Business Owner's Reliance on Competent Bookkeepers Helps Avoid Penalties

(Parker Tax Publishing March 2021)

The Tax Court held that a taxpayer who owned various types of business entities could not take deductions for charitable contributions of property for which appraisals were not obtained. However, in determining whether the taxpayer had reasonable cause for avoiding penalties on the resulting tax deficiencies as well as deficiencies relating to conceded tax deductions, the Tax Court looked at the different sources of advice relied on by the taxpayer and concluded that his reliance on two of his three bookkeepers was reasonable enough to avoid penalties. Pankratz v. Comm'r, T.C. Memo. 2021-26.

Facts

Duane Pankratz was raised on a farm in South Dakota. After high school, Pankratz completed veterinary school and obtained a doctorate in veterinary medicine. He went on to invent a vaccine for an animal virus, started a company, and bought a number of laboratories that had gone out of business to ramp up production of the vaccine. He sold his company for a large profit and began buying small businesses such as gas stations, restaurants, motels, and a campground. He subsequently bought ranch land across South Dakota and then some other real estate in Florida and Mississippi. Most of Pankratz's tourist investments were held under an umbrella entity called Project, LLC. Project, LLC, owned five hotels, two gas stations, and a management company. Out from under Project, LLC, were a couple other small businesses including Keystone Beverage, the holder of a liquor license; and LaGrand Station, which held a gas station/convenience store, a tourist information center and some other businesses. Pankratz had enough businesses to keep at least two bookkeepers fully employed.

Pankratz hired Casey Peterson & Associates to do the bookkeeping for some, but not all, of these businesses. That firm chose Kasey Gerlach, a licensed CPA, to work on the account. Pankratz had a different bookkeeper for LaGrand Station and Keystone Convenience, Elaine Nash, who was the onsite manager's ex-wife, and whom Pankratz found to be a great bookkeeper. Finally, the bookkeeping for Pankratz's ranches was done by Jim Horning, one of Pankratz's longest serving employees. Horning had a Bachelor of Arts degree in accounting and worked briefly at an accounting firm. He is not a CPA, attorney, or licensed tax preparer, but over the years his role grew to include paying and filing invoices, depositing checks, reconciling bank statements, and compiling and collecting other financial information. He also prepares information for Pankratz's income-tax return every year.

In 2008, Pankratz hired BDO USA, LLP to prepare cost segregation studies for several of his businesses. Casey Peterson received draft cost-segregation studies to review in 2008. While BDO didn't put the studies into final form until 2010, Casey Peterson used the draft studies to prepare Pankratz's 2008 tax return and calculate depreciation deductions for 2008 and 2009. There were only insubstantial changes between the 2008 draft and the final 2010 BDO tax opinion.

During 2008 and 2009, Pankratz made three large charitable contributions. In 2008, he donated his interests in four oil and gas projects to Missionary Church, Inc. He valued the donation at $2 million based on his purchase price as well as what he said he expected its appreciation to be. He did not obtain a professional appraisal of these interests before he filed his return. Also in 2008, Pankratz donated 5.78 acres of land to Rapid City, South Dakota for road and utility improvements for which he took a deduction on his 2008 tax return. Pankratz, who never obtained a professional appraisal of this property, subsequently conceded that this deduction should be disallowed.

In 2009, Pankratz donated a conference center - both the building and surrounding land - to Keystone Project, Inc., another religious charity. To determine its value, Pankratz contracted with a certified general appraiser in South Dakota. The appraiser reviewed with Pankratz the three traditional valuation methods used by appraisers - comparable sales, income, and replacement cost - that appraisers use, and then explained why he felt uncomfortable using any of them. The appraiser believed the property was a very elaborate complex, and he had never seen a similar building in his appraisal career. He felt he couldn't complete the appraisal according to Uniform Standards of Professional Appraisal Practice (USPAP). Pankratz did not try to get another appraisal, but instead totaled up the cost of the conference center and claimed that amount as a charitable contribution deduction on his 2009 tax return.

