Even though the 2024 filing season started a week later than normal, the IRS reports that website visits have increased 6% over last year. The IRS credits some of the inquiries to an improved "Where’s My Refund?" tool. There also are numerous other updates to the website that are designed to help taxpayers.

The latest available statistics as of February 16 show a lower number of total returns received and processed and a reduced number of refunds. However, the IRS stated on its website, "Considering the loss of seven days in this comparison, filing season statistics below show a strong start to filing season 2024, with all systems running well."

On February 15, IRS Commissioner Daniel Werfel testified before the House Ways and Means Committee. He noted, "I am pleased to report the 2024 tax filing season opened on schedule on January 29 and has gone smoothly so far."

By February 9, the IRS reported receipt of over 25 million individual tax returns. Nearly all returns were e-filed. These tax returns included 9.4 million filed by CPAs and other tax preparers and 15.6 million filed by taxpayers using online software.

The IRS issued 7.5 million refunds for a total in excess of $13 billion. The average refund this year has been $1,741.

An ongoing question for CPAs and other tax preparers is whether to wait for Congress to pass legislation. The Tax Relief for American Families and Workers Act of 2024 passed the House on January 31, but is currently on hold in the Senate. The bill would enhance the child tax credit, the low-income housing tax credit, enhance the research and development expense deduction, restore bonus depreciation and expand tax relief for some victims of designated disasters.

Commissioner Werfel has been adamant that taxpayers should immediately file returns. If Congress passes retroactive legislation, he indicates the IRS will quickly update its computers.

Melanie Lauridsen is a representative of the American Institute of CPAs. She agreed with Commissioner Werfel. Lauridsen stated, "This bill is moving very slowly. There is no guarantee it will pass. When it is all said and done, as Commissioner Werfel said, do not wait. File your returns. Go ahead and move forward. And that is pretty much a blanket statement."

Council on Foundations Critiques DAF Proposed Regulations

On February 15, 2024, Kathleen Enright, President and CEO of the Council on Foundations (COF), sent a letter on behalf of 140 foundations to the Internal Revenue Service (IRS). She offered extensive comments and critiques on the REG-142338-07 proposed regulations with the title "Taxes on Taxable Distributions From Donor Advised Funds Under Section 4966."

COF appreciated the efforts of Treasury, and the IRS to create and publish the new proposed regulations on donor advised funds (DAFs). Some of the provisions are helpful to the philanthropic sector, but COF expressed concern that some provisions would be harmful.

DAFs remain a very important giving vehicle during the current era. The Giving USA 2023 annual report on philanthropy noted that there were over $499 billion in gifts to nonprofits in 2022. However, for the first time in decades, total giving decreased by 3.4% compared to the prior year. Individual giving also experienced a substantial decline, particularly when adjusted for inflation. COF stated, "At a time when charitable giving is declining, it is important for the regulatory environment to foster a thriving philanthropic sector."

The new DAF proposed regulations do have some helpful provisions, but they also have provisions that may "inadvertently stifle or disincentivize charitable giving."

The favorable provisions include language that will facilitate DAF grants to foreign charities. DAFs will be permitted to rely on existing equivalency determination and expenditure responsibility rules. There will be the potential for grants to some international organizations without expenditure responsibility if there is a reasonable certainty that the grants are used for charitable purposes.

Another favorable provision is the exception for scholarship and disaster relief funds. Donors often provide gifts for scholarship funds and may have expertise in the area of education. These donors should be permitted to sit on the scholarship grants committee, provided the donor does not have control. There is also an exception for disaster relief funds. COF encourages the final regulations to go farther and expand the exception by allowing the disaster or emergency declaration to be issued by a state or local government.

However, COF has major concerns with several provisions of the regulations. These include separate identification by reference to contributions, the personal investment advisor as donor-advisor rules, the advisory committee limits for donors and the taxable distribution rules. Furthermore, the applicability date could cause substantial issues.

1. Separate Identification by Reference to Contributions — This proposed rule could require many funds to be reclassified as DAFs. The field of interest funds with a donor on the committee, a collaborative fund with multiple donors where one of the group serves on the committee, giving circles, which are groups of donors who pool their gifts, and fiscal sponsorship could all lead to reclassification as a DAF. President Enright notes that one of the foundations signing the letter has an estimated 75 funds that would be reclassified and must comply with the DAF requirements under the proposed regulations.

