CSG Law Alert: Time is Not on Your Side (At Least for Charitable Gifts of Appreciated Assets)

For charitably-minded taxpayers, gifting an appreciated asset can provide a double tax benefit. First, because the asset was gifted before the sale or other disposition of the asset, the taxpayer might avoid a taxable gain, and second, the taxpayer may be able to take a tax deduction for their charitable contribution. However, this strategy is not without risk – and timing is of the essence.

In Estate of Hoensheid v. Commissioner,1 one unlucky taxpayer and his spouse learned this lesson the hard way, which resulted in a taxable gain on the sale of the asset and the denial of the charitable contribution deduction.

BACKGROUND

Mr. Hoensheid and his two brothers each held one-third of the shares in a manufacturing business. When they decided to sell the business, Mr. Hoensheid consulted with his financial advisors and long-time attorney about donating some of his shares in this business to charity and made plans to donate the shares to Fidelity Charitable Gift Fund (“Fidelity”). Nervous that the sale would not occur after making the gift, Mr. Hoensheid held on to his shares for as long as possible. Further, he did not specify the number of shares he planned to donate to Fidelity until almost at the closing date of the sale of the business.

The relevant dates for the sale of the business and the gift Mr. Hoensheid made on which the IRS based its determination are as follows:2

  • June 11, 2015: The date on which the shareholders (Mr. Hoensheid and his two brothers) approved the sale.
  • July 7, 2015: Cash sweep from the business to prepare for closing, pay for employee bonuses on July 10, 2015, and for distribution to the brothers on July 14, 2015.
  • On or around July 9, 2015: Finalization of the number of shares that Mr. Hoenseheid intended to gift to Fidelity.
  • July 13, 2015: Stock certificates delivered to Fidelity Charitable for the purposes of effectuating the gift.
  • July 15, 2015: Final purchase agreement signed and approved by the business’s shareholders and directors.

No one date was dispositive in the Tax Court’s analysis. However, considering all the facts and circumstances surrounding the transaction, the Tax Court determined that the transaction had moved past the point in time where Mr. Hoensheid could avoid the assignment of income from the sale.

ANTICIPATORY ASSIGNMENT OF INCOME DOCTRINE

A fundamental concept in income tax law involves the “the anticipatory assignment of income doctrine.” Rooted in early case law, this concept provides that a taxpayer cannot shift their earning of income to avoid income tax if their right to income becomes fixed.3 A right to income becomes fixed when, “based on the realities and substance of the underlying transaction,” the receipt of income is “practically certain to occur” even if the taxpayer transfers the right before receiving the income.4

With respect to gifts to charity made before an asset is sold, taxpayers should consider whether a fixed right to income has occurred, which may not be easily discernible. To determine whether a taxpayer’s fixed right to income has occurred before making a gift of an appreciated asset, the Tax Court relies on in the Humacid test, which considers the facts and circumstances of the transaction, and the question revolves around the timing of when the gift was made in relation to the sales transaction timeline.5

To satisfy the Humacid test, “[t]he donor must (1) give the appreciated property away absolutely and divest title (2) ‘before the property gives rise to income by way of a sale.’”6

In evaluating the transaction between Mr. Hoensheid and Fidelity, the Tax Court outlined four factors it considered in determining whether the transaction satisfied the Humacid test. These factors included “(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 corporate formalities required to finalize the transaction.”7

For the first factor, the Tax Court found that because Fidelity disclaimed any obligation to sell the shares and because there was no finding of a “prearranged understanding” between Mr. Hoensheid and Fidelity to sell, this factor was against an anticipatory assignment of income.

For the second factor, the Tax Court found that the July 7, 2015 cash sweep essentially represented that the sale was virtually certain to occur and that the taxpayer’s right to income was fixed when it delivered the stock certificates to Fidelity on July 13, 2015 because the cash sweep rendered the certificates valueless.8 The Tax Court reasoned that the certificates amounted to “’hollow receptacles’ for conveying the proceeds of the transaction with HCI, ‘rather than an interest in a viable corporation.’”9 This factor was strongly in favor of Mr. Hoensheid’s fixed right to income.10

For the third factor, the Tax Court found that only minor revisions had been made to the transaction – none of which were substantial enough to constitute unresolved contingencies that would prevent the sale from closing. This factor also strongly weighed in favor of Mr. Hoensheid’s fixed right to income.11

Finally, for the fourth factor, the only remaining corporate formality needed to effectuate the sale was formal shareholder approval by written consent, which occurred on July 15, 2015. Because of the brothers’ extensive involvement through the entire transaction, the Tax Court found this act to be a foregone conclusion and determined that this approval was “all but assured as of July 13, 2015.”12 The Tax Court deemed this act ministerial, which was neutral in its analysis.

Weighing these factors, the Tax Court held that Mr. Hoensheid’s right to income was fixed as of July 13, 2015. As of this date, the transaction “had simply proceeded too far down the road to escape taxation on the gain attributable to the donated shares.”13 Regarding the anticipatory assignment of income, the Tax Court concluded that a donor must bear some risk that the sale will not close to avoid being deemed to have assigned income, which after considering all the facts and circumstances, Mr. Hoensheid failed to do when he delayed transferring his stock shares to Fidelity.14 As a result of Mr. Hoensheid’s fixed right to income, the Hoensheids should have accounted for the recognized gain from Mr. Hoensheid’s sale of his business shares on their individual income tax return.

