The IRS recently determined that a partner’s contribution of partnership units to an exempt organization where the exempt organization then transferred the same units to a corporation owned by the partner was, in substance, a transfer of partnership units from the partner directly to the corporation and, therefore, did not result in a charitable deduction.

The IRS has a long history of reviewing the substance of claimed charitable deductions resulting from the transfer of business interests.  While the transactions giving rise to the charitable deductions appear valid in form, the IRS will nevertheless review the true substance of the transaction to see if the charitable deduction is valid.

In CCA 201507018, a partner in a partnership transferred partnership units to an exempt organization.  The units were subject to a partnership agreement that required the partner to approve any transfer of the units to a third party.  The units could also be recalled by the partnership at any time at a special call price based on a partner’s contribution to the partnership, which in the case of the exempt organization, would be zero.

Once the partner transferred the units to the exempt organization, the exempt organization sold the units to a corporation run by the same partner.  In return, the exempt organization received a note.

As a result of these two transactions, the partner took a charitable contribution deduction on his personal tax return for the value of the units contributed to the exempt organization.  The corporation owned by the partner then took deductions for the interest payments on the loan and for goodwill amortization.

Upon reviewing the substance of the transactions, the IRS determined that the corporation, and not the exempt organization, received an interest in the partnership.  The exempt organization merely received a promise to pay under the note.

The IRS noted that the exempt organization was never a partner in the partnership because the exempt organization was compelled to transfer the units to the corporation due to (1) the partner’s ability to approve any transfer of units to a third party and (2) the fact that the exempt organization could not continue to own the units without violating its representation to the IRS that it would not engage in a partnership with nonexempt partners.

The IRS also noted that the exempt organization was never a partner in the partnership because, under the partnership agreement, the exempt organization had no indicia of ownership other than rights to distributions, the timings of which were controlled by the partner.

As a result of its findings, the IRS recharacterized the transaction as a transfer of partnership units to the corporation, thereby disallowing the partner’s claimed charitable contribution deduction.

In sum, if a taxpayer desires to make charitable contributions of business interests, he or she should be cognizant of any restrictions placed on the transferred interests and should avoid compelling the donee charitable organization to turn around and sell the transferred interests.  While these transactions may give the appearance of a charitable contribution, the IRS will likely recharacterize the transactions and disallow the taxpayer’s deduction.