When Proof of Payment Is Not Enough

6/1/2012 | Written by: Karen Reed

Two recent Tax Court decisions reinforce the need for taxpayer vigilance in obtaining proper documentation to support items claimed on federal income tax returns. In both cases, legitimate deductions were denied because the taxpayers did not meet the substantiation requirements set forth by the Internal Revenue Code for their specific types of charitable contributions.

On May 17, 2012, the Tax Court sided with the IRS in Durden v. Commissioner of Internal Revenue, disallowing $22,517 in charitable contribution deductions claimed by David and Veronda Durden on their 2007 tax return. The Durdens had obtained an acknowledgement letter from their church, but it did not include a specific statement as to whether goods or services had been received in exchange for the gifts, a requirement of the Code for charitable contributions over $250. The Durdens obtained a second letter from the church during the audit, but the IRS disallowed the document because it did not meet the contemporaneous requirement prescribed by the Code, and the Court agreed.

Just twelve days later the Tax Court sided with the IRS in Mohammed v. Commissioner, denying Joseph Mohammed 19 million in legitimate charitable deductions. He had failed to meet the specific substantiation rules for property contributions in excess of $5,000, which require a “qualified appraisal” of the property within a specified period before or after the gift is made.

Mohammed, who had prepared his own tax return, completed the IRS appraisal form himself, believing his certification as a real estate appraiser qualified him to do so. He was unaware of the requirement for an independent appraisal and only obtained one when he was already under audit. At that point it was too late; even though the independent appraisal he provided during the audit showed that the value of the property at the time of the gift was higher than the amount he had claimed, it had not been done by the required due date and therefore could not be considered a “qualified appraisal” in the eyes of the IRS and Tax Court.

As a general rule, the types of records you are required to keep in order to substantiate your deductions are not specified by the Internal Revenue Code – they will generally be accepted if they allow the IRS to determine your correct tax. However, certain deductions, such as charitable contributions, have their own specific rules, and the proof needed becomes increasingly onerous depending on the amount claimed. As the taxpayer, it is your responsibility to know and comply with the requirements for each deduction you take, even when they are not clearly spelled out on the tax forms. The Tax Court has acknowledged that while the form – and the written form instructions – may not be clear, their decisions are based on the Internal Revenue Code. As these decisions show, strict compliance is essential to ensure that your deductions stand in an audit.