Two (husband-and-wife) doctors bought into a plan promoted by a financial services advisor specializing in aggressive tax-avoidance programs for doctors. Under the plan, the doctors would make a charitable contribution to the advisor’s foundation and take a charitable contribution deduction. They could then use the contributed funds to educate their children.
The foundation had obtained an IRS determination letter stating it was a 501(c)(3) tax-exempt organization, and the foundation was listed in the IRS’s Publication 78, which identifies such organizations for taxpayers’ guidance.
In practice, though, the foundation operated for the benefit of its donor-doctors. Each doctor’s donations were kept in a segregated fund to be used as directed by the doctor. The promotional materials stated: “You could take the money out of your family public charity and pay yourself compensation to do good works.”
Under the foundation’s student loan program, a doctor could arrange for his children to receive scholarship loans from the family charity and repay the loan with 2000 hours of charitable work for the foundation for each year of the scholarship.
The foundation provided letters from lawyers and an accountant supporting the arrangement. The letters were, however, heavily qualified and limited.
The IRS disallowed the deduction, imposed a further tax for capital gains occurring while the foundation “owned” the funds, and added a 20% penalty for negligence. Not surprisingly, it also revoked the tax exemption of the foundation.
The Tax Court upheld the IRS position on February 14, including the penalty. The doctors should have gone beyond the attorney and accountant letters, the Court held, because the plan on its face was just “too good to be true.”
We share news of this case with our readers — not because any of our charitable clients or friends would operate a scheme like this — but because many of our readers are themselves doctors who are solicited for such schemes. Our advice: If a financial advisor comes up with a tax scheme that sounds too good to be true — it probably is.