In Kunkel v. Commissioner of Internal Revenue, T.C. Memo. 2015-71 (April 8, 2015), the Tax Court agreed with the Internal Revenue Service that because the taxpayers didn’t substantiate their charitable contributions, they were liable for a deficiency of $12,388 and an accuracy-related penalty of $2,468.
Kenneth James Kunkel and Susan Kathryn Kunkel timely filed their 2011 federal tax returns, claiming a charitable deduction of $42,455. They substantiated $5,140 of their cash contributions. However, they didn’t substantiate $37,315 non-cash contributions to four charities. The Kunkels donated books, clothing, household items, telescopes, toys, jewelry and furniture allegedly worth $13,115 to a church’s flea market in 2011. They didn’t produce a receipt or acknowledgment from the church for these donations; they had no photographs of the donated property; and they didn’t have any evidence regarding the prices for which the items were sold.
The Kunkels also claimed they donated clothing, household items, furniture and toys to Goodwill, Purple Heart and Vietnam Veterans, for a total value of $24,200. They produced no evidence documenting which items were donated to which charity. They did, however, provide a spreadsheet they created during the IRS audit, which listed various items with estimated amounts as to each item’s fair market value (FMV).
The Kunkels claimed that they dropped off their items to Goodwill in large bins that were unattended. They claimed they bundled their donations in batches worth less than $250 because they believed that this procedure would eliminate the need to get receipts. For Purple Heart and Vietnam Veterans, the Kunkels left items outside their house to be picked up. Purple Heart and Vietnam Veterans left doorknob hangers that said, “Thank you for your contribution,” but there was no other information indicated. To document contributions to these three organizations, the Kunkels created index cards describing the donated items. They entered information from the cards onto a master list to complete their 2011 tax returns. They didn’t produce the index cards into evidence and supplied no evidence regarding cost bases or FMV.
Notice of Deficiency
The IRS issued a notice of deficiency for lack of substantiation of $300 for the claimed cash contributions and $37,315 for the noncash contributions. It also issued an accuracy-related penalty. The Kunkels sought review of both of the IRS’ actions.
The Tax Court noted that IRS determinations of deficiencies are presumed correct and the burden falls on a taxpayer to prove the determinations erroneous.
Under Internal Revenue Code Section 170(f)(8), a taxpayer must provide written acknowledgment from a donee for contributions of $250 or more. For property with a claimed value exceeding $500, a taxpayer must provide additional substantiation (IRC Section 170(f)(11)(B)), and for property with a claimed value exceeding $5000, a taxpayer must provide a qualified appraisal. (Section 170(f)(11)(C)). To determine whether a donation exceeds the $500 and $5,000 thresholds, similar items of property must be aggregated (Section 170(f)(11)(F)).
The Kunkels claimed that each of the seven categories of property (clothing, books, furniture, household items, toys, telescopes, jewelry) exceeded $500 to total $37,315. Thus, in addition to the general substantiation requirements for items over $250, the Kunkels needed to meet additional requirements. However, they didn’t even provide to the IRS or to the Tax Court any written acknowledgement from any of the four charities; they didn’t provide any acknowledgements at all from the church or Goodwill; and the doorknob hangers left from the drivers from Vietnam Veterans or Purple Heart were undated and didn’t describe any of property.
Contributions Claimed to be Under $250
The Kunkels incorrectly claimed that they didn’t need written acknowledgments because all of the individual batches totaled less than $250. The Tax Court found their testimony not to be credible:
Petitioners’ testimony that they intentionally made all other contributions in batches worth less than $250 requires the assumption that they made these donations, with an alleged value of $24,200, on 97 distinct occasions. This assumption is implausible and has no support in the record.
As such, the court stated that their claimed deductions of bundled items must be denied for lack of substantiation under Section 170(f)(8)(A).
Contributions Exceeding $500
The Tax Court noted that the Kunkels’ failure to satisfy the substantiation requirements for donations of $250 or more was “fatal to their claim;” however, the court proceeded to address the other substantiation requirements for non-cash contributions in excess of $500. For those such contributions, a taxpayer must provide “reliable written records” that includes the approximate date the property was acquired and the manner of acquisition; a description of the property in reasonable detail; the cost or other basis of the property; the FMV of the property at the time of contribution; and the method used to determine FMV.
Additionally, the court stated that under Section 170(f)(16)(A), for a taxpayer to receive a deduction, he must donate property that’s in “good used condition or better.” The Kunkels failed to present credible evidence regarding the condition of the donated items and didn’t provide a qualified appraisal with their returns. “For all these reasons,” said the court, “petitioners have not satisfied the substantiation requirements for donations of property valued over $500.”
Under IRC Section 6662, a 20 percent penalty will be imposed on any part of underreporting attributable to negligence of the regulations. “Negligence” includes any failure to keep adequate books and records or to substantiate items properly (Treasury Regulations Section 1.6662-3-(b)(1)). The court held that the IRS met its burden of production that the penalty was appropriate, by showing that the Kunkels failed to keep adequate records.
Under Treas. Regs. Section 1.6664-4(b)(1), however, there’s an exception to the imposition of an accuracy-related penalty: when a taxpayer acts with reasonable cause and in good faith including an honest misunderstanding of fact or law that’s reasonable in light of all of the facts and circumstance, including the taxpayer’s knowledge and education. Despite the Kunkels’ arguments that they dropped off their property at unattended locations and they believed they didn’t need acknowledgment letters because each batch was valued at under $250, the court was unpersuaded. Accordingly, the Tax Court sustained the IRS’ imposition of an accuracy-related penalty.