2. Personal Investment Advisor as Donor-Advisor — COF urges "Treasury and the IRS to remove this provision." Under the proposed regulations, an investment advisor who manages both the donor's personal investments and the DAF investments is classified as a donor-advisor. Payments to that investment advisor would constitute a taxable distribution and an excess benefit under Section 4958. The COF concern is that this limit on investment advisors managing investments of the DAF would have a "potential chilling effect on donors who wish to contribute sizable gifts to establish a charitable fund for the benefit of their community." These donors may have substantial investment portfolios and have confidence in their investment advisors. COF notes some of these donors may choose to create a private foundation rather than a DAF to be able to involve their personal investment advisor. There is also uncertainty with this rule because the investment advisor may work for a larger company, and so the question is whether or not the entire larger entity is now prohibited from granting advice or providing investment management.

3. Advisory Committees — There are two similar, but slightly different rules on an advisory committee. The advisory committee rules should be based on existing rules for scholarship selection committees. On these committees, the donor or relatives are not permitted to have a controlling voice or a deciding vote on grants. The scholarship committees must appoint members on objective criteria and no single individual or family members as a group may make up a majority of the committee.

4. Taxable Distributions — The proposed regulations indicate there will be taxable distributions if grants are made to organizations that are active in influencing legislation. There are many public charities that engage in various voter education activities and grants to these organizations could be reclassified as taxable distributions. This rule would create serious administrative problems for DAF custodians, because it may be difficult to determine whether a public charity is prohibited from receiving a grant under this proposed taxable distribution rule.

5. Proposed Applicability Date — Finally, COF is concerned that the transition to the proposed DAF rules will require time. If foundations are required to reclassify a significant number of funds as DAFs and comply with those rules, there should be a reasonable period of delay before the final regulations are applicable. It will require staff and accounting changes to manage this transition period.

Conservation Easement Deduction Denied Plus Penalties

In Oconee Landing Property LLC et al. v. Commissioner; No. 11814-19; T.C. Memo. 2024-25, the Tax Court disallowed a $20.67 million charitable deduction for a conservation easement. The Tax Court determined that there was not a qualified appraisal under Section 170(f)(11)(D) and the property was ordinary income under Section 170(e)(1). Therefore, the charitable deduction was zero. In addition, the 40% gross valuation misstatement penalty and the 20% penalty on the portion of underpayment not attributable to the valuation misstatement applied.

The easement property was in Greene County, Georgia, a rural area close to the South Carolina border. The 355 acres in the easement property was part of a 1,130-acre tract owned by James M. Reynolds III and Mercer Reynolds. The 1,130-acre tract was near Lake Oconee and there was residential development in the area. The Reynoldses attempted to sell or develop the property and experienced challenges. There was a downturn in resort and retirement building during 2015. The $7.7 million asking price was not acceptable to any purchaser.

However, the Reynoldses explored the possibility of creating a conservation easement. In order to increase the net benefits to over $7 million, the conservation easement would need to be valued at a much higher level. If the property were valued at approximately $60 million, the conservation easement would produce a charitable deduction that would net the required amount.

The Reynoldses divided the property into three sections with the Oconee partnership receiving 355 acres. Appraisers Thomas Wingard and Martin Van Sant determined the before value was $21.2 million, the after value $0.53 million and the easement deduction value $20.67 million. The Oconee Investors partnership offered 95 Class A units at $49,000 per unit. The 26 members who purchased units were offered an opportunity on December 24, 2015 to pursue a "conservation strategy" option. The conservation easement was deeded on December 31, 2015 to Georgia-Alabama Land Trust (GALT).

The partnership claimed a deduction of $20.67 million. The IRS audited the partnership, denied the deduction and assessed a 40% penalty under Section 6662(e) and a 20% penalty under Section 6662A(b).

At trial, taxpayers presented four different experts who offered opinions on the appraised value. The IRS offered expert testimony from appraiser Robert Driggers. Based on seven Georgia comparable property sales, Driggers calculated a value of $4.972 million for the easement.

