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<p><strong>Setty Gundanna and Prabhavathi Katta Viralam, (2011) </strong><span style="text-decoration: underline;"><span style="color: #3366ff;"><a target="_blank" href="http://ustaxcourt.gov/InOpHistoric/VIRALAM.TC.WPD.pdf">136 TC No. 8 </a></span></span></p>
<p style="text-align: justify;"><strong>Transactional Facts.</strong>  Setty Gundanna Viralam (“Husband”) and Prabhavathi Katta Viralam (“Wife”) were medical doctors and parents of three children.  In 1997, Husband sold his interest in his medical practice for $2,262,000, which resulted in a taxable gain of $2,261,750.  Around this time, Wife joined a financial planning company for doctors called “Xélan,” which provided Husband and Wife with financial planning services, including investment management, pension plans, asset protection and tax reduction strategies, and insurance products.</p>
<p style="text-align: justify;">One such financial planning strategy was a recommendation to donate funds to a xélan foundation (the “Foundation”), which was characterized as a “donor advised fund” or “family public charity.”  The Foundation claimed to allow doctors to contribute a portion of their pre-tax earnings to their own family charity tax-deferred account, and then use such funds to pay their family members for working on behalf of the charity.  Since the Foundation “was created to benefit not only charitable causes, but also doctors and their families,” Husband and Wife were also told that their donations would be segregated for investment, and eventual distributions would be made, as recommended by Husband and Wife, for projects such as personal teaching, research, and college scholarship programs.</p>
<p style="text-align: justify;">The Foundation also offered Husband and Wife a “student loan program,” in which donated funds could be distributed as a loan for college tuition and expenses.  These types of loans were typically repaid with interest, and usually became due five years after the student graduated.  However, in cases where the student preferred to provide charitable services as payment, they were also allowed to “work off” their student loan debt.  Since Husband and Wife had three children who were planning to attend college, they decided to establish a donor-advised fund for this purpose, designating Husband as the fund’s advisor.</p>
<p style="text-align: justify;">In 1998, Husband transferred stocks worth $262,433 (with an aggregate basis of $131,360) into the Foundation account.  Subsequently that same year, the Foundation sold all of the stocks and invested the net proceeds of $224,684, segregating them in Husband’s Foundation account. These Foundation account assets also earned $981 in dividends and interest in 1998.  Upon establishing the donor advised fund, the legal department of the Foundation sent Husband an opinion letter, including advice that donors were “more likely that not” entitled to a charitable contribution deduction for donations made to the Foundation; however, they refused to opine as to the tax effect of each individually offered investment program (including the student loan program).</p>
<p style="text-align: justify;">Husband and Wife filed a joint federal income tax return for 1998, and reported a $2,261,750 gain from the sale of Husband’s interest in his medical practice.  They also claimed a charitable contribution deduction of $263,933 (equal to the fair market value of the stocks transferred to the Foundation in 1998, plus related fees); however, acting upon the advice of his accountant, they did not include the proceeds from the stock sales or dividends and interest generated by the Foundation account.</p>
<p style="text-align: justify;">Throughout the following years, Husband made distributions ranging from $500 to $5,000 from the donor-advised fund.  In 2001, he distributed $17,247 to the University of Pennsylvania as a loan to his son for tuition and room and board under the Foundation’s student loan program.  Husband made a second distribution to the University of Pennsylvania for his son’s tuition in 2002.  The son agreed to participate in the program allowing him to provide annual charitable services as repayment of his debt.</p>
<p style="text-align: justify;">In 2003, Husband repaid the Foundation $70,300 (the total distributions made from the account on the son’s behalf) from an entity that was controlled by him and his son.  The Foundation waived all accrued interest and confirmed that the payment fulfilled the son’s service obligation to the Foundation.</p>
<p style="text-align: justify;">On Sept. 16, 2003, the IRS issued a notice of deficiency to Husband and Wife disallowing the charitable contribution deduction claimed for the transfers of stocks to the Foundation in 1998 (and assessed an accuracy-related penalty).</p>
<p style="text-align: justify;"><strong>Tax Court’s Ruling. </strong> The IRS argued that Husband and Wife were not entitled to a charitable deduction because: (i) they never surrendered dominion and control over the contributed property; or (ii) they failed to substantiate the deduction as required by <a target="_blank" href="http://www.law.cornell.edu/uscode/html/uscode26/usc_sec_26_00000170----000-.html"><span style="text-decoration: underline;"><span style="color: #3366ff;"> </span></span></a><span style="text-decoration: underline; color: #3366ff;"><a target="_blank" href="http://www.law.cornell.edu/uscode/html/uscode26/usc_sec_26_00000170----000-.html">I.R.C. §170(f)(8)</a></span>.  Husband and Wife countered that their account was a legitimate donor-advised fund since they only were given the authority to “suggest” investment strategies.  Further, they argued that they did not receive any substantial benefit for their contribution of stock, and also that their deduction was properly substantiated.</p>
<p style="text-align: justify;">In large part due to the distributions made for his son’s college tuition (totaling 82% of the account), the Tax Court ultimately held that Husband and Wife were not entitled to the charitable deduction because Husband retained dominion and control over the property transferred to the Foundation account.  The Court also noted that Husband could make distributions of account funds to compensate himself or his family members for “good works,” and Foundation approval of such distributions was essentially a formality.</p>
<p style="text-align: justify;">The Tax Court upheld the inclusion of $93,324 in long-term capital gain generated by the sales of the stocks, and $981 of interest and dividends from the Foundation account, on Husband and Wife’s 1998 federal income tax return, as well as the assessment of an accuracy-related penalty for negligence on the part of Husband and Wife.</p>
<p style="text-align: justify;"><strong>Recommendations.</strong>  In order for charitable contributions to qualify for income tax deductions, (i) the donor must have relinquished dominion and control over the donated property; (ii) the contribution must have been made with donative intent and without the expectation of a substantial benefit in return; and (iii) a contribution equal to or greater than $250 must be substantiated by a contemporaneous written acknowledgment (meeting the appropriate I.R.C. requirements) from the charitable organization.  In determining whether a proposed charitable contribution is deductible, the I.R.S. examines the donor’s conduct and the facts and circumstances surrounding each case.  Accordingly, these requirements should be strictly observed.</p>
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