The IRS has issued a warning to taxpayers about a surge in fraudulent tax schemes involving donations of ownership in closely held businesses, often referred to as Charitable LLCs (IR 2024-304, 12/4/2024). We have seen this in our own practice, and it can be disastrous for charities that naïvely accept them.
How Charitable LLC Schemes Work
According to the IRS, these schemes frequently target high-income individuals. Promoters encourage participants to establish LLCs, transfer assets into them, and donate non-voting, non-managing membership units to a charity.
Meanwhile, taxpayers retain control of the voting units and, in many cases, reclaim the assets for personal use. Some schemes even involve promoters controlling the charity that receives the donation. Promoters may also offer an “exit strategy,” allowing taxpayers to repurchase the donated interests at a discounted rate.
However, taxpayers cannot generally deduct charitable contributions if they retain any rights to control the donated interests or repurchase the assets. In such cases, the IRS deems the donation ineligible for a deduction.
Legal Consequences
The IRS emphasizes that taxpayers are responsible for the accuracy of their tax returns. Participation in these schemes could lead to audits, penalties, interest, fines, and even imprisonment. Charities found to knowingly engage in these transactions may also face legal and financial consequences.
The IRS has actively investigated these transactions, resulting in several criminal convictions, including a donor who pleaded guilty to obstruction.
How to Spot the Red Flags
A valid charitable contribution requires donors to relinquish control over the donated assets. Taxpayers should be cautious if offered personal benefits beyond the tax deduction associated with a charitable donation. The following are red flags that may indicate a fraudulent transaction:
- Promoters claim the scheme allows taxpayers to grow wealth in a “tax-free environment” while claiming charitable deductions.
- The plan involves creating one or more entities solely for charitable donations.
- The LLC created for the donation engages in no legitimate business activities.
- Donated interests in an LLC loan cash or other assets back to the taxpayer or related parties.
- As the majority owner of the LLC, the charity lacks control over the LLC or its assets.
- Taxpayers are allowed to personally use the assets contributed to the LLC after donation.
- Promoters assist taxpayers in creating intellectual property to fund the LLC before donation.
- LLC funds are used to purchase life insurance policies benefiting the taxpayer’s heirs or related parties after the donation.
- Taxpayers can reclaim the donated LLC interests for less than fair market value.
- Promoters require the use of specific appraisers or charities.
- Appraisals fail to account for the entire transaction’s circumstances, such as taxpayers’ ability to remove assets from the LLC post-donation.
How to Claim a Charitable Deduction
Taxpayers must adhere to stringent documentation requirements to claim a charitable deduction for closely held business interests. The following information is mandatory:
- Name and address of the charitable organization that received the donation.
- Date of the contribution.
- Detailed description of the closely held business interest.
For higher-value donations, additional documentation is required:
- $250 or more: Obtain a contemporaneous written acknowledgment from the charity before filing the tax return.
- Over $500 to $5,000: Complete Form 8283, Section A, and attach it to the tax return.
- Over $5,000: Obtain a qualified appraisal and complete Form 8283, Section B, with appraiser and charity signatures.
- $500,000 or more: Include all the above and attach a copy of the qualified appraisal to the return.
Related Post: Tax-Free IRA Distributions: IRS Raises QCD Limit for 2024
How to Report Charitable LLC Schemes
If you suspect a tax scheme, the IRS encourages reporting through the following methods:
- Submit Form 14242, Report Suspected Abusive Tax Promotions or Preparers.
- Visit the Treasury Inspector General for Tax Administration website.
- Call (800) 366-4484 to file a complaint.
The IRS’s warning underscores the importance of careful due diligence when making charitable donations. To avoid becoming entangled in fraudulent schemes, taxpayers should consult qualified professionals and ensure compliance with all applicable laws.
Ellis Carter is a nonprofit lawyer with Caritas Law Group, P.C. licensed to practice in Washington and Arizona. Ellis advises nonprofit and socially responsible businesses on federal tax and fundraising regulations nationwide. Ellis also advises donors concerning major gifts. To schedule a consultation with Ellis, call 602-456-0071 or email us through our contact form.