Contributing Appreciated Property
Gerald and Henrietta Rauenhorst were the sole partners in Arbeit, which owned warrants to purchase NMG stock at a substantial discount. On September 8, 1993, World Color Press Inc. agreed to purchase NMG. On November 9, Arbeit donated the NMG warrants it owned to several charities. Six days later Arbeit agreed to sell those warrants to World Color. The charities subsequently agreed to abide by this agreement. World Color and NMG finalized their merger on November 22.
On their 1993 income tax return the Rauenhorsts deducted the full fair market value of the donated warrants. The IRS increased their reported income by $4,722,484—the appreciation in the warrants—under the assignment of income doctrine. The couple appealed.
Result. For the taxpayer. Normally, a taxpayer does not report income on a gift of appreciated property to a charity provided there was a completed gift before the charity sold the property. However, if the sale took place before the contribution was made, the taxpayer must report the gain under a number of different theories including assignment of income.
The courts previously had considered the issue of reporting precontribution income on a subsequent sale by a charity in Palmer . The Tax Court concluded the assignment of income doctrine should not apply even if the taxpayer had known the sale was imminent unless an obligation to sell existed at the time of the contribution. The IRS acquiesced to Palmer in revenue ruling 78-197, saying that “the Service will treat the proceeds of a redemption (or sale) of stock…as income to the donor only if the donee is legally bound or can be compelled by the corporation to surrender the shares for redemption (or sale),” (parentheses added).
In spite of the bright-line test in the revenue ruling, the IRS sought to assign income to the donor in this case, which clearly falls within revenue ruling 78-197. The IRS argued it should not be bound by the revenue ruling since prior courts had not accepted its bright-line test. The Tax Court acknowledged that some courts did not accept this rule as correct in prior cases; however, the IRS is not permitted to ignore or argue against a long-standing revenue ruling. Therefore the court said revenue ruling 78-197 will apply unless the facts of the case are distinguishable from the ones in the ruling. The court concluded they were not in this case. Therefore, the taxpayer did not have to report the gain on the sale of the warrants.
Until such time as the Treasury Department revokes revenue ruling 78-197, taxpayers can be reasonably certain they will not have to report income on a donation of appreciated property absent a legally binding sales agreement. This should help CPAs plan charitable contributions on their behalf.
Gerald A. Rauenhorst v. Commissioner, 119 TC no. 9.
Prepared by Edward J. Schnee, CPA, PhD, Hugh Culverhouse Professor of Accounting and director MTA program, Culverhouse School of Accountancy, University of Alabama, Tuscaloosa.