By Tom Umstattd, CPA December 6, 2004

If you were thinking about donating your old car to charity, you better do so quick, and in 2004, because on January 1, 2005, Congress (in the American Jobs Creation Act of 2004) and the IRS will begin discriminating against those who would donate vehicles, boats and planes to charities.  Historically, when someone donates property to their favorite charity they may deduct its fair market value.  The common definition of fair market value is what a willing buyer will pay a willing seller.  When we donate a car (or boat) to a charity, they typically will sell it to a whole seller at an auction or for a bargain sale, who in turn sells it to a used car lot, who in turn sells it to the end user.  Although the whole seller is a willing buyer, the charity is not a willing seller.  The willing seller and buyer tests, establishing the fair market value, are not satisfied until the used car company sells it to the end user.  For example, a car worth $5,000 donated to a charity might be sold by the charity to the whole seller for $3,000, who might sell it for $4,000 to the used car company, who then sells it for $5,000 to the end user, which establishes the fair market value of the car.  Since the contributor could not likely ever know the details of the final sale, estimations of this value have historically been estimated by either consulting a used car value guide, such as Kelly Blue Book, or for assets over $5000, hiring an appraiser.  Beginning January 1, 2005, no longer.  In the example above, under the old rules the charitable contribution deduction is $5,000, next year the contribution would be only $3,000.

In order to close a perceived abuse of taxpayers by Congress, claiming higher values than reasonable, we can only deduct the amount charity is able to sell the car for, assuming that they actually sell it.  All other property given to charity such as clothes, toys and furniture can still be valued at fair market value.  Therein is the discrimination.  The IRS in IR-2004-142 has spelled out many of the details of the new law.  I have included it below.

Tom Umstattd, CPA

IRS Officials Urge Care for Those Making a Car Donation; New Law Changes Rules at End of the Year

IR-2004-142, Nov. 30, 2004

WASHINGTON — The Internal Revenue Service issued a consumer alert today to help taxpayers avoid potential pitfalls when they donate their automobiles to charities.

In addition, as taxpayers plan their charitable giving, donors should understand the way that the American Jobs Creation Act of 2004 will alter the rules for the contribution of used motor vehicles, boats and planes after Dec. 31, 2004.

Next year, if the claimed value of the donated motor vehicle, boat or plane exceeds $500 and the item is sold by the charitable organization, the taxpayer is limited to the gross proceeds from the sale.

Under the new rules, the charitable organization must provide an acknowledgement to the donor within 30 days of the sale stating the amount of gross proceeds. Alternatively, if the charity significantly uses or materially improves the vehicles, the charity must certify this intended use and duration and provide an acknowledgement to the donor within 30 days of the contribution. If the charity significantly uses or materially improves the vehicle, generally, the donor may deduct the vehicle’s market value.

For the remainder of 2004, however, the new rules do not apply. Under the rules in effect for 2004, taxpayers will be able to deduct the fair market value of the contributed property.

“Just because the rules will be tightened for vehicles donated next year doesn’t mean anyone should give a car to charity and claim an inflated value this year,” said IRS Commissioner Mark W. Everson.

IRS officials recommend that people who want to donate their vehicle by Dec. 31, 2004, take the following steps:

*  Check That the Organization is Qualified — Taxpayers should make certain that they contribute their car to an eligible organization; otherwise, their donation will not be tax deductible. Taxpayers can use the IRS Web site to check that an organization is qualified by searching Publication 78. Publication 78 is an annual, cumulative list of most organizations that are qualified to receive deductible contributions. Publication 78 is also available in many public libraries. In addition, taxpayers can call IRS Tax Exempt/Government Entities Customer Service at 1-877-829-5500. Be sure to have the organization’s correct name and its headquarters location, if possible. Churches, synagogues, temples, mosques and governments are not required to apply for this exemption in order to be qualified. They frequently are not listed in Publication 78. Donations to these institutions are tax deductible.

*  Itemize in Order to Benefit — Many taxpayers can’t take a deduction for car donations because they don’t itemize deductions on their personal tax return. For taxpayers, the decision to itemize is determined by whether their total itemized deductions are greater than the standard deduction (for 2004, the standard deduction will be $4,850 for single; $9,700 for married filing jointly). Slightly more than one-third of the 130 million individual taxpayers itemized in 2001, the last year for which complete data is available.