CHARITABLE CONTRIBUTION DEDUCTION

Despite holding that Mr. Hoensheid recognized gain from the sale of his stock shares, the Tax Court determined that Mr. Hoensheid did make a valid gift to Fidelity under state law.

Taxpayers are entitled to take a charitable contribution deduction for valid gifts made to charity; however, the taxpayer must comply with IRS requirements to claim the deduction. These requirements include a contemporaneous written acknowledgment and a qualified appraisal.15

Contemporaneous Written Acknowledgment

For gifts valued over $500,000, the taxpayer must provide a contemporaneous written acknowledgment that substantiates the deduction with the amount of cash and a description of any property contributed.16 Moreover, for gifts to a donor-advised fund, such as the contribution Mr. Hoensheid made to Fidelity, the taxpayer must include a statement that the donee “has exclusive legal control over the assets contributed.”17 The Tax Court determined that Mr. Hoensheid satisfied this requirement with the contribution letter that Fidelity issued.

Qualified Appraisal

In addition to the contemporaneous written acknowledgment, the taxpayer must also provide a “qualified appraisal” for the donated asset.18 For the IRS, a qualified appraisal must be performed by a qualified appraiser, defined as a credentialed person with experience and education in valuing the type of property subject to the appraisal in question and who regularly performs such appraisals for payment.19 The appraisal cannot be performed more than 60 days before the date the gift was made.20

Qualified appraisals further require certain information to meet IRS standards. This information includes a sufficiently detailed description of the property, the date of the gift, information about the appraiser (including their qualifications), statement that the appraisal was prepared for income tax purposes, the date of the appraisal, and the method of and basis for the valuation.21

Unfortunately, the Hoensheids did not provide a qualified appraisal. The Tax Court noted the following deficiencies in the appraisal they submitted to the IRS:

  • No statement that the appraisal was being prepared for federal income tax reasons;
  • Incorrect date of the contribution of the gift;
  • Premature date of the appraisal;
  • Insufficient description of the valuation method used by the appraiser;
  • No signature by the appraiser or his company;
  • No description of the appraiser’s qualifications;
  • Insufficient detail of the property subject to the appraisal; and
  • No explanation of the specific basis for the valuation.

The Tax Court paid particular attention to the appraiser’s failure to meet the IRS standard for a “qualified” appraiser, reiterating that a qualified appraiser is “the “most important requirement” of the regulations.”22 Although the Hoensheids’ appraiser had experience as an investment banker, he had no other credentials certifying him as an appraiser and he did not hold himself out publicly as an appraiser. His experience with valuations was limited – performed on occasion and often for free, as was the case here.

Finally, the Tax Court addressed the incorrect date of the contribution, which the Hoensheids listed as June 11, 2015 instead of July 13, 2015. Various communications made by Mr. Hoensheid, along with his close involvement in the transaction suggested to the Tax Court that he knew or should have known that June 11, 2015 was not the correct date of the gift.23

CONCLUSION

Timing matters for gifts of appreciated assets. Planning to gift appreciated stock is not straightforward and can yield unwelcome results if the transaction is not properly executed. Even then, there is no guarantee because the Tax Court did not extend a bright-line rule that could help taxpayers mitigate their risks with this type of transaction.

Given the unsettling outcome of this case, taxpayers should be aware of the risk involved in gifting an appreciated asset so close to its sale. Otherwise, like the Hoensheids, they too, risk forfeiting favorable tax benefits for their charitable gift.


1 Estate of Hoensheid v. Comm’r, T.C. Memo 2023-24.

2 This timeline has been condensed to maintain brevity of this article.

3 Helvering v. Horst, 311 U.S. 112,119 (1940) (recognizing that income is taxed “to those who earn or otherwise create the right to receive it”); Lucas v. Earl, 281 U.S. 111 (1930) (holding that tax cannot be avoided “by anticipatory arrangements and contracts however skillfully devised”).

4 Hoensheid, T.C. Memo 2023-34 at 27 (citing the approach in Jones v. United States, 531 F.2d 1343, 1345-46 (6th Cir. 1976) (en banc)).

5 Humacid v. Comm’r, 42 T.C. 894, 913 (1964).

6 Hoensheid, T.C. Memo 2023-34 at 16. (internal citations omitted)

7 Id.

8 Id. at 31 (“In reality of the transaction, the cash sweeps were thus highly significant conditions precedent to consummating the transaction with HCI.”).

9 Id.

10 Id.

11 Id. at 32.

12 Id. at 33.

13 Id. at 34 (citing Allen v. Comm’r, 66 T.C. 340, 348 (1976).

14 Id. at 33-34.

15 I.R.C. § 170(a)(1).

16 Id. § 170(f)(8)(B).

17 Id. § 170(f)(18)(B).

18 Id. § 170(f)(11).

19 Id. § 170(f)(11)(E)(ii).

20 Treas. Reg. § 1.170A-13(c)(3)(i).

21 Id. § 1.170A-13(c)(3)(ii).

22 Hoensheid, T.C. Memo 2023-24 at 40.

23 Id. at 45.

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