TREASURY
INSPECTOR GENERAL FOR TAX ADMINISTRATION
The Internal Revenue Service
Needs to Improve Procedures to Identify Noncompliance With the Reporting Requirements
for Noncash Charitable Contributions
March 5, 2007
Reference Number: 2007-30-049
This
report has cleared the Treasury Inspector General for Tax Administration
disclosure review process and information determined to be restricted from
public release has been redacted from this document.
Phone Number |
202-927-7037
Email Address | Bonnie.Heald@tigta.treas.gov
Web Site |
http://www.tigta.gov
March 5, 2007
MEMORANDUM
FOR
Deputy Commissioner FOR Services
and Enforcement
FROM: Michael R. Phillips /s/ Michael R. Phillips
Deputy Inspector General for Audit
SUBJECT: Final Audit Report – The Internal Revenue Service Needs to Improve Procedures to Identify Noncompliance With the Reporting Requirements for Noncash Charitable Contributions (Audit # 200630012)
This report presents the results of our review of Provision 883 (Increased Reporting for Noncash Charitable Contributions) of the American Jobs Creation Act of 2004.[1] The overall objective of this review was to evaluate the implementation of Provision 883 and the processing of individual income tax returns reporting deductions for noncash contributions.
Impact on the Taxpayer
Gifts of donated property, clothing, and other noncash items have long been a popular deduction for taxpayers. In recent years, the legitimacy of the values placed on some of these noncash donations has been questioned by the Internal Revenue Service (IRS) and Congress. As a result, Congress passed legislation adding additional reporting requirements to substantiate the value of some of these donations. Currently, taxpayers who may not be entitled to deductions for noncash contributions are reducing their tax liabilities and may receive refunds regardless of whether they provide the required substantiation. This could result in a loss of revenue to the Federal Government and inequitable treatment of taxpayers.
Synopsis
Individual taxpayers are required to file Noncash Charitable Contributions (Form 8283) if their charitable deductions claimed for noncash contributions exceed $500. If the value of donated property exceeds $5,000, taxpayers are required to obtain signatures on their Forms 8283 acknowledging receipt of the donated property. In addition, taxpayers are required to attest on their Forms 8283 that the value placed on the donated property was determined by a qualified appraisal;[2] however, until passage of the American Jobs Creation Act of 2004, taxpayers were not required to attach the appraisals to their tax returns regardless of the value placed on the donated property.
The IRS revised tax forms and publications and provided training and information to employees to facilitate implementation of the new requirements for claiming noncash charitable contributions. However, taxpayers and tax practitioners still need to be better educated concerning requirements for claiming charitable contributions. Also, additional procedures need to be established to identify noncompliance with charitable contribution requirements during returns processing. Better education of taxpayers and preparers and additional returns processing procedures will enable the IRS to address potential noncompliance, as Congress intended in its legislation. We estimate 101,236 taxpayers could have claimed unsubstantiated noncash contributions totaling approximately $1.8 billion for the period January 15 through September 21, 2006.
Recommendations
We recommended the Commissioner, Large and Mid-Size Business Division, coordinate with the other affected operating divisions to develop a comprehensive outreach plan on the reporting requirements for noncash charitable contributions for affected taxpayers and tax practitioners. We also recommended the Commissioner, Small Business/Self-Employed Division, and the Commissioner, Wage and Investment Division, develop procedures to correspond with taxpayers to obtain missing Forms 8283 and supporting documentation. Taxpayers failing to provide missing Forms and substantiation should have a specific audit code input on their tax returns to alert the Examination function of returns without required substantiation for noncash charitable contributions.
Response
IRS
management agreed with the first recommendation and plans to supplement their
outreach plan by 1) partnering with several professional stakeholders to
promote awareness of the increased reporting requirements, 2) coordinating the IRS’
efforts to promote awareness of the increased reporting requirements to donee
organizations, and 3) partnering with professional appraisal stakeholders to
promote awareness of the increased reporting requirements and appraiser
responsibilities.
IRS management partially agreed with the second recommendation. The IRS will continue to correspond with taxpayers claiming noncash contributions over a specific dollar threshold but with no Forms 8283 attached to their returns. In addition, the IRS agreed to use a specific indicator to identify for the Examination function returns claiming noncash contributions over the same threshold dollar amount but with no Forms 8283 attached. Management’s complete response to the draft report is included in Appendix IV.
