On 11/4/24, the Internal Revenue Service issued a warning to taxpayers regarding the dangers of engaging with promoters of fraudulent tax schemes that involve donating ownership interests in closely held businesses, often referred to as “Charitable LLCs.” These schemes frequently target individuals with higher incomes and are classified as abusive transactions by the IRS. Typically, these schemes encourage higher-income taxpayers to establish limited liability companies (LLCs), contribute cash or other assets to these LLCs, and then donate a significant percentage of nonvoting, non-managing membership units to a charity. Meanwhile, the taxpayer retains control over the voting units and may reclaim the cash or assets for personal use, either directly or indirectly. In some cases, the promoter may have influence and or control over the charity receiving the donation. While it is permissible for taxpayers to deduct legitimate donations of closely held business interests, dishonest promoters may entice them into schemes that involve fraudulent charitable deductions.
Taxpayers ought to understand that they bear full responsibility for the accuracy of the information provided on their tax returns. Involvement in such abusive schemes to lower tax liabilities can lead to the assessment of the correct tax owed, along with penalties, interest, and the possibility of fines or imprisonment. Charitable organizations should also exercise caution to avoid inadvertently facilitating these schemes.
What is the framework in Charitable LLCs?
In the Charitable LLCs framework, promoters create documentation to establish the LLC for a fee. They facilitate the transfer of the taxpayer’s assets into the LLC and generate documents that claim to transfer membership units in the LLC to a charitable organization. The promoter may provide an appraisal to support the valuation of the gift and could offer a list of charities willing to accept the membership units or identify a specific charity that will accept the donation.
Promoters may mislead clients into believing they can maintain control and legally access the cash or other assets transferred to the LLC for personal use after making the donation. Additionally, promoters might implement an “exit strategy” allowing taxpayers to repurchase their contributions at a significantly reduced price after a certain period.
Typically, taxpayers are not permitted to deduct a charitable contribution that does not encompass their entire interest in the property. Retaining control over the donated interests or the ability to repurchase assets will render the transaction ineligible for a deductible charitable contribution.
Charitable LLCs Red Flags
Taxpayers need to exercise caution regarding any arrangement that entails transferring assets to an LLC and subsequently “donating” a significant portion of nonvoting, non-managing membership units to a charity as a supposed “charitable contribution,” all while maintaining control and access to those assets. For a charitable contribution to be legitimate, the taxpayer must relinquish control of the donated assets to the charity. Additionally, taxpayers should be wary of any promises of personal benefits, aside from the tax deduction, which may arise from a charitable donation. It is essential for taxpayers to carefully evaluate transactions that may present potential warning signs.
Following are extracts of Charitable LLCs Red Flags presented in the IRS Warning:
- Promoters marketing a transaction as a way to grow wealth in a “tax-free environment” and claim charitable contribution deductions.
- Promoters marketing a plan that requires the creation of one or more entities in order to make a charitable donation.
- Creating entities that do not engage in any business activity to facilitate a charitable donation.
- Donating an interest in an LLC that loans cash or other assets back to the taxpayer or a related party.
- The charity, as the majority owner of the LLC, has no control over the LLC or its assets.
- The taxpayer is allowed to personally use the assets contributed to the LLC after the donation.
- The promoter assists the taxpayer in the creation of intellectual property to fund the LLC prior to the donation.
- The taxpayer uses the LLC funds to purchase life insurance policies benefitting their heirs or a related party after the donation.
- The taxpayer retains the ability to reclaim the donated LLC interests from the charity for less than fair market value.
- The promoter requires the taxpayer to use specific appraisers and/or charities.
- Appraisals fail to take into account all facts and circumstances of the entire transaction, like the ability of the taxpayer to remove all assets from the LLC after the donation.
Taxpayers must keep records in order to claim a charitable contribution deduction for a donation of a closely held business interest:
- Name and address of the charitable organization that received the business interest.
- Date of the contribution.
- Detailed description of the closely held business interest.
There are other requirements for donations of:
- $250 or more, the taxpayer must obtain a contemporaneous written acknowledgement of the contribution from the charitable organization. They need to have that document on or before the earlier of the date on which they file a return for the taxable year in which they made the contribution, or the due date, including extensions, for filing such return.
- More than $500 but not over $5,000, the taxpayer must also complete Form 8283, Noncash Charitable Contributions, Section A, and attach it to their tax return.
- More than $5,000, the taxpayer must obtain a qualified appraisal of the donated property and complete Form 8283, Section B, including the signature(s) of the qualified appraiser(s) and the charity.
- $500,000 or more, the taxpayer must do all the above and attach a complete copy of the qualified appraisal to their tax return.
Best to work with a qualified Tax Expert
The IRS is intensifying its compliance efforts targeting high-income and high-wealth taxpayers, along with complex partnerships and corporations. Moreover, the IRS is particularly focused on identifying abusive schemes that involve invalid or unacceptable donations of LLC units and other dubious transactions. Currently, the IRS is conducting several investigations into abusive promoters and is actively auditing donations related to closely held businesses.
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