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Value of Stock Donated to Charitable Organization Was Overstated

Estate Planning Journal

In Bergquist, 1 the Tax Court held that the taxpayers had overstated the value of the stock in their medical professional service corporation which the taxpayers donated to a hospital. The court, therefore, held that the taxpayers had overstated the amount of the charitable deduction allowable to them.

Facts

The taxpayers in this consolidated case were five anesthesiologists and a certified public accountant. The six taxpayers were stockholders in a medical professional service corporation (“UA”), and the accountant was the chief executive officer of the corporation. The parties in 20 related but nonconsolidated cases pending before the court agreed to be bound by the decision rendered by the court in this case.

The five doctors, through the UA corporation, were the exclusive provider of anesthesiology services to a public teaching and research hospital located in Oregon. The doctors were employed by UA on the basis of month-to-month contracts that did not contain noncompete or nonsolicitation provisions. In addition to the anesthesiology medical practice, there were approximately 30 other medical practice specialty groups (e.g., gynecologists-obstetricians, cardiologists, radiologists, and orthopedic surgeons) that were affiliated with the hospital through separate medical professional service corporations.

Consistent with the typical management of medical professional service corporations, at the end of each year UA paid bonuses, salaries, and prepaid expenses that offset reported income. The corporation never declared or paid cash dividends to its stockholders, and its only significant booked asset was its accounts receivable.

The hospital decided to consolidate all of the affiliated medical professional service corporations into a single medical practice group which would be controlled and managed by the hospital. As a result of the consolidation, the doctors were to leave their separate medical professional service corporations and were to become employees of a newly formed single consolidated medical practice group operating and providing medical services through a newly formed tax-exempt professional services corporation. Once the consolidation was complete, UA would have no doctors and no patients, and would not operate and would continue in existence for a period of time only to collect outstanding accounts receivable. It was expected that after the consolidation, UA's winding-down expenses would reduce UA's taxable income to zero.

The chief executive officer of the UA corporation learned at a medical group management association conference that for federal income tax purposes, some doctors throughout the country were claiming substantial charitable contribution deductions relating to donations of stock in their medical professional service corporations to academic-affiliated institutions. Upon returning from the conference, the chief executive officer discussed with UA's attorney and accountant the possible tax benefits to the taxpayers of donating their UA stock to the hospital and thereby claiming a charitable contribution deduction as part of the consolidation with the hospital. The stockholders of the corporation agreed to pursue the consolidation and the donation of their stock.

The corporation retained Houlihan Valuation Advisors to value the UA stock to be donated. In a letter to Houlihan, the attorney for UA described the planned consolidation and wrote that the hospital would be the employer of all the doctors after the consolidation was completed. Houlihan appraised the donated stock as of August 31, 2001, at $401.79 per share.

On September 14, 2001, the taxpayers donated to the hospital their stock in the UA corporation. The hospital did not expect to derive any economic benefit from the donated stock, and the hospital did not receive any dividends or distributions from UA. On January 1, 2002, the corporation was consolidated into the hospital and the doctors became employees of the hospital. After the consolidation, the corporation no longer operated as a provider of anesthesiology services but continued in existence only to collect its outstanding accounts receivable. After the consolidation, any proceeds UA received as a result of collecting accounts receivable were, after payment of expenses, distributed to the UA anesthesiologists in the form of bonus and severance payments. By letter dated January 8, 2002, the hospital's president notified the doctors that on its books the hospital would enter a value of zero for the donated stock.

On their respective 2001 federal income tax returns, using the Houlihan appraised per-share value of $401.79 for the shares, 26 of the 28 stockholders of the UA corporation claimed charitable contribution deductions with respect to the donation of their stock to the hospital. The remaining two stockholders claimed no charitable contribution deduction with respect to the donation of the stock. On audit of the returns of the UA stockholders, the IRS determined that on September 14, 2001, the UA stock had no value, and therefore disallowed entirely the claimed charitable contribution deductions relating to the donation of the stock. At trial, based on an expert appraisal, the IRS agreed that the stock had a value of approximately $36 per share and that charitable contribution deductions were allowable to the taxpayers only on that basis.