Office of Audit Comment
Although the IRS plans to continue corresponding with taxpayers and will add a specific indicator for instances in which Forms 8283 are missing, we believe few instances of unsubstantiated deductions will be addressed by these actions. The dollar threshold, which remains unchanged, has been set too high and needs to be lowered to ensure most of the returns claiming unsubstantiated deductions are addressed in concert with Congressional concerns. Also, the IRS does not plan any additional actions concerning incomplete documentation, such as missing signatures and appraisals. Based on our sampling, we estimate fewer than 1 percent of the returns with noncash charitable contribution deductions are above the IRS’ dollar threshold. We applaud the IRS’ efforts to increase its outreach program to better educate taxpayers and tax practitioners, but we urge the IRS to lower the dollar threshold and address returns with incomplete documentation to better deal with these unsubstantiated deductions.
Copies of
this report are also being sent to the IRS managers affected by the report
recommendations. Please contact me at
(202) 622-6510 if you have questions or
Daniel R. Devlin, Assistant Inspector General for Audit, (Small Business and
Corporate Programs), at (202) 622-5894.
Appendices
Appendix
I – Detailed Objective, Scope, and Methodology
Appendix
II – Major Contributors to This Report
Appendix
III – Report Distribution List
Appendix
IV – Management’s Response to the Draft Report
Abbreviations
|
AJCA |
American Jobs Creation Act of 2004 |
|
IRS |
Internal Revenue Service |
|
LMSB |
Large and Mid-Size Business |
|
TIGTA |
Treasury Inspector General for Tax
Administration |
The Tax Code allows individuals and businesses to make noncash contributions (e.g., vehicles, paintings, used clothing, and household goods) to qualifying charities and to claim deductions for these contributions on their tax returns. Gifts of donated property, clothing, and other noncash items have long been an important source of revenue for many charitable organizations and a popular deduction for taxpayers. In recent years, the legitimacy of the values placed on some of these noncash donations has been questioned by the Internal Revenue Service (IRS) and Congress. In Tax Year 2003,[3] individuals reported 14.3 million noncash donations valued at $36.9 billion.[4]
On October 22, 2004, President Bush signed the American Jobs Creation Act of 2004 (AJCA).[5] AJCA Provision 883 (Increased Reporting for Noncash Charitable Contributions) created additional reporting requirements for individual taxpayers making noncash charitable contributions valued at more than $500,000. The IRS Large and Mid-Size Business (LMSB) Division was assigned primary responsibility for implementation of Provision 883. The implementation of this Provision involved multiple actions, including training and providing guidance to IRS employees, creating and revising tax forms and publications, and coordinating extensively with various IRS functions.
This review focused on noncash donations other than vehicles
and works of art. The review was
performed at the IRS office in
Tax Forms and Publications Were Revised, and Training and Information Were Provided to Employees to Facilitate Implementation of the New Requirements for Claiming Noncash Charitable Contributions
To facilitate implementation of the new requirements for claiming noncash charitable contributions, the LMSB Division created on its web site an AJCA webpage that contained links to notices, news releases, fact sheets, and other existing technical guidance relating to the Act. Tax forms and publications related to noncash charitable contributions were properly updated in accordance with the new law. In addition, training covering the new law was provided to IRS employees.
The LMSB Division used the Legislative Implementation Tracking System, which is an IRS Intranet-based planning and monitoring system, to monitor implementation of the legislation. This System lists the required actions with estimated due dates and the functions responsible for taking the necessary actions.
Taxpayers and Tax Practitioners Need to Be Better Educated
Concerning Requirements for Claiming Charitable Contributions
Individual taxpayers are required to file a Noncash Charitable Contributions (Form 8283) if their charitable deductions claimed for noncash contributions exceed $500. If the value of donated property exceeds $5,000, taxpayers are required to obtain signatures on their Forms 8283 acknowledging receipt of the donated property. In addition, taxpayers are required to attest on their Forms 8283 that the value placed on the donated property was determined by a qualified appraisal;[6] however, until passage of the AJCA, taxpayers were not required to attach the appraisals to their tax returns regardless of the value placed on the donated property.
AJCA Provision 883 requires all donors who contribute property (other than cash, inventory, or publicly traded securities) for which a deduction of more than $500,000 is claimed to attach a qualified appraisal to their tax returns. Provision 883 is effective for donations made after June 3, 2004.
We reviewed statistically valid samples of Tax Year 2005 individual income tax returns on which the deductions claimed for noncash charitable contributions were greater than $5,000. In 46 (22 percent) of 211 cases, taxpayers failed to provide the required substantiation for deductions of approximately $23 million.[7] Paid preparers prepared 161 (76 percent) of the returns in our samples and prepared 33 (72 percent) of the 46 error cases.[8]
Figure 1: Tax Returns Filed
Without Substantiation for Noncash Contributions
|
|
Returns Sampled |
Signature Missing |
Appraisal Missing |
Form 8283 Missing |
Totals |
Percentage
With Missing Documentation |
|
Noncash Contributions $5,001-$500,000 |
121 |
27 |
Not Applicable |
2 |
29 |
24% |
|
Noncash Contributions Greater Than
$500,000 |
90 |
1 |
16 |
0 |
17 |
19% |
|
Totals |
211 |
28 |
16 |
2 |
46 |
22% |
Source: Our analysis of cases in which the deductions
for noncash contributions were greater than $5,000.
