TIGTA Says More Education Needed on Charitable Contributions

Impact on the Taxpayer

Gifts of donated property, clothing, and other noncash items have long been a popular deduction for taxpayers. In recent years, the legitimacy of the values placed on some of these noncash donations has been questioned by the Internal Revenue Service (IRS) and Congress. As a result, Congress passed legislation adding additional reporting requirements to substantiate the value of some of these donations. Currently, taxpayers who may not be entitled to deductions for noncash contributions are reducing their tax liabilities and may receive refunds regardless of whether they provide the required substantiation. This could result in a loss of revenue to the Federal Government and inequitable treatment of taxpayers.

Synopsis

Individual taxpayers are required to file Noncash Charitable Contributions (Form 8283) if their charitable deductions claimed for noncash contributions exceed $500. If the value of donated property exceeds $5,000, taxpayers are required to obtain signatures on their Forms 8283 acknowledging receipt of the donated property. In addition, taxpayers are required to attest on their Forms 8283 that the value placed on the donated property was determined by a qualified appraisal;² however, until passage of the American Jobs Creation Act of 2004, taxpayers were not required to attach the appraisals to their tax returns regardless of the value placed on the donated property.

The IRS revised tax forms and publications and provided training and information to employees to facilitate implementation of the new requirements for claiming noncash charitable contributions. However, taxpayers and tax practitioners still need to be better educated concerning requirements for claiming charitable contributions. Also, additional procedures need to be established to identify noncompliance with charitable contribution requirements during returns processing. Better education of taxpayers and preparers and additional returns processing procedures will enable the IRS to address potential noncompliance, as Congress intended in its legislation. We estimate 101,236 taxpayers could have claimed unsubstantiated noncash contributions totaling approximately $1.8 billion for the period January 15 through September 21, 2006.

Recommendations

We recommended the Commissioner, Large and Mid-Size Business Division, coordinate with the other affected operating divisions to develop a comprehensive outreach plan on the reporting requirements for noncash charitable contributions for affected taxpayers and tax practitioners. We also recommended the Commissioner, Small Business/Self-Employed Division, and the Commissioner, Wage and Investment Division, develop procedures to correspond with taxpayers to obtain missing Forms 8283 and supporting documentation. Taxpayers failing to provide missing Forms and substantiation should have a specific audit code input on their tax returns to alert the Examination function of returns without required substantiation for noncash charitable contributions.

Response

IRS management agreed with the first recommendation and plans to supplement their outreach plan by 1) partnering with several professional stakeholders to promote awareness of the increased reporting requirements, 2) coordinating the IRS' efforts to promote awareness of the increased reporting requirements to donee organizations, and 3) partnering with professional appraisal stakeholders to promote awareness of the increased reporting requirements and appraiser responsibilities.

IRS management partially agreed with the second recommendation. The IRS will continue to correspond with taxpayers claiming noncash contributions over a specific dollar threshold but with no Forms 8283 attached to their returns. In addition, the IRS agreed to use a specific indicator to identify for the Examination function returns claiming noncash contributions over the same threshold dollar amount but with no Forms 8283 attached. Management's complete response to the draft report is included in Appendix IV.

Office of Audit Comment

Although the IRS plans to continue corresponding with taxpayers and will add a specific indicator for instances in which Forms 8283 are missing, we believe few instances of unsubstantiated deductions will be addressed by these actions. The dollar threshold, which remains unchanged, ****2(a)**** and needs to be lowered to ensure ****2(a)**** returns claiming unsubstantiated deductions are addressed in concert with Congressional concerns. Also, the IRS does not plan any additional actions concerning incomplete documentation, such as missing signatures and appraisals. Based on our sampling, we estimate ****2(a)**** percent of the returns with noncash charitable contribution deductions are above the IRS' dollar threshold. We applaud the IRS' efforts to increase its outreach program to better educate taxpayers and tax practitioners, but we urge the IRS to lower the dollar threshold and address returns with incomplete documentation to better deal with these unsubstantiated deductions.

Copies of this report are also being sent to the IRS managers affected by the report recommendations. Please contact me at (202) 622-6510 if you have questions or Daniel R. Devlin, Assistant Inspector General for Audit, (Small Business and Corporate Programs), at (202) 622-5894.

                    Table of Contents

On October 22, 2004, President Bush signed the American Jobs Creation Act of 2004 (AJCA).⁵ AJCA Provision 883 (Increased Reporting for Noncash Charitable Contributions) created additional reporting requirements for individual taxpayers making noncash charitable contributions valued at more than $500,000. The IRS Large and Mid-Size Business (LMSB) Division was assigned primary responsibility for implementation of Provision 883. The implementation of this Provision involved multiple actions, including training and providing guidance to IRS employees, creating and revising tax forms and publications, and coordinating extensively with various IRS functions.

