Charitable Contributions

Legal Developments

Archdiocese Faces Fraud Suit for Using Donations to Defend, Settle Sex Abuse Claim

The church tried—and failed—to have the case dismissed under the ecclesiastical abstention doctrine.

Richard R. Hammar, Attorney, CPA
Bio

Summary : A Michigan appellate court ruled that the ecclesiastical abstention doctrine did not bar a lawsuit alleging a Catholic archdiocese committed fraud by redirecting donations raised for a specific ministry to instead be used to defend and settle a sex abuse claim.

Fraud suit rooted in call for donations

Several church members sued a Catholic archdiocese for fraud, claiming that it asked its parishioners to donate money to the Catholic Services Appeal (CSA) when in fact the donations were used for the defense and settlement of a sex abuse claim.

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The trial court ruled that the plaintiffs’ claims were barred by the ecclesiastical abstention doctrine, a judicially created legal doctrine based upon the First Amendment that bars civil courts from resolving disputes involving doctrine and polity.

WATCH: Church Law & Tax Editor and Attorney-at-Law Matt Branaugh explains why lawsuits like these are so important for church leaders involved in fundraising campaigns.

The plaintiffs appealed, arguing the ecclesiastical abstention doctrine is not applicable to the facts of this case because no questions of church doctrine or polity had to be examined to resolve their claims.

Allegations of fraud

The plaintiffs claimed the archdiocese committed fraud when it said CSA donations would be used for charitable ministries and were not and would not be used to settle claims “of any nature” against it. According to the plaintiffs, the archdiocese made a false representation because the CSA donations were used to investigate and respond to a sex abuse claim.

Did you know? A similar lawsuit, against the late Ravi Zacharias’ ministries, is moving through the courts in Georgia. In that case, donors claim the ministry’s use of designated offerings for unrelated purposes constitutes fraud.

The appellate court’s decision

The appellate court reversed the lower court’s decision, allowing the lawsuit to proceed.

The appellate court noted that the elements of fraud are:

(1) the defendant made a material representation; (2) the representation was false; (3) when the defendant made the representation, the defendant knew that it was false, or made it recklessly, without knowledge of its truth as a positive assertion; (4) the defendant made the representation with the intention that the plaintiff would act upon it; (5) the plaintiff acted in reliance upon it; and (6) the plaintiff suffered damage.

In weighing whether the ecclesiastical abstention doctrine prevented such a claim from proceeding against the archdiocese, the appellate court concluded:

… contrary to defendants’ arguments, resolution of … plaintiffs’ fraud claim would not impermissibly permit the trial court to second guess how the Archdiocese spends its money. (emphasis added) In order to adjudicate plaintiffs’ claim that the CSA donations were not and would not be used to settle claims against the Archdiocese, the trial court would only be required to decide whether the Archdiocese’s statement was true or false when made. Such an inquiry by the trial court would not involve delving into internal church policies or otherwise substituting its opinion in lieu of that of the authorized tribunals of the church in ecclesiastical matters. The inquiry would not relate to the propriety of how the donations were spent, but rather whether the Archdiocese lied about their purpose when it solicited them. This does not cross the line imposed by the First Amendment.

What this means for churches

A failure by a church to spend designated offerings for the donors’ designated purposes may subject a church to liability on the basis of fraud or misrepresentation.

In this case, the appellate court concluded that such a claim of fraud or misrepresentation could be subject to the civil courts’ jurisdiction without violating the archdiocese’s First Amendment rights.

Dux v. Bugarin, 2021 WL 6064359 (Mich. App. 2021).

Legal Developments

Update: RZIM, Inc. Liable for Unjust Enrichment, Fair Business Practices Violation

Georgia case opens door for donors to sue churches and ministries to recoup contributions.

Richard R. Hammar, Attorney, CPA
Bio

Editor’s Note: On March 3, 2023, a Georgia federal district court denied the plaintiffs the ability to bring their lawsuit against Ravi Zacharias International Ministries, Inc. as a class action. Instead, the plaintiffs can only bring individual claims. The court noted:

None of the donors were actually harmed by their contributions to RZIM, and it appears from the face of the [complaint] that only a very small amount of the money contributed to RZIM was actually used to facilitate or cover up the sexual misconduct of [Ravi] Zacharias. Therefore, a class-wide damages award (even if possible) of all contributions would be inequitable and implausible. …

Church Law & Tax will continue to monitor the case, including whether the class-action decision gets appealed.

Key point. Churches and other religious ministries may be liable on various grounds for using designated funds for undesignated purposes. Those grounds include unjust enrichment and violation of a state Fair Business Practices Act.

A federal court in Georgia ruled that it was not barred by the ecclesiastical abstention doctrine from resolving a lawsuit by donors to a religious ministry claiming fraud based on the ministry’s use of designated offerings for unrelated purposes.

Background

Ravi Zacharias, who died in May 2020, was a well-known Christian apologist and evangelical minister who founded the Ravi Zacharias International Ministries, Inc. (“RZIM”) in 1984. The organization’s stated “vision” is “to build a team with a fivefold thrust of evangelism, apologetics, spiritual disciplines, training, and humanitarian support.”

RZIM works toward this vision through conferences, lectures, and seminars held around the world; it also produces podcast and radio shows as well as online videos which featured Zacharias. For many years, these programs found a dedicated audience of millions.

Plaintiffs: RZIM “bilked hundreds of millions of dollars”

Among the ministry’s followers were two couples (the “Plaintiffs”) who considered Zacharias and RZIM to be “spiritually aligned with the Gospel of Jesus Christ and … completely dedicated to a mission of spreading the Gospel, teaching new apologists, and trying to help people through humanitarian efforts.”

While listening to RZIM’s programs, the Plaintiffs recall hearing Zacharias and other speakers solicit donations to RZIM. For example, on one occasion they heard the following message:

The vision of RZIM is built on five pillars made up of evangelism, apologetics, spiritual disciplines, training, and humanitarian support. A fundamental part of this mission is to train men and women to defend the power and coherence of the Gospel of Jesus Christ. Our hope is to empower you to engage in earnest conversations with those who have questions about the Christian faith. Your donations make it possible for us to continue to reach others with the gospel and we cannot do this work without your help.

The Plaintiffs heeded these calls and made donations of several thousand dollars. Both couples allege that they “reasonably relied on Zacharias’s and RZIM’s uniform messaging that they were dedicated to a mission of Christian apologetics and that contributions made by people like the [Plaintiffs] would be used to financially support that mission.” The Plaintiffs initiated a class action lawsuit on August 4, 2021, against RZIM.

They alleged that RZIM “bilked hundreds of millions of dollars from well-meaning contributors who believed RZIM and Zacharias to be faith-filled Christian leaders,” when in fact, Zacharias was “a prolific sexual predator who used his ministry and RZIM funds to perpetrate sexual and spiritual abuse against women.”

To that end, the proposed class included “all persons in the United States who made contributions of monetary value to Ravi Zacharias or the Ravi Zacharias International Ministry from 2004 through February 9, 2021.”

The Plaintiffs further claimed that RZIM’s failure to respond appropriately to reports of Zacharias’s sexual misconduct “furthered the public deception that Zacharias was a faith-filled, moral, and upstanding Christian leader … and allowed Zacharias to continue sexually abusing women under the cover of Christian ministry and permitted Zacharias’s ongoing, deceptive fundraising efforts for RZIM.”

The complaint asserted four claims on behalf of the Plaintiffs and the proposed class against RZIM:
  1. misrepresentation
  2. unjust enrichment
  3. violation of the Georgia Charitable Solicitations Act
  4. violation of the Georgia Fair Business Practices Act

RZIM asked the court to dismiss all claims against it.

RZIM argues the ecclesiastical abstention doctrine applies

RZIM argued that the Plaintiffs’ claims dealt with religious issues relating to pastoral conduct that were barred from consideration by the civil courts under the so-called ecclesiastical abstention doctrine.

The court responded:

As the Court reads the Complaint, the Plaintiffs’ claims rest on two general categories of misrepresentations by Zacharias and RZIM.

First, the Plaintiffs make “faith-based allegations”—namely that the Defendants “misrepresented that they were faith-filled Christians of upstanding moral character.”

These faith-based allegations include that “[Zacharias and RZIM] held themselves out to be pious followers of the Holy Gospel, maintaining a religious level of morality and following the teachings of Jesus Christ.

Zacharias explicitly presented himself as a devoted Christian who was living a Christian lifestyle in keeping with the Gospel of Jesus Christ and who was worthy of leading others in their Christian faith. …” Second, the Plaintiffs make “misuse-of-funds allegations”—namely, that “[Zacharias and RZIM] affirmatively misrepresented that funds contributed to RZIM were to support its purported mission of Christian evangelism, apologetic defense of Christianity, and humanitarian efforts, when such funds were in fact used to support and hide Zacharias’s sexual abuse.”

The Plaintiffs allege that “RZIM funds were funneled to women subjected to Zacharias’s sexual misconduct,” and that “Zacharias provided money to these survivors, gave them large tips following massages, and showered them with expensive gifts.”

For example, “Touch of Hope was a discretionary fund that RZIM earmarked as a humanitarian effort, but a significant portion of its wire payments were made to or for the benefit of four women who were, at some point, Zacharias’s massage therapists.”

All the while, Zacharias and RZIM allegedly solicited donations with the stated purpose to fund travel, training, humanitarian aid, and other expenses “to continue reaching those around the globe with the Gospel.”

The court concluded that it could not address the Plaintiffs’ “faith-based allegations” since doing so would ask the court

to examine the theology and customs of Christianity and Christian apologetics to determine whether Zacharias and RZIM fulfilled the religion’s (and the Plaintiffs’) moral standards. The Court would have to make inherently ecclesiastical determinations as part of this inquiry, such as what it means to be a “faith-filled, moral, and upstanding Christian leader” and whether Zacharias’s alleged sexual misconduct is “diametrically opposed to the teachings of Christianity.”

It is not the role of federal courts to answer these kinds of questions “because that would require defining the very core of what the religious body as a whole believes.” In doing so, a court risks “establishing” a religion by “putting the enforcement power of the state behind a particular religious faction.”

Court: misuse-of-funds allegations can be decided

On the other hand, the court concluded that the Plaintiffs’ misuse-of-funds allegations did not implicate these concerns:

Those allegations, and the claims associated with them, raise what amounts to a secular factual question: whether the Defendants solicited funds for one purpose (i.e., Christian evangelism) but instead used those funds for another purpose (i.e., to perpetrate and cover up sexual abuse).

That dispute “concerns the [actions of Zacharias and RZIM] not their beliefs,” and can be decided according to state statutes and common law principles.

Unjust enrichment

The Plaintiffs asserted a claim for unjust enrichment on the grounds that it would be inequitable for the Defendants to keep donations raised on false pretenses. The court agreed, noting that “a conclusion that one party has obtained benefits from another by fraud is one of the most recognizable sources of unjust enrichment.” The court added:

According to the Complaint [RZIM] “induced [Plaintiffs and Class Members] to fund its purported Christian apologetic evangelism, training, and humanitarian efforts,” but then “failed to use the funds for these purposes, diverting funds to massage parlors and as financial support to survivors of Zacharias’s sex abuse.”

The Plaintiffs allege that they would not have donated to [RZIM] had it “truthfully represented that it would … use those financial benefits for their own, wrongful purposes, including in the furtherance of, and to hide, Zacharias’s sexual misconduct.” Taken as true, these allegations … support that [RZIM] unfairly obtained financial benefits by misrepresenting their intended or ultimate use.

