Monday March 8, 2021
Stress-Free Tax Filing Tips
- Keep Good Records — Taxpayers should gather their records. A key to easy tax filing is maintaining good records. These records enable taxpayers to take appropriate deductions and receive credits.
- Use IRS.gov — The IRS website is available around the clock. It is often the fastest way to obtain assistance from the Service. You can use IRS.gov to file your tax returns, pay taxes, receive information about your returns or find answers to various tax questions. The IRS Services Guide on the website explains the best ways to obtain assistance from the IRS.
- Use Helpful Online Tools — IRS.gov includes a wealth of helpful tools. The Interactive Tax Assistant provides quick answers to many tax questions. The IRS has upgraded this tool and it generally provides the same answers that would be available over the phone.
- Use a Reputable Preparer — Over half of taxpayers use a CPA, attorney, enrolled agent or other preparer. You can go to IRS.gov/chooseataxpro to find many qualified preparers. The IRS Directory of Federal Tax Return Preparers also lists professionals along with their credentials for filing returns.
- File Electronic Returns — The IRS Free File program can help you calculate your earned income tax credit, child and dependent care credit and recovery rebate credit. MilTax online software is available for members of the military and certain Department of Defense veterans. There are also Free File options available in Spanish.
- Use Direct Deposit — By filing an electronic return and choosing direct deposit, you can ensure both an accurate tax return and a rapid refund.
- Report All Income — Income from all sources is taxable. This includes your IRS Forms W-2, Wage and Tax Statements, IRS Forms 1099, gig economy income, tips and other income. All income from any source must be reported. This is true even if you do not receive a formal statement for that income.
- Report Unemployment Benefits — If you received unemployment benefits during 2020 (as did tens of millions of Americans due to the pandemic), this is reportable as taxable income on IRS Form 1040.
- Review to Avoid Errors — Take extra time to review your tax return. Any taxpayer can understand the basic income, deductions and tax amounts. It is important that you file a complete and accurate return. An electronic filing is generally the most accurate way to eliminate clerical or math errors. Make certain names and Social Security numbers are correct. You should double check your bank account and routing numbers to ensure direct deposit of your refund.
Donor Advised Fund (DAF) Victory
In Emily Fairbairn et al. v. Fidelity Investments Charitable Gift Fund; No. 3:18-cv-04881, the District Court determined that the Fidelity Investments Charitable Gift Fund (Fidelity Charitable) was not liable for negligence in the sale of a large block of stock transferred to a donor advised fund (DAF).
Malcolm and Emily Fairbairn managed a successful hedge fund. They had substantial compensation earned offshore and were required to repatriate and report income from the funds in 2017. Their income for 2017 was approximately $250 million.
The Fairbairns decided to make a large charitable gift to reduce their income tax. They owned stock in a company named Energous, which trades under the name WATT on the NASDAQ exchange. They had acquired the stock for $3 to $12 per share.
While they considered a family foundation, they preferred the simplicity of a donor advised fund. Previously, they had made a gift of $10 million to the J.P. Morgan Donor Advised Fund and $20 million to the Fidelity Charitable Donor Advised Fund. They used donated funds to support Lyme disease research.
On December 20, 2017, the FCC approved some of Energous' technology and the stock dramatically increased in value. On December 26, 2017, the FCC approval was made public. The Fairbairns transferred 1.93 million shares of Energous stock to Fidelity Charitable. On December 29, 2017, Fidelity Charitable sold the 1.93 million shares for approximately $22 per share. The stock traded at over $22 on December 27 and 28, 2017, but had declined to $5 by February of 2021.
The Fairbairns claimed that Fidelity Charitable violated promises made by Representative Justin Kunz. The Fairbairn's claimed that Fidelity Charitable agreed not to sell more than 10% of the daily trading volume, it would employ sophisticated methods for liquidating a large block of stock, permit the Fairbairns to advise on a price limit and not liquidate the Energous shares until the next year. They brought suit against Fidelity Charitable for common law misrepresentation, breach of contract, promissory estoppel and violating the California unfair competition law.
Kunz noted that "typically" Fidelity Charitable would sell no more than 10% of the daily trading volume. This was a policy, but not a binding commitment. The 1.93 million shares sold on December 29 represented 6.7% of the daily trading volume, but was 15.3% of the participation rate during the approximate three hours required for the sale.
The Fairbairns claimed Fidelity did not use sophisticated methods for trading a large block. However, there was no specific promise to use different methods. Fidelity did use volume–weighted average price algorithms for the trade.
While Kunz did indicate that they could consult with donors on sale of assets, there was no written record to show a promise by Kunz to the Fairbairns. The written policy of Fidelity Charitable is to promptly sell any appreciated property transferred to a donor advised fund. Therefore, there was no evidence of a specific promise to grant the Fairbairns the ability to contest the sale.
Finally, the claim by the Fairbairns that Fidelity was negligent was rejected. The Fairbairns claimed the sale should have been spread out over several days, rather than completed on December 29, 2017.
The Fidelity Charitable Policy Guideline Program Circular states: "Fidelity Charitable processes contributions periodically throughout the day and will liquidate contributions as quickly as possible after all the requisite paperwork has been received, and after the assets have been received in good order."
