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IRS Employs "Substance Over Form" to Deny Charitable Deductions in Partnership Transaction.

(Parker Tax Publishing March 10, 2015)

The IRS's Office of Chief Counsel advised that a transaction involving a newly formed charitable organization and a wholly owned corporation was to be recast under the "substance over form" doctrine, denying the claimed charitable deduction. CCA 201507018.


Taxpayer partnership is a limited liability company that produces a popular consumer product. Ostensibly to reap tax benefits, the partnership entered into a series of transactions with two of its partners, a non-profit organization, and a corporation.

The partners first formed an organization, initially funded entirely by an assignment of a portion of one partner's membership units in the partnership. The organization was formed as a Code Sec. 509(a)(3) public charity.

The partners then formed a for-profit corporation, initially listing the daughters of one partner as directors, and the other partner as the president and CEO. The sole shareholder of the corporation was a trust managed and controlled by the CEO partner, and as such, the corporation was considered wholly owned by that partner.

After the formation of the entities, the partners carried out their plan. First, one partner assigned a portion of his membership units, having nominal basis but a high fair market value, to the organization. The day after the assignment became effective, the partnership, corporation, and organization executed a purchase agreement whereby the organization sold the assigned units to the corporation in exchange for a twenty-year promissory note with quarterly interest payments. Pursuant to the sale of the membership units, the partnership made a Code Sec. 754 election to adjust the partnership basis, allocated to goodwill. At the time of the sale, the corporation had no assets or equity with which to make the payments.

As a result of this transaction, the assigning partner reported a charitable deduction under Code Sec. 170 for the value of the assigned units, the corporation took amortization deductions related to the partnership's basis adjustment to goodwill, and the corporation took interest deductions related to the promissory note. No party recognized any gain on the transactions.

The partnership requested advice from the IRS's Office of Chief Counsel (IRS) on whether the transaction would be respected, or recast under the "substance over form" doctrine.


In general, a deduction may be allowed for charitable contributions of property (Code Sec. 170(a)(1)). However, a promissory note delivered to a charitable organization represents a mere promise to pay, and is not a payment for purposes of deducting a charitable contribution (Rev. Rul. 68-174).

In determining the tax consequences of a transaction, courts look to the objective economic realities rather than to the particular form the parties employed to achieve the transaction (the "substance over form" doctrine) (Gregory v. Helvering, 293 U.S. 465 (1935)).

The IRS advised that the actual substance of the transaction was that the membership units were transferred to the corporation, not the organization, as the organization never received an interest in the partnership and instead only received a note containing a mere promise of payments. The organization only held the assigned membership units for a day before transferring them to the corporation. Additionally, the organization had no say in the assignment or transfer, as it was restricted under the partnership agreement from transferring its interest without the consent of the partners. Because the transaction was, in substance, a contribution of a promissory note to a charitable organization, the partner was limited by Rev. Rul. 68-174 and Counsel's Office determined he was not entitled to a charitable deduction. In addition, the partner was to be treated as having transferred the units to the corporation.

The IRS also determined the basis adjustment was improper, and concluded the transaction should be recast under the substance over form doctrine. Because, in substance, the organization never held an interest in the partnership's property and no sale of the units took place between the organization and the corporation, Counsel's Office advised that the partnership was not entitled to a basis adjustment under Code Sec. 743(b) and the corporation was not entitled to the corresponding amortization deductions.

For a discussion of the substance over form doctrine and partnership anti-abuse rules, see Parker Tax ¶ 20,510. (Staff Editor Parker Tax Publishing)

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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