Georgia Charitable Solicitations Act

The Plaintiffs asserted that RZIM had violated the Georgia Charitable Solicitations Act. The Charitable Solicitations Act, which has been enacted in most states, creates a private cause of action against a “charitable organization” to recover damages resulting from a violation of the statute. The term “charitable organization” is defined to exclude a “religious organization”—or any entity which (A) “conducts regular worship services” or (B) “is qualified as a religious organization under Section 501(c)(3) of the Internal Revenue Code … that is not required to file IRS Form 990 . …”

The court concluded that:

RZIM “has satisfied the elements of a religious organization under the Act as it is exempt from federal income tax under Section 501(c)(3) and is not subject to the filing requirements of Form 990.”

Georgia Fair Business Practices Act

The Plaintiffs asserted a claim under the Fair Business Practices Act on the grounds that RZIM’s charitable solicitations were unfair and deceptive consumer practices. The statute permits “any person who suffers injury or damages … as a result of consumer acts or practices in violation of this part … [to] bring an action individually for damages and injunctive relief.”

The court rejected RZIM’s motion to dismiss this basis of liability.

RZIM: Plaintiffs lacked “standing” to sue

RZIM argued that the Plaintiffs lacked “standing” to sue in federal court. Article III of the US Constitution limits the jurisdiction of federal courts to “cases” and “controversies,” which is interpreted to mean that the plaintiff bringing a lawsuit in federal court must have suffered some form of tangible injury to be redressed. RZIM pointed to several decisions as support that “donating money to a charitable fund does not confer standing to challenge the administration of that fund … and that the Plaintiffs’ unrestricted charitable gifts to RZIM cannot constitute an injury for purposes of Article III standing.”

The court agreed that “at common law, a donor who has made a completed charitable contribution, whether as an absolute gift or in trust, had no standing to bring an action to enforce the terms of his or her gift or trust unless he or she had expressly reserved the right to do so.” The court noted:

The Plaintiffs asserted that they “sustained monetary and economic injuries” arising out of their donations to RZIM. The Plaintiffs donated several thousand dollars to RZIM. … Before making donations to RZIM, the Plaintiffs allege that they listened to radio programs, podcasts, and CDs featuring Zacharias; watched videos published by RZIM on YouTube; and read books by Zacharias and others within RZIM. The Plaintiffs recall hearing messages [that] solicited financial contributions to advance that work. The Plaintiffs also allege that they reasonably relied on Zacharias’s and RZIM’s uniform messaging … that contributions made by people like the [Plaintiffs] would be used to financially support that mission.” The Court concludes that these allegations satisfy Article III’s standing requirements. …

What this means for churches

Donors sometimes request a return of contributions made to their church. This may occur for several reasons, including:
  1. A donor has begun attending another church.
  2. Theological disagreement(s).
  3. A need for funds for health and other emergencies.
  4. A church fails to use designated funds for the specified purpose.

Church leaders often do not know how to respond to such requests. The federal court in this case ruled that donors were entitled to a return of their contributions on the basis of:
  • RZIM’s egregious misrepresentations regarding the use of donated funds,
  • the principle of unjust enrichment (“a conclusion that one party has obtained benefits from another by fraud is one of the most recognizable sources of unjust enrichment”),
  • a violation of the state Fair Business Practices Act

Note a few other important aspects of the court’s ruling:

First, the court allowed the case to proceed as a class action, meaning that the number of plaintiffs in the case would grow significantly to include all donors victimized by RZIM’s misrepresentations regarding the use of funds.

Second, the court concluded that the Plaintiffs had “standing” to sue in federal court. Standing is a requirement in any federal lawsuit, and generally means that the plaintiff bringing a lawsuit must suffer some form of tangible injury. While the court agreed that “at common law, a donor who has made a completed charitable contribution, whether as an absolute gift or in trust, had no standing to bring an action to enforce the terms of his or her gift or trust unless he or she had expressly reserved the right to do so,” it concluded that “RZIM’s uniform messaging … that contributions made by people like the [Plaintiffs] would be used to financially support that mission” satisfied the standing requirements.

Carrier v. Ravi Zacharias International Ministries, 2022WL1540206 (N.D. Ga, 2022)

Legal Developments

Donor Denied Deduction for His Gift of a Conference Center

Make sure donors of large, noncash gifts understand substantiation rules so that they don’t miss out on deductions.

Richard R. Hammar, Attorney, CPA
Bio

Key point. Charitable contributions are subject to several substantiation requirements. A failure to comply with these requirements may lead to a denial of a charitable contribution deduction.

The United States Tax Court ruled that a taxpayer was not entitled to a charitable contribution deduction for the donation of property to a religious charity since he failed to comply with the strict substantiation requirements set forth in the tax code.

Background

A taxpayer made several donations to a religious charity, including a conference center. To determine the center’s value, he contracted with a certified general appraiser for his help.

After viewing the property, however, the appraiser felt uncomfortable providing an appraised value. He believed the property was a very elaborate complex, and he had never seen a similar building in his appraisal career. He felt he couldn’t complete the appraisal according to the Uniform Standards of Professional Appraisal Practice (USPAP).

However, the appraiser did describe the three traditional valuation methods—comparable sales, income, and replacement cost—that appraisers use, and then explained why he felt uncomfortable using any of them. He told the taxpayer that of the three methods, the replacement cost approach had “the most solid evidence.”

The taxpayer did not try to get another appraisal, but instead totaled up the cost of the conference center and claimed that amount as a deduction. The IRS denied a charitable contribution deduction for the conference center, and the taxpayer appealed to the United States Tax Court.

Tax Court: Taxpayer failed to provide a Form 8283

The Court affirmed the IRS denial of any contribution deduction. It noted that for any noncash contribution exceeding $5,000 (with some exceptions) the income tax regulations require the donor to: (1) obtain a qualified appraisal for the contributed property, (2) attach a fully completed appraisal summary (Form 8283) to the tax return on which the deduction is claimed, and (3) maintain records pertaining to the claimed deduction.

A qualified appraisal must include, among other things:

  • a description of the property in sufficient detail for a person who is not generally familiar with the type of property to ascertain that the property appraised is the property that was contributed;
  • a description of the property’s physical condition;
  • the valuation method used to determine the fair market value; and
  • the specific basis for the valuation.

A qualified appraisal must be made no earlier than 60 days before the date of the contribution and no later than the due date of the return, including extensions. Additionally, it must be prepared by a qualified appraiser.

The definition of a qualified appraiser includes the following:

  • It is a person with verifiable education and experience in valuing the type of property for which the appraisal is performed. In addition, the individual: (a) has earned an appraisal designation from a generally recognized professional appraiser organization, or (b) has met certain minimum education requirements and has two or more years of experience.
    To meet the minimum education requirement, a qualified appraiser must have successfully completed professional or college-level coursework obtained from: (i) a professional or college-level educational organization, (ii) a professional trade or appraiser organization that regularly offers educational programs in valuing the type of property, or (iii) an employer as part of an employee apprenticeship or education program similar to professional or college-level courses.
  • The person regularly prepares appraisals for compensation.
  • The person is not an “excluded individual” (i.e., the donor or donee, a relative of the donor, and so on).

In addition, the taxpayer must obtain a contemporaneous written acknowledgment from the donee organization for any contribution of $250 or more. The contemporaneous written acknowledgment must include a description of any property contributed, a statement as to whether the donee provided any goods or services in exchange, and a description and good faith estimate of the value of such goods or services.

The Tax Court concluded that no deduction was allowable because the taxpayer failed to attach a copy of Form 8283 to his tax return, and the donated property was never appraised by a qualified appraiser.

The taxpayer conceded that he did not attach a qualified appraisal of the donated property to his returns.

The Court concluded:

The complete denial of a deduction can be harsh, but this failure alone might be enough for us to deny the contested deductions. There is but one hope for the taxpayer—section 170(f)(11)(A)(ii)(II). Congress … added an escape hatch from nondeductibility for well-intentioned taxpayers. Section 170(f)(11)(A)(ii)(II) tells us not to deny a deduction for failure to comply with [the substantiation requirements pertaining to gifts of noncash property exceeding $5,000] “if it is shown that the failure to meet such requirements is due to reasonable cause and not to willful neglect.”

The Court determined that this exception did not apply since the taxpayer had considerable business experience and should have understood the substantiation requirements from a cursory review of Form 8283 and its instructions.

What this means for churches

Churches should note the following guidelines for certain noncash donations.

1. Don’t assume donors understand rules for noncash gifts

Do not assume that donors are familiar with the substantiation rules that apply to gifts of noncash property. Church treasurers should obtain copies of Form 8283 each year to give to persons who donate noncash property to the church during the year. You can download copies of Form 8283 on the IRS website. Be sure to get the form and the instructions (two separate, downloadable documents).

2. Ask for a qualified appraisal for large gifts

Ask donors of noncash property to be sure that they obtain a qualified appraisal if you believe they may claim a charitable contribution deduction of more than $5,000.

3. Know that donations of stock are handled differently

No qualified appraisal is required for donations of publicly traded stock. However, a qualified appraisal is required for donations of privately held stock when the claimed value exceeds $10,000.

Pankratz v. Commissioner, T.C. Memo. 2021-26 (2021).

Legal Developments

Donors Can Sue for Improper Use of Restricted Funds

Contributions were not used as per their wishes, say donors.

Richard R. Hammar, Attorney, CPA
Bio

Key point. Donors who make restricted contributions to a church may be legally entitled to a return of their contributions if not used for the donor-restricted purpose.

A federal district court in Arkansas allowed a group of 185,000 donors to move forward with a class-action lawsuit against a missions agency for allegedly violating its repeated assurance to donors that their restricted contributions would be spent “100%” for the designated purposes chosen by the donors.

Background

A US-based Christian missionary organization (the “defendant”) worked mostly in Asia. To fulfill its charitable purposes, the defendant solicits donations from donors across the world. Each year more than one million unique donations are made to the defendant from tens of thousands of donors in the United States. The defendant then works with its overseas agents to ensure that the donor-restricted money reaches its intended purposes in Asia (the “field”).

To maintain its ability to send sufficient funds to the field, the defendant arranges fundraising pitches in several mediums, including in-person solicitations at churches in the United States, on its own website, and through advertising efforts on social media and in various mailings and radio broadcasts.

Because the needs of the poor in Asia are so many, the defendant allows potential donors to specify for what purpose their field donations will be spent. For instance, donors who give online or in response to catalogs may direct their donations to any of 179 different donation categories. Donors make these designations by either checking boxes on order forms or, if ordering online, by adding the item (which lists the corresponding price) to their shopping cart. At other times, the defendant directly solicits donations for particular items, such as “emergency grams” sent in the wake of natural disasters and advertisements sent around the holidays asking for donations for blankets.

Funds not used as per donors’ wishes, claim donors

Several donors (the “donors”) sued the defendant in a federal district court in Arkansas, claiming that the defendant was not spending restricted contributions consistently with donors’ designations. The donors alleged that whether solicitations for contributions were made by the defendant or its agents at in-person church presentations, through catalog mailings, on its website, or in radio presentations, the defendant included a similar promise to its donors that 100 percent of the money given by donors would be sent to the field and spent in accordance with the donors’ wishes, rather than being applied to cover administrative costs or overhead. Moreover, every donor received receipts that contained a representation that “100% of all contributions designated for use on the mission field are sent to the mission field.”

