Private Wealth Matters

Last week, in his blog Double Taxation (5/29/2012), my partner, Tony Nitti, analyzed the Tax Court case J. Mohamed, Sr., TC Memo 2012-152.  Lest one ever forget that form over substance often prevails in the tax world, one need only read this case to be shocked back into reality.  I won’t attempt to analyze the case itself (Tony is far better at that than I, and you can read his words directly) but I would like to summarize the planning take-aways:

• The best planning is all for naught if you don’t complete the paperwork.  On the face of it, the Mohamed’s plan was a good one but it failed for lack of form – and how painful is that? They transferred several pieces of valuable real estate into a charitable remainder unitrust (CRUT) which was structured to pay income to the couple for a period of time (either their joint lives or 20 years; this is not specified in the TCM case).  A well-designed CRUT is a beautiful instrument, particularly when interest rates are trending upward – it enables you to take a current charitable deduction equal to the actuarially determined remainder value of the property transferred to the trust, it potentially increases your cashflow from the redeployment of those assets within the trust, and it can defer or even eliminate capital gains tax on the ultimate sale of the properties.  Whatever is left at the termination of the trust passes to specified charities.  Risk can be mitigated and cashflow increased in a tax-efficient manner – a work of art!  But essentially, the Mohamed’s did not complete this great plan because they did not properly complete the paperwork.  How frustrating, and what an expensive waste!

• Remember the proverb “He who is his own lawyer has a fool for a client.”  Substitute the word “accountant” for “lawyer” and you have just about summed it up.  Not that bright, intelligent folks can’t prepare simple tax returns – in many cases they can but they have to be cognizant of the law.  Mr. Mohamed apparently overlooked that fact:  Joseph filled out the 2003 tax return himself, including the Form 8283, Noncash Charitable Contributions. He admits that he did not read the instructions before completing the form, because he says it seemed so clear that he didn’t think he needed to… even though, in fairness to the Commissioner, the form does say right at the top and center: “See separate instructions.” 

Now, my mother always told me that men have trouble reading and following instructions, but still……  You can’t overestimate the value of good, solid professional advice.

• Finally, form over substance absolutely matters.  In this case, the Tax Court denied a legitimate $19,000,000 charitable contribution deduction (yes, 6 zeros on that one) because Mr. Mohamed did not dot his I’s and cross his T’s when filing his 2003 and 2004 tax returns.  The law is very specific – contributions of property valued at $5,000 or more (only 3 zero’s there) MUST be accompanied by a qualified appraisal and such appraisal cannot be completed by the taxpayer or his spouse.  Because his self-described occupation was that of “real estate broker, certified real estate appraiser, and a prominent Sacramento entrepreneur,” Mr. Mohamed felt quite qualified in valuing the property himself.  Apparently, not qualified enough.  In his simultaneous roles as the donor and the donee (trustee of the CRUT), Mr. Mohamed by definition was not a qualified appraiser.  (Editorial comment:  Mr. Mohamed may have been qualified to determine the value, but would you hire him to provide a “tax appraisal” if he did not understand the basic tax rules?  It’s probably a moot point; he’s already made his millions elsewhere, so I suspect he is not completing too many tax appraisals for clients.)

In fact, once the transactions were under audit, the Mohamed’s did engage independent appraisers to essentially verify Mr. Mohamed’s valuations, but the damage had already been done.  Ironically, the independent appraisers determined the total value to be about $1.7MM HIGHER than Mr. Mohamed had and subsequent sales of the properties supported both sets of appraisals.  Nevertheless, the Tax Court was absolutely clear in its decision that a greater good was at stake:

We recognize that this result is harsh–a complete denial of charitable deductions to a couple that did not overvalue, and may well have undervalued, their contributions–all reported on forms that even to the Court’s eyes seemed likely to mislead someone who didn’t read the instructions. But the problems of misvalued property are so great that Congress was quite specific about what the charitably inclined have to do to defend their deductions, and we cannot in a single sympathetic case undermine those rules.

This is a stark reminder that tax deductions are truly a matter of legislative grace.  Good intentions may be helpful but they are not enough.  You must follow the rules to the letter!