In recent years the IRS has seen its budget slashed by Congress—which has led to a 23 percent reduction in the IRS’s workforce, scaled back employee training and delays in much-needed upgrades to information technology systems. At the same time, the IRS has seen its workloads increasing with the enactment of the Affordable Care Act, changes in tax laws and the general increases in the numbers of taxpayer forms filed each year. Being forced to do more with less has led to some interesting unintended consequences.
Case in point: charitable deductions for property donated to thrift organizations such as Goodwill and the Salvation Army. Historically, the IRS would challenge a taxpayer’s valuation of the property donated. However, this process required the IRS to use an independent appraiser to assert that the taxpayer’s valuation was inflated. With no funding to pay independent appraisers, the IRS has been forced to change tactics and now takes the less expensive approach of challenging the substantiation of the deduction altogether—which can lead to disallowance of the entire deduction.
For example, in a recent case before the Tax Court, Payne v. Comm’r, TC Summary Opinion 2016-30, married taxpayers had claimed noncash charitable deductions of $169,000 for the donation of property to thrift stores over the course of two years when their combined earnings for the same time period was roughly $300,000—meaning that the taxpayers had donated property worth nearly half of their earnings to charity for two years. In past years, the IRS likely would have challenged the valuation of the property, but in this case the Tax Court was not faced with looking to valuation, only substantiation. Because of the taxpayers’ poor record-keeping, the Court found they had not substantiated their deductions as required, and disallowed them in full. Further, the Court affirmed the 20 percent accuracy-related penalties amounting to another nearly $10,000 assessed by the IRS under Section 6662(a) of the Code.
This change in tactics means that taxpayers are losing the entire value of the charitable deduction claimed, rather than just seeing the amount of the deduction reduced (usually to a point somewhere between what the taxpayer claimed and what the IRS believed was reasonable historically). Further, this shift in tactics is leading to more successful rates of enforcement given that many taxpayers are terrible about keeping records of their donations and the substantiation requirements are unforgivingly specific and complex.
The take away is that the IRS’s new trend of challenging deductions for lack of substantiation has made accurate record-keeping more important than ever in order to avoid the Payne of losing deductions and paying penalties for charitable property donations. For more information on the substantiation requirements, see our previous blog post here.