The lawsuit centers on claims that, despite these numerous representations, the defendant did not, in fact, spend donor-restricted funds in accordance with the donors’ wishes or with the defendant’s representations. The parties agree that approximately $375 million in donations are at issue. As a result, the donors asserted a number of claims against the defendant, including Civil RICO (the Racketeer Influenced and Corrupt Organizations Act), fraud, unjust enrichment, and a state law claim. For its Civil RICO, fraud, and unjust enrichment claims, the donors attempted to bring a class-action lawsuit seeking monetary damages for about 185,000 donors nationwide who were affected by the alleged failure of the defendant to apply restricted contributions in the manner specified by donors.

The court certified the donors’ proposed nationwide class for the Civil RICO claim but limited the class for the fraud and unjust enrichment claims to donors residing in Arkansas.

What this means for churches

It is common for church members to make “donor-restricted” charitable contributions to their church specifying that their contributions be used for a specified purpose. What happens if a church board applies such contributions to some other purpose? Are there legal consequences for either the church or the church board? Consider the following rules based on a comprehensive review of all relevant precedent:

Restricted contributions—project not abandoned

Donors who make donor-restricted contributions to their church may have a legal right to a refund of their contributions if the church fails to use the contributions for the designated purpose. This may occur because the church board simply ignores donors’ designations and applies the funds to other uses. Or, it may occur because a church has failed to use the funds for the designated purpose within a reasonable amount of time.

But, so long as a specified project for which contributions are solicited has not been abandoned by a church, then donors who made contributions restricted for the specified project generally have no legal right to a refund of their contributions.

However, at some point, a church’s delay in using restricted funds for a specified purpose may be so substantial that it amounts to an abandonment of the project entitling donors to a refund of their donor-restricted contributions. As the Maine Supreme Court has noted: “Where no particular time is mentioned for the performance of a condition attached to a charitable grant, devise, or bequest, the law requires that it should be done in a reasonable time, to be determined from all the surrounding circumstances, and unreasonable delay may be considered as a refusal of the gift. . . . In light of . . . the fact that nearly forty years has passed . . . a reasonable amount of time has expired.” Estate of Champlin, 684 A.2d 798 (Me. 1996).

Restricted contributions—project abandoned

What if a donor contributes money for a designated church project (e.g., a new building) that the church abandons? Should the church refund contributions to donors who stipulated that their contributions were for the donor-restricted project? A number of possibilities exist, including the following:

Donors can be identified. If donors can be identified, they should be asked if they want their contributions to be returned or retained by the church and used for some other purpose. As one court noted: “Where a religious society raises a fund by subscription for a particular purpose, it cannot divert the funds to another purpose, and, if it abandons such purpose, the donors may reclaim their contributions.” Schmidt v. Catholic Diocese, 18 So.3d 814 (Miss. 2009).

A church should send a letter to donors who request a refund of a prior donor-restricted contribution informing them that (1) there may be tax consequences; (2) they may want to consider filing an amended tax return to remove any deduction claimed in previous years as a result of their restricted contribution; and (3) they should discuss the options with their tax advisor.

Some churches have issued donors a Form 1099-MISC under these circumstances to reduce the church’s risk of liability for aiding and abetting in the substantial understatement of tax. IRC 6701(b). But this approach presents two problems.

First, it assumes that the donor claimed a charitable contribution deduction for the donor-restricted gift and will not file an amended tax return. In fact, some donors did not get a tax deduction for their gifts because they could not itemize their deductions on Schedule A. Others received a “discounted” deduction because of the amount of their income (prior to 2018, high-income taxpayers only received a partial deduction for their charitable contributions). A church treasurer would have to inspect the actual tax return of each donor who requests a return of his or her contribution. Most church leaders consider such precautions excessive and unnecessary, especially for smaller contributions.

Second, Form 1099-MISC is not designed to report this kind of income. It is designed for nonemployee compensation. In what sense have these donors performed services for the church for which they are being compensated?

In summary, the best approach is for the church to inform donors who request a refund of a donor-restricted contribution to address the tax consequences with their tax advisor. They can either do nothing, report the amount of the returned contribution as “other income” on line 21 of Schedule 1 (Form 1040), or file an amended return for the year the restricted contribution was made, which removes the prior contribution from Schedule A. Keep in mind that amended returns can be made for only one of the previous three years.

Donors cannot be identified. A church may not be able to identify all donors who contributed to a specified project, such as a building fund. This is often true of donors who contributed small amounts, or donors who made anonymous cash offerings to a project. In some cases, donor-restricted contributions were made many years before the church abandoned its planned project, and there are no records that identify donors. Under these circumstances, the church has a variety of options.

One option is to address the matter in a membership meeting. Inform the membership of the amount of donor-restricted contributions that cannot be traced to specific donors, and ask the membership to adopt a resolution with regard to the disposition of the fund. Members often will authorize the transfer of the funds to the general fund. Note that this procedure is appropriate only for contributions that cannot be traced to specific donors. If donors can be identified, use the procedure described above.

Another option is to ask a court for authorization to transfer the building fund to another church fund. Most states have adopted the Uniform Prudent Management of Institutional Funds Act (UPMIFA), and this Act permits churches to ask a civil court for authorization to remove a restriction on charitable contributions to permanent endowment funds in some situations.

Other options are available. Churches should consult with an attorney when deciding how to dispose of donor-restricted funds if the specified purpose has been abandoned or is no longer feasible.

Some donors can be identified, and some cannot. In most cases, some donor-restricted contributions can be traced to specific donors, but some cannot. Both of the procedures summarized above may apply.

Key point. Some courts have ruled that a donor has no legal standing to enforce a donor-restricted gift to charity, but this doesn’t mean that a church or charity can ignore it. Some courts have ruled that the state attorney general can enforce a trust created by a donor-restricted gift, and so can any other person with a “special interest” in the trust. While this does not ordinarily include donors, their families, their heirs, or even beneficiaries of the gift or trust, it may include fiduciaries (such as a trustee of a written trust).

Class-action lawsuits

The case summarized above demonstrates another vulnerability of churches that divert donor-restricted funds to a restricted purpose—a class-action lawsuit by donors seeking a return of their contributions. There were 185,000 donors whose common interests were being advanced by the class action described in this case. About $375 million of donations was at issue. These numbers were inflated because a national ministry was involved. But the same principle can apply to church members seeking redress for a church’s violation of donors’ designations. 2018 U.S. Dist. LEXIS 155586; 2018 WL 4323938.

Legal Developments

Church Not Obligated to Return Undesignated Contributions

There generally is no legal basis for honoring such requests since charitable contributions constitute “gifts,” and gifts represent an irrevocable transfer of all of a donor’s right, title, and interest in donated funds or property.

Richard R. Hammar, Attorney, CPA
Bio

Key point. The word contribution is synonymous with the word gift, and since no gift occurs unless a donor absolutely and irrevocably transfers all title, dominion, and control over the gift, it follows that donors who make an undesignated contribution to a church have no legal right to a refund.

A California court ruled that a church is not obligated to return undesignated contributions to donors absent fraud or mistake.

A church member (the “plaintiff”) sued his church seeking a refund of contribution he had made to the church on the ground that his contributions were “converted” from legitimate church use to the inappropriate and unauthorized expenses including the purchase of a home, furnishings, landscaping, cars, clothes, a swimming pool, a Jacuzzi, and other items. The trial court disagreed, and the member appealed.

A state appeals court noted that the elements of conversion are “the plaintiff owns or has a right to possession of personal property; defendant disposed of the personal property in a manner that is inconsistent with the plaintiff’s rights; and damages.” However, “where plaintiff neither has title to the property alleged to have been converted, nor possession thereof, he cannot maintain an action for conversion.”

The question is whether the plaintiff “had title to or possession of the money, or whether he relinquished both title and possession by making valid gifts. If he made valid gifts, then the trial court did not commit error because he could not establish the requisite title to or possession of the money. If he did not make valid gifts, then the trial court’s ruling is not supported by its logic.”

The court noted that there are three requirements for a valid gift: “There must be an intent on the part of the donor to make an unconditional gift; there must be an actual or symbolical delivery that relinquishes all control; and the donee must signify acceptance.”

The court concluded that the plaintiff

failed to establish that any of the necessary elements of a gift are missing. He suggests he did not intend to make unconditional gifts of money because he was deceived. But he misses the point. Even if he was deceived, he was induced into making unconditional gifts. He indicates in his brief that he gave the money for “specific non-profit needs within the church,” and his “giving was akin to a conditional gift, with the specific intent that he was not giving up ownership of his monies as if he was tossing those funds in the trash.” Thus, he suggests that the money was converted because it was not used as he intended. . . . To dispel the plaintiff’s notion he has a conversion claim, we highlight that his gifts were unconditional because they were present transfers. He may have wished his money to be used in a specific way, but he relinquished all control. To the degree he communicated his wishes, the church may have had a moral obligation to honor those wishes, but it did not have a legal obligation.

The court added that the plaintiff “cannot be heard to complain that he was left with no remedy if he was, in fact, deceived by [the church].” It pointed out that “if a donor’s intent is induced by mistake or fraud, the gift may be rescinded or set aside in an action in equity. Consequently, the plaintiff could have sued to rescind or set aside his gifts,” but “a conversion claim was not a viable substitute.”

What this means for churches

Most churches have been confronted with a donor asking for a return of his or her contributions. Such requests usually are generated by a decision to change churches or a financial emergency. For whatever reason, such requests can be perplexing. Church leaders often do not know how to respond. This case reflects the conclusion that most courts have reached when considering the legal basis of donors’ requests for a return of some or all of their undesignated contributions. As this court noted, there generally is no legal basis for honoring such requests since charitable contributions constitute “gifts,” and gifts represent an irrevocable transfer of all of a donor’s right, title, and interest in donated funds or property. Therefore, there is no legal justification for donors to reclaim donations they previously made for which they have no more legal interest to support a request or demand for a refund.

However, this court mentioned two possible exceptions to this general rule. First, donors who make a designated contribution for a stated purpose (e.g., building fund) may have a legal right to enforce their designation. And second, the court suggested that donors may be able to reclaim a contribution based on fraud or mistake. Lewis v. Double Rock Baptist Church, 2017 WL 491693 (Cal. App. Unpub.).

Legal Developments

Court Not Barred by First Amendment’s Religion Clauses in Donor’s Designated Contribution Claim

The court concluded that each of the plaintiff’s claims could be resolved without recourse to “questions of religious doctrine or ecclesiastical polity,”

Richard R. Hammar, Attorney, CPA
Bio

Key point. Donors may be able to recover designated contributions to a church if their contributions were not applied to the designated purpose, so long as doing so would not implicate religious doctrine.

A Michigan appeals court ruled that the civil courts are not barred by the First Amendment’s religion clauses from resolving a donor’s claim that the church failed to apply his designated contribution to his designated purpose, so long as religious doctrine was not implicated.

The chairman of a church’s board of trustees (the “plaintiff”) donated more than $41,000 into a restricted fund whose purpose “was to raise money to expand the church and build a fellowship hall.” Several years later, the plaintiff sued the church, claiming that the donated funds had not been used to build a fellowship hall, that the funds were used for other purposes without plaintiff’s permission, and that the plaintiff unsuccessfully asked for a return of the money numerous times.

The lawsuit claimed that the plaintiff was entitled to a refund of his donation on the basis of several grounds, including conversion, breach of contract, and fraud and misrepresentation.

A trial court dismissed the lawsuit, and the plaintiff appealed. A state appeals court began its opinion by noting:

It is well settled that courts, both federal and state, are severely circumscribed by the First and Fourteenth Amendments to the United States Constitution and … the Michigan Constitution in resolution of disputes between a church and its members… . Jurisdiction over disputes between churches and their members is limited to property rights which can be resolved by application of civil law. A court loses jurisdiction over disputes when resolution requires the court to entertain “questions of religious doctrine or ecclesiastical polity.”

