Luke Chiarelli is the only child of an only child.  So when his mother passed not long after his father, he ended up with a lot of stuff, not only from his parents, but indirectly from his grandparents. Nice stuff – vintage clothing, furniture, antiques and the like. He got Tarquino F. Durante of Cedarburg Auction and Estate Sales to help him with it.  Although quite a bit was sold at estate sales, Mr. Durante recommended that quite a bit be donated to charity.

Mr. Chiarelli is a tax attorney and a veteran of the Arthur Andersen tax department so he prepares his own returns.  His 2012, 2013 and 2015 returns included noncash charitable deduction of $89,110, $93,087 and $77,300 respectively. The resulting audits resulted in notices of deficiency for all three years including penalties for 2012 and 2013,  Mr. Chiarelli ended up in Tax Court arguing about just shy of $65,000 (not including interest). It did not go well for him.

A Good Sport

We can use this opinion to illustrate three of Reilly’s Laws of Tax Planning – The Fourth – Execution isn’t everything but it’s a lot – ,The Seventh – Read the instructions -, and The Sixteenth – Being right without substantiation can be as bad as being wrong. You can quibble about the 16th, since there was a good bit of substantiation. It was just not quite what was required.

Mr. Chiarelli, although gracious and dignified in defeat has a problem with the IRS approach to cases such as this that I think is worth considering.  He compliments IRS attorneys George Bezold, Lauire Downs and Mark Miller on their honor and professionalism and Judge Nega and the staff at the Tax Court and the overworked IRS people who were second to none even when they were yelling at him.  His problem is that he thinks the IRS has let go of the concept of “substantial compliance”.

In explaining his theory to me Mr. Chiarelli inadvertently outed himself as having an old-fashioned Catholic education. (It takes one to know one) In his view none of the deficiencies in his reporting were “mortal sins”.  A “mortal sin” would have been not giving the property away during the relevant tax year, not using a qualified appraiser or having the appraisal not include the relevant information.  With that in mind we can look at Mr. Chiarelli’s venial sins and decide whether he really deserved absolution.  I confirmed with Mr. Chiarelli that he agrees that the opinion is accurate as to facts.

Form 8283

The opinion get’s into the detailed instructions of Form 8283.  (Link is to the 2012 form. Reference would be different on a current form.) For items or groups of items over $5,000 the form calls for a summary of physical condition, appraised fair market value, date it was acquired, manner of acquisition and cost or adjusted basis. On the  2012 the $89,110 was described as “miscellaneous household items” in “excellent” condition with an aggregate fair market value of $89,110.  The manner of acquisition was indicted as purchase with a basis of $251,800 but no information on how that number was derived.

2013 was filled out in a similar manner except that method of acquisition was listed as “inheritance”.  2015 was also similar going back to purchase as method of acquisition. Most significantly Parts II, III and IV which call for signatures by the taxpayer, the appraiser and the donee were all unsigned.  Mr. Chiarelli might have saved himself a lot of grief here if he had gone to a CPA or EA with a substantial tax practice.  There are very few such that would have let the return out of their office without all the signatures.

The opinion gets into the nitty gritty of the audit relating how additional substantiation was provided in response to IRS requests.  One sentience is very telling:

The 2015 appraisal grouped purported donation items into generic categories and did not provide identifying information about the individual items donated, such as the age or condition. (Emphasis added)

Whenever any form of the word “purport” appears in a Tax Court opinion, you know that things are not going to go well for the taxpayer.

Substantial Compliance 

Mr. Chiarelli’s arguments are based on the notion of substantial compliance.  He provided the IRS enough to establish that he had donated the property and that he had it appraised.  Rather than challenging the appraisal IRS is throwing out the deduction on technical grounds.  This is very common in charitable cases, particularly conservation easements.  Judge Nega notes:

As a general matter, taxpayers have had great difficulty in meeting the substantial compliance standard for charitable deductions.

Judge Nega also noted that taxpayers cannot meet the 170(f)(8) requirement for “contemporaneous written acknowledgement” (CWA) with substantial compliance.  The Code requires that you have the CWA in your hot little hand by the earlier of the due date of the return or when the return is filed.  In the high net wroth group where I spent much of my career calling charities for our clients to get the CWA was a routine part of our service.  That included making sure the wording was correct.

Judge Nega could have left it at that, but he went into some detail on the insubstantiality of the compliance.  The IRS had conceded on the penalty for 2015.  Judge Nega upheld the 20% penalty for 2012 and 2013.  Mr. Chiarelli argued that he relied on Mr. Durante on the appraisal matters, but Judge Nega held him to a higher standard, him being a tax attorney qualified to practice in the Tax Court.

Don’t Know If There Will Be Appeal

When I spoke to Mr. Chiarelli he indicated that he wasn’t sure whether he would appeal, but he remains passionate on the “substantial compliance” notion.  As a practical matter once your charitable contributions break into the mid to high five figures, plan on rigorous compliance.  I doubt that Mr. Chiarelli has much chance on his appeal, but it would be entertaining if he won, because then he would have to duke it out on the merits of the appraisals.  Regardless, I give him high marks in sportsmanship for his kind comments about his IRS adversaries.

Originally published on Forbes.com.

For great value continuing professional education.  I recommend the Boston Tax Institute

You can register on-line or reach them by phone (561) 268 – 2269 or email vc@bostontaxinstitute.com.  Mention Your Tax Matters Partner if you contact them.