Good Intentions, Bad Tax Results, a recent Tax Court case* illustrates what can go wrong when taxpayers don’t have all the documentation required to support their deductions for charitable contributions. The case involves a couple who had made a series of cash donations totaling approximately $25,000 to a tax-exempt organization (their church). They claimed a deduction for their contributions, and the IRS disallowed it on audit.
The couple defended their deduction by producing records of the contributions. The records included copies of their canceled checks and a letter from the organization acknowledging the donations. But that wasn’t enough proof to satisfy the IRS.
Why? The letter failed to state whether the organization had provided any goods or services in consideration for the contribution. This statement, along with a description and good faith estimate of the value of any goods and services provided, must be included in acknowledgments of contributions of $250 or more. (The value of any goods and services provided is subtracted from the amount contributed to determine the deductible amount.)
The couple then obtained a second letter that included the required information. However, this still wasn’t good enough. The reason: The letter hadn’t been provided to them contemporaneously (they didn’t have it when they filed their return) — another substantiation rule.
The couple argued they had substantially complied with the regulations, but the court did not agree. The statement about goods and services is necessary to determine the amount of a charitable contribution, and the second letter that contained the statement was not contemporaneous. As a result, the couple couldn’t claim the deduction.
* David P. Durden, et ux. v. Comm’r (TC Memo. 2012-140, 5/17/2012)
Writing Off Bad Debts
In any economic environment, businesses typically have a percentage of customers who don’t pay their invoices. The problem only gets worse in a slow economy.
Cut Your Loss
If a customer or client owes your business money you can’t collect, you might be able to claim a bad debt deduction on your business return. You must be able to show the debt is partially or totally worthless. This may be the case if you have taken reasonable steps to collect a debt and there is no longer any possibility you will receive payment. Business bad debts typically arise from credit sales to customers.
Timing Is Critical
The tax law doesn’t allow a deduction for any part of a debt after the year in which it becomes totally worthless. To ensure you don’t miss out on bad debt deductions this year, review your records carefully to pinpoint any potentially worthless receivables you may still be carrying on the books. Make sure you carefully document your failed collection efforts in case the IRS challenges the bad debt deduction.
Note that bad debt deductions generally aren’t available to businesses that use the cash method of accounting. To deduct a bad debt, you must have previously included the amount in your income. Since cash-method taxpayers don’t report income until payment is received, no deduction is allowed for uncollectible amounts, even if the money is owed to you for services you performed.
Drop in Value of IRAs
According to the IRS, the year-end market value of all individual retirement accounts (IRAs) fell from $4.7 trillion in 2007 to $3.7 trillion in 2008. Unfavorable market conditions, along with an increase (28%) in the number of taxpayers taking IRA withdrawals and an average decrease (33.5%) in the value of rollovers to IRAs, were cited as reasons for the decline.
Failure To Claim Higher Education Tax Benefits
Approximately 14% of eligible taxpayers failed to claim the Lifetime Learning Credit or the tuition deduction on their 2009 tax returns. The Government Accountability Office (GAO) reports that, on average, these taxpayers lost a tax benefit of $466.
Higher Fees for Smaller Plans
A GAO survey of 401(k) plan sponsors found that sponsors of small plans (fewer than 50 participants) paid an average fee amount of 1.33% of assets, whereas sponsors of larger plans (more than 500 participants) paid an average fee amount of only 0.15% of assets.
The general information in this publication is not intended to be nor should it be treated as tax, legal, or accounting advice. Additional issues could exist that would affect the tax treatment of a specific transaction and, therefore, taxpayers should seek advice from an independent tax advisor based on their particular circumstances before acting on any information presented. This information is not intended to be nor can it be used by any taxpayer for the purpose of avoiding tax penalties.