IRS Private Letter Ruling 200623063
Background. Church members made “contributions” to their church as part of a scheme to deduct tuition payments made to private schools their children were attending. Here is how it worked. Members contributed to the church an amount equal to or exceeding the amount of their child’s tuition at a private school unrelated to the church. The school billed the church for the tuition, and the church paid it. At the end of the year the church provided a receipt to the members reflecting their total contributions for the year without any reduction for tuition the church paid. The receipt also stated that the member had received nothing in exchange for the contributions except intangible religious benefits.
The IRS ruling. The IRS classified this arrangement as a “disguised tuition payment program” that triggered the following two tax penalties:
(1) aiding and abetting the understatement of tax
Section 6701 of the tax code imposes a penalty for “aiding and abetting” an understatement of tax, and it concluded that this penalty would apply to churches that participate in a disguised tuition payment program because “they know, or have reason to believe, that members will rely upon the contribution statements the church provides in connection with reporting their tax liability and that the reliance on those statements will result in an understatement of tax.”
The IRS noted that the section 6701 penalty for aiding and abetting an understatement of tax was $1,000 for each person receiving a contribution statement per year, and that this penalty was in addition to any penalty under section 6714 (see below).
(2) quid pro quo penalty
A “quid pro quo” contribution is a payment to a charity that is partly or wholly in exchange for goods or services provided to the donor by the charity. Section 6115 of the tax code requires charities that receive a quid pro quo contribution in excess of $75 to provide a written receipt to the donor that (1) informs the donor that the amount of the contribution that is deductible for federal income tax purposes is limited to the excess of the amount of any money and the value of any property other than money contributed by the donor over the value of the goods or services provided by the organization, and (2) provides the donor with a good faith estimate of the value of such goods or services.
Section 6714 of the tax code imposes a penalty of $10 for each quid pro quo contribution for which a charity fails to provide a written receipt that complies with these reporting requirements, with a limit of $5,000 for any one fundraising event or mailing. Further, no penalty is imposed under section 6714 “with respect to any failure if it is shown that such failure is due to reasonable cause.” The IRS added:
Evidence that a church conducted an actual fundraising event or mailing involving a disguised tuition program would yield a maximum $5,000 penalty. For example, some churches may solicit pledges of contributions or mail offering envelopes to members. When this is done with the understanding that certain member-families will participate in a disguised tuition payment program, contributions to fulfill a pledge or made with offering envelopes would be subject to the $5,000 penalty cap for contributions associated with each pledge drive or mass offering-envelope mailing. Otherwise, evidence of a fundraising event or mailing may not turn up in a disguised tuition context because the participants may hear about the program by word of mouth or may participate in the program year after year without mailings or fundraising by the church. In such cases, we do not read section 6714 as imposing a limit on the penalty.
The IRS acknowledged that a penalty can be waived if a failure to comply with the disclosure requirement was due to reasonable cause. However, it cautioned that “a disguised tuition payment program so plainly violates the provisions giving rise to the quid pro quo penalty that we find it difficult to imagine a scenario in which a church could establish reasonable cause based on a misunderstanding of law or fact.”
Relevance to church leaders. It is common for church members to claim a tax deduction for their children’s tuition expenses, whether the children attend a church-affiliated school or some other institution. Churches often are directly involved in such arrangements. This ruling should serve as a warning to church leaders that “creative” programs to allow members to claim a tax deduction for the tuition expenses of their children may expose the church to the following penalties:
- A penalty of $1,000 for aiding and abetting in the understatement of tax. This penalty would apply for each member whom the church aids and abets in the understatement of tax through a misleading contribution receipt or some other document. For example, if 10 church members participate in the same scheme, then the combined penalty could be $10,000.
- A penalty of $10 for failing to comply with the quid pro quo reporting requirements. This penalty applies to each person to whom a contribution receipt is issued that fails to comply with the quid pro quo reporting rules summarized above.
According to the IRS, the “aiding and abetting” penalty can apply whenever a church aids or abets in the preparation of a false or fraudulent tax document that would result in the understatement of tax. The IRS Exempt Organizations Continuing Professional Education Technical Instruction Program for 1999 (“CPE for 1999”) contains the following examples illustrating the application of the aiding and abetting penalty in the context of charitable contributions:
Example. Charity Y is exempt from federal income tax. It conducts many charitable activities and is engaging in a fund raising campaign. Any contributor who makes a $1000 contribution receives a wireless telephone whose fair market value is $100. Charity Y and its officers are financially sophisticated and knowledgeable. Charity Y purposely states in its written acknowledgement to Contributor B, a frequent supporter, that the entire payment is tax deductible. Contributor B told Charity Y’s president that he would include that contribution as a charitable contribution deduction on his income tax return. Charity Y and its president are subject to a section 6701 aiding and abetting penalty.
Example. B offered to donate a sculpture to a museum on February 1, 2007. C, the curator of the museum, agrees to accept the sculpture, and offers to backdate an acknowledgment statement for the donation to December 31, 2006. C intends that the statement will be used to substantiate B’s charitable deduction. B uses the backdated acknowledgement statement to claim a charitable deduction for 2006. C has aided in the preparation of a federal tax document knowing that it will be used in connection with a material tax matter and that it will result in an understatement of tax, and so C is liable for the section 6701 aiding and abetting penalty.
The CPE for 1999 mentions the following examples of charitable contribution transactions that might trigger the aiding and abetting penalty: “Charities may negligently or intentionally provide inaccurate information to a contributor concerning the monetary value of gifts made. Charities in other instances may provide erroneous information to indicate that a quid pro quo contribution is fully tax deductible when in fact no full deduction would be permitted. Continued misrepresentations about these matters raise the possibility that the aiding and abetting penalty could come into play.”
Key point. IRS Form 8283 is used by donors to substantiate contributions of property valued at more than $5,000. Donors are required to obtain a qualified appraisal of such contributions, and use Form 8283 to provide the IRS with a summary of the appraisal. The appraiser is required to make the following declaration on this form: “I understand that a false or fraudulent overstatement of the property value as described in the qualified appraisal or this Form 8283 may subject me to the penalty under section 6701 (aiding and abetting the understatement of tax liability).”
This article first appeared in Church Treasurer Alert, September 2006.