*  Calculate the Fair Market Value — The donor must take many factors into consideration to establish the value of the car. Many used-car buying guides contain step-by-step instructions so that readers can make adjustments to the value of a car for accessories, mileage and other indicators of its general condition. Both Publication 526, Charitable Deductions, and Publication 561, “Determining the Value of Donated Property,” provide detailed instructions.

*  Deduct Only the Car’s Fair Market Value — Some car donation program operators have mistakenly claimed that donors can deduct the highest value listed in a used-car buyer’s guide for their make and model of car, regardless of the donated car’s condition. The IRS, however, will only allow a deduction for the fair market value of the car. Fair market value takes into account many factors, including the vehicle’s condition. The fair market value of the taxpayer’s car may be substantially different than the highest value listed in a used-car buyer’s guide for that make and model of car.

*  Document the Charitable Contribution Deduction — For vehicle donations, taxpayers must document the car donation and its fair market value. Recordkeeping requirements are comprehensive and vary depending on the amount of the contribution and the total amount of the charitable deduction. IRS Publication 526 details requirements for the types of receipts taxpayers must obtain and the forms they must file.

*  Contact State Charity and IRS Officials When in Doubt — Donors with questions about whether a contribution is deductible should call the IRS at 1-800-829-1040 or for TTY/TDD help, call 1-800-829-4059. They can also find IRS forms and publications at IRS.gov. Donors concerned that contributions are being solicited for fraudulent purposes should contact the appropriate state charity official, who is often located in the state attorney general’s office. A list of state charity official offices can be found online.

Related Items:

*  IRS Publication 78
*  State Charity Officials
*  State Attorneys General
*  Publication 526, Charitable Deductions (PDF 177K)
*  Publication 561, Determining the Value of Donated Property ( PDF 101K)

Written by Tom Umstattd, CPA, April 1, 2002.

Some of my colleagues offer electronic filing (E-File); I do not, yet.  This procedure is currently most appropriate with low-budget, seasonal, non-CPA tax return preparers who prepare 1000s of very fast and easy returns with refunds; we prepare almost no easy returns.  We first looked into E-Filing about 8 years ago and every year since.  When a return is E-Filed, the “pertinent information,” according to the IRS, from a tax return is downloaded via the internet directly into the IRS’s computer system.  E-Filers cannot send explanations or attachments.  When a return is filed via the mail, IRS employees keypunch certain entries from the return.

If a return, as the IRS calls it:  gets “kicked out of the pipeline” or, gets selected with “audit potential” by other means, then an IRS employee looks at the paper filed return with all of the attachments and explanations and professionally decides whether to proceed further.  But for E-Filed returns, were no paper is filed, then the IRS is left with little alternative but to contact the taxpayer and begin the arduous experience of examining the taxpayer’s receipts and records which corroborate his or her income, deductions, etc.  And, if the IRS goes through this much trouble, as many of you already know, they tend to examine everything.  Ray Sommerfield, one of my UT tax professors warned us, “When it comes to audits, the IRS has determined that there’s a lot of gold in ‘them thar hills.’”  For example, we have many philanthropic clients who give more than 10% of their income to charities.  This 10% benchmark is one of the IRS’s benchmarks for high audit probability.  If we can attach statements from 1 or more of the charities proving most of the charitable contributions deduction, we have likely assuaged an audit.  This cannot be done with E-Filed returns.

Perhaps the IRS’s chronic lack of security measures is the best reason not to E-File.  Click here for our privacy policy.  Government investigators each year try to hack into the IRS’s computer system, and each year are able to access private information from E-Filed returns in the IRS’s computer system.  Each year we link to an article on this website concerning this reoccurring problem, but these links seem to expire quickly.  So this year, I have copied an Associate Press article in its entirety.  It is now below.  Note:  a hacker can retrieve information and exit without the IRS even knowing that they were ever there.

Study:  IRS Data Open to Hackers, Thursday March 15, 2002, 1:24 PM ET

WASHINGTON (AP) –Government investigators were able to hack into the Internal Revenue Service computer system last year and access Social Security numbers and other sensitive information from electronically filed tax returns, a congressional report said Thursday.

“We demonstrated that unauthorized individuals, both internal and external to IRS, could have gained access to IRS’ electronic filing systems and viewed and modified taxpayer data contained in those systems during the 2000 tax filing season,” the General Accounting Office report stated.