The taxpayers obtained testimony from securities expert, Dr. Domowitz. He indicated that there was no industry standard for an acceptable participation rate and the 15.3% rate was therefore not a violation of any sale method. Because the trading of Energous had historically been 300,000 shares per day, the sale of 1.93 million shares on a day when 25 million shares were traded was unusual. While Fidelity Charitable did have four tranches for the sale, this was not explicitly prohibited.
The court noted that Fidelity Charitable was not a financial representative of the donors. Therefore, it did not have the specific duties that a financial representative would have with respect to a client. Finally, Fidelity Charitable owned the assets outright (as stated in the donor advised fund agreement). The court did not specify the duty of care owed by a DAF custodian to a donor, but determined that the actions of Fidelity Charitable did not violate the standard of care for a DAF custodian.
Editor's Note: DAFs are growing rapidly. Most nonprofits that maintain DAFs have a prompt sale policy for both stock and real estate. The court did not specify the exact nature of the duty of care owed to a donor. Most DAF custodians will follow a "sale within a reasonable time period" policy for both securities and real estate. It is good practice to discuss the sale with the donors. This is particularly important if the assets are volatile and could change rapidly in price.
Deductions Denied Due to Failure to Attach Appraisals
In Duane Pankratz v. Commissioner; No. 21255-13; No. 27239-13; T.C. Memo. 2021-26, the Tax Court denied charitable deductions for substantial gifts due to failure to attach appraisals to the tax returns.
Dr. Duane Pankratz was a veterinarian in the Midwest. While teaching at Iowa State University, he developed a vaccine for a virus that affects animals. Dr. Pankratz organized Grand Laboratories, Inc. and acquired multiple laboratories to produce and market the vaccine. In 2002, he sold Grand Labs to Novartis for $85 million.
Dr. Pankratz returned to his native South Dakota and acquired multiple small businesses in the western part of the state. He hired accountant Jim Horning to manage the financial affairs of many of the businesses. Horning was not a CPA, attorney or enrolled agent, but had a background in accounting and managed many of the financial affairs of the Pankratz businesses.
In 2008, Pankratz donated interests in four oil and gas projects to Missionary Church, Inc. He also gave 5.78 acres of land to Rapid City, South Dakota. He did not obtain an appraisal of either property.
In 2009, he donated a conference center to a qualified nonprofit named Keystone Project, Inc. He sought to have certified general appraiser Ron Rossknecht complete the appraisal. However, Rossknecht felt that the conference center was quite complex and that he could not complete the appraisal based on the Uniform Standards of Professional Appraisal Practice (USPAP).
Pankratz did not attempt to obtain another appraisal, but simply deducted the cost of the conference center on his tax return. The Pankratz tax returns were prepared by CPA Blaine Meier. Meier would normally meet with clients in a face–to–face meeting to discuss the tax returns. However, Pankratz had a practice of giving information to accountant Jim Horning, and that information then was transferred to Meier. Meier did not normally have personal direct contact with Pankratz.
Horning visited with Meier and used his software to enter the information for IRS Form 8283, Noncash Charitable Contributions for tax years 2008 and 2009. Pankratz and Horning discussed the gifts, but did not obtain appraisals.
The IRS audited Pankratz and assessed deficiencies and penalties over $10 million for 2008 and 2009. The issues were largely resolved with the exception of the charitable deductions and the penalties.
Pankratz acknowledged that he did not file an appraisal with his 2008 tax return. Under Reg. 1.170A–13(e)(1) and (2), a taxpayer claiming a charitable deduction over $500,000 must attach the qualified appraisal to his return. However, under Section 170(f)(11)(A), a deduction may still be granted if the failure to meet the requirements is "due to reasonable cause and not to willful neglect."
The Tax Court analyzed whether Pankratz could qualify under the reasonable cause exception. This exception requires that the taxpayer be advised by a competent tax advisor with sufficient expertise, that the taxpayer provides necessary and accurate information to the advisor and that he or she relies in good faith on the professional advice.
While CPA Meier was a competent tax advisor, accountant Jim Horning was not deemed to be a competent tax advisor. He is not a CPA, or attorney, and is not a full-time tax preparer. Pankratz did provide the necessary information to Meier, but Meier told Horning that there needed to be an appraisal and Pankratz did not rely on this advice.
In addition, Pankratz was a veterinarian with a doctorate degree. He also was a skilled businessman who built a business that sold for $85 million. He had multiple investments and therefore was expected to have reasonable knowledge about tax and financial matters. Therefore, he did not qualify for the reasonable cause exception.
With respect to the 2009 gifts to Keystone Project, Inc., the taxpayer did not obtain an appraisal from a second appraiser. Because the taxpayer had discussions with appraiser Rossknecht, the reasonable cause exception also does not apply.
Because Pankratz did not have reasonable cause for omitting the appraisals and did not take CPA Meier's advice to obtain appraisals, he is subject to the penalties.
Applicable Federal Rate of 0.8% for March -- Rev. Rul. 2021-5; 2021-10 IRB 1 (16 February 2021)
The IRS has announced the Applicable Federal Rate (AFR) for March of 2021. The AFR under Section 7520 for the month of March is 0.8%. The rates for February of 0.6% or January of 0.6% also may be used. The highest AFR is beneficial for charitable deductions of remainder interests. The lowest AFR is best for lead trusts and life estate reserved agreements. With a gift annuity, if the annuitant desires greater tax-free payments the lowest AFR is preferable. During 2021, pooled income funds in existence less than three tax years must use a 2.2% deemed rate of return.