June 27, 2002 | Read Time: 3 minutes
The U.S. Tax Court, in a pair of rulings, has disallowed donors’ charitable deductions because the receipts the nonprofit group gave the donors were incorrect. The rulings, charity experts say, could have broad implications, causing some donors to become wary about making gifts.
In the first case it decided, the court ruled that Charles H. and Cindi Addis were not entitled to any deduction for two $36,000 contributions they made in 1997 and 1998 to the National Heritage Foundation because the organization did not estimate the value of the benefits the couple received in exchange for their donation. The foundation’s receipt read, “In accordance with Internal Revenue Service regulations, the National Heritage Foundation did not provide any goods or services to the donor in return for the contribution.”
The case dealt with a controversial giving technique that was effectively abolished by a 1999 law. It involves premiums paid into a trust as part of a so-called charitable split-dollar plan. Under such plans, the insurance trust buys a cash-value life-insurance policy on the donor, and the trust arranges to pay a small part of the policy’s annual premium. The charity designated as a beneficiary of the plan pays most of the premium.
In this case, the Addises arranged to buy a life-insurance policy on Cindi Addis through a family trust and split the benefits with the National Heritage Foundation. Upon her death, Mr. Addis was to receive $434,509; the foundation would have received $557,380. For two years, the Addises paid $4,000 of the $40,000 annual premium for the policy. Each year, National Heritage paid the remaining $36,000 — the amount of the couple’s charitable donations to the group.
The IRS denied the deductions, saying the couple violated a federal law that bars people from deducting as a charitable gift money they have paid in exchange for goods or services. The Addises said they did not violate the law because the charity was not required to spend the donated money on the insurance policy and could have spent it on something else.
The court agreed with the IRS. Although the couple made it appear that they made an outright gift, “they expected, and they told NHF they expected, NHF to use their contributions for both their and NHF’s benefit,” the court said in its opinion (Charles H. Addis and Cindi Addis v. Commissioner of Internal Revenue, 118 T.C. 32). In a second case involving the National Heritage Foundation — Gary L. Weiner v. Commissioner of Internal Revenue — the court applied similar reasoning.
Although most observers anticipated that the court would rule against the donors in the cases, the way the court reached its decisions raises questions about whether the IRS will begin more strictly enforcing the rules on receipts in the future, says J.J. MacNab, a Bethesda, Md., consultant who specializes in planned giving and tax planning. “If a charity doesn’t make that best-guess estimate on receipting, could that kill an entire deduction?” she asked.
Marc Owens, a Washington lawyer who used to head the IRS’s Exempt Organizations Division, says the court rulings could also affect donor-advised funds.
Donors who set up such funds can give cash, stock, or other assets, claim a charitable deduction on their federal income-tax returns, and then recommend how the money in the funds should be distributed to charities.
In a rationale similar to that of the Addises, donors claim a deduction at the time they put money into donor-advised funds because the charities that oversee such funds are “expected” but not “required” to spend the money on the charities the donors select. But since the court rejected that distinction in the Addis case, “it’s certainly suggesting some hostility to the notion of a donor-advised fund,” Mr. Owens said.
