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Friday, August 1, 2008

Scam Highlights Abuses In Charitable Write-Offs

A recent criminal case involving wealthy donors, religious groups and secret kickbacks of donations provides an object lesson in how not to give to charity.

The government contends that two men solicited millions of dollars in contributions to charitable organizations by promising to secretly refund large portions of those gifts -- typically 80% to 95% -- to donors, who would then deduct the full amount of their original gifts on their tax returns. One of those men and another individual recently pleaded guilty to participating, and others accused of wrongdoing are scheduled to face trial later this year. The government is targeting more than 100 donors as part of its continuing investigation, says Daniel O'Brien, an assistant U.S. attorney in Los Angeles.

While most contributors play by the rules, law-enforcement officials say some don't -- and are robbing the U.S. Treasury Department of large amounts of revenue. Sometimes the abuse appears to be intentional, resulting in criminal charges. In other cases, donors may be led astray by professional tax preparers, or they may inadvertently run afoul of complex tax-law provisions.

Whatever the case, the Internal Revenue Service has been turning up the heat in recent years on what officials consider to be abuses ranging from fabricating deductions to making improper noncash gift valuations.

According to the latest IRS data, more than 41.4 million individual income-tax returns claimed charitable donations for 2006. Their donations totaled a record $173.02 billion, up 0.6% from the prior year.

Here are a few areas IRS and Justice Department officials have been focusing on and advice from lawyers and accountants on how to avoid trouble:
• Kickbacks. Consider the case of the two men who pleaded guilty recently to criminal misconduct involving donations to a variety of charitable groups operating under the umbrella of Spinka, a religious group within orthodox Judaism. One was Joseph Roth, a Tel Aviv-based banker, according to the U.S. Attorney's office for the central district of California. The other was Rabbi Moshe E. Zigelman of Brooklyn, N.Y., who "pled guilty because he accepts full responsibility for his actions and seeks to atone for any harm he caused," says Michael J. Proctor, a lawyer at Caldwell Leslie & Proctor in Los Angeles.

They were among eight individuals and five charitable entities indicted in the Spinka case late last year. The government accused Rabbi Naftali Tzi Weisz and Rabbi Zigelman, formerly an assistant to Rabbi Weisz, of soliciting donations to Spinka-related groups by promising to secretly refund up to 95% of the "contributions." Rabbi Weisz pleaded not guilty, says Brian Hennigan, a lawyer with Irell & Manella in Los Angeles.

In some cases, contributors got cash payments through an "underground money transfer network" involving various parties, some of whom operated businesses in and around the Los Angeles jewelry district, the U.S. Attorney's office said. Among other things, Mr. Roth admitted to facilitating tax evasion by setting up secret bank accounts in Israel involving the use of bogus trusts, according to a U.S. Attorney's office statement.

• Professional preparers. Government officials have been cracking down on professional preparers who manufacture phony charitable deductions. Earlier this year, for example, a Washington, D.C., preparer pleaded guilty to conspiring to prepare false returns that included overstated charitable gifts and other items, according to the Justice Department. The man faces up to five years' incarceration and a $250,000 fine.

The department also is seeking court injunctions to put some preparers out of business. Recently, a federal court permanently barred a Texas woman from preparing federal income-tax returns for others. The government said the woman had prepared returns that included false deductions for charitable gifts, among other things.

How can you avoid picking a crooked preparer? There's no bulletproof method, but here are a few tips: Beware of anyone who bases his or her fee on the size of your refund, or who promises a bigger refund than anyone else, or who prepares your return but refuses to sign it. Also, never, ever, sign a blank return.

• Disguised payments and overvaluations. The IRS says it's concerned by an upturn in the number of cases in which taxpayers have tried to disguise tuition payments as tax-deductible contributions to charitable or religious organizations. Asked for more detail, an IRS spokesman said Tuesday the agency is "aware that some taxpayers improperly claim charitable contribution deductions for payments that are earmarked for the benefit of individuals." The IRS "continues to examine whether payments to tax-exempt schools benefit individuals." In addition, the IRS "has noticed that some taxpayers are trying to claim deductions for payments to other types of tax-exempt or government-sponsored organizations but earmarked for the benefit of individuals." The IRS "reminds taxpayers that payments to charitable organizations but earmarked for the benefit of individuals are not deductible."

IRS officials say valuation problems typically are greatest with noncash charitable gifts, such as a stake in a closely held family business, for which there isn't any easily accessible public market. Officials have said overvaluations may arise from errors by taxpayers or even appraisers, deliberate abuse or overly aggressive positions.

• Valuing noncash donations. Valuing used clothing or household items can be tricky. If you make such gifts, consider buying tax software-preparation software, such as Intuit Inc.'s TurboTax, which includes a feature with estimates of thousands of commonly donated items. Keep a list of what you donate, take photos of especially valuable items, and be sure to get a professional appraisal when required. You can't deduct clothing or most household items unless they're in "good used condition or better," the IRS says. What does that mean? The government hasn't yet defined it.

Donating stocks and other investments that have risen in value over the years can be a great idea since you generally get a deduction for the current market value and don't owe tax on the gain, says John M. Olivieri, a tax partner at White & Case LLP in New York. But don't make the mistake of donating investments that have declined in value, he says. Instead, consider selling losers and using those losses to reduce your taxes. Then give the proceeds to your favorite charity.

An IRS ruling could spark creation of more private trust companies.

A small number of very wealthy people have created private trust companies in recent years, in part to give them greater control over how family trust assets are managed. A proposed IRS revenue ruling, issued late last week, "provides a roadmap" for creating a private trust company "without falling into various tax traps," says Mr. Olivieri of White & Case. "Once the ruling is issued in final form, it will not be necessary for each individual family to apply for its own private letter ruling" from the IRS "in order to be sure of the tax consequences of having their family trusts managed by a company controlled by the family," Mr. Olivieri says.

The ruling, if finally adopted, "eliminates virtually every uncertainty now existing" as to whether a private trust company "has any per se negative implications for the exposure of family members to tax risk," says John P.C. Duncan, a lawyer at Duncan Associates in Chicago.

Fred Nathan, a lawyer at Kelley Drye & Warren in New York, says that once the ruling has been finalized, "it will undoubtedly increase the use of private trust companies by very wealthy families."

By: Tom Herman
Wall Street Journal; July 16, 2008