Related taxpayers were allowed to treat a charitable contribution as made by a partnership rather than a related corporation that accidentally made the contribution in the case of Green v. United States, 117 AFTR 2d ¶ 2016-418, DC WD Okla., Case No. CIV-13-1237-D.
The case involved Hob-Lob Limited Partnership which owns many, not all, Hobby Lobby Stores. Hobby Lobby (the corporation) paid $7.5 in contributions to two charitable organizations in 2004. The taxpayers claimed that this had been a mistake, and that the contributions were intended to have been made by the partnership, of which a 99% interest was held by the taxpayer in this case.
The error had been noticed by the taxpayers. Letters of correction were sent to the charities, the amount was reflected as Hob-Lob’s on its audited financial statements and Hob-Lob reimbursed the corporation for the contribution.
Charitable contributions are subject to very different limits on the amounts deductible based on the type of taxpayer making the contribution and, generally, a C corporation faces the smallest percentage of income limitation while a trust (which is the ultimate taxpayer in this case), while subject to various special rules for allowance of a deduction, has no percentage of income limitation on the deduction.
As well, the value of a deduction to the different taxpayers is impacted by the marginal rates imposed, which again are different based on the type of taxpayers involved. Here a C corporation has the lowest top marginal rate, while trusts very quickly pay at the highest individual marginal rates.
Even if the corporation were an S corporation, if the contribution is made by that entity it would flow to the shareholders (which very likely would not end up being the trust, at least in whole) and would be subject to basis limitations that might deny those shareholders a current benefit.
So the question of what entity gets this deduction (the partnership or the corporation) is most often not a trivial matter. The IRS argued that the test is simply based on what entity paid the expense—the taxpayers cannot assign the deduction after the fact when they determine that the original structure carries tax disadvantages.
The IRS cited the case of Comm'r. v. Nat'l Alfalfa Dehydrating & Milling, Co., 417 U.S. 134 (1974) where the Supreme Court denied the taxpayer a deduction where the taxpayer argued it could have been structured differently. The IRS argued that fact that Hob-Lob could have made the contribution is not relevant since it did not actually make the contribution.
The District Court in this case disagreed. First, the Court briefly indicated that charitable contributions are subject to a different standard than other deductions (quoting from the Sixth Circuit decision in the case of Weingarden v. Comm'r, 825 F.2d 1027, 1029 (6th Cir. 1987) that charitable deductions are not matters of legislative grace, but rather statements of public policy).
The Court then goes on to hold it found this was a true mistake and that the deduction should be allowed to the partnership:
Although originally issued on Hobby Lobby checks, the Subject Contributions were ultimately borne by Hob-Lob. Once discovered, the clerical error was thoroughly addressed — letters of correction were sent, affidavits were signed, books were corrected, and most importantly, Hob-Lob reimbursed Hobby Lobby's account for the full amount of the Subject Contributions. Plaintiff is not seeking a deduction for the Trust based on a hypothetical situation as was the case in Nat'l Alfalfa Dehydrating & Milling, Co. Rather, Plaintiff requests relief in accordance with corrected financial statements that reflect actual contributions made by Hob-Lob. To disallow a charitable deduction simply because of a clerical error goes against the liberal policy of encouraging charitable giving and distorts the Supreme Court's holding in Nat'l Alfalfa Dehydrating & Milling, Co.
Advisers should be careful not to take too much comfort in this decision. First, as the above paragraph makes clear, the Court found a true mistake rather than after-the-fact tax planning. Second, the opinion strongly suggests that had the deduction been other than a charitable contribution the decision might be different.
The decision is based on the very specific facts in this case. It does not stand for the proposition that anything an adviser finds the taxpayer did during the year that could have been done differently can be “restructured” before preparing the return to be more tax advantageous (that would seem right in line with the Nat’l Alfalfa decision’s fact pattern.)
Rather, it can provide some justification where there is a true mistake to claiming the deduction on the proper return, assuming that the parties are made whole. But it will be important to document how the mistake was uncovered and to show that the intent all along had been to have the transaction undertaken by the other taxpayer.
Better yet is to advise clients strongly to be very careful when they have a number of related entities they control to be sure to make payments out of the proper checkbook. While this was a “win” for the taxpayers, a bigger win would have been never to have had an issue for the IRS to question to begin with, and that’s the goal we should have our clients strive for.