The IRS has recently announced that they will be concentrating staffing efforts towards High Net Worth (HNW) and pass-through entities. Individuals usually taking non-cash charitable donations are often HNW. It is critical that our clients and their CPAs and tax advisors understand the risks and the requirements for an IRS Qualified Appraisal produced by an IRS Qualified Appraiser.
Are Deconstruction Tax Deductions High Risk? Yes.
Noncash charitable contributions can be considered high risk for several reasons:
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Valuation Challenges: Determining the strictly defined Fair Market Value of noncash items, such as clothing, electronics, or artwork, can be subjective and open to interpretation. Overvaluing these items can result in legal and tax consequences.
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Potential for Fraud: Some individuals may exaggerate the value of donated items to inflate their tax deductions. This can lead to tax audits, penalties, or even legal action if fraud is suspected.
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Documentation Requirements: The IRS and other tax authorities require detailed documentation for noncash charitable contributions. Failure to keep accurate records of donated items, their condition, and their value can result in denied deductions. This includes the careful completion of IRS Form 8283. Most of this form is the responsibility of the taxpayer and tax preparer. Appraisers should not be providing any of the information on page one. That hinders their independence and is a job for the taxpayer’s CPA.
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Limited Deduction Limits: There are limits to the amount of deductions you can claim for noncash contributions, depending on your income and the type of organization you donate to. Exceeding these limits can lead to complications with your tax return.
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Compliance Risk: If the nonprofit organization you donate to is not properly qualified or tax-exempt, your contributions may not be eligible for deductions, and you could face tax issues.
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Subject to Audit: Noncash charitable contributions can trigger audits or closer scrutiny from tax authorities due to their potential for abuse and misreporting.
To mitigate these risks, it is essential to follow IRS guidelines for noncash contributions carefully. Keep detailed records, obtain proper appraisals, and work with reputable charitable organizations. If you have concerns about the tax implications of noncash charitable contributions, it's advisable to consult with a tax professional or accountant who can provide guidance and ensure compliance with tax laws.
How Can the Risk be Mitigated? Hire the right appraiser and CPA.
The IRS has specific qualifications and requirements for individuals who wish to act as qualified appraisers for charitable contributions, particularly when it comes to valuing noncash charitable contributions. To be considered a qualified appraiser for IRS purposes, an individual must meet the following criteria:
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Education and Experience: The appraiser must have earned a recognized appraisal designation from a professional appraiser organization or have equivalent education and experience. This may include completing coursework and passing exams related to appraisal principles and methodologies. Go beyond the letters behind a name and ask about requisite college education. Who is signing the appraisal? USPAP (Uniform Standards of Professional Appraisal Practice) requires all contributing appraisers to sign both the report and the Form 8283. Does a company have all participating appraisers signing the reports?
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Experience in Appraising the Type of Property: The appraiser must have experience in appraising the specific type of property being valued. For example, if they are appraising artwork, they should have expertise in valuing art.
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Demonstrated Verifiable Education and Experience: The appraiser should have a history of completing appraisals for similar types of property and be able to provide verifiable records of their work.
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Compliance with Professional Standards: The appraiser must perform appraisals in accordance with generally accepted appraisal standards, such as the Uniform Standards of Professional Appraisal Practice (USPAP).
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No Conflict of Interest: The appraiser must not have a financial interest in the property being appraised or the organization that benefits from the donation. This ensures objectivity and impartiality. The appraiser must not be a “captive appraiser”.
A "captive appraiser" is a term used to describe an appraiser who is closely affiliated with a particular party or entity and may not be entirely independent or impartial in their appraisals. Typically, the term "captive appraiser" implies that the appraiser's work may be influenced or biased in favor of the party with whom they have a close relationship. This can raise concerns about the objectivity and accuracy of their appraisals.
Ask the appraiser what percentage of work they perform for each nonprofit. If it is over 50%, they are not considered independent.
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Qualification Period: To be considered a qualified appraiser, the individual must not have been prohibited from practicing before the IRS during a three-year period ending on the date of the appraisal.
Potential Issues:
Circular 230 Violations—Appraisers are held to the same standards as CPAs:
Circular 230 is a set of regulations issued by the U.S. Department of the Treasury that governs the practice of tax professionals, including attorneys, certified public accountants (CPAs), and enrolled agents, who represent clients before the Internal Revenue Service (IRS). Circular 230 outlines the rules and standards for ethical and professional conduct for tax practitioners.
Ask any appraiser if they have ever been or could be in violation of Circular 230.
