With inflation running at the highest levels in several decades, Members of Congress are concerned about adjusting taxpayer credits and deductions to account for the soaring inflation. Senator Chuck Grassley (R–IA) has been a leader in proposing inflation adjustments that will help Americans.

He published a press release on July 21, 2022 and said that he seeks "to help Americans struggling to afford everyday expenses keep more of their hard–earned money." Grassley notes an Iowa State University study shows most individuals are paying $669 more per month for living expenses. This increase occurred during the past two years.

Grassley proposes to index several tax benefits for inflation. He stated, "The relentless 40–year high inflation we are seeing today has made it increasingly difficult for Americans to afford their trips to the gas station and grocery store. Indexing useful tax credits to inflation—like the Child Tax Credit and the Lifetime Learning Credit—will help parents and students keep up with rising costs. I will continue to work on commonsense policies that will help Americans weather this soaring inflation."

The proposed bill would provide indexing for the Child Tax Credit, the American Opportunity Tax Credit, the Lifetime Learning Credit, the Student Loan Interest Deduction and the charitable mileage eduction.

1. Child Tax Credit — This is a $2,000 credit for families with dependent children under 17. This credit and a $500 credit for other dependents would be indexed.
2. Child and Dependent Care Credit — The credit for child–care expenses is currently $2,100 for two or more children and $1,050 for one child. It would be also indexed.
3. American Opportunity Tax Credit — To enable individuals to attend college, there is a $2,500 credit for tuition expenses. This would be indexed.
4. Lifetime Learning Credit — Another potential benefit for payment of eligible tuition is the Lifetime Learning Credit of $2,000.
5. Students Loan Interest Deduction — Many Americans complete college, or university with substantial student loans. Up to $2,500 in interest on student loans may be deducted.
6. Charitable Mileage Deduction — Individuals who volunteer for charitable organizations will frequently incur costs to drive to various organizational events. The current $0.14 per mile deduction is far lower than the rate for medical or business driving. The bill proposes to allow the IRS to adjust the mileage rate based on current costs.

Editor's Note: All of these tax benefits, except the charitable mileage deduction, have phaseouts for taxpayers with higher incomes. These phaseout amounts would be indexed. Individuals who volunteer for charitable organizations hope that the charitable mileage deduction will finally be increased. With the dramatic increase in the cost of gasoline this year, the $0.14 per mile rate is outdated. Members of Congress have proposed increasing the charitable mileage rate to the business rate of 62.5 cents per mile.

Conservation Easement Penalty Approved

In Donald W. Thompson v. Commissioner; No. 8792-20; T.C. Memo. 2022-80, the Tax Court determined that Section 6662(e) and Section 6662(h) penalties were applicable because the appropriate supervisory approval had been granted.

The taxpayer owns DWT Properties, LLC (DWT). DWT purchased 176 acres of land in Edgefield County, South Carolina on June 28, 2012. On November 5, 2013, the property was appraised at $10,989,000, an 890% appreciation rate from the purchase price 16 months earlier for $1,234,597. On November 18, 2013, DWT granted the city of North Augusta a conservation easement on the property and reported a charitable deduction of $10,800,000. DWT retained the right to construct a golf course with food concession stands and other structures on the property. The extinguishment provision on the deed included that the proceeds of sale granted to the nonprofit would be reduced by any "amount attributable to the improvements constructed upon the property by the grantor."

The IRS audited and Revenue Agent Bernard Dawson assessed a penalty that was approved by his supervisor Amber Carper. The IRS issued deficiencies of approximately $1.3 million for the carryforward charitable deductions for years 2016 through 2018. Subsequently, the IRS assessed a 40% gross valuation misstatement under Section 6662(h). This penalty was included in litigation documents and was signed by Christopher D. Bradley, an IRS Senior Attorney from Atlanta, and John T. Arthur, his supervisor.