In this case, the court concluded, “resolution of the plaintiff’s claims does not require a court to analyze questions of religious doctrine or ecclesiastical polity. The claims are based on the alleged facts that the restricted fund had a designated purpose of expanding the church and building a fellowship hall, that plaintiff donated money into the fund for that purpose, and that plaintiff’s donations were not used for the designated purpose.”

The court analyzed each of the plaintiff’s claims:

Looking to the substance of the specific claims, the conversion claims add additional allegations that plaintiffs were entitled to return of their money, asked for return of the money, and did not receive the money. The contract claims add the allegation that there was an agreement that the donated money would be used for the sole purpose of building a fellowship hall. The fraud claim adds the allegation that defendants made a material misrepresentation that induced them to donate the money… . Under the alleged facts, the dispute does not require a court to analyze questions of religious doctrine or ecclesiastical polity. Rather, resolving the issues merely involves property rights and applying civil law.

On appeal, the church insisted that the plaintiff’s donations had not been used for other purposes, and as proof pointed out that the fund contained more than the $41,000 donated by the plaintiff. The court rejected this defense, noting that the plaintiff had alleged that the donated money was used for other purposes, and the church had not directly rebutted this claim with affidavits or other evidence.

The church cited a previous Michigan case in support of the trial judge’s dismissal of the case. In McDonald v. Macedonia Missionary Baptist Church, 2003 WL 1689618 (Mich. App. 2003), a Michigan appeals court ruled that a married couple did not have a legal right to a refund of a $4,000 contribution they made to their church’s building fund. The congregation planned to construct a new church the following year, but these plans were put on hold when the church received an unused school building. The couple sued their church, seeking a return of their building fund donation on the basis of the church’s “breach of contract.” Church leaders noted that the church had $500,000 in its new building fund and insisted that it still planned to build a new sanctuary as soon as the fund grew to $6 million. A trial court agreed with the couple and ordered the church to refund their contributions. The church appealed.

A Michigan appeals court reversed the trial court’s ruling and dismissed the case. It concluded that the civil courts are barred by the First Amendment guaranty of religious freedom from intervening in such internal church disputes:

We hold that this dispute involves a policy of the church for which our civil courts should not interfere. Because the decision of when and where to build a new church building is exclusively within the province of the church members and its officials, the trial court erred in not dismissing the couple’s lawsuit.

In dismissing the relevance of this case, the appeals court noted in the present case that the McDonald case “is distinguishable because it involved decisions over when and where to build a new church building … not whether funds donated for a specific purpose were being used for a different purpose.”

What this means for churches

Few courts have addressed the right of church members to a return of their designated contributions in the event a church does not apply the funds as the donor specified. The court in this case concluded that such cases may be resolved by the civil courts if they can do so without reference to “questions of religious doctrine or ecclesiastical polity.” The court concluded that each of the plaintiff’s claims could be resolved without recourse to “questions of religious doctrine or ecclesiastical polity,” and therefore the civil courts were not barred by the First Amendment guaranty of religious freedom from resolving the plaintiff’s lawsuit seeking a return of the $41,000 he had donated to his church. Rogers v. Methodist Church, 2017 WL 2791002 (Mich. App. 2017).

Legal Developments

$65 Million Charitable Contribution Deduction Denied by IRS

Donor not entitled to a charitable contribution deduction because it was unable to meet the strict substantiation requirements

Richard R. Hammar, Attorney, CPA
Bio

Key point. Charitable contribution deductions for contributions of noncash property are subject to various substantiation requirements. Failure to comply with these requirements can result in a loss of any deduction, even if there is no doubt that a contribution was made.

The United States Tax Court upheld the IRS's denial of a $65 million charitable contribution deduction because the written acknowledgment issued by the donee charity was not "contemporaneous" as required by the tax code.

On its 2007 tax return, a partnership claimed a charitable contribution deduction of $65 million. In order to substantiate a charitable contribution deduction of $250 or more, a taxpayer must secure and maintain in its files a "contemporaneous written acknowledgment" (CWA) from the donee organization. IRC 170(f)(8)(A). The CWA must state (among other things) whether the donee provided the donor with any goods or services in exchange for the gift. IRC 170(f)(8)(B)(ii).

The IRS audited the partnership's tax return and disallowed the charitable contribution deduction in its entirety. The donee organization thereafter submitted an amended return that included the information specified in subparagraph (B), including whether the donee provided the donor with any goods or services in exchange for the gift. The partnership appealed to the United States Tax Court. The partnership asked the court to dismiss the case on the ground that the substantiation requirements had been met. The court declined to do so.

The court began its opinion by stressing that "the requirement that a CWA be obtained for charitable contributions of $250 or more is a strict one. In the absence of a CWA meeting the statute's demands, no deduction shall be allowed." If a taxpayer fails to meet the strict substantiation requirements of section 170(f)(8), "the entire deduction is disallowed."

Further, the doctrine of "substantial compliance" does not apply to the failure to obtain a CWA meeting the statutory requirements. In other words, a taxpayer's substantial compliance with the tax code's substantiation requirements is no defense to noncompliance. The court explained:

Section 170(f)(8)(B) [of the tax code] provides that a CWA must include the following information:

(i) The amount of cash and a description (but not value) of any property other than cash contributed.
(ii) Whether the donee organization provided any goods or services in consideration, in whole or in part, for any property described in clause (i).
(iii) A description and good faith estimate of the value of any goods or services referred to in clause (ii)… .

An acknowledgment qualifies as "contemporaneous" only if the donee provides it to the taxpayer on or before the earlier of "the date on which the taxpayer files a return for the taxable year in which the contribution was made" or "the due date (including extensions) for filing such return."

The court concluded that the partnership failed to comply with the tax code's requirement of a CWA, despite its attempt to rectify the mistake by filing an updated form after the deadline had expired.

What this means for churches

This case illustrates the consequences that can result from a church's failure to comply with the substantiation requirements for charitable contributions. Those requirements are stricter for contributions of $250 or more, and, as this case demonstrates, require the written acknowledgment (receipt) provided by a charity to donors to be contemporaneous and include a statement indicating whether the charity provided goods or services to the donor in consideration of the contribution. If goods or services were provided, the church's written acknowledgment must provide a description and good faith estimate of the value of those goods or services, or, if only intangible religious benefits were provided, a statement to that effect.

Churches failing to provide donors with a proper acknowledgment jeopardize the deductibility of donors' contributions. In this case, that meant the loss of a $65 million contribution deduction.

Both the IRS and the Tax Court stressed that whether or not the donor actually made the donation was irrelevant. Even assuming that the donor made the $65 million contribution, it was not entitled to a charitable contribution deduction because it was unable to meet the strict substantiation requirements that apply to contributions of $250 or more. When it comes to the substantiation of charitable contributions, it is form over substance. And, "substantial compliance" with the law is no excuse or defense. 15 West 17th Street LLC v. Commissioner, 147 T.C. 19 (2016).

Tip. To avoid jeopardizing the tax deductibility of charitable contributions, churches should advise donors at the end of 2017 not to file their 2017 income tax returns until they have received a written acknowledgment of their contributions. This communication should be in writing. To illustrate, the following statement could be placed in the church bulletin or newsletter for the last few weeks of 2017 or included in a letter to members: "IMPORTANT NOTICE: To ensure the deductibility of your church contributions made this year, please do not file your 2017 income tax return until you have received a written acknowledgment of your contributions from the church. You may lose a deduction for some contributions if you file your tax return before receiving a written acknowledgment of your contributions from the church."

Tip. Be alert to any donation of noncash property that may be valued by the donor at more than $500. Be sure the donor is aware of the need to complete Section A of Form 8283 for donations of property valued at more than $500 but not more than $5,000, and Section B of Form 8283 for donations of property (other than publicly traded stock) valued at more than $5,000. The instructions to Form 8283 contain a helpful summary of the substantiation requirements that apply to these kinds of gifts. Different rules apply to donations of vehicles. Failure to comply with these rules may lead to a loss of a deduction. Churches should have these forms on hand to give to donors who make contributions of noncash property.

Legal Developments

Defective Charitable Contribution Receipt from Church Bars Donor’s Deduction

Church Law and Tax Report Defective Charitable Contribution Receipt from Church Bars Donor’s Deduction Key

Church Law and Tax Report

Defective Charitable Contribution Receipt from Church Bars Donor’s Deduction

Key point. Taxpayers are subject to substantial penalties for not filing a tax return (if one is required) and for reporting inaccurate information on a tax return. Some taxpayers view the risk of being audited as so low that they deliberately underreport income, overstate expenses, or adopt questionable interpretations of the tax laws. You should bear in mind the following penalties before adopting aggressive tax positions.

The United States Tax Court ruled that a taxpayer was not entitled to deduct charitable contributions made to her church because the church’s receipt was defective. A taxpayer made several donations to her church in 2009, many of which were for more than $250. The donations were recorded in the church’s financial records. In 2014, after the IRS audited the taxpayer’s 2009 tax return and questioned contributions of $250 or more that she had made to her church, the church sent her a letter certifying that she had made $3,230 in contributions to the church in 2009. The IRS denied this deduction, and the taxpayer appealed to the Tax Court.

The Tax Court began its opinion by observing:

Contributions of cash or property of $250 or more generally require the donor to obtain a contemporaneous written acknowledgment of the donation from the donee. At a minimum, the contemporaneous written acknowledgment must contain a description of any property contributed, a statement as to whether any goods or services were provided in consideration by the donee, and a description and good-faith estimate of the value of any goods or services provided in consideration. A written acknowledgment is contemporaneous if it is obtained by the taxpayer on or before the earlier of (1) the date on which the taxpayer files a return for the taxable year in which the contribution was made, or (2) the due date (including extensions) for filing such return.

The IRS insisted that canceled checks for donations of $250 or more and the written statement from the church were insufficient to substantiate her contributions. The court agreed: “The canceled checks do not qualify as contemporaneous written acknowledgments because they do not state whether the taxpayer received any goods or services in exchange for her contributions. Additionally, the written statement from the church does not qualify as a contemporaneous written statement because it was written more than four years after the taxpayer’s tax return had been filed.”

The Tax Court also affirmed the IRS’s imposition of a “negligence penalty” upon the taxpayer. The tax code allows the IRS to assess a penalty of 20 percent of the amount of an understatement of taxes that is due to negligence. Negligence includes (1) failure to make a reasonable attempt to comply with the tax law; (2) failure to exercise reasonable care in the preparation of a tax return; or (3) failure to keep adequate records or to substantiate items properly. Reliance on the advice of a tax adviser does not relieve the liability for a negligence penalty.

Taxpayers can avoid the negligence penalty only “with respect to any portion of an underpayment if it is shown that there was a reasonable cause for such portion and that the taxpayer acted in good faith with respect to such portion.” The Court upheld the assessment of this penalty on the taxpayer: “The IRS satisfied its burden of production with regard to negligence. It established that the taxpayer … did not substantiate several items properly … . Accordingly, we hold that the taxpayer is liable for a penalty.”

What This Means For Churches:

This case illustrates the consequences that can result from a church’s failure to comply with the substantiation requirements for charitable contributions. Those requirements are stricter for contributions of $250 or more, and, as this case demonstrates, require the written acknowledgment (receipt) provided by a charity to donors to be contemporaneous and include a statement indicating whether the charity provided goods or services to the donor in consideration of the contribution. If goods or services were provided, the church’s written acknowledgment must provide a description and good faith estimate of the value of those goods or services, or, if only intangible religious benefits were provided, a statement to that effect.

