Gundanna v. Comm'r of Internal Revenue, 21355–03.

• Citation: 136 T.C. 151,136 T.C. No. 8
• Decision Date: 14 February 2011
• Docket Number: No. 21355–03.,21355–03.
• Parties: Setty Gundanna and Prabhavathi Katta VIRALAM, Petitioners v. COMMISSIONER of INTERNAL REVENUE, Respondent.
• Court: United States Tax Court

136 T.C. 151
136 T.C. No. 8

Setty Gundanna and Prabhavathi Katta VIRALAM, Petitioners
v.
COMMISSIONER of INTERNAL REVENUE, Respondent.

No. 21355–03.

United States Tax Court.

Feb. 14, 2011.

[136 T.C. 151]

In 1998 P–H transferred stocks and cash to X, an organization described in I.R.C. sec. 501(c) that was not a private foundation. X sent P–H acknowledgment letters for the stock transfers which stated that no goods or services were provided for the “donation” of the stocks. X sold the stocks in 1998. X maintained a segregated account for P–H in its records, reflecting the stocks and cash received, the proceeds from the sales of the stocks and their reinvestment, the dividends and interest generated by the assets in the account, and the disbursements from the account in subsequent years.

Promotional materials provided to P–H by X represented that P–H would be able to direct the distribution of the funds in the account for purported charitable purposes, including student loans and as compensation for the performance of charitable services by P–H or members of his family. P–H anticipated at the time of the transfers of the stocks to X that account funds could be used for student loans to his children. Ps claimed a charitable contribution deduction on their 1998 Federal income tax return equal to the fair market value of the stocks and the cash transferred to X.

In 2001 and 2002 X transferred at P–H's request a total of $70,299 from the account to an educational institution in payment of the college tuition and related expenses of P–H's son. P–H's son executed loan documents that obligated him to repay the amounts transferred, plus interest, in cash or by providing designated amounts of charitable services.

R issued a notice of deficiency for 1998 disallowing the charitable contribution deduction claimed, requiring the inclusion in Ps' gross income of capital gains realized upon the sales of the stocks by X in 1998 after the transfers as well as the dividends and interest generated by the account assets in 1998, and determining a penalty under I.R.C. sec. 6662(a) and (b)(1) and (2).

Held: P–H retained dominion and control over the property transferred to X. Accordingly, Ps are not entitled to any charitable contribution deduction on account of the transfers and must include in

[136 T.C. 152]

gross income the capital gains realized upon X's sales of the transferred stocks as well as the dividends and interest generated by the assets in the segregated account.

Held, alternatively, Ps are not entitled to any charitable contribution deduction for failure to comply with the substantiation requirements of I.R.C. sec. 170(f)(8).

Held, further, Ps are liable for a penalty under I.R.C. sec. 6662(a) and (b)(1) or (2).

Michael C. Durney, for petitioners.

Thomas A. Dombrowski and Mark A. Weiner, for respondent.

GALE, Judge:

Respondent determined a deficiency of $91,948 and an accuracy-related penalty of $18,389 with respect to petitioners' 1998 Federal income tax.

The issues for decision are: (1) Whether petitioners are entitled to a charitable contribution deduction under section 170 ¹ of $263,933 for purported transfers of appreciated stocks and cash to the xélan Foundation; (2) whether petitioners must include in gross income $93,324 of capital gain resulting from the sales of the appreciated stocks by the xélan Foundation in 1998 and $981 of interest and dividend income generated in 1998 by property purportedly transferred by petitioners to the xélan Foundation; and (3) whether petitioners are liable for an accuracy-related penalty under section 6662.

FINDINGS OF FACT

Some of the facts have been stipulated and are so found. The stipulation of facts and the attached exhibits are incorporated herein by this reference. At the time the petition was filed, petitioners resided in Florida.

xélan

Petitioners are both medical doctors. Petitioner Setty Gundanna Viralam (petitioner) owned a 50–percent interest in a medical practice, which he sold in 1998 for $2,262,500, generating a taxable gain of $2,261,750 in that year. In late 1997, when negotiating the sale of his medical practice, petitioner learned of xélan,² a financial planning company for

[136 T.C. 153]

doctors. Petitioner attended a presentation promoting the financial planning programs of xélan and became a member in November 1997.

xélan, also known as the Economic Association of Health Professionals, Inc., was a membership organization for doctors during the years relevant to this case. It provided member doctors with financial planning services, including pension plans, insurance products, tax reduction and asset protection strategies, and investment management. These financial services were provided through a network of xélan financial counselors.

