Timing is everything. That was the lesson learned in a recent Tax Court case that resulted in a lost charitable deduction and capital gains tax. Here’s what happened.
Background
Commercial Steel Treating Corp., or CSTC, was founded in 1927 by the Hoensheid family. Over the years, the company performed well and remained in the family.
By 2014, Scott Hoensheid and his two brothers, Craig P. Hoensheid and Kurt L. Hoensheid, held equal interests in CSTC. That same year, Kurt announced that he wanted out, and the remaining brothers were reluctant to take on debt to buy his shares—so they looked into selling the business. To help, they engaged a financial adviser and generally agreed on a target price of $80 million.
Within months, there was interest, and on April 1, 2015, HCI Equity Partners—HCI—submitted a letter of intent to acquire CSTC for $92 million.
The Donation
Around the same time—in mid-April 2015—Scott Hoensheid started discussing the prospect of establishing a Fidelity Charitable donor-advised fund. He intended to contribute certain of his CSTC stock, as one of his advisers noted, “to avoid some capital gains.”
This isn’t a novel concept—donating appreciated assets to charity is often considered a win-win for taxpayers. Typically, not only do you avoid paying the capital gains, but you also get the benefit of the charitable deduction for the stock’s fair market value. The timing, however, is important.
And here’s where Scott Hoensheid got into trouble. His advisers told him he needed to make the gift before the sale to avoid any “anticipatory assignment of income.” This is a doctrine that’s been around for awhile and was famously memorialized in Lucas v. Earl, 281 U.S. 111 (1930). It stands for the idea that income is taxed to the person who has the right to receive it. I can’t simply sign my paycheck away to someone else, for example, and claim that the tax doesn’t apply to me.
In this case, Scott was reluctant to “pull the trigger” and wanted to delay the donation as much as possible. He was concerned that if the sale did not go through, he would have relinquished most of his shares, and his brothers could end up owning more stock than he did.
On April 23, the parties executed a nonbinding letter of intent for HCI to acquire CSTC for $107 million. Weeks later, on June 1, Scott’s representatives sent Fidelity Charitable a Letter of Understanding outlining his plan to donate the stock, but did not specify the number of shares. He followed up by emailing one of his advisers, “I do not want to transfer the stock until we are 99% sure we are closing.”
CSTC held its annual board meeting nearly two weeks later. At the meeting, the company approved the request to transfer shares of CSTC to Fidelity Charitable—the number of shares still needed to be clarified. The following day, HCI approved the purchase, subject to the completion of due diligence. The deal eventually closed on July 15.
On November 18, 2015, Fidelity Charitable sent a contribution confirmation letter acknowledging a charitable contribution of 1,380.400 shares of CSTC. The letter also indicated that Fidelity Charitable had received the shares on June 11, 2015.
Filing & Disallowance
Taxpayers (plural, since Scott filed a joint income tax return with his wife) claimed a charitable deduction for the gift of the stock. The IRS disallowed the deduction on the basis that his appraisal was insufficient, and issued a notice of deficiency that included a penalty.
The taxpayers appealed, and in response, the IRS amended its answer to claim that the sale itself was an anticipatory assignment of income and that he would also have to pay tax on the capital gain.
Tax Court
The Tax Court looked at several aspects of the case. Specifically, since the stock was sold immediately after the sale, the Court found that the donor must (1) give the appreciated property away absolutely and divest of title (2) “before the property gives rise to income by way of a sale.” That meant that when the title was transferred was clearly at issue.
The Hoensheids argued that they made the gift on June 11, pointing to Fidelity Charitable’s confirmation letter. However, the IRS argued that the gift was not completed until at least July 13, when Fidelity Charitable received a stock certificate. Ultimately, the Court found that the taxpayers failed to establish that any of the elements of a valid gift were present on June 11—instead, the Court found that title to the shares was transferred on July 13.
The Court also ruled that to avoid an anticipatory assignment of income, the taxpayers had to bear at least some risk at the time of contribution that the sale would not close. Here, the taxpayers didn’t have any real risk since they held onto the shares as long as possible. The Court found that by the time the shares were actually gifted, the transaction with HCI had “proceeded too far down the road to enable petitioners to escape taxation on the gain attributable to the donated shares.” In other words, the income was already attributable to them and couldn’t simply be assigned to another person or entity like a charity.
Conclusion
For the most part, the case didn’t go the Hoensheids’ way. While the Court found that they made a valid gift of the CSTC shares, the date of the gift was held to be on July 13—too late to avoid the recognition of gain. Their right to proceeds from the sale, the Court ruled, became fixed before the gift.
The Hoensheids also missed out on a charitable contribution deduction because they lacked a proper appraisal.
But there was some good news for petitioners—the Court found the taxpayers had reasonable cause for their underpayment. Specifically, the anticipatory assignment of income issue was not “so clear cut” that the taxpayers should have known it was unreasonable to rely on advice from their tax professional. As a result, they were not liable for a section 6662(a) penalty.
Lessons
There are a lot of takeaways from this case. At the top? Pay attention to timing and the rules—those details matter. The failure to substantiate the charitable gift with a proper appraisal, as required, and the effort to hang onto the shares until the last minute proved to be the undoing for the taxpayers.
The taxpayers did, however, smartly consult with tax and financial professionals— and they kept good records. While that ultimately didn’t result in a complete win, it did help mitigate their losses.
The case is Estate of Scott M. Hoensheid, et al. v. Commissioner (T.C. Memo 2023-34). You can read it here.