On March 15, 2023, the Tax Court decided an anticipatory assignment of income case and disallowed a charitable deduction for a gift of stock to a donor-advised fund. Estate of Scott M. Hoensheid et al. v. Commissioner, TC Memo 2023-34. Although it is not completely surprising that the Court found the contribution of stock to be an anticipatory assignment of income based on the facts of the case, the opinion is instructive in that it identifies the factors the Court will consider in determining whether an assignment of income transaction has occurred. Note: The Donor, Scott Hoensheid, died while the case was pending so his estate was substituted as the taxpayer.
The Donor, who was the president and one of only three shareholders in his family-owned company, Commercial Steel Treating Corporation (the “Company”), was preparing to retire at the time of the transaction. He, along with his two brothers, decided that instead of having the Company redeem his shares of stock, they would sell the entire Company to a third-party buyer, HCI Equity Partners (“HCI”). The Donor also decided that he wanted to make a charitable contribution of a portion of his shares to a DAF at Fidelity Charitable. Although his lawyer and Fidelity Charitable each told him that he had to make the donation before there was a definitive purchase agreement in place, the Donor wanted to wait as long as possible before making the contribution so that he would not end up a minority owner of the family business if the sale fell through.
On June 11, 2015, the Company held its annual shareholders meeting at which the Donor and his two brothers were present and unanimously approved the Donor’s request to ratify the sale of all outstanding stock of the Company to HCI. The Donor’s brothers also unanimously approved the Donor’s request to transfer a portion of his stock to Fidelity Charitable and executed a Consent to Assignment Agreement to that effect.
On July 1, 2015, HCI prepared and circulated an initial draft of a Minority Stock Purchase Agreement for a purchase of shares from Fidelity Charitable. The draft Minority Stock Purchase Agreement included a clause appointing the Donor as Fidelity Charitable’s representative with authority to accept delivery of, on behalf of the Fidelity Charitable, all documents deemed necessary to consummate the agreement, and to endorse and to deliver on behalf of Fidelity Charitable certificates representing the shares. Fidelity Charitable noted their concern with this clause as well as the fact that the shares had not yet been transferred to Fidelity. The final version of the agreement included the share contribution provision, which specified that the Donor had transferred 1,380 shares to Fidelity Charitable on “July 10, 2015.”
On November 18, 2015, Fidelity Charitable sent the Donor a confirmation letter acknowledging his charitable contribution of 1,380 shares of the Company’s stock on June 11, 2015. The letter also stated that Fidelity Charitable had exclusive legal control over the contributed assets, and that the contribution was irrevocable and could not be refunded.
A subsequent appraisal determined that the 1,380 shares of Company stock had a value of $3,282,511 as of June 11, 2015. This was $340,545 higher than the actual proceeds Fidelity Charitable received from the sale of those shares to HCI on July 15, 2015. The appraisal attached a final version of the Minority Stock Purchase Agreement, which included an amended clause appointing the Donor’s lawyer as Fidelity’s representative.
Upon examination of the Donor’s 2015 tax return, the IRS proposed to disallow his charitable contribution deduction and to assess a deficiency penalty of $647,489 resulting from the disallowance of the claimed charitable contribution deduction, and a penalty of $129,498 under section 6662(a) for understatement of tax.
At trial, the Donor and the IRS each advanced different dates for when the gift of the Company’s shares was made to Fidelity Charitable. The Donor asserted that a gift was made on June 11, 2015, while the IRS claimed that a valid gift was not made until at least July 13, 2015, when Fidelity Charitable first received a stock certificate from the Donor’s representative.
In reviewing the details of the transaction, the Court found that, on July 6, 2015, the Donor stated in an email that he was still “not totally sure of the shares being transferred to the charitable fund yet.” Thus, the Court found that as of July 6, the details of the contribution were still unclear. In fact, the Court stated that the record did not support a finding of present intent to make a gift until July 9, 2015, when the Donor settled on a number of 1,380 shares. From that point on, the Donor took several actions that confirmed his present intent to transfer his stock and on July 9th or 10th delivered the physical stock certificate to his lawyer’s office.
