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Archive for July 31st, 2012

Back in early June, we discussed the latest in a string of cases in which the IRS successfully attacked a taxpayer’s charitable deduction for failing to properly substantiate the contribution. From our earlier write-up:

During 2004, Steve and Rory Rothman executed a conservation deed of easement to the National Architectural trust, a donee that likely doomed the taxpayers from the start. The Rothmans engaged Mitchell, Maxwell & Jackson, Inc. (MMJ) to perform the qualified appraisal supporting the contribution. (For more on the qualified appraisal rules, see here).

This is where the problem started.

In determining the value of the conservation easement, MMJ set out to perform a “before and after valuation,” a commonly accepted methodology. This required MMJ to first determine the value of the Brooklyn home without the easement, then the value of the home after the easement, with the reduction in value representing the value of the conservation easement.

In attempting to value the home with the easement, MMJ looked to a series of previous court cases that generally valued the loss in value caused by a conservation easement at 10-15% of the total value. MMJ then “backed in” to the loss in value of the Brooklyn property, multiplying the $2.6M “before” value by 11.5% to determine a value for the conservation easement of $290,000.

The IRS denied the charitable contribution deduction, and the Tax Court upheld the deduction. Relying heavily on its 2010 decision in a case with similar facts called Scheidelman – in which MMJ was also the appraiser — the Tax Court held that MMJ merely estimated the value of the conservation easement by applying a set percentage to the property’s “before” value. In both cases, this percentage was not determined through a detailed analysis of the easement’s terms and covenants relative to the specific contribution, but rather on a review of previously approved relative values of conservation easements to gross values. This, the court determined, did not constitute a valuation method approved under I.R.C. § 170 for determining the property’s “after” value, and thus the Tax Court agreed with the IRS that the appraisal failed to contain the required method of valuation.

Similarly, the court sided with the IRS that the appraisal did not include the specific basis for the valuation. While MMJ ‘s appraisal generally cited elements that may affect the value of eased properties, it never expounded upon how, if at all, the factors affected the fair market value of the encumbered Brooklyn property. Thus, the appraisal did not specifically mention what restrictions supported the proffered 11.15% reduction in value.

Four days after the Tax Court published Rothman, the Court of Appeals for the Second Circuit ruled on the taxpayers appeal in Scheidelman, holding that MMJ’s appraisal in that case did indeed satisfy the “method and basis for valuation” requirements of Section 170 [see a great write-up on the appeals court decision here.] The taxpayers in Rothman immediately filed with the Tax Court to vacate its previous decision, since Rothman would also be appealable to the Second Circuit.

In response, the Tax Court agreed to vacate the portion of Rothman concluding that the appraisal was not qualified because it lacked a valuation method and a specific basis for the underlying value. a victory for the taxpayer.

It wasn’t all good news for the Rothman taxpayers, however. Unlike the taxpayer in Scheidelman, there were initial defects in the Rothman appraisal that prevented it from meeting the definition of a qualified appraisal. From our initial post:

Citing numerous other missed appraisal requirements — for example, the appraisal was performed more than 60 days prior to the contribution – the court concluded that the appraisal was not a “qualified appraisal,” and denied the full deduction.

In reconsidering its initial decision in Rothman, the Tax Court remained steadfast in its belief that these deficiencies continue to doom the appraisal:

The cumulative effect of the defects discussed in Rothman… deprives the Internal Revenue Service of sufficient information to evaluate the deductions claimed. The appraisal describes (and values) a property right different from the one petitioners contributed, and in doing so, fails to describe the easement accurately or in sufficient detail for a person unfamiliar with the property to ascertain whether the appraised property and the contributed property were one and the same…Moreover, the appraisal values a property interest greater than the one petitioners contributed, and it applies the wrong measure of value. Against this backdrop, even when we view the appraisal in the light of the Court of Appeals’ decision in Scheidelman, we decline to conclude the appraisal is qualified…[the court originally ruled that] the appraisal failed to satisfy 10 of 15 regulatory requirements, and following reconsideration, we conclude that the appraisal still fails to satisfy 8 of 15 requirements.

So what happens now? The Rothman’s failure to meet the appraisal requirements is not deadly, because the charitable contribution deduction can still be allowed if the failure was due to reasonable cause and not to willful neglect, an issue the Tax Court must now reconsider in a future trial.

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Betty Loren-Maltese was the well-known president of a Chicago suburb before being convicted of attempting to defraud the town out of $10,000,000 in an insurance scheme, which is apparently frowned upon. 

Maltese is a free woman now, having paid her debt to society in a federal corrections facility. But that doesn’t mean the IRS is done with her; to the contrary, after Maltese was released from prison, the Service accused her of underreporting her 1994 taxable income by nearly half a million dollars in misappropriated campaign funds,assessing tax, penalties and interest on the alleged deficiency.

Typically, the IRS would be barred from assessing a deficiency after the expiration of the statute of limitations: normally three years from the due date of the return pursuant to Section 6511. The statute can be extended indefinitely, however, when any portion of the underpayment is the result of fraud. Thus, under Section 6501, if the IRS could establish that Maltese “intentionally evaded a tax that she believed was due,” it would stop the clock on the statute and allow for a collection of taxes nearly twenty years after the return was filed.

While serving as town president, Maltese was also the town’s Republican committeeman, a role that granted her access to certain campaign funds. During 1994, Maltese used the campaign funds to purchase a Cadillac and invest in a luxury golf course, with both assets held in her individual name. It is well established that once Maltese converted the campaign funds for her personal use, they became taxable income to her… but did her actions rise to the level of fraud?

When grilled about the expenditures during trial, Maltese repeatedly sought the shelter of the Fifth Amendment, refusing to testify. Below is a courtroom sketch of the proceedings:

Faced with her silence, the Tax Court was forced to look to the facts and circumstances, keeping a careful eye out for the following  “badges of fraud:”

  • inadequate records,
  • implausible or inconsistent explanations of behavior,
  • concealing assets,
  • engaging in illegal activities, and
  • attempting to conceal activities.

The Tax Court quickly determined that enough of the necessary facts were present to conclude that Maltese had fraudulently evaded her 1994 income tax.

  • She used the campaign funds to hide her expenditures.
  • She falsified campaign disclosures.
  • She tried to hide the Cadillac once she found out she was the subject of a grand jury investigation, and
  • She offered less than credible testimony with regards to the golf course investment.

As a result, Maltese is now on the hook for over $100,000 in tax, a 75% fraud penalty, and twenty years worth of interest.

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