131,360, the Foundation sold the gifted stock and provided him with a receipt. The receipt included the Sec. 170(f)(8) statement that “no goods or services” were transferred in exchange for the gift.

At the recommendation of Dr. Viralam, the Foundation accountant distributed $15,500 to religious organizations for the next two years. However, his Foundation account also made distributions to the University of Pennsylvania of $70,299. Dr. Viralam’s son Vinay was at that time a student at that university. The IRS audited Dr. Viralam and issued a notice of deficiency for 1998. The IRS denied the charitable deduction, assessed a tax on the sale of the appreciated stock by Xelan Corporation and also accessed an accuracy-related penalty under Sec. 6662.

The Court and IRS Opines

The court noted that under Sec. 170(c)(2), a charitable contribution is permitted if it is given to “a foundation organized and operated exclusively for charitable or educational purposes.”

The IRS claimed that the supposed “student loan” to Vinay showed that Dr. Viralam had “never surrendered dominion and control” over the fund. When Dr. Viralam created the fund in 1998, he anticipated that his three children would receive most of the fund for their college expenses. The initial distributions for the benefit of Vinay were made and “the Foundation’s approval of petitioner’s son as a student loan beneficiary was perfunctory.”
While it was true that the Foundation had been granted exempt status and was listed in Publication 78, the issue of the operation exclusively for the benefit of charitable purposes remained. Even though the purported donor advised fund was supposedly for charitable purposes, the facts indicated that Dr. Viralam had retained dominion and control.

The Sec. 170(f)(8)(A) receipt issued by Xelan Foundation indicated that there were no “goods or services” provided in consideration of the gift. However, the “student loans” were clearly within the regulatory definition of “cash, property, services, benefits and privileges.” Because the student loans were contemplated as part of the fund benefits, the gift failed the “no goods or services” test. Under Sec. 170(f)(8), there is “no deduction” if that test is failed.


Because there was no charitable deduction, Dr. Viralam is also taxable on the long-term capital gain produced by sale of the stock in 1998. In addition, the penalty under Sec. 6662 applied. Dr. Viralam pointed to the legal opinion by the law firm Connor & Winters. However, that legal opinion explicitly excepted a potential student loan program. In the view of the court, the arrangement fails the “too good to be true” test. In the view of a reasonable person, a taxpayer should realize that this gift to provide university-level educations for children would not be deductible.


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