The investigators said they were able to gain access to taxpayer information because the IRS had not securely configured its operating systems, implemented adequate password management practices or used encryption technology.

The IRS said it had no evidence that real intrusions actually occurred, but the GAO concluded the agency did not have “adequate procedures to detect such intrusions.”

The IRS also said in its response that it had taken steps to better protect taxpayer privacy this year.

Sen. Fred Thompson, R-Ten., Chairman of the Governmental Affairs Committee, asked for the investigation.

GOLD AT THE END OF THE RAINBOW:

MEDICAL EXPENSES AND BELOW-MARKET-RATE LOANS IN

CONTINUING CARE RETIREMENT COMMUNITIES

By Robert Atkins Walker, Ph.D., CPA and Chad E. Turner, CPA

Published in 18 Virginia Tax Review 1 (Summer 1998: The University of Virginia School of Law) under the title “Gold at the End of the Rainbow:  Medical Expenses and Below-Market-Rate Loans in Continuing Care Retirement Communities,”

I.  Introduction

A.  Purpose

Residents of continuing care retirement communities (CCRCs) or their children, if the residents are the children’s dependents,¹ face significant tax consequences associated with the fees they pay to a CCRC.  On the positive side, they usually can take a large tax deduction for the medical expense portion of their entrance fee² and may also deduct the medical portion of their monthly fees.  Negative consequences may occur, however, if the CCRC is obliged to refund some or all of the entrance fee when a resident vacates or dies.  The refundable portion of the fee may be treated as a below-market-rate loan in which case residents may have to report imputed interest income, and the CCRC, imputed interest expense, on the refundable portion of the entrance fee.³ Residents also may have taxable income on the refund if they took a medical expense deduction on the entire original fee.  This article addresses these consequences and analyzes the methods CCRCs use in estimating the portions of the entrance and monthly fees allocable to medical care.

In many cases, the tax impact of moving into a CCRC may be very large, resulting in a medical expense deduction of $20,000 or more for the entrance fee and $3,000 or more annually for the monthly fees.⁴ Residents in assisted living units (ALUs) generally should be able to deduct 100% of their monthly fees.  Nursing care residents also may deduct 100% of their monthly fees.

The IRS has provided little guidance regarding the mechanics of computing the deduction, the acceptability of the various rationales used by CCRCs in computing the medical expense percentage of their residents’ fees, or the tax effects on residents or their estates of an entrance fee refund.  Furthermore, there is little consistency among CCRCs in advising their residents as to what is deductible or in their methods of computing the percentage of fees allocable to medical costs.

The need for consistent and proper treatment of the CCRC medical expense deduction is growing in importance.  Since the 1970’s, the number of CCRCs has increased dramatically.  In 1994 there were over 350,000 residents in nearly 1,200 CCRCs.⁵ This number is growing steadily and will accelerate after 2010 as the baby boomers reach retirement age.

To our knowledge, four articles to date have addressed the tax deductibility of CCRC fees.  The first focused on nursing home residents,⁶ the second misinformed the readers,⁷ the third devoted only one paragraph to the issue,⁸ and the fourth discussed the effects of the Health Insurance Portability and Accountability Act of 1996⁹ on deductibility of long-term care expenses and insurance.¹⁰ The second article stated, “[i]n counseling on the tax deductibility . . . of CCRC costs, you must first establish whether the principal reason for entry into the CCRC is the availability of medical and nursing care . . . .”¹¹ This is wrong.  As we discuss in section II.B.2., non-medical reasons for entering a CCRC will not prevent the deductibility of the medical expense portion of the fees.¹²

Our objectives are: (1) to clarify the tax deduction opportunities for CCRC residents, (2) to alert both the residents and CCRC administrators as to the potential tax effects of refundable entrance fees, and (3) to give CCRC administrators direction on allocating the medical expense fee portion properly so as to maximize their residents’ potential tax savings.

Regarding entrance fee refunds, we examine three issues: (1) whether the section 7872¹³ below-market-rate loan rules will trigger imputed interest on the refundable portion of entrance fees, (2) whether an anticipated entrance fee refund must be subtracted from the entrance fee in calculating the medical expense deduction, and (3) whether the residents, their estates, or their heirs will have to recognize income in the year the refund is received to the extent of the previously deducted medical expenses attributed to the refund.

The following example of a CCRC resident related to one of the authors illustrates most of the issues involved as well as the magnitude of the tax savings available in properly taking advantage of the deduction.

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