Churches that fail to provide donors with a proper acknowledgment are jeopardizing the deductibility of donors’ contributions.

On many occasions the IRS and the Tax Court have stressed that whether or not a donor actually made a donation is irrelevant. What matters is strict compliance with the technical substantiation requirements imposed by the tax code. When it comes to the substantiation of charitable contributions, it is form over substance.

This case also illustrates that a church’s failure to provide donors with valid acknowledgments of their contributions may result in the IRS assessing a negligence penalty. Beaubrun v. Commissioner, T.C. Memo. 2015-217.

Key point. The income tax regulations clarify that separate contributions of less than $250 are not subject to these additional requirements “regardless of whether the sum of the contributions made by the taxpayer to a charity during a taxable year equals $250 or more.”

Tip. Be alert to any donation of noncash property that may be valued by the donor at more than $500. Be sure the donor is aware of the need to complete Section A of Form 8283 for donations of property valued at more than $500 but not more than $5,000, and Section B of Form 8283 for donations of property (other than publicly traded stock) valued at more than $5,000. The instructions to Form 8283 contain a helpful summary of the substantiation requirements that apply to these kinds of gifts. Different rules apply to donations of vehicles. Failure to comply with these rules may lead to a loss of a deduction. It is a good practice for churches to have some of these forms on hand to give to donors who make contributions of noncash property.

Substantiating Contributions of $250 or More—a Summary

Section 170(f)(8) of the tax code imposes special substantiation requirements for individual contributions of $250 or more:

(A) No deduction shall be allowed for any contribution of $250 or more unless the taxpayer substantiates the contribution by a contemporaneous written acknowledgment of the contribution by the [charity] that meets the requirements of subparagraph (B).

(B) An acknowledgement meets the requirements of this subparagraph if it includes the following information:

(i) The amount of cash and a description (but not value) of any property other than cash contributed.

(ii) Whether the [charity] provided any goods or services in consideration, in whole or in part, for any property described in clause (i).

(iii) A description and good faith estimate of the value of any goods or services referred to in clause (ii) or, if such goods or services consist solely of intangible religious benefits, a statement to that effect. For purposes of this subparagraph, the term “intangible religious benefit” means any intangible religious benefit which is provided by an organization organized exclusively for religious purposes and which generally is not sold in a commercial transaction [e.g., worship services, teaching, and sacraments].

(C) An acknowledgment shall be considered to be contemporaneous if the taxpayer obtains the acknowledgment on or before the earlier of (i) the date on which the taxpayer files a return for the taxable year in which the contribution was made, or (ii) the due date (including extensions) for filing such return.

Legal Developments

Couple’s Charitable Contribution Deductions Denied after Failing to Meet Precise Requirements

Church Law and Tax Report Couple’s Charitable Contribution Deductions Denied after Failing to Meet Precise

Church Law and Tax Report

Couple’s Charitable Contribution Deductions Denied after Failing to Meet Precise Requirements

Key point. Charitable contribution deductions are subject to a variety of substantiation requirements depending on the type and amount of a contribution. Failure to comply with these requirements can result in loss of a deduction.

The United States Tax Court ruled that a married couple was not entitled to a charitable contribution deduction for scholarships they made to three students using funds from a memorial account they established in the name of their deceased son. In 2006, a married couple received $75,000 in life insurance proceeds from the death of their son. That same year, the couple used the life insurance proceeds to establish a scholarship fund in honor of their son. The scholarship fund was structured as an irrevocable trust. The trust agreement states that income from the trust is to be used exclusively for educational purposes. The trust is irrevocable, although the couple reserved the right to amend the trust so long as all funds would be distributed to students solely for educational purposes. The trust did not apply to the Internal Revenue Service (IRS) for tax-exempt status as a charitable organization.

During 2008, the trust made payments of $2,000 each to three high school students. Each payment was by check directly to the student. The money for the three payments came from the trust’s investment income, and the checks were written on an account owned solely in the name of the trust.

In filing their 2008 Form 1040, U.S. Individual Income Tax Return, the couple did not include the investment income from the trust in their gross income; however, they claimed the $6,000 of payments as a charitable contribution deduction. In 2012, the IRS audited the couples’ 2008 tax return and denied the $6,000 charitable contribution deduction. The couple appealed to the Tax Court.

The Tax Court concluded that the couple was not entitled to a charitable contribution deduction for “multiple reasons.” These included:

First, the trust’s payments “do not qualify as charitable contributions.” The court noted that “section 170(c) of the tax code lays out specific rules for who must be the recipient of a contribution or gift in order for the payment to qualify as a charitable contribution deduction. Here, the trust paid the money directly to the students, and the students do not fall into any of the recipient categories under section 170(c).”

Second, the couple “did not produce any evidence of a contemporaneous written acknowledgment of the charitable contribution. The closest thing to a contemporaneous written acknowledgment was the list of charitable contributions that they attached to their [tax return] which showed three $2,000 contributions. That document does not show the dates of the contributions or any of the other information required to comply with the more stringent substantiation requirements for contributions over $250.”

What This Means For Churches:

Memorial scholarship funds are often established by the relatives of a deceased family member. This case demonstrates that these arrangements often fail to comply with the requirements for a charitable contribution, and therefore distributions from the fund may not be deductible. Kalapodis v. Commissioner, T.C. Memo. 2014-205.

Legal Developments

Married Couple’s $37,315 Charitable Contribution Deduction Disallowed

The deduction lacked proper substantiation.

Key point. Charitable contribution deductions for contributions of noncash property are subject to various substantiation requirements. Failure to comply with these requirements can result in a loss of any deduction even if there is no doubt that a contribution was made.

The United States Tax Court disallowed a married couple's $37,315 charitable contribution deduction for lack of proper substantiation.

On Schedule A, Itemized Deductions, of their 2011 federal income tax return, a married couple (the "taxpayers") claimed a charitable contribution deduction of $37,315 for noncash charitable contributions, which the IRS disallowed in its entirety.

Taxpayers did not produce a receipt

The taxpayers contend that they donated property during 2011 to four charitable organizations: the Upper Dublin Lutheran Church (Church), Goodwill Industries (Goodwill), the Military Order of the Purple Heart Service Foundation (Purple Heart), and Vietnam Veterans of America (Vietnam Veterans). The taxpayers' noncash contributions to the Church consisted of items they allegedly donated to its 2011 annual flea market. These items included books valued at $8,000, household items valued at $1,303, clothing valued at $1,000, toys valued at $822, telescopes valued at $800, jewelry valued at $780, and household furniture valued at $410, for a total of $13,115.

The taxpayers did not produce a receipt or an acknowledgment from the Church for their donations of any of these items. The Church was evidently equipped to provide such receipts, because petitioners claimed to have a receipt from the Church for their contributions to the 2012 flea market. The taxpayers produced no evidence, such as photographs, that any of the listed items were actually delivered to the Church. The Church did not inform the taxpayers whether any of the items allegedly contributed were sold or at what price.

The taxpayers' noncash contributions to Goodwill, Purple Heart, and Vietnam Veterans allegedly consisted of clothing valued at $20,920, household furniture valued at $2,680, household items valued at $350, and toys valued at $250, for a total of $24,200. They produced no documentary evidence, and had no recollection, as to which items were donated to which charity. They produced a spreadsheet, created during the IRS audit, that listed various items—e.g., 67 blouses, 45 dresses, 70 dress shirts, 22 dress coats, and 100 baby outfits—and assigned "estimated amounts" as the fair market values of these items. The taxpayers contended that these items, in the aggregate, were divided in some manner among the three charities.

For Goodwill, the taxpayers testified that they took batches of items at various times to a Goodwill location. They generally made these trips in the early morning or evening, when the Goodwill warehouse was unattended. They placed soft goods in large bins intended for after-hours drop-offs. They left large items, such as furniture, outside the warehouse door. The taxpayers testified that they were careful to ensure that the items in each batch were worth less than $250 because they thought this eliminated the need to get receipts.

For Purple Heart and Vietnam Veterans, the taxpayers allegedly scheduled a pickup and left the items outside their house. The charity sent a truck to pick up the items, generally while petitioners were away, and usually left a doorknob hanger saying, "Thank you for your contribution." These doorknob hangers contained no other information. They were undated; they were not specific to the taxpayers; and they did not list or describe the property contributed.

The taxpayers testified that they created index cards recording the items as they were delivered to Goodwill or left for pickup by Purple Heart or Vietnam Veterans. They later aggregated this information into a master list. When the time came to prepare their 2011 tax return, they assigned estimated values to the items. The taxpayers did not introduce into evidence the index cards they allegedly prepared or any other contemporaneous records supporting their contention that they made the alleged gifts. They supplied no evidence concerning their cost bases in these items or the manner in which they determined fair market values.

The IRS timely issued petitioners a notice of deficiency disallowing for lack of substantiation all of their claimed noncash contributions totaling $37,315. The IRS also determined an accuracy-related penalty. Petitioners timely sought review in the Tax Court.

Substantiation of charitable contributions

The court began its opinion by noting that charitable contribution deductions are allowed "only if the taxpayer satisfies substantiation requirement," and that "the nature of the required substantiation depends on the size of the contribution and on whether it is a gift of cash or property."

For contributions of $250 or more, the taxpayer must obtain a "contemporaneous written acknowledgment" from the charity. Separate contributions of less than $250 are not subject to this requirement regardless of whether the sum of the contributions made by a taxpayer to a charity during a taxable year equals $250 or more. The main substantiation requirements are summarized below.

Contributions of property valued at $250 or more

Contributions of noncash property valued by a donor at $250 or more must be substantiated with a contemporaneous written acknowledgment that

(1) includes "a description (but not value) of any property other than cash contributed"; (2) states whether the donee provided any goods or services in exchange for the gift; and (3) if the donee did provide goods or services, include a description and good-faith estimate of their value. The acknowledgment is "contemporaneous" if the taxpayer obtains it from the donee on or before the earlier of: (1) the date the taxpayer files a return for the year of contribution; or (2) the due date, including extensions, for filing that return.

Contributions of property valued at more than $500

The court noted that while the taxpayers' failure to satisfy the substantiation requirements for contributions of $250 or more "was fatal to their claim," it went on to summarize the substantiation requirements for noncash contributions in excess of $500:

Taxpayers are required to maintain additional reliable written records with respect to each item of donated property. These records must include, among other things: (1) the approximate date the property was acquired and the manner of its acquisition; (2) a description of the property in detail reasonable under the circumstances; (3) the cost or other basis of the property; (4) the fair market value of the property at the time it was contributed; and (5) the method used in determining its fair market value.

The taxpayers claimed that they made noncash contributions to four different charities of seven categories of items, each with a claimed value exceeding $500, "but they did not maintain written records establishing when or how these items were acquired or what their cost bases were. Nor did they maintain written records establishing how they calculated the items' fair market value."

Donations of clothing and household items

No deduction is allowed for "any contribution of clothing or a household item" unless such property is "in good used condition or better." The tax regulations specify that the term "'household items" includes "furniture, furnishings, electronics, appliances, linens, and other similar items." Food, paintings, antiques, and other objects of art, jewelry and gems, and collections are excluded from the definition.

A deduction may be allowed for a charitable contribution of an item of clothing or a household item not in good used condition or better only if the amount claimed for the item is more than $500 and the taxpayer obtains a qualified appraisal of the property and attaches a qualified appraisal summary (Form 8283) to the tax return claiming the deduction.

If the donated item is in good used condition or better and a deduction in excess of $500 is claimed, the taxpayer must file a completed Form 8283 (Section A or B, depending on the type of contribution and claimed amount), but a qualified appraisal is required only if the claimed contribution amount exceeds $5,000.