A Circular 230 violation refers to a breach of these regulations by a tax professional. Violations of Circular 230 can result in disciplinary actions, penalties, or sanctions imposed by the IRS or the Office of Professional Responsibility (OPR). These violations can include:
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Failure to Exercise Due Diligence: Tax professionals are required to exercise due diligence when preparing and signing tax returns and other documents. Failing to do so and knowingly or recklessly making false statements can be considered a violation.
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Conflict of Interest: Circular 230 prohibits tax professionals from representing clients in situations where there is a conflict of interest. This includes situations where the tax professional has a personal or financial interest in the client's tax matters.
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Incompetence or Negligence: Tax professionals are expected to provide competent and diligent services to their clients. Incompetence or negligence in handling tax matters can result in violations.
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Misleading or False Statements: Making false or misleading statements to the IRS or clients can be a violation of Circular 230.
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Failure to Keep Records: Tax professionals are required to maintain records related to their practice for a specified period. Failure to do so can lead to violations.
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Failure to Cooperate with OPR Investigations: If a tax professional fails to cooperate with investigations conducted by the OPR, it can be considered a violation.
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Disreputable Conduct: Engaging in conduct that reflects negatively on the tax profession, such as criminal activity or dishonesty, can be a Circular 230 violation.
Section 6695 Penalty—Ask the appraiser if they have ever received this penalty
A 6695 penalty, as referred to in the context of U.S. tax law, relates to penalties imposed on tax return preparers who fail to meet certain requirements or engage in improper conduct when preparing federal income tax returns. These penalties are outlined in section 6695 of the Internal Revenue Code.
There are several different penalties under section 6695, including:
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6695(a) Penalty for Understatement of Tax Liability: This penalty may be imposed if a tax return preparer understates a client's tax liability due to an unreasonable position or willful or reckless conduct. The penalty amount can vary depending on the circumstances.
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6695(b) Penalty for Preparing a Substantially Inaccurate Return: If a tax return preparer is found to have prepared a substantially inaccurate return, they can be subject to a penalty. This penalty is generally assessed per return or claim for refund.
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6695(c) Penalty for Failure to Furnish Copy to Taxpayer: Tax return preparers are required to provide a copy of the return or claim for refund to the taxpayer for whom it was prepared. Failure to do so may result in a penalty.
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6695(d) Penalty for Failure to Sign Return: Tax return preparers must sign tax returns they have prepared. Failure to do so can lead to a penalty.
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6695(e) Penalty for Failure to Furnish Identifying Number: Tax return preparers must include their Preparer Tax Identification Number (PTIN) on the returns they prepare. Failure to do so can result in a penalty.
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6695(f) Penalty for Failure to Retain a Copy of the Return: Tax return preparers are required to retain a copy of each return or claim for refund they prepare. Failure to do so may lead to a penalty.
Tax Audit and Penalties, Who Loses? The Client.
Here is a brief list of penalties for taxpayers who rely upon a noncompliant appraisal:
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Disallowed Deduction: If a taxpayer fails to obtain a qualified appraisal or does not adhere to the IRS's rules regarding appraisals for noncash donations, the IRS may disallow the charitable deduction claimed on the tax return. This means the taxpayer may lose the tax benefit they expected to receive.
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Accuracy-Related Penalty: In cases of substantial or gross valuation misstatements on the tax return, the IRS may impose an accuracy-related penalty. This penalty can be up to 20% of the underpayment of tax attributable to the misstatement.
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Civil Penalties: The IRS can assess civil penalties on taxpayers who engage in fraudulent or willful misconduct in connection with noncash charitable contributions. The penalties can be substantial and may include fines.
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Potential Audit: Noncompliance with appraisal requirements can trigger an IRS audit. Audits can be time-consuming, stressful, and costly for taxpayers, even if they ultimately prevail.
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Loss of Tax-Exempt Status for the Receiving Organization: If the charitable organization that receives the noncash donation is found to be involved in fraudulent or noncompliant activities, it may face penalties, fines, and even the loss of its tax-exempt status.
Due Diligence—Keeping the taxpayer safe.
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Select a qualified appraiser. Our team is led by two IRS Qualified Appraisers, with MS degrees in complementary subjects and accreditation through a recognized Personal Property Appraiser organization sponsoring The Appraisal Foundation. Both sign all appraisals.
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Watch for gimmicks. Appraisers cannot guarantee that their work will be accepted by the IRS.
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Ask about prior audits of the appraiser’s work. Ask how the audits were resolved and what additional fees were required from the appraiser to defend the appraisal.
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Ensure the numbers make sense. Zero acquisition typically means zero deductions.
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Ensure long-term capital gains treatment is allowable. Dealers are precluded from capital gain taxation, limited to ordinary income, and precluded from taking the Fair Market Value of the deduction.
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Review our appraisals. Ask for samples and have your CPA check to ensure we are compliant and that our CVs substantiate our education and experience.