The Tax Court noted a qualified conservation easement deduction is permitted where there is a gift of a qualified real property interest to a qualified organization and the use is exclusively for conservation purposes. Section 170(h)(1). The IRS maintained there was no qualified deduction because this was simply an "economic benefit in the form of tax savings." The Tax Court noted there were intentions by the Reynoldses and their agents to produce tax benefits, but that alone is not sufficient to disallow a deduction.

However, under Reg. 1.170A-13(c)(5)(ii), the qualified appraisal is not valid "if the donor had knowledge of facts that would cause a reasonable person to expect the appraiser falsely to overstate the value of the donated property." While Wingard and Van Sant met the general education and competence requirements, there was an agreement the valuation would be far in excess of the potential $10 million for the total parent contract — the valuation would exceed approximately $60 million for the entire tract.

The Tax Court found that "the Reynoldses, acting through their intermediaries, had reached a meeting of the mind with Messrs. Wingard and Van Sant that the Parent Tract would be appraised at roughly $60 million (before carve-outs) and fairly close to $52.8 million (after carve-outs)." Therefore, because of the extensive communications that demonstrated an agreement to value property (that had not been sold at $7.7 million) at over $60 million, this was not a minor defect or technical flaw. Rather, this was an agreement that should cause a reasonable person to expect the appraiser to falsely overstate the value. Therefore, the appraisal was not valid.

A second claim by the IRS is that under Section 170(e)(1)(A) the character of the property as ordinary income, carried through from the Reynoldses to the partnership. Section 724(b) indicates that a contribution to a partnership retains its character. Capital gain or ordinary income status is primarily a question of fact. The Court has to determine the nature and purpose of the properties, the duration of the ownership, the extent of efforts to sell property, the number of sales, the efforts to subdivide or develop the property, the use of a business office for sale, the use of a broker to sell property and the time and effort devoted to the sales activities. Based on all of these factors, the Tax Court determined taxpayers held their interests “for sale to customers in the ordinary course of their real estate business."

They acquired the tract, developed plans for a mixed-use community, marketed the tract, sold 10 parcels out of the tract, did initial infrastructure work on the tract and employed an office sales staff. Therefore, all of the cumulative factors showed that this property was at all times "ordinary income property" in the hands of the owners and the partnership.

The taxpayer appraisal was based on the assumption that there would be "immediate development" as a mixed-use community. However, IRS appraiser Driggers concluded that the development would not occur "for 7 to 10 years." Therefore, the Tax Court called the immediate development claim "an extremely improbable scenario."

In reviewing the appraisals, the Tax Court noted that three of the seven comparables by Driggers were quite similar to the Oconee property. Alternatively, all of the comparables by the taxpayer's experts were significantly different properties in terms of potential for future development. The appraisers for the taxpayers produced valuations that were "outlandish when compared to the actual historical record."

Therefore, the Tax Court determined that the Driggers valuation of the conservation easement at $4,972,002 was accurate. However, because the taxpayers did not establish the basis for their deduction under Section 170(e)(1)(A), the deduction was zero. Because the reported deduction was over 200% of the correct amount, it was a gross misstatement under Section 6662(h). In addition, the 20% penalty under Section 6662A(b) was applicable because the Reynoldses lacked reasonable cause for their failure to obtain a qualified appraisal.

Editor’s Note: The IRS has transitioned to a battle of the appraisers with the conservation easement cases. This is a good analysis of Tax Court rules for good and bad comparables used in appraisals.

Applicable Federal Rate of 5.0% for March -- Rev. Rul. 2024-4; 2024-9 IRB 1 (14 February 2024)

The IRS has announced the Applicable Federal Rate (AFR) for March of 2024. The AFR under Sec. 7520 for the month of March is 5.0%. The rates for February of 4.8% or January of 5.2% also may be used. The highest AFR is beneficial for charitable deductions of remainder interests. The lowest AFR is best for lead trusts and life estate reserved agreements. With a gift annuity, if the annuitant desires greater tax-free payments the lowest AFR is preferable. During 2024, pooled income funds in existence less than three tax years must use a 3.8% deemed rate of return. Charitable gift receipts should state, “No goods or services were provided in exchange for this gift and the nonprofit has exclusive legal control over the gift property.”