If the donor claims a deduction of less than $250, the donor must obtain a receipt from the church or charity or maintain reliable written records of the contribution. A reliable written record for a contribution of clothing or a household item must include a description of the condition of the item. If the donor claims a deduction of $250 or more, the donor must obtain from the church or charity a receipt that meets the requirements of a contemporaneous written acknowledgment (see above).

The court concluded:

Most of the items the taxpayers allegedly donated consisted of clothing and household items. They failed to present credible evidence that these items were "in good used condition or better," and they did not furnish a qualified appraisal with their return. For all these reasons, petitioners have not satisfied the substantiation requirements for donations of property valued over $500.

The court has no doubt that the taxpayers did donate some property to charitable organizations during 2011. But the tax code imposes a series of increasingly rigorous substantiation requirements for larger gifts, especially when they consist of property rather than cash. Because the taxpayers did not satisfy these requirements, we are unable to allow a deduction for their claimed noncash gifts.

What this means for churches

Americans love to donate used clothing and household items to charity. The IRS reports that the amount claimed as deductions in a recent year for clothing and household items was more than $9 billion. These items are notoriously difficult to value, and the attempt to do so wastes valuable time and resources.

The tax code responds to this dilemma by denying a charitable contribution deduction for a contribution of clothing or household items unless the clothing or household items are in "good used condition or better." The Treasury Department is authorized to deny (by regulation) a deduction for any contribution of clothing or a household item that has minimal monetary value, such as used socks and used undergarments.

A deduction may be allowed for a charitable contribution of an item of clothing or a household item not in good used condition or better only if the amount claimed for the item is more than $500 and the taxpayer obtains a qualified appraisal of the property and attaches a qualified appraisal summary (Form 8283) to the tax return claiming the deduction.

Household items include furniture, furnishings, electronics, appliances, linens, and other similar items. Food, paintings, antiques, and other objects of art, jewelry and gems, and collections are excluded from the definition.

If the donated item is in good used condition or better and a deduction in excess of $500 is claimed, the taxpayer must file a completed Form 8283 (Section A or B, depending on the type of contribution and claimed amount), but a qualified appraisal is required only if the claimed contribution amount exceeds $5,000.

Failure to understand and comply with these rules can lead to a loss of a charitable contribution deduction. As a result, it is helpful for church leaders to be familiar with these rules so they can advise persons who donate clothing and household itemss. Kunkel v. Commissioner, T.C. Memo. 2015-71 (U.S. Tax Court 2015).

Legal Developments

Donor Denied $25,000 Charitable Deduction

Why specific substantiation requirements must be followed to claim a charitable contribution deduction on tax returns.

Richard R. Hammar, Attorney, CPA
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Donors must comply with specific substantiation requirements in order to claim a charitable contribution deduction on their tax return. Special rules apply to any contribution of cash or property valued by the donor at $250 or more. Failure to comply with these requirements may result in a loss of a tax deduction. It is important for church treasurers to be familiar with these requirements, since they generally are responsible for the issuance of contribution statements and receipts. A recent Tax Court case illustrates the importance of compliance with these rules.

A donor made a cash contribution of $25,000 to a religious organization. The IRS audited the donor's tax return and denied the charitable contribution deduction on the ground that it was not properly substantiated. The donor appealed to the United States Tax Court.

The Tax Court's ruling

The Tax Court agreed with the IRS that the charitable contribution was not tax-deductible:

Because the amount of the alleged contribution exceeds $250, it must be evidenced by a contemporary written acknowledgment in order to be deductible. As evidence of his alleged contribution [the donor] provided a self-generated letter signed by himself. The letter states that the amount of cash contributed was $25,000, but it does not include any of the other required information. In particular, the letter is silent as to whether the donor received any goods or services in exchange for the cash. Both the Code and the regulations provide that such information is a necessary element of the contemporary written acknowledgment. Because he failed to provide a contemporary written acknowledgment of his contribution, we find that he is not entitled to deduct any amount for contribution.

What this means for churches

This case illustrates the consequences that can result from a church's failure to comply with the substantiation requirements for charitable contributions. Those requirements are stricter for contributions of $250 or more, and, as this case demonstrates, require the written acknowledgment (receipt) provided by a charity to donors to be contemporaneous and include a statement indicating whether the charity provided goods or services to the donor in consideration of the contribution. If goods or services were provided, the church's written acknowledgment must provide a description and good faith estimate of the value of those goods or services, or, if only intangible religious benefits were provided, a statement to that effect.

Churches that fail to provide donors with a proper acknowledgment are jeopardizing the deductibility of donors' contributions.

Both the IRS and the Tax Court stressed that whether or not the donor actually made the donation was irrelevant. Even assuming that he did make the $25,000 contribution, he was not entitled to a charitable contribution deduction because he was unable to meet the strict substantiation requirements that apply to contributions of $250 or more. When it comes to the substantiation of charitable contributions, it is form over substance.

Longino v. C.I.R., T.C. Memo. 2013-80 (2013)

Legal Developments

Tithing When You’re Bankrupt

Can bankruptcy trustees recover charitable contributions made by bankrupt debtors?

Richard R. Hammar, Attorney, CPA
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Key point 9-09. Bankruptcy trustees are prohibited by the federal Religious Liberty and Charitable Donation Protection Act from recovering contributions made by bankrupt debtors to a church or other charity prior to declaring bankruptcy, unless the contributions were made with an intent to defraud creditors. This protection extends to any contribution amounting to less than 15 percent of a debtor's gross annual income, or more if the debtor can establish a regular pattern of giving more. In addition, the Act bars bankruptcy courts from rejecting a bankruptcy plan because it allows the debtor to continue making contributions to a church or charity. Again, this protection applies to debtors whose bankruptcy plan calls for making charitable contributions of less than 15 percent of their gross annual income, or more if they can prove a pattern of giving more.

A bankruptcy court in Colorado addressed the authority of bankruptcy trustees to recover charitable contributions made by bankrupt debtors within a year of filing a bankruptcy petition. A married couple (the "debtors") filed for Chapter 7 bankruptcy relief on December 31, 2009. In 2008, the debtors' gross earned income was $6,800 and they received $22,036 in Social Security benefits. Throughout 2008, the debtors made 25 donations to their church totaling $3,478. In 2009, the debtors' gross earned income was $7,487 and they received $23,164 in Social Security benefits. Throughout 2009, the debtors made 7 donations totaling $1,280 to their church.

The bankruptcy trustee attempted to avoid these charitable contributions and have the church return them to the court on the basis of a provision in the Bankruptcy Code that empowers a trustee to recover any transfer of funds or assets by a debtor for less than "reasonably equivalent value" within a year of filing a bankruptcy petition. The church cited section 548 of the Bankruptcy Code, which was amended by the Religious Liberty and Charitable Donation Protection Act of 1997 ("RLCDPA") to provide a defense against a bankruptcy trustee's power to recover transfers by debtors within a year of filing a bankruptcy petition. Amended section 548 provides: "A transfer of a charitable contribution to a qualified religious or charitable entity or organization shall not be considered to be a [voidable] transfer in any case in which—(A) the amount of that contribution does not exceed 15 percent of the gross annual income of the debtor for the year in which the transfer of the contribution is made."

The court addressed two questions: (1) Are Social Security payments included in gross annual income for purposes of the section 548 exception; and (2) if transfers exceed 15 percent, is the entire transferred amount voidable or just the transferred amount that exceeds 15 percent?

Social Security payments

The court noted that the plain language of section 548 was ambiguous as to whether "gross annual income" should include Social Security benefits. It also noted that the Bankruptcy Code does not define the term "gross annual income," and no court has defined the term within the meaning of section 548. However, the court noted that the Bankruptcy Code does exclude Social Security benefits when calculating current monthly income, and, the Internal Revenue Code only includes Social Security benefits in gross annual income if the taxpayer's modified adjusted gross income for the taxable year, plus one-half of Social Security benefits received during the taxable year, exceeds a "base amount" ($32,000). As a result, the court concluded that Social Security benefits are not included in computing gross annual income under section 548, and as a result only 15 percent of the debtors other income was shielded from the bankruptcy trustee.

voidable amount

If a debtor contributes more than 15 percent of gross annual income to a church, is the entire contribution recoverable by the bankruptcy trustee, or only the portion that exceeds 15 percent of gross annual income? The court concluded that only the excess above 15 percent is recoverable. It observed:

The RLCDPA was created to reverse the trend among the courts allowing avoidance actions to recover funds contributed by debtors to churches. The House Report states, "the safe harbor protects annual aggregate contributions up to 15 percent of the debtor's gross annual income." The term "up to" indicates an intent by Congress to bifurcate the avoidance amount beyond the 15% threshold …. It is doubtful that Congress would protect a debtor's right to donate 15% of their gross annual income to a charitable organization, but allow a trustee to avoid all donations if one cent over the 15% threshold is donated. From the church's perspective, voiding entire transfers above 15% of a debtor's gross annual income would place an undue burden upon churches. If the entire donation amount is voided churches would be obligated to investigate a donor's financial background in order to use funds within two years of receipt.

What This Means For Churches:

This case is significant because it represents the only court to address the question of whether Social Security payments are included in computing "gross annual income" for purposes of applying the section 548 exclusion. The court concluded that gross annual income excludes Social Security benefits, meaning that Social Security beneficiaries' contributions to their church are more likely to be recoverable by bankruptcy trustees. But, the court also ruled that if a bankruptcy debtor contributes more than 15 percent of gross annual income to his or her church, the bankruptcy trustee can recover only the contributions in excess of 15 percent of gross annual income. In re McGough, 2011 WL 2671253 (D. Colo. 2011).

Legal Developments

Substantiating a Charitable Contribution

The IRS requires that donors provide specific documentation in order to claim a deduction.

Richard R. Hammar, Attorney, CPA
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Church Law & Tax Report

Substantiating a Charitable Contribution

The IRS requires that donors provide specific documentation in order to claim a deduction.

Richard R. Hammar, J.D., LL.M., CPA

Charitable Contributions

Key point. Charitable contributions are subject to a number of substantiation requirements. A failure to comply with these requirements may lead to a denial of a charitable contribution deduction.

The United States Tax Court ruled that a married couple could not claim a $217,500 charitable contribution deduction on their tax return due to their failure to comply with the substantiation requirements. A married couple (the “donors”) claimed noncash charitable contribution deductions of $217,500 on their tax return. To substantiate the donations the donors attached to their return three Forms 8283 (qualified appraisal summary).

Two of these forms were prepared by appraisers who appraised various items of donated property, and the third form summarized the other two. The IRS audited the donors’ return and denied a charitable contribution deduction due to a lack of substantiation. The donors appealed.

The Tax Court affirmed the disallowance of any charitable contribution deduction for the donated property. It noted that for any noncash contribution exceeding $5,000 the income tax regulations require the donor to: (1) obtain a qualified appraisal for the contributed property, (2) attach a fully completed appraisal summary (Form 8283) to the tax return on which the deduction is claimed, and (3) maintain records pertaining to the claimed deduction.

A qualified appraisal must include, among other things, a description of the property in sufficient detail for a person who is not generally familiar with the type of property to ascertain that the property appraised is the property that was contributed, a description of the property’s physical condition, the valuation method used to determine the fair market value, and the specific basis for the valuation. A qualified appraisal must be made no earlier than 60 days before the date of the contribution and no later than the due date of the return, including extensions.