This review focused on noncash donations other than vehicles and works of art. The review was performed at the IRS office in Holtsville, New York, during the period March through September 2006. It included a review of tax returns filed nationwide and discussions with personnel in the Submission Processing function of the Wage and Investment Division and the Field Specialists function of the LMSB Division. The audit was conducted in accordance with Government Auditing Standards. Detailed information on our audit objective, scope, and methodology is presented in Appendix I. Major contributors to the report are listed in Appendix II.

To facilitate implementation of the new requirements for claiming noncash charitable contributions, the LMSB Division created on its web site an AJCA webpage that contained links to notices, news releases, fact sheets, and other existing technical guidance relating to the Act. Tax forms and publications related to noncash charitable contributions were properly updated in accordance with the new law. In addition, training covering the new law was provided to IRS employees.

The LMSB Division used the Legislative Implementation Tracking System, which is an IRS Intranet-based planning and monitoring system, to monitor implementation of the legislation. This System lists the required actions with estimated due dates and the functions responsible for taking the necessary actions.

Taxpayers and Tax Practitioners Need to Be Better Educated Concerning Requirements for Claiming Charitable Contributions

Individual taxpayers are required to file a Noncash Charitable Contributions (Form 8283) if their charitable deductions claimed for noncash contributions exceed $500. If the value of donated property exceeds $5,000, taxpayers are required to obtain signatures on their Forms 8283 acknowledging receipt of the donated property. In addition, taxpayers are required to attest on their Forms 8283 that the value placed on the donated property was determined by a qualified appraisal;⁶ however, until passage of the AJCA, taxpayers were not required to attach the appraisals to their tax returns regardless of the value placed on the donated property.

AJCA Provision 883 requires all donors who contribute property (other than cash, inventory, or publicly traded securities) for which a deduction of more than $500,000 is claimed to attach a qualified appraisal to their tax returns. Provision 883 is effective for donations made after June 3, 2004.

We reviewed statistically valid samples of Tax Year 2005 individual income tax returns on which the deductions claimed for noncash charitable contributions were greater than $5,000. In 46 (22 percent) of 211 cases, taxpayers failed to provide the required substantiation for deductions of approximately $23 million.⁷ Paid preparers prepared 161 (76 percent) of the returns in our samples and prepared 33 (72 percent) of the 46 error cases.⁸

  Figure 1: Tax Returns Filed Without Substantiation for Noncash Contributions

Unlike other provisions of the AJCA, for which the IRS provided information to practitioners and other stakeholders through news releases and other communications, guidance on Provision 883 has generally been limited to the revision of tax forms and publications. More than 2 years after enactment of the legislation, an IRS notice under Internal Revenue Code Section 170⁹ providing guidance and transitional rules for increased reporting for noncash charitable contributions was approved for release. Also, a draft of new regulations under Internal Revenue Code Section 170 with more formal guidance on increased reporting for noncash charitable contributions is not scheduled for release until 2007. Our samples were identified from returns processed from January 15 through March 18, 2006. Based on the results of our samples, we estimate 51,502 taxpayers claimed unsubstantiated noncash charitable deductions of approximately $676 million on Tax Year 2005 returns processed during this time. If the error rate for the returns processed from March 19 through September 21, 2006, remained the same as the rate in our samples,¹⁰ we estimate 101,236 taxpayers could have claimed unsubstantiated noncash contributions totaling approximately $1.8 billion for the period January 15 through September 21, 2006.¹¹ Without proper documentation, these taxpayers, by law, are not entitled to these deductions.

Recommendation

The procedures used by the IRS Submission Processing function were not adequate to ensure taxpayers met requirements for deducting noncash charitable deductions. Tax laws related to noncash charitable contributions state that no deduction shall be allowed for various noncash charitable contributions unless taxpayers provide specific substantiating information with their tax returns. In general, individuals who claim noncash charitable contributions must provide the following with their returns:

• Noncash contributions of $501 to $5,000 -- Form 8283 containing a description of the donated property.

• Noncash contributions of $5,001 to $500,000 -- Form 8283 containing a description of the donated property, a signature from the charitable organization acknowledging receipt of the donated property, and the signature of a qualified appraiser.

• Noncash contributions of more than $500,000 -- Form 8283 containing a description of the donated property, a signature from the charitable organization acknowledging receipt of the donated property, the signature of a qualified appraiser, and a copy of the appraisal.