The Eleventh Circuit determined in Hewlett v. Comm'r, 21 F.4th 1336 (11th Cir. 2021) that the Reg. 1.170A-14(g)(6) provision requiring an extinguishment clause to grant a charity "a proportionate share of the proceeds" was in violation of the Administrative Procedure Act and therefore not valid. The Tax Court determined that the IRS motion for Partial Summary Judgment on that point would be denied.

However, the question remained about the penalties. Revenue Agent Dawson and Senior Attorney Bradley both had the signatures of their supervisors on the applicable documents claiming the deficiencies. The taxpayer claimed that the supervisors Arthur and Carper were not able to do a meaningful review because they "lacked real estate expertise."

The Tax Court noted that taxpayer claimed the property had appreciated by 890% in just over a year. Therefore, the taxpayer had created an obvious valuation issue. The court continued, "In any event, we have held that a supervising attorney's signature on an answer, without more, is sufficient to satisfy the statutory requirements for penalties first asserted in the answer." Therefore, the IRS motion for approval of the penalties was granted.

Editor's Note: In most circuit Court of Appeals, the IRS has continued to claim that the regulation requiring a proportionate share in the extinguishment clause is valid. There is a split in the Circuits and, eventually, the Supreme Court may address the issue. The IRS will continue to litigate the valuation issues in the future.

Nonprofit Tax Law Violations Do Not Void Contract

In Wine Education Council v. Arizona Rangers; No. 2:29-cv-02235, a District Court determined that a breach of contract claim by one nonprofit against a second nonprofit was not void due to potential violations of the federal nonprofit law.

Arizona Rangers (AZR) and Wine Educations Council (WEC) are both nonprofits in Arizona. AZR is a nonprofit law enforcement auxiliary with multiple companies. It accepted six grants from the American Endowment Foundation (AEF) with a total amount of $175,000. The grants were to be used "exclusively for charitable purposes."

The grants from AEF were made by donor advisor Grant Winthrop, and were then subsequently administered through AZR by Mr. Winthrop. AZR claims that Winthrop spent "large sums of money on a private charter flight from Phoenix to Los Angeles, expensive dinners, expensive cowboy hats and other large, allegedly inappropriate charges with the Grant funds."

WEC is the contingent beneficiary of the $175,000 in grants and hoped that the grants would be used on projects involving alcohol-related law enforcement. Because the grants were not used as contemplated, WEC brought a breach of contract action against AZR. In response, AZR claimed that because these activities by Winthrop were illegal, the breach of contract claim should be dismissed.

AZR pointed out that under Section 4966(a)(1) a donor advisor is prohibited from receiving benefits from a DAF distribution. It notes that "any direct or indirect benefit to the donor advisor from the donor advised fund is an excess benefit transaction subject to sanctions." Because donor advisor Winthrop violated Section 4966(a), there may be a penalty assessed under Section 4958.

The court noted that the grants required AZR to use them "exclusively for charitable purposes." However, the fact that there are potential penalty taxes for wrongful conduct does not invalidate the agreement between WEC and AZR. The grants were not made for an illegal purpose or contrary to public policy. While there may merely be penalty taxes paid under the Internal Revenue Code provisions, the court found the illegality defense of AZR failed and granted summary judgment on this point in favor of WEC.

Editor's Note: The donor advisor is prohibited from receiving benefits from a DAF distribution and most nonprofits have a clear understanding of this rule. While AEF may claim that it simply made a distribution to a qualified exempt nonprofit, AZR discovered that it could not void the contract based upon its failure to enforce the IRS rules on DAF distributions.

Applicable Federal Rate of 3.8% for August -- Rev. Rul. 2022-14; 2022-31 IRB 1 (15 July 2022)

The IRS has announced the Applicable Federal Rate (AFR) for August of 2022. The AFR under Section 7520 for the month of August is 3.8%. The rates for July of 3.6% or June of 3.6% also may be used. The highest AFR is beneficial for charitable deductions of remainder interests. The lowest AFR is best for lead trusts and life estate reserved agreements. With a gift annuity, if the annuitant desires greater tax-free payments the lowest AFR is preferable. During 2022, pooled income funds in existence less than three tax years must use a 1.6% deemed rate of return.