Normally, the onus is on taxpayers and their preparers to stay abreast of existing and new tax law provisions. However, the IRS also has a responsibility to help taxpayers understand and meet their tax responsibilities. The fact that over 20 percent of taxpayers and/or preparers were not complying with the specific requirements (both old and new) for claiming noncash charitable contributions indicates the need for further action by the IRS.
Unlike other provisions of the AJCA, for which the IRS provided information to practitioners and other stakeholders through news releases and other communications, guidance on Provision 883 has generally been limited to the revision of tax forms and publications. More than 2 years after enactment of the legislation, an IRS notice under Internal Revenue Code Section 170[9] providing guidance and transitional rules for increased reporting for noncash charitable contributions was approved for release. Also, a draft of new regulations under Internal Revenue Code Section 170 with more formal guidance on increased reporting for noncash charitable contributions is not scheduled for release until 2007. Our samples were identified from returns processed from January 15 through March 18, 2006. Based on the results of our samples, we estimate 51,502 taxpayers claimed unsubstantiated noncash charitable deductions of approximately $676 million on Tax Year 2005 returns processed during this time. If the error rate for the returns processed from March 19 through September 21, 2006, remained the same as the rate in our samples,[10] we estimate 101,236 taxpayers could have claimed unsubstantiated noncash contributions totaling approximately $1.8 billion for the period January 15 through September 21, 2006.[11] Without proper documentation, these taxpayers, by law, are not entitled to these deductions.
Recommendation
Recommendation 1: The Commissioner, LMSB Division, should coordinate with the other affected operating divisions to develop a comprehensive outreach plan on the reporting requirements for noncash charitable contributions for affected taxpayers and tax practitioners.
Management’s Response: IRS management agreed with the recommendation and plans to supplement
their outreach plan by 1) partnering with several professional stakeholders to
promote awareness of the increased reporting requirements, 2) coordinating the IRS’
efforts to promote awareness of the increased reporting requirements to donee
organizations, and 3) partnering with professional appraisal stakeholders to
promote awareness of the increased reporting requirements and appraiser
responsibilities.
Additional Procedures Need to Be Established to Identify Noncompliance
With Charitable Contribution Requirements During Returns Processing
The procedures used by the IRS Submission Processing function were not adequate to ensure taxpayers met requirements for deducting noncash charitable deductions. Tax laws related to noncash charitable contributions state that no deduction shall be allowed for various noncash charitable contributions unless taxpayers provide specific substantiating information with their tax returns. In general, individuals who claim noncash charitable contributions must provide the following with their returns:
Instructions for Form 8283 inform the
taxpayer that his or her deduction generally will be disallowed if he or she
fails to attach Form 8283, get a required appraisal, or attach an appraisal
when required. However, the IRS Submission
Processing function did not adjust or stop these returns during processing or implement
any type of review of these returns.
Submission Processing function guidelines allow returns with such deductions
to be processed except in the most egregious cases where the deductions are of
a very significant amount and Form 8283 is missing. All other income tax returns filed without
substantiation for the claimed noncash contribution deductions are processed as
filed by the taxpayers.
Further, the IRS indicated the Examination
function would be responsible for any review of information related to these returns;
however, the returns were not coded or processed in any way to alert the
Examination function of the unsubstantiated deductions. Instead, the returns go through the same
Examination function selection criteria as any other tax returns. The Examination function generally audits fewer
than 1 percent of the individual income tax returns filed each year.
By not identifying returns filed without the required substantiation for charitable contributions, the IRS is not addressing the Congressional intent of this legislation. Taxpayers who are not entitled to deductions for noncash contributions are reducing their tax liabilities and may receive refunds regardless of whether they provide the required substantiation. This could result in a loss of revenue to the Federal Government and inequitable treatment of taxpayers.
Recommendation
Recommendation 2: The Commissioner, Small Business/Self-Employed Division, and the Commissioner, Wage and Investment Division, should develop the following procedures to address returns without required substantiation for noncash charitable contributions:
a) Correspond with taxpayers to obtain missing Forms 8283 and supporting documentation.
b) Input a specific audit code on tax returns that fail to provide missing Forms and substantiation, to alert the Examination function of returns without required substantiation for noncash charitable contributions.
Management’s Response: IRS management partially agreed with this recommendation. The IRS will continue to correspond with taxpayers claiming noncash contributions over a specific dollar