News Notes

Substantial Compliance Insufficient to Allow Charitable Deduction • IRS Announces Program to Share Employment Tax Exam Results with States • Temp. Regs. Give Rules on e-Postcards for Exempt Organizations • Final Regs. Provide Rules for Entities Required to File Electronically

Alistair M. Nevius, J.D.

Court Decisions

Substantial Compliance Insufficient to Allow Charitable Deduction

The Seventh Circuit has held that the doctrine of substantial compliance would not allow a trust to take a charitable deduction where the trustee had intended, but failed, to reform the trust as a charitable remainder unitrust (Estate of Tamulis, 7th Cir., 11/30/07, aff’g TC Memo 2006-183).

The Rev’d Anthony Tamulis, a Catholic priest, died in 2000, leaving the bulk of his $3.4 million estate to a living trust. The trust was to continue during the joint lives of Tamulis’s brother and his wife; they would have a life estate in a house owned by the trust and the trust would pay the real estate taxes on the house. The net income of the trust, as “determined in accordance with normal accounting principles,” would go to Tamulis’s two grandnieces. On the termination of the trust the assets—the charitable remainder—would pass to a Catholic diocese.

The estate tax return, filed in 2001, claimed a charitable deduction of $1.5 million. The return described this as the present value of the charitable remainder, the “residue following 10 year term certain charitable remainder unitrust at 5% quarterly payments to two grand nieces.”

The Service refused to allow the charitable deduction. The charitable remainder, as defined in the trust instrument, was not a charitable remainder unitrust as defined in Sec. 664(d)(2). In particular, the trust instrument failed to specify either a fixed dollar amount or the percentage of the trust’s fair market value that would go to the income beneficiaries, as required by Sec. 664. This defect could be cured only by a judicial proceeding to reform the trust, filed within 90 days after the estate tax return was due (Sec. 2055(e)(3)(C)(iii)).

The trustee/executor discovered that the trust did not qualify as a charitable remainder unitrust but never instituted a judicial proceeding in state court to reform the trust. And although the trustee circulated to the income beneficiaries a proposed reformation of the trust to bring it into compliance with the Code, one grandniece did not sign it, and the trust was never reformed. The trustee continued to administer the trust in accordance with the Sec. 664 requirements for qualified unitrusts.

The trustee argued before the Tax Court and the Seventh Circuit that the statement in the return, coupled with the trustee’s continued administration of the trust as if it were a qualified unitrust, should be deemed substantial compliance with the Code, even though it was not literal compliance. Under the substantial compliance doctrine, the Tax Court will occasionally excuse taxpayers from strict compliance with tax law requirements as long as the taxpayer has substantially complied with the essential statutory purpose. (See, e.g., American Air Filter Co., 81 TC 709 (1983), and Sperapani, 42 TC 308 (1964).)

The Tax Court and the Seventh Circuit both rejected the trustee’s argument. The Seventh Circuit took a strict view of the substantial compliance doctrine: “[T]he ‘doctrine of substantial compliance should not be allowed to spread beyond cases in which the taxpayer had a good excuse (though not a legal justification) for failing to comply with either an unimportant requirement or one unclearly or confusingly stated in the regulations or the statute’” (quoting Prussner, 896 F2d 218, 224 (7th Cir. 1990)). The trustee/executor had no excuse for failing to bring a judicial proceeding in state court to reform the trust. The court found that the requirement is not unimportant and is not unclear or confusing. The trustee/exec-utor was represented by legal counsel. Therefore, according to Judge Posner, writing for the Seventh Circuit, “it makes compellingly good sense to hold a taxpayer to the requirements of the tax code.”

From the IRS

IRS Announces Program to Share Employment Tax Exam Results with States

On November 6, 2007, the IRS and 29 state workforce agencies jointly announced that they have entered into agreements to share with each other the results of employment tax examinations. They hope that creating a uniform method for exchanging data will help them increase businesses’ compliance with state and federal employment tax requirements by reducing fraudulent filings, uncovering employment tax avoidance schemes, and ensuring proper worker classification.

Under the agreement, in addition to sharing information, the states and the IRS say they will collaborate on outreach and education to help businesses understand their employment tax responsibilities.

The states that have signed agreements with the Service are Arizona, Arkansas, California, Colorado, Connecticut, Hawaii, Idaho, Kentucky, Louisiana, Maine, Massachusetts, Michigan, Minnesota, Nebraska, New Hampshire, New Jersey, New York, North Dakota, Ohio, Oklahoma, Rhode Island, South Carolina, South Dakota, Texas, Utah, Vermont, Virginia, Washington, and Wisconsin.