2008 and 2009 Tax Returns

As in prior years, Pankratz retained Wohlenberg Ritzman & Co. to prepare his 2008 and 2009 returns. Blaine Meier, a CPA and partner at Wohlenberg, had taken over as the primary preparer of Pankratz's tax returns starting in 2005, and was in charge of his 2008 and 2009 returns. His process for preparing Pankratz's return was different than his normal routine. Neither he nor the staff at Wohlenberg prepared the return directly. Instead, Horning gathered information and took it to Wohlenberg where Horning personally entered information into the firm's tax-preparation software. Meier would then review what Horning had prepared. If any issues were flagged by the computer program, Meier discussed those issues with Horning and then Horning was supposed to discuss them with Pankratz. After this indirect review, Meier would sign the return.

Pankratz never had a professional appraisal performed and no appraisals were attached to either his 2008 or 2009 return for any of the large noncash charitable donations that he claimed. With respect to the 2008 tax return, Meier raised the issue of the lack of an appraisal with Horning. However, neither Horning nor Meier raised the issue with Pankratz. When he reviewed the 2009 tax return, Meier again told Horning that the lack of an appraisal was a problem. This time, however, Horning called Pankratz and told him that he needed an appraisal if he wanted a deduction for his donation of the conference center. Pankratz asked Horning if instead he could just deduct the cost of the building. Pankratz and Horning discussed it and finally decided this informal valuation would work. They valued the conference center at its cost. As with the 2008 return, Pankratz never had a face-to-face meeting with Meier nor spoke on the phone with Meier. And Pankratz never reviewed the final return before it was filed shortly before it was due.

The IRS audited Pankratz's 2008 and 2009 tax returns and Pankratz conceded many of the deficiencies relating to business expenses that were disallowed, including the depreciation deductions that he thought he was entitled to because he'd paid BDO for the cost-segregation studies. However, he did not concede the charitable contribution deductions that the IRS had denied because of Pankratz's failure to attach appraisals. Similarly, Pankratz argued he also was not liable for the penalties assessed on the various deficiencies. Before the Tax Court, Pankratz argued that he had reasonable cause for the positions he took on his return because he reasonably relied on Meier's and Horning's advice.

Analysis

The Tax Court held that Pankratz was not entitled to charitable contribution deductions for the donation of his interests in the oil and gas fields and the donation of the conference center. The court noted that a taxpayer does not have to be a tax expert to be able to read Form 8283, Noncash Charitable Contributions, and see that an appraisal is generally required for property donations listed in Section B of the form. For a man as smart as Pankratz, the court said, this would have suggested that there was a potential major error on the return and should have prompted him to ask more questions rather than just signing the return.

The Tax Court was a little more lenient with respect to the penalties assessed on the tax deficiencies relating to the disallowed business expense deductions. The court looked at the different sources of advice relied on by Pankratz and concluded that Pankratz's reliance on BDO's tax guidance was reasonable and in good faith and it thus immunized him against the Code Sec. 6662 penalties relating to the depreciation deductions taken in reliance on the BDO cost segregation studies. With respect to other expenses disallowed by the IRS, the court looked at how the books were kept - and more importantly, who kept them. This led the court to three groupings: businesses for which Casey Peterson performed the bookkeeping, businesses for which Horning performed the bookkeeping, and businesses for which Elaine Nash performed the bookkeeping.

With respect to Pankratz's reliance on Peterson, the court concluded that, though there were errors in the bookkeeping, these errors were reasonable given the number of expenses. The court found that neither these errors nor Pankratz's reliance on Peterson's bookkeeping was made in bad faith and thus found that no penalties should apply to the incorrect deduction of business expenses relating to the businesses which Peterson oversaw. With respect to Horning, the court noted that while he did not have the expertise to make reliance on him for the deductibility of noncash-charitable contributions reasonable, Pankratz's reliance on him to keep the books on the ranching businesses was reasonable because Horning had been keeping these records competently for several years. With respect to Nash, however, the court said it had nothing aside from Pankratz's word that she was a qualified, competent bookkeeper. And there was nothing in the record to show that Nash's work was reviewed by any more obviously qualified tax professional. Thus, the court held that penalties should apply to any erroneous deductions taken for businesses where Nash did the bookkeeping.

For a discussion of appraisal requirements for charitable deductions, see Parker Tax ¶84,198.

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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