Monday, March 27, 2023
The True Story of a Charitable Contribution Whipsaw
Cool kids have their own slang. Words and phrases like "say less" to mean "I'm convinced, we needn't discuss it further," or "hit me up" or "holla" to mean "please return my call at your earliest convenience." I am not sure what "AF" means, but it seems to be used for emphasis. As in "Judge Nega's Tax Court Memo opinion in Hoensheid v. Commissioner is crazy AF."
Tax kids have cool slang too. One of them is the word "whipsaw," used to refer to a situation involving two taxpayers in a single transaction each taking mutually exclusive positions against the Service and both winning. An employer claiming a deduction for wages paid, while the employee excludes the money as a gift. Or a business seller allocating most of a sale price to capital assets, but buyer allocating it to inventory. The Code responds to those whipsaws in Sections 102(c) and 1060, respectively. And the Service can even make "whipsaw assessments," designed to preclude "heads I win, tails you lose." But I gotta tell you, it sure looks like the Service, with Judge Nega's intentional or unintentional wink and nod, has whipsawed a taxpayer.
Here is what happened. Three brothers decided to sell their highly appreciated stock. One of them sought the use of a familiar, if not shady tax strategy. Locate a buyer and agree in principal to sell the stock at a tentative price. In this case it was HCI, a private equity fund. Donate some of that appreciated stock worth about $3.5 million to a charity, in this case Fidelity Charity DAF. Donor get's full fair market value for the charitable contribution deduction. Meanwhile, HCI reduces the tentative price by $3.5 million (hopefully in non-obvious ways) to account for its purchase of fewer shares. The savings, of course, are set aside and later used to redeem Fidelity Charity. Other machinations are necessary but by no means insurmountable so that the sellers end up with cash and go happily along their way. The opinion, thankfully, doesn't go into the number crunching details but sure enough the bros end up with cash and lower taxes. I mean, this is some real twilight zone stuff if its done right. No tax on the appreciation, full fair market value charitable contribution deduction, and capital gains rates on the rest! It is hard out here for a rich pimp, I'll tell you that much.
Long story short, the bros did not do it right. Frankly, there should be no "right" way to do this, but there is and that's a rant for another day. Their tax lawyer actually told them how to do it several times but they didn't listen. Good thing she kept the emails and is even quoted in the opinion as saying "you would have to be crazy AF to "donate" two days before the redemption!" I am not making this up. To do this right, she explained more than once, the donation has to be real (or real enough), not an obviously intermediate step in a preplanned redemption in which the charity is merely an intermediary in a step transaction. Alas, and despite those warnings, even from Fidelity later on, HCI's redemption of Fidelity was a fait accompli well before the "donation," so that it was all a disguised sale. Andrea Kanski, the tax lawyer who advised them was heard in her office banging her head against the corner of a bookshelf and was later wheeled out in a straight jacket. That part I made up. For all intents and purposes, the ostensibly unrelated donation, stock purchase, and redemption from Fidelity might as well "coincidentally" have happened on the same day at the same time with the same people using all the same pens. The Service argued, and Judge Nega agreed that this was mere assignment of income, meaning the donated stock had already been sold to HCI, with Fidelity merely serving as a conduit to get a fair market value deduction and gain exclusion. Pigs turned into hogs and hogs got slaughtered.
None of the foregoing is surprising because it was all so clumsy. But as a matter of substance it necessarily means that the donor sold the stock for cash, triggering income, and then made a cash donation, triggering an offsetting deduction. Well, in a remarkable demonstration of whipsawing, the Service said you must recognize gain, you get no deduction and here is a penalty. And Judge Nega agreed!
Judge Nega: For tax purposes, you effectuated a sale not a donation, and then you donated cash to Fidelity. Its all deemed.
Taxpayer: Well shoot. I guess I'll just take the deemed $3.5 million charitable cash donation, that will wipe out the deemed gain on the deemed sale of stock. Its better than nothing.
Judge Nega: Not so fast fella. There's something called a 170(f)(11) qualified appraisal and you didn't get one! Maybe you oughta try listening to your tax attorney.
Taxpayer: Wait, what? You just said that in substance I donated cash, 170(f)(11) applies to property not cash.
Judge Nega: For federal tax law purposes you sold stock and donated the cash, sure enough. Substance not form fella. But for state law purposes you donated stock and stock is property. You can't just ignore an appraisal any time you damn well deem. No appraisal no deduction. Form not substance fella. Now whether you get your money back from the charity to whom you foolishly donated your amount realized when you sold the stock, and then you donated the stock you previously sold (you know what I mean, don't act dumb) is not my concern. You donated stock with no appraisal, you get no deduction. Look, I explain it right here in my opinion:
As a matter of state law, we have held that petitioners made a valid gift of [stock] to Fidelity Charitable. However, for federal income tax purposes, we have classified those shares as carrying a fixed right to income as of July 13, 2015, such that petitioners effectively realized and recognized gains before transfer. That second holding does not disturb our conclusion that petitioners made a valid gift of stock [for which a qualified appraisal is required].
Taxpayer: Wait, what kinda . . . ?!
Judge Nega: You been whipsawed, son. Crazy AF, right?
I am not making this up.