Regulations

Temp. Regs. Give Rules on e-Postcards for Exempt Organizations

The IRS has issued temporary and proposed regulations (TD 9366) governing how certain tax-exempt organizations that are not currently required to file annual information returns will be required to submit an annual electronic notice. The Service has also developed a new form, Form 990-N, Electronic Notice (e-Postcard) for Tax-Exempt Organizations Not Required to File Form 990 or 990-EZ, that organizations can use to satisfy the electronic notice requirements.

The temporary regulations were effective November 15, 2007, and are applicable to tax years beginning after December 31, 2006.

Certain exempt organizations that are not required to file an annual information return under Sec. 6033(a)(1) must still file annual electronic notices under Sec. 6033(i)(1). The preamble to the temporary regulations notes that churches are exempt from the notice requirement (just as they are exempt from the return-filing requirement).

These annual notices must contain (1) the legal name of the organization, (2) any name under which the organization operates or does business, (3) the organization’s mailing address and website address (if any), (4) the organization’s taxpayer identification number, (5) the name and address of a principal officer, and (6) evidence of the continuing basis for the organization’s exemption from the filing requirements under Sec. 6033(a)(1) (Secs. 6033(i)(1)(A) through (F)).

Caution: The penalty for failing to file the annual electronic notice is the same as the penalty for failure to file a required annual information return: After three consecutive years of failing to file, the organization’s tax-exempt status will be revoked (Sec. 6033(j)).

The IRS says it plans to develop “a simple, Internet based process” for submitting Form 990-N. Because it will be internet based, organizations will not have to purchase software, and the Service suggests that organizations without access to a computer (if any such organizations exist) can go to their local public library to file the notice.

Sec. 6033(i)(1) requires electronic notification, and there is no provision in the regulations for paper notification. However, an organization can file a complete Form 990, Return of Organization Exempt from Income Tax, or Form 990-EZ, Short Form Return of Organization Exempt from Income Tax, and the Service will deem the notification requirement to be satisfied for that organization. Note that the information return must be complete: The regulations say that submitting a Form 990 or 990-EZ containing just the information required in the electronic notice will not satisfy the electronic notice requirement.

Organizations must submit their electronic notification on or before the 15th day of the fifth calendar month following the close of the period for which the notification is required to be submitted. In other words, an organization with an account-ing period ending December 31, 2007, is required to submit the annual notification by May 15, 2008.

Final Regs. Provide Rules for Entities Required to File Electronically

In November, the Service issued final regulations on the requirements for electronically filing returns for corporations and other entities (TD 9363). The regulations affect (1) C corporations and S corporations with assets of more than $10 million and that file at least 250 returns during the year; (2) exempt organizations with assets of more than $10 million that are required to file under Sec. 6033 and that file at least 250 returns during the year; and (3) private foundations and Sec. 4947(a)(1) trusts that are required to file under Sec. 6033 and that file at least 250 returns during the year. The regulations were effective November 13, 2007.

The final regulations adopt, with revisions, proposed regulations (REG- 130671-04) that were issued in 2005. They require affected organizations to file returns on magnetic media (including electronic filing), as permitted by applicable regulations and IRS guidance.

In theory, the regulations apply to all forms in the Form 1120, U.S. Corporation Income Tax Return, the Form 1120S, U.S. Income Tax Return for an S Corporation, and the Form 990, Return of Organization Exempt from Tax, series of returns, including amended and superseding returns. A member of the Form 1120 series includes, for example, Form 1120-F, U.S. Income Tax Return of a Foreign Corporation. However, certain forms are excluded from the requirement because the IRS currently cannot accept them in electronic format. The Service will publish a list of the forms required to be filed electronically and the forms that are excluded from the electronic filing requirement in form instructions and publications and on its website. The IRS intends for all forms in the above series to be required to be filed electronically eventually, as it develops the capability to accept all forms electronically.

The 250-return threshold applies to returns of any type, including information returns, income tax returns, employment tax returns, and excise tax returns. All members of a controlled group of corporations must file electronically if, in the aggregate, they meet the 250-return threshold.

Affected organizations can request a waiver of the requirement if it would cause undue economic hardship. However, the Service believes that the electronic filing requirement will not have a significant impact on affected entities