The appraisal summary must include, among other things, a description of the property in sufficient detail for a person who is not generally familiar with the type of property to ascertain that the property appraised is the property that was contributed, a brief summary of the property’s physical condition, the manner of acquisition, and the cost or other basis of the property.

In addition to the substantiation requirements a taxpayer must obtain a contemporaneous written acknowledgment from the donee organization for any contribution of $250 or more. The contemporaneous written acknowledgment must include a description of any property contributed, a statement as to whether the donee provided any goods or services in exchange, and a description and good faith estimate of the value of such goods or services.

The donors conceded that they had not strictly complied with the appraisal and appraisal summary requirements, and had not received receipts indicating whether they had received any goods or services in exchange for their contributions. But, they insisted that they were nonetheless entitled to deduct their contributions since they had “substantially complied” with the substantiation requirements. The Tax Court concluded that even if the contributions were allowable based on substantial compliance with the law, the donors had not satisfied this test since their compliance with the law was far from substantial:

The donors’ documents fail to provide an adequate description of or the condition of the donated items. The Forms 8283 and the appraisal reports provide very generic descriptions, stating the items were in “good working condition” or “operational, clean and in good saleable condition.” An adequate description is necessary because “without a more detailed description the appraiser’s approach and methodology cannot be evaluated.” In fact, their documents fail to even indicate the valuation method used or the basis for the appraised values. We have previously held such information to be essential because “without any reasoned analysis, … [the appraiser’s] report is useless.”

The court also concluded that in addition to their failure to substantially comply with the regulations, the donors failed to demonstrate that they obtained adequate written acknowledgments for their contributions as required by the tax code.

The donors argue that the Forms 8283 can also serve as written acknowledgments because they were signed by the donee. However, neither the Forms 8283 nor the receipts from [the donee charity] contain a statement that no goods or services were provided by the donee in exchange, as required by [the tax code]. We have previously held that statement necessary for a charitable contribution deduction under section 170(f)(8) (B)(ii) of the tax code. The donors argue that section 170(f)(8)(B)(ii) can be read to require the statement only when the donee actually furnishes goods or services to the donor. We disagree. “[C]ourts must presume that a legislature says in a statute what it means and means in a statute what it says there.” In the absence of a clearly expressed legislative intent to the contrary, unambiguous statutory language ordinarily must be regarded as conclusive.

Section 170(f)(8)(B)(ii) plainly states that the written acknowledgment is sufficient if it includes information as to “whether the donee organization provided any goods or services in consideration, in whole or in part, for any property” donated by the taxpayer. The language used is clear and unconditional. There is no reason to read into section 170(f)(8)(B)(ii) the limitation suggested by petitioners. Friedman v. Commissioner, 99 T.C.M. 1175 (2010).

This Recent Development first appeared in Church Law & Tax Report, January/February 2011.

Legal Developments

Protection of Charitable Donations

Court rules that charitable contributions made by bankrupt church member cannot be recovered.

Richard R. Hammar, Attorney, CPA
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Church Law & Tax Report

Protection of Charitable Donations

Court rules that charitable contributions made by bankrupt church member cannot be recovered.

Richard R. Hammar, J.D., LL.M., CPA

Key point 9-09. Bankruptcy trustees are prohibited by the federal Religious Liberty and Charitable Donation Protection Act from recovering contributions made by bankrupt debtors to a church or other charity prior to declaring bankruptcy, unless the contributions were made with an intent to defraud creditors. This protection extends to any contribution amounting to less than 15 percent of a debtor’s gross annual income, or more if the debtor can establish a regular pattern of giving more. In addition, the Act bars bankruptcy courts from rejecting a bankruptcy plan because it allows the debtor to continue making contributions to a church or charity. Again, this protection applies to debtors whose bankruptcy plan calls for making charitable contributions of less than 15 percent of their gross annual income, or more if they can prove a pattern of giving more.

A federal court in California ruled that a bankruptcy trustee could not recover charitable contributions made by a church member to his church in the year preceding his filing of a bankruptcy petition, since the amount of his contributions were less than 15 percent of his gross annual income. A physician filed a Chapter 7 bankruptcy petition that listed $90,000 in assets and nearly $600,000 in debts. Shortly after the bankruptcy petition was filed, the bankruptcy trustee brought an adversary proceeding against the physician’s church, seeking to recover $18,000 in charitable contributions he made to the church during the previous year.

The court noted that the Religious Liberty and Charitable Donation Protection Act of 1998 (“RLCDPA”) amended the Bankruptcy Code to protect certain contributions to qualified religious or charitable organizations by debtors. The RLCDPA prevents bankruptcy trustees from recovering a charitable contribution to a qualified religious or charitable organization if (1) the amount of the contribution was not more than 15 percent of the debtor’s gross annual income; or (2) the amount of the contribution exceeded 15 percent of the debtor’s annual income but was consistent with the debtor’s practices of making charitable contributions.

The trustee claimed that the physician’s contributions for the prior year exceeding the 15 percent limitation. He further argued that donations for the two years before that consisted of 12 percent of his income for each year, so the donations in the most recent year were not consistent with his practice of contributing 12 percent. The church argued that the amount of the physician’s contributions fell below 15 percent of his gross annual income, and, even if they exceeded 15 percent of his income they were consistent with practice of making charitable contributions.

The court rejected the trustee’s claim that “gross annual income” meant annual income less expenses, or “disposable income.” It concluded:

This court’s refusal to apply the definition of disposable income is buttressed by the fact that this term was in existence before the enactment of the RLCDPA in 1998. When Congress [enacted] the RLCDPA, it was aware of the term “disposable income” and chose not to use this term. Instead “gross annual income” was used. In addition, Congress also amended [the Bankruptcy Code] to deduct from disposable income “charitable contributions that do not exceed 15 percent of the debtor’s gross income.” Congress could have easily used the term “disposable income”; however, it chose to use “gross income” in both [contexts]. As a result, because “disposable income” was defined as income less reasonably necessary expenses to live and continue to operate a business, “gross annual income” must mean something different. If Congress wanted to have business gross income reflect deductions for operation of a business, it would have used the term “disposable income” … when the RLCDPA was passed. It decided not to do so ….

The court added that the policy behind the RLCDPA supported its definition of gross annual income: “The legislative history of the RLCDPA states that the act ‘protects religious and charitable organizations from having to turn over to bankruptcy trustees donations these organizations received from individuals who subsequently file for bankruptcy relief. In addition, the bill protects the rights of debtors to continue to make religious and charitable contributions after they file for bankruptcy relief.'” The court noted that its interpretation of “gross annual income” furthered this policy “by allowing a higher earner to give more money to charitable organizations without fear of that organization surrendering the money in an avoidance action in the event that the higher earner files for bankruptcy.”

Since the physician’s charitable contributions during the year preceding the filing of his bankruptcy petition were less than 15 percent of his gross annual income, they could not be recovered by the bankruptcy trustee.

“Tithing is not per se unnecessary and unreasonable.” [A federal bankruptcy court, in a case addressing the discharge-ability in bankruptcy of a church member’s debts who insisted on continuing to tithe to his church. In re Halverson, 401 B.R. 378 (D. Minn. 2009).]

Application. This court’s interpretation of the key term “gross annual income” is both broad and reasonable. Any court that follows this interpretation will reduce the authority of bankruptcy trustees to recover charitable contributions made by donors to their church or other charity in the year preceding the filing of a bankruptcy petition. In re Lewis 401 B.R. 431 (C.D. Cal. 2009).

This Recent Development first appeared in Church Law & Tax Report, November/December 2009.

Legal Developments

Enforcing a Charitable Trust

Court rules that a potential beneficiary to a charitable trust lack the legal authority to enforce the trust.

Richard R. Hammar, Attorney, CPA
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Church Law & Tax Report

Enforcing a Charitable Trust

Court rules that a potential beneficiary to a charitable trust lack the legal authority to enforce the trust.

Richard R. Hammar, J.D., LL.M., CPA

Key Point 6-07.05. Church board members may be personally liable for diverting designated funds or trust funds to some other purpose.

The Alabama Supreme Court ruled that a church lacked the legal authority to enforce a charitable trust in which it was named as a potential beneficiary. A decedent died in 1950, leaving a will which created a trust providing for the distribution of income to unnamed charitable, educational, and religious entities, in the trustee’s discretion. A church and school sued the trustees on behalf of the class of all potential trust beneficiaries in an attempt to compel them to make distributions.

The court concluded that “identifiable and actual beneficiaries” of charitable trusts have a sufficient special interest in the enforcement of the trust that they can sue to enforce the trust terms. But in this case, the beneficiaries were merely potential beneficiaries and, as such, “did not have the sufficient special interest in the enforcement of the trust to entitle them to bring suit. Indeed, as the trustees argue, “the difference in status between a person or entity that has a vested or fixed right to receive a benefit from a charitable trust and a person or entity that might merely potentially receive a benefit in the discretion of the trustees, is at the very heart of the distinction between one who has a ‘special interest’ and, thus, standing to sue, and one who does not.” The court noted that “other courts, also applying the special-interest rule, have held that mere potential beneficiaries, whose interest is no greater than the interest of all the other members of a large class of potential beneficiaries of a charitable trust, have no standing to maintain an action for the enforcement of the trust.”

The court concluded that “we do not mean to imply that a potential beneficiary of a charitable trust can never avail himself of legal process to enforce the provisions of such a trust. In the absence of a showing of special interest, however, a party seeking enforcement of a charitable trust should have the Attorney General commence an action when it appears that the trust is being mismanaged through negligence or fraud.” Rhone v. Adams, 2007 WL 2966822 (Ala. 2007).

Resource. The related issue of the enforceability of designated gifts to churches and other charities is addressed in chapter 8 of Richard Hammar’s annual Church & Clergy Tax Guide, available from publisher of this newsletter by calling 1-800-222-1840.

This Recent Development first appeared in Church Law & Tax Report, November/December 2008.

Legal Developments

Fundraising and Designated Gifts

Church board members may be personally liable for diverting designated funds or trust funds to some other purpose.

Richard R. Hammar, Attorney, CPA
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Key point 6-07.05. Church board members may be personally liable for diverting designated funds or trust funds to some other purpose.

* The Massachusetts Supreme Judicial Court ruled that the First Amendment guarantee of religious freedom prevented it from resolving the claims of a donor that her gift to her church should be rescinded due to misrepresentations made by the pastor at the time of the gift. An Italian immigrant (James) established a successful gravel business and owned several tracts of land. Upon the death of James and his wife, most of their property passed to their six children. The pastor of a Catholic church was interested in acquiring an 8-acre tract from the family as the site of a new sanctuary. Two of the six siblings agreed to donate their interest in the land to the church, but the other four siblings were reluctant to transfer their interests until the pastor assured them that the new church would be named "St. James" in honor of their father, and that the church would remain a tribute to James "forever." During the negotiations for the property the pastor did not inform any members of the family that canon law permitted the closure of the church in the future. A church was constructed on the land in 1958. By the 1990s, however, question arose concerning the continuing viability of the church. A local newspaper story listed the church among those that the archdiocese planned to close. The current pastor of the church assured the congregation that the story was false. The church launched a capital fundraising campaign. A retiree in her 80s (Eileen) contributed $35,000 to the campaign. She later testified, "If I had known that the archdiocese … was giving any consideration to closing St. James, I would not have made the gift of $35,000." In 2004, the archdiocese ordered the closure of St. James. During one of the last worship services before the church closed, Eileen asked the pastor, "Why didn't you tell us the church was closing?" He replied, "I didn't know it."