Analysis

The court began its analysis by noting that the dramatic difference in the appraised value of the stock between the taxpayers' expert and the IRS's expert stemmed primarily from the fact that the taxpayers' expert valued the corporation as of September 14, 2001, as a going concern because that expert viewed the consolidation of the medical practice into the hospital as uncertain.

The court stated that after examining the evidence, it concluded that as of September 14, 2001, the corporation should not be valued as a going concern. The court found that it was beyond any reasonable question that the taxpayers would not have donated their stock to the hospital had there existed any realistic possibility that the consolidation would not occur. In addition, the court found that the evidence established that as of September 14, 2001, it was highly likely that UA and the hospital would take part in the consolidation.

The court determined that the evidence did not indicate that the stockholders of the corporation had any reservations about the planned consolidation or might decline to participate in the consolidation. The court stated that while the date of the consolidation may not have been set in stone, by September 14, 2001 there was tremendous commitment by the corporation and the hospital to ensure that the consolidation would occur. The court concluded that a reasonably informed and willing buyer or seller certainly would have known about and would have taken into account the fact that as of September 14, 2001, there was an extremely high likelihood that by early 2002, UA would no longer be an operating entity.

The court accepted the valuation of the IRS's expert. The IRS's expert valued the corporation as an assemblage of assets based on his conclusion that it was known or knowable on 9/14/01 that the corporation very likely would no longer be operating. The IRS's expert rejected the income approach and the market approach to valuation because those approaches generally presume ongoing business operations. To account for the noncontrolling, nonmarketable nature of the stock of the corporation, the IRS's expert applied a 35% discount for lack of control and a 45% discount for lack of marketability.

The court also upheld the IRS's assessment of the accuracy-related penalty of Section 6662. The taxpayers argued that the penalty should not apply because they qualified for the exception of Section 6664 which requires that the taxpayer act in good faith and that the taxpayer make a good faith investigation of the value of the property contributed.

The court held that the taxpayers did not qualify for the exception. First, the court found that the taxpayers should have been aware of the imprudence of valuing the stock at such a high value given the fact that the corporation would no longer be an operating entity. Second, the court found that because the taxpayers were aware of the letter from the hospital stating that the hospital was valuing the donated stock at zero, the taxpayers should have questioned the difference in valuation. Third, the court rejected the taxpayers' claim that they relied in good faith on the valuation report prepared by Houlihan and on the advice of the lawyers and accountants of the corporation. The court stated that taxpayers cannot blindly rely on advice from advisors or on an appraisal report, and a taxpayer will not be considered to have acted in good faith if the advice is based on an unreasonable assumption the taxpayer knows, or had reason to know, is unlikely to be true.

Comments

This case illustrates the danger of engaging in a transaction that appears too good to be true. Many transactions of this type may appear legitimate if each step of the transaction is examined in isolation. However, an examination of the entire transaction as a whole would lead taxpayers and their advisors to conclude that such transaction cannot reasonably be justified as in compliance with fundamental concepts of taxation. The case also illustrates that a blind reliance on a valuation report, in circumstances that render it questionable at best, will not protect the taxpayers from accuracy-related penalties.

1 131 TC No 2, Tax Ct Rep (CCH) 57492, Tax Ct Rep Dec (RIA) 131.2, 2008 WL 2834171 (2008).

Frank S. Baldino is an attorney at Lerch, Early & Brewer in Bethesda, Maryland who practices in the areas of estate planning and probate administration and who co-chairs the firm's Estate Planning and Probate Group. He has extensive experience in the areas of estate planning, charitable giving, estate planning for non-U.S. citizens, tax planning with respect to retirement plans and stock options, asset protection planning, business succession planning and estate and trust administration. Frank may be contacted at 301-657-0715 or fsbaldino@lerchearly.com.

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