Accordingly, the Court found that, as of July 9, 2015, the Donor had present intent to make a gift. However, because his lawyer held the stock certificate at that time, the Donor retained dominion and control over the stock and delivery of the shares did not occur before July 13, 2015. Despite the fact that Fidelity’s contribution confirmation letter and year-end account statement each indicated that the shares were contributed on June 11, 2015, the Court concluded that the Donor had failed to establish that any of the elements of a valid gift was present on June 11, 2015. Thus, it held that the gift was not completed until July 13, 2015.
In reviewing the anticipatory assignment of income issue, the Court noted that a donor’s right to income from shares of stock is fixed if a transaction involving those shares has become “practically certain to occur” by the time of the gift, “despite the remote and hypothetical possibility of abandonment.” To determine whether the sale of the Donor’s shares was virtually certain to occur at the time of the gift, the relevant factors the Court considered were (1) any legal obligation to sell by the donee, (2) the actions already taken by the parties to effect the transaction, (3) the remaining unresolved transactional contingencies, and (4) the status of the corporate formalities required to finalize the transaction.
Although the Court concluded that the IRS did not establish that Fidelity Charitable had any legal obligation to sell the shares, it noted that as of July 13, 2015, a number of acts had already taken place that suggested the transaction was a virtual certainty. For example, one week before the gift, HCI had caused the incorporation of a new holding company to acquire the Company’s shares. Three days before the gift, the Company had amended its Articles of Incorporation to allow for written shareholder consent, an action requested by HCI. Most significantly, however, it found that certain cash sweeping actions taken by the Company strongly suggested that the transaction with HCI was a virtual certainty before the gift was made on July 13. In fact, the Court thought it highly improbable that the Donor and his two brothers would have drained the Company of its working capital if the transaction had even a small risk of not being consummated. Moreover, certain employee compensation and excess real estate issues appear to have been resolved in drafts of the agreement prepared before July 13, 2015. Even though formal shareholder approval of a transaction is often thought to be sufficient to demonstrate that a right to income from shares was fixed before a subsequent transfer, the Court noted that such approval is not necessary for a right to income to be fixed when other actions taken establish that a transaction was virtually certain to occur.
Thus, the Court found that on June 11, 2015, the Donor and his two brothers (the sole shareholders of the Company) unanimously approved pursuing a sale of all outstanding Company stock to HCI. Although written consent to the final Contribution and Stock Purchase Agreement was not provided until July 15, 2015, the record showed that final written consent was a foregone conclusion. Thus, the Donor was required to recognize gain on the sale of the 1,380 appreciated shares of the Company’s stock.
Even though the gift was considered an assignment of income, the Court concluded that the Donor may still be entitled to a charitable contribution deduction because he had, in fact, made a gift of the shares. Nevertheless, to be entitled to a charitable contribution deduction, the Donor must have substantiated the claimed deduction with both a contemporaneous written acknowledgement (“CWA”) and a qualified appraisal. The IRS claimed that Fidelity’s contribution confirmation letter failed to satisfy the statutory CWA requirements because it described the Donor’s contribution as “shares of stock” rather than cash. The Court dismissed this argument because it found that even though the shares had a fixed right to income, the Donor had still made a valid gift of stock on which he subsequently was required to recognize income. Thus, the CWA provided by Fidelity Charitable correctly described the contributed property as shares of stock and met the statutory requirements.
Nevertheless, the Court found that the Donor’s appraisal failed to meet the substantive requirements to be considered a qualified appraisal. In particular, the Court found that the Donor’s appraiser was not a qualified appraiser because he did not regularly perform appraisals. Moreover, the appraisal did not sufficiently describe the appraiser’s qualifications and valuation experience and the appraisal used an incorrect date of contribution.
Finally, with respect to the IRS’s claim for an accuracy related penalty for an understatement of tax, the Court concluded that the Donor had reasonable cause for his underpayment of tax because he relied on appropriate professionals to advise him. Accordingly, he was not liable for this penalty.
Based on the above, the Court found that the Donor: (1) made a valid gift of the Company’s shares on July 13, 2015, (2) realized and recognized gain because his right to proceeds from the sale became fixed before the gift, (3) was not entitled to a charitable contribution deduction, and (4) was not liable for a section 6662(a) penalty.
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