Eileen, as well as the sole surviving sibling to have transferred the land to the church, sued the archbishop. The lawsuit claimed that the oral assurance by church officials that the church would be named "St. James" forever was a binding and enforceable commitment that was breached by the church's closure. The lawsuit also alleged negligent misrepresentation, breach of a fiduciary duty, and asked the court to order a reversion of the property to the surviving sibling.

The Supreme Judicial Court noted that the First Amendment guaranty of religious freedom "places beyond our jurisdiction disputes involving church doctrine, canon law, polity, discipline, and ministerial relationships," and that "among the religious controversies off limits to our courts are promises by members of the clergy to keep a church open." The court concluded that it had jurisdiction over church property disputes "if and to the extent, and only to the extent, that they are capable of resolution under neutral principles of law" involving no inquiry into church doctrine or polity.

The court concluded that the sole surviving sibling who conveyed property to the church had standing, since she gave up her rights in the property in reliance on the pastor's assurance that the property would always be used as a church in memory of James. In other words, her rights were different from members of the congregation generally. Similarly, the court concluded that Eileen had standing to sue:

It is clear that Eileen has alleged an individual stake in this dispute that makes her, and not the state attorney general, the party to bring suit …. A gift to a church generally creates a public charity. It is the exclusive function of the attorney general to correct abuses in the administration of a public charity by the institution of proper proceedings. It is his duty to see that the public interests are protected … or to decline so to proceed as those interests may require. However, a plaintiff who asserts an individual interest in the charitable organization distinct from that of the general public has standing to pursue her individual claims. In this case, Eileen's claims are readily distinguishable from those of the general class of parishioner-beneficiaries …. She claims that she lost substantial personal funds as the result of the archbishop's negligent misrepresentation to her. This claim is personal, specific, and exists apart from any broader community interest in keeping the church open. She has alleged a personal right that would, in the ordinary course, entitle her to standing.

However, the court ruled that the First Amendment prevented it from resolving the sibling's claims. For example, the sibling claimed that the pastor breached a fiduciary duty to her by not informing her at the time she conveyed her interests in the property to the archbishop that the church could be closed according to canon law. In rejecting this argument, the court observed:

A ruling that a Roman Catholic priest, or a member of the clergy of any (or indeed every) religion, owes a fiduciary-confidential relationship to a parishioner that inheres in their shared faith and nothing more is impossible as a matter of law. Such a conclusion would require a civil court to affirm questions of purely spiritual and doctrinal obligation. The ecclesiastical authority of the archbishop and [the pastor] over the parishioners, the ecclesiastical authority of the archbishop over the pastor, the state of canon law at the date of the property transfer … the canonical obligation of the pastor, if any, to inform parishioners of canonical law—all of these inquiries bearing on resolution of the fiduciary claims would take us far afield of neutral principles of law. We decline to hold that, as a matter of civil law, the relationship of a member of the clergy to his or her congregants, without more, creates a fiduciary or confidential relationship grounded in their shared religious affiliation for which redress is available in our courts.

The court also rejected Eileen's claim that the archbishop acted negligently in failing to inform the local pastor of the plans to close the church when he knew he would be soliciting funds to sustain the church "now and for the future." The court noted that Eileen's gift was made in 2002, nearly two years before the archbishop decided to close the church. As a result, the pastor's efforts to raise funds for the maintenance of the church, both now and in the future, was not negligent or a misrepresentation. Maffei v. Roman Catholic Archbishop, 867 N.E.2d 300 (Mass. 2007).

Legal Developments

State Laws for Charitable Contributions

State laws prohibiting state employees from making charitable contributions through payroll deduction to religious organizations violates the First Amendment.

Richard R. Hammar, Attorney, CPA
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Church Law & Tax Report

State Laws for Charitable Contributions

State laws prohibiting state employees from making charitable contributions through payroll deduction to religious organizations violates the First Amendment.

Richard R. Hammar, J.D., LL.M., CPA

Key point. State laws prohibiting state employees from making charitable contributions through payroll deduction to religious organizations violates the First Amendment guaranty of association.

* A federal district court in Wisconsin ruled that a state law allowing state employees to make charitable contributions through salary deductions to several charities except churches that required their board members to agree with their doctrinal beliefs was unconstitutional. The Wisconsin State Employees Combined Campaign (SECC) is a program through which state employees may make voluntary contributions to listed charitable organizations through payroll deduction. A state regulation limits eligible charities to those that do not discriminate on the basis of religion (or several other factors) with respect to employees or board members. The state interpreted this regulation to prevent religious organizations from participating in the SECC if their board members were required to share the doctrinal beliefs of the organization. Several religious organizations sued the state, claiming that the regulation violated the First Amendment guarantees of free speech, freedom of religion, and freedom of association. The court agreed:

Wisconsin does not espouse a policy against discrimination by religious groups in choosing members of their faith as directors and employees, and has affirmatively supported such rights. Such discrimination is, of course, fundamental to the nature of religious organizations and their right of expressive association. The Wisconsin Fair Employment Act expressly permits a nonprofit religious organization to discriminate in its hiring in favor of employees of the same denomination and beliefs …. The articles of incorporation of a religious organization may specify that officers and trustees must be communicants of the faith of its affiliated church …. Wisconsin’s public policy as embodied in its statutes unequivocally supports the right of religious organizations to control their internal governance and hire employees who share the organization’s religious beliefs. Excluding religious charities from the SECC appears as a single stark exception to a consistent state policy …. The claim that excluding religious charities from the SECC is dictated by a larger state policy disfavoring discrimination in the governing boards and staff of religious organizations is simply unsupported.

The court also rejected the state’s argument that allowing religious organizations to be approved charities under the SECC program would diminish the amount of contributions going to other charities.

The court noted that the charitable campaign for federal employees does not exclude religious entities from participation, and there is no evidence that other charities have suffered as a result. Association of Faith-Based Organizations v. Bablitch, 454 F.Supp.2d 812 (W.D. Wis. 2006).

Legal Developments

No Contribution Deduction for Church School Tuition

Court rejects argument that tuition resulted in an “intangible religious benefit.”

Richard R. Hammar, Attorney, CPA
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A federal appeals court rejected a married couple's claim that they could deduct 55% of the cost of their son's tuition at a religious school since religious instruction comprised 55% of the curriculum and constituted an "intangible religious benefit" that did not reduce the value of their charitable contribution.

The court concluded, "Not only has the Supreme Court held that, generally, a payment for which one receives consideration does not constitute a contribution or gift … but it has explicitly rejected the contention … that there is an exception for payments for which one receives only religious benefits in return."

The parents also argued that they could claim a charitable contribution deduction for the amount by which their tuition payments exceeded the market value of their son's education. They claimed that the value of the education their son received was zero since the cost of an education at a public school was "free," and therefore they could fully deduct the cost of their son's tuition since the entire amount exceeded the "value" of the education received.

The court disagreed, noting that the value of their son's education was the cost of a comparable secular education offered by private schools. Further, the court noted that the parents presented no evidence of the tuition that private schools charge for a comparable secular education, and so there was no evidence showing that they made an "excess payment" that might qualify for a tax deduction.

Sklar v. Commissioner,2002-1 USTC 50,210 (9th Cir. 2002)

Legal Developments

Returning Donations to Bankruptcy Trustees

Federal court rules in favor of church in bankruptcy dispute.

Richard R. Hammar, Attorney, CPA
Bio

Church Law and Tax 1996-11-01

Bankruptcy

Richard R. Hammar, J.D., LL.M., CPA

• Key point. Some courts have ruled that bankruptcy trustees do have the legal authority to require churches to return contributions made by bankrupt debtors during the year prior to filing a bankruptcy petition.

A federal appeals court ruled that a bankruptcy trustee could not require a church to return $13,000 in contributions that had been made by a member during the year prior to filing a bankruptcy petition. The church and the member both believed in tithing, and the member faithfully tithed up until the time he filed for bankruptcy. The trustee demanded that the church return the $13,000 in contributions made during the previous year. It relied on a provision in the bankruptcy code giving trustees the authority to “avoid” transfers made by debtors within a year of filing for bankruptcy unless they receive property or services of “reasonably equivalent value” in exchange. The church insisted that the member received valuable benefits in exchange for his contributions, but a bankruptcy court disagreed. The case was appealed. A federal appeals court acknowledged that the debtor received valuable benefits in exchange for his contributions to the church, including preaching, teaching, and counseling. But, it concluded that these benefits were provided to members whether or not they tithed, and as a result they were not provided “in exchange” for the debtor’s contributions. Therefore, under the bankruptcy law the trustee had the authority to recover the debtor’s contributions from the church. However, the court further concluded that allowing the trustee to do so would violate the rights of the church and debtor under the Religious Freedom Restoration Act. This Act specifies that the government may not “substantially burden” a person’s religious practices unless a compelling governmental interest exists. The court concluded that the practice of tithing was a religious practice that would be substantially burdened if the trustee could recover the debtor’s tithes since it would discourage persons from tithing to their church if they suspected that they might file for bankruptcy within the next year. Further, the court concluded that there was no compelling governmental interest that would justify the substantial burden on the practice of tithing. This issue is now resolved in the eighth federal circuit, which includes the states of Arkansas, Iowa, Minnesota, Missouri, Nebraska, North Dakota, and South Dakota-at least with respect to those churches for which tithing is an important religious practice. The trustee has indicated that he will appeal this decision to the United States Supreme Court. In re Young, 82 F.3d 1407 (8th Cir. 1996). [ Limitations on Charitable Giving]

© Copyright 1996, 1998 by Church Law & Tax Report. All rights reserved. This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is provided with the understanding that the publisher is not engaged in rendering legal, accounting, or other professional service. If legal advice or other expert assistance is required, the services of a competent professional person should be sought. Church Law & Tax Report, PO Box 1098, Matthews, NC 28106. Reference Code: m05 c0696

Legal Developments

Gift to Church Orphanage Lapsed, Court Says

Orphanage no longer existed; succeeding charity technically not an orphanage.

Richard R. Hammar, Attorney, CPA
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• Key point. A gift in a decedent's will to a defunct charity may "lapse."

An Illinois court ruled that a gift to a church orphanage lapsed since the orphanage no longer existed and it was succeeded by another charity that was not organized as an orphanage. A decedent died leaving one—fourth of his estate to the Lutheran Orphan Home, Paris, Missouri. There was no Lutheran Orphan Home in Paris, Missouri at the time of the decedent's death, and never had been. There was a Lutheran Orphan Home in Des Peres, Missouri, but it closed some 25 years prior to the decedent's death. The assets of the orphanage were transferred to the Lutheran Family & Children's Services of Missouri, which claimed that it was entitled to the portion of the decedent's estate that was earmarked for the Lutheran Orphan Home. A court concluded that the decedent must have intended that one—fourth of his estate go to the Lutheran Orphan Home in Des Peres, Missouri, since this was the only entity by that name that had ever existed in the state of Missouri. However, the court refused to distribute this portion of the decedent's estate to the Lutheran Family & Children's Services of Missouri, even though it was the legal successor of the orphanage, since its purposes were not closely enough related to the decedent's express purpose of benefiting an orphanage. The court observed: "[Lutheran Family & Children's Services of Missouri] provides services such as foster care, adoption, counseling for families, and medical care for at—risk infants, which are very commendable; however, they are not in the nature of services provided by an orphanage and cannot be construed as such. [The decedent's will] makes clear that [he] intended his bequest to directly benefit the children at the orphanage and not an organization which provides general child welfare services to the community. If the [decedent] had intended to generally benefit a Lutheran charity that assisted children and families through general services, he could have made a specific bequest to [such an entity]." In re Estate of Beck, 649 N.E.2d 1011 (Ill. App. 1995).

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