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Setty Gundanna Viralam et ux. v. Commissioner
[A Case Model]
By Children’s Home Society of Florida Foundation
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.
Assessment
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.
Conclusion
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Filed under: "Advisors Only", "Doctors Only", Estate Planning, Experts Invited, Retirement and Benefits | Tagged: charitable deduction, Conner & Winters, donor advised funds, Dr. Viralam, gift tax, IRS Publication 78, Marcinko, Sec. 170(f)(8), Setty Gundanna Viralam, Xelan Foundation |
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Estate State Charitable Deduction Permitted
In Estate of Antonio J. Palumbo et al. v. United States; No. 2:10-cv-00760 (8 Mar 2011), the District Court upheld a charitable deduction for a bequest to a testamentary trust.
Decedent Antonio Palumbo had created multiple wills during his lifetime. His last will and testament was executed July 6, 1999 and he passed away in 2001.
His previous wills had transferred the residuary estate to a charitable trust. However, the 1999 will included no residuary provision. In the view of the court, this was “due to a scrivener’s error on the part of Mr. Palumbo’s attorney.”
Because there was no residuary provision, a negotiation ensued between Mr. Palumbo’s son, who was a beneficiary under the will, and the trustees of the charitable trusts as stated in previous wills. Following extensive negotiations, the Pennsylvania Court of Common Pleas determined that the son would receive $5,600,000 and certain real property. The balance of $11,721,141 was transferred to the charitable trust.
The estate filed Form 706 and reported the charitable trust payment as a Sec. 2055 charitable deduction. The IRS audited the estate and denied the deduction because it was a settlement payment and not a charitable transfer mandated under the will.
The court reviewed the facts and noted that Sec. 2055(a)(3) permits a charitable deduction for transfers to a trust that complies with basic requirements concerning charitable purpose and benefit. The decedent had clearly shown in multiple documents his intent to transfer the estate residue to a charitable trust. While the IRS maintained that other cases indicated the Sec. 2055 statute should be strictly interpreted, the court noted that the Palumbo estate was in excess of $16 million. Under the estate documents, there was a large sum available and uncertainty as to how it should be distributed.
Because of the obvious scrivener’s error, the normal “four corners of the document” principle for construction of a will was subject to an exception. The Pennsylvania Court normally excludes collateral evidence or documents. However, given the nature of the error, the court permitted examination of previous wills to determine the decendent’s intent.
In addition, the negotiations were clearly arms-length. The estate division between the son and the charitable trust was therefore a reliable representation of their respective legal interests. Because the decedent had clearly established donative intent and the charitable trust had a basis under Pennsylvania law for claiming a portion of the estate, the Sec. 2055 charitable estate deduction was qualified.
Source; Children’s Home Society of Florida Foundation
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Massachusetts House Votes To Repeal Gift Ban
On Doctor Gifts – For the third time in two years, the Massachusetts House of Representatives has voted to repeal a controversial law that bans drug and device makers from giving gifts to doctors.
The latest effort, however, goes further than the previous two tries: the House also agreed to repeal a disclosure rule that requires all financial arrangements between drug and device makers with prescribers is posted on a website maintained by the state Department of Public Health.
Comments?
Enoch
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Rich Pass On Tax-Free Gifting
Only a small percentage of clients have taken advantage of the individual $5 million gift-tax exemption, which is set to drop to $1 million on January 1, 2013.
http://www.fa-mag.com/pw-mag/pw-news/11603-rich-pass-on-tax-free-gifting.html
And, what about doctors?
Carmine
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