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Using the Substantial Compliance Doctrine to Defeat the IRS

By Joel N. Crouch on August 31, 2020

On August 17th, the Tax Court held in favor of the taxpayers regarding a $4 million charitable contribution deduction for donating land to a town in Emanouil v. Commissioner, T.C. Memo 2020-10. The IRS had challenged the taxpayer’s deduction for a number of reasons including the taxpayers’ appraisals did not include all the required information and therefore failed to comply with the qualified appraisal requirements.  In holding for the taxpayers, the Tax Court cited the taxpayer-friendly substantial compliance doctrine. 

The substantial compliance doctrine says that taxpayers do not need to be perfect, but they need to act in good faith and substantially comply with requirements in a statute or regulation.  In a prior blog post (HERE), we discussed the substantial compliance doctrine in relation to the filing of and penalties associated with international information returns. The first case that cited the substantial compliance doctrine is a 1928 Board of Tax Appeals case, Indiana Rolling Mills Co. v. Commissioner, 13 B.T.A. 1141 (1928), where the court held that the taxpayer’s return, which was not signed by the statutorily required corporate officer, was still considered a validly filed tax return.  The Court stated that the general rule of statutory construction is that provisions that relate to the “essence of the thing to be done are mandatory” and those that do not relate to the essence of the thing to be done are “directory.”   The “essence” of the statute was making an honest return.  The fact that the Vice President, rather than the President, signed the return did not go to the essence of the statute.

In Emanouil, the taxpayers donated 16 acres and 71 acres to the town of Westford in Massachusetts in 2008 and 2009, respectively.  The taxpayers reported the donations on their 2008 and 2009 tax returns, included complete Forms 8283, “Noncash Charitable Contributions” and attached appraisals to each return.  The IRS disallowed the deductions, arguing that the donations were not properly substantiated under Section 170 because the appraisals did not identify the dates of the contributions and did not contain statements that the appraisals were prepared for income tax purposes.  In holding for the taxpayers, the Court noted that the purpose of the qualified appraisal statute is to provide the IRS with adequate information to address overvaluation:  “If the appraisal at issue does not generally provide the information required in the regulations… then the ‘essential requirements of the governing statute’ … can be satisfied despite certain defects that may not be significant in a given case.” The Court found that the taxpayers’ failure to provide the dates of the donations on the appraisals was not fatal because the appraisals were dated within 30 days of the contributions, and each explicitly stated that it gave “a current market value,” rather than a historic value of the previous date. The Court also noted that the taxpayers had disclosed the contribution dates on the Forms 8283 attached to their returns.  The Court said the failure of the appraisals to state that they were prepared for income tax purposes was not fatal because each appraisal (i) valued the correct asset according to the correct standard, (ii) was prepared within 30 days of the date of the contribution, and (iii) used a commonly accepted approach to estimate fair market value.  “In other words, the appraisals do not have multiple cumulative defects that we previously held to be fatal for deducting charitable contributions”.

Obviously, it behooves all taxpayers and their advisors to comply with the statutory and regulatory requirements.  Failure to do so gives the IRS a potential opportunity to challenge a tax return based on “foot faults.”  However, a reasonable judge and the substantial compliance doctrine may provide taxpayers the opportunity to avoid potential “foot faults.”

For questions related to this or any other civil tax or criminal tax-related matter, please feel free to contact Joel Crouch at (214) 749-2456 or jcrouch@meadowscollier.com.