One of this publication's regular writers, and editorial board member, delves into the implications of an important legal case and the lessons it brings about charitable deductions as they operate in the US.

The following article comes from regular FWR contributor and editorial board member, Matthew Erskine, who is also managing partner of law firm Erskine & Erskine. He discusses a recent court case in the US and its implications for charities and the tax deductions that arise. 

As always, we urge readers to use these articles as stimulus for a conversation, so please comment if you have thoughts. The usual editorial disclaimers apply. Thanks to Matthew Erskine for this important contribution. To comment, email tom.burroughes@wealthbriefing.com and amanda.cheesley@clearviewpublishing.com

The recent IQ Holdings v. Commissioner decision (T.C. Memo. 2024-104) (1) serves as a cautionary tale for corporations and high net worth individuals attempting to leverage charitable deductions for tax benefits. The case underscores the critical importance of complying with IRS regulations to substantiate deductions and avoid substantial tax penalties.

Background of the IQ Holdings case
In this case, IQ Holdings, Inc (IQH) found itself in hot water with the IRS after claiming substantial deductions on its 2014 tax return. The IRS disallowed deductions for damaged inventory, charitable contributions, and net operating loss (NOL) carryforwards, resulting in a deficiency determination of nearly $2.9 million and a $622,061 accuracy-related penalty under Section 6662(a) of the Internal Revenue Code.

Charitable contribution deductions: IQH faced scrutiny for its claimed charitable deductions of equipment, property, and cash valued at over $2.9 million, donated to its affiliated non-profit, IQ Life Sciences Corp (IQLS). The IRS disallowed these deductions due to non-compliance with statutory requirements for acknowledgment and appraisal, which the court ultimately upheld.

Charitable deductions: The IRS requirements
The IQ Holdings case highlights several critical requirements that taxpayers must meet to successfully claim charitable deductions under Section 170 of the Internal Revenue Code:

1. Contemporaneous written acknowledgment:
-- For contributions of $250 or more, a donor must obtain a written acknowledgment from the charity by the earlier of the filing date or the due date of the tax return. This acknowledgment must include:
-- The amount of any cash contribution; 
-- A description (but not the value) of any non-cash property contributed; and 
-- A statement on whether the charity provided any goods or services in return for the donation, and a good faith estimate of their value if applicable.

2. Qualified appraisal for non-cash contributions:
-- For non-cash contributions exceeding $5,000, a taxpayer must obtain a qualified appraisal and attach a summary to their tax return. If the donation exceeds $500,000, a full copy of the appraisal must be submitted. 
-- IQ Holdings failed to meet these requirements, as the acknowledgment letter it received from IQLS lacked the necessary details regarding whether goods or services were provided in exchange. Additionally, IQH did not secure a qualified appraisal for property and equipment donations, which ultimately disqualified these deductions.

3. Substantial compliance doctrine:
-- IQH attempted to argue that it substantially complied with the acknowledgment requirements, contending that using the term "donation" implied that no goods or services were exchanged. However, the court rejected this argument, emphasizing that substantial compliance does not apply to statutory requirements where explicit documentation is mandated. 

The takeaway for taxpayers
The IQ Holdings decision serves as a stark reminder that the IRS maintains strict standards for charitable contribution deductions. Even minor lapses in substantiation can lead to disallowance of deductions and significant tax penalties.

Here are some practical steps to ensure compliance:
-- Secure proper acknowledgments: Ensure that all charitable contributions over $250 are documented with a contemporaneous written acknowledgment that includes all required details. The acknowledgment should explicitly confirm whether any goods or services were received in exchange.
-- Obtain qualified appraisals: For non-cash contributions over $5,000, engage a qualified appraiser and include the necessary appraisal summary with your tax return. Contributions exceeding $500,000 require the submission of the full appraisal report.
-- Document loans and forgiveness clearly: If charitable deductions involve debt forgiveness or property transfers, retain clear documentation, including loan agreements and forgiveness terms, to substantiate the gift's completion and tax deductibility.
-- Consult with professionals: Engaging tax professionals for advice and ensuring compliance with IRS regulations can serve as a defense against penalties if reasonable reliance on professional advice is demonstrated.

As the landscape of charitable giving and tax planning becomes increasingly complex, adherence to IRS requirements is not just a recommendation but a necessity to safeguard against penalties and maximize tax benefits.

Footnotes
IQ Holdings, Inc. v. Comm'r, T.C. Memo. 2024-104 (Nov. 7, 2024)