Further, the IRS indicated the Examination function would be responsible for any review of information related to these returns; however, the returns were not coded or processed in any way to alert the Examination function of the unsubstantiated deductions. Instead, the returns go through the same Examination function selection criteria as any other tax returns. The Examination function generally audits ****2(a)**** percent of the individual income tax returns filed each year.

By not identifying returns filed without the required substantiation for charitable contributions, the IRS is not addressing the Congressional intent of this legislation. Taxpayers who are not entitled to deductions for noncash contributions are reducing their tax liabilities and may receive refunds regardless of whether they provide the required substantiation. This could result in a loss of revenue to the Federal Government and inequitable treatment of taxpayers.

Recommendation

We also support the premise that obtaining missing documentation may increase reporting compliance for noncash contributions. Therefore, we agree to correspond with taxpayers to obtain missing Forms 8283, "Noncash Charitable Contribution," and supporting documentation in situations involving 2(a) noncash charitable contributions. We also agree to your recommendation to assign specific audit codes on returns with 2(a) noncash charitable contributions missing Forms 8283. The procedures in place will be closely monitored and adjusted as necessary.

Attached is a detailed response outlining our corrective actions.

If you have any questions, please contact me or call Kathy Petronchak, Commissioner, Small Business/Self-Employed Division, at (202) 622-0600.

Attachment

The Commissioner, Large and Mid-Sized Business (LMSB) Division, should coordinate with the other impacted Operating Divisions to develop a comprehensive outreach plan on the reporting requirements for noncash charitable contributions for the affected taxpayers and tax practitioners.

CORRECTIVE ACTIONS:

The LMSB Division will fully discuss and coordinate the following corrective actions with impacted Operating Divisions before they are implemented:

The Field Specialists Office in the LMSB Division will coordinate with SB/SE, W&I and, to the extent necessary, TE/GE to develop an action plan by March 31, 2007. We anticipate that any corrective actions agreed upon may be implemented by September 30, 2007.

RESPONSIBLE OFFICIAL:

Director, Field Specialists Office, Large and Mid-Sized Business Division

CORRECTIVE ACTION(S) MONITORING PLAN:

The Director, Field Specialists Office, LMSB Division, will advise the LMSB Commissioner of any delays in implementing this corrective action.

RECOMMENDATION 2:

The Commissioner, Small Business/Self-Employed, and the Commissioner, Wage and Investment Division, should develop the following procedures to address returns without required substantiation for noncash charitable contributions:

² In general, the appraiser must sign the Form 8283 attesting to his or her qualifications, impartiality, and independence.

³ Tax Year 2003 was the most current year for which complete data were available.

⁴ IR-2006-113, July 18, 2006.

⁵ Pub. L. No. 108-357, 118 Stat. 1418 (2004).

⁶ In general, the appraiser must sign the Form 8283 attesting to his or her qualifications, impartiality, and independence.

⁷ The actual tax losses cannot be determined because the IRS did not identify these returns and therefore took no actions to determine whether the taxpayers could provide the required documentation.

⁸ We also reviewed a judgmental sample of 54 tax returns on which the noncash charitable contributions claimed were more than $500 but less than or equal to $5,000. We found that the Forms 8283 were attached to the returns and were prepared correctly.

⁹ 26 U.S.C. Section 170 (2005).

¹⁰ For contributions of $5,001 to $500,000, the error rate was 24 percent and the average contribution amount was $10,809. For contributions over $500,000, the error rate was 19 percent and the average contribution amount was $1,338,967.

¹¹ These estimates were determined using the two samples described in Figure 1. For the sample of noncash contributions of $5,001 to $500,000, we estimate 100,677 taxpayers could have claimed unsubstantiated noncash contributions totaling approximately $1.1 billion. For the sample of noncash contributions greater than $500,000, we estimate 559 taxpayers could have claimed unsubstantiated noncash contributions totaling approximately $700 million.

¹² Pub. L. No. 108-357, 118 Stat. 1418 (2004).

¹³ This is an IRS Intranet-based planning and monitoring system to monitor implementation of legislation. This System lists the required actions with estimated due dates and the functions responsible for taking the necessary actions.

¹⁴ This is the IRS database that maintains transactions or records of individual tax accounts.

¹⁵ The Return Transaction File contains line items transcribed during return processing and other fields such as math calculations.

¹⁶ The TIGTA Data Center Warehouse provides data and data access services; centralizes storage, security, and administration of files; and develops uniform and user-friendly interfaces for users to access data.

¹⁷ We selected this tax period so any deductions for noncash charitable contributions would be subject to AJCA Provision 883. The TIGTA Data Center Warehouse file included Tax Year 2005 returns processed from January 15 through March 18, 2006.

¹⁸ We used the error rates from the original samples to arrive at this figure.