Payment of a $975 membership fee entitled a xélan member to the “xélan Tax Reduction Plan”, including a questionnaire on which he or she provided personal financial information from which xélan made financial planning recommendations. Members were also provided various promotional materials, including a Program Summary describing xélan programs and services, and the xélan Doctors Financial Education Program (Financial Education Program), which provided similar material in video and audio tape formats.³ After joining xélan, petitioners received copies of the xélan Tax Reduction Plan and the Financial Education Program in December 1997 and, at some time before engaging in the transfers at issue, a copy of the Program Summary. Petitioner was familiar with these materials.

xélan Foundation

One of the financial planning strategies summarized in the xélan promotional materials was establishment through donations to the xélan Foundation (Foundation) of an account that the materials characterized as a “donor advised fund” or “family public charity” (Foundation account), by means of which a donor's donations would be segregated for

[136 T.C. 154]

investment and future distribution as the donor might recommend.⁴ A xélan financial counselor recommended, on the basis of the personal financial information petitioners provided, that petitioner establish a Foundation account.

For the periods relevant to this case, the Foundation was recognized by the Commissioner as an organization described in section 501(c)(3), having received a determination letter to that effect on March 20, 1998 (determination letter). The Foundation was listed as a public charity in Publication 78, Cumulative List of Organizations described in Section 170(c) of the Internal Revenue Code of 1986, published in January 1999.⁵ The Commissioner issued a determination in 2002 that the Foundation was not a private foundation within the meaning of section 509.

The promotional materials characterized Foundation accounts as a “tax reduction” program and stated that the Foundation “was created to benefit not only charitable causes, but also doctors and their families.” The Program Summary describes the Foundation as follows:

The xélan Foundation is a public charity that enables doctors to contribute pre-tax earnings to their own family public charities that are subaccounts of the “umbrella” xélan Foundation charity. * * * Growth on contributions within the Family Public Charity accounts accrue [sic] tax deferred. Doctor donors may direct the use of funds accumulated within their family public charity accounts to finance charitable projects including personal teaching, research, pro bono works, [and] college and graduate scholarship programs * * *.

Donors and their family members may work for and be compensated by their family public charities for good works (teaching, research, or providing pro bono services) they perform on behalf of their family public charities. * * *

[136 T.C. 155]

The Financial Education Program also explained with reference to Foundation accounts that

Your family then is the advisor to that fund as to the way the money is invested. And the growth on the invested money accrues tax deferred. Anytime you want to you could take the money out of your family public charity and pay yourself compensation to do good works.

The Foundation also offered Foundation account holders a student loan program whereby Foundation account funds could be disbursed as loans for college and graduate school tuition and related expenses. The program's terms further provided that the loans could be repaid (with interest) either through repayments generally commencing 5 years after graduation or by the recipient's providing charitable services for designated periods. A xélan financial counselor wrote petitioner in April 1998 recommending that he “Establish a Foundation account for charitable giving, income tax reduction planning, estate tax reduction, educational funding, and future retirement planning.” (Emphasis added.)

Petitioners had three children, and petitioner advised Foundation personnel in the questionnaire he completed in late 1997 that he anticipated paying for 8 years of college and graduate school for each of his children, at a cost of approximately $40,000 annually for each. Petitioner was interested in the Foundation's student loan program; he understood that his own children would be able to benefit from the student loan program if he established a Foundation account and he intended to use the account for that purpose.

Petitioner's Establishment of Foundation Account

Following the xélan financial counselor's recommendation, petitioner took the initial steps to establish a Foundation account in April 1998. Using funds already on deposit with xélan, petitioner paid a $1,400 setup fee to establish a Foundation account and made a $100 initial contribution to the account.

On May 12, 1998, petitioner submitted an “Application To Establish a Donor Advised Fund” to the Foundation, designating himself as the “fund advisor”. Petitioner signed the application under a provision labeled “Fund Advisor Statement”, which stated:

[136 T.C. 156]

I certify that I understand the...