Doctors get socked with big tax and penalties for donations tied to consolidation of their practice
Berquistist and Kendrick, et al., (2008) 131 TC No. 2
The Tax Court has determined that doctors grossly overvalued charitable donations of stock in their medical professional service corporation (PSC) that arose in connection with a consolidation of their practices. Accordingly, it hit them with large deficiencies and substantial accuracy related penalties. The claimed value of the stock was $401.79 per share but the Tax Court found the value to be only $37 per share.
Facts. IRS determined deficiencies for tax years 2001 to 2002 for five doctors and an accountant, and additional deficiencies for 2003 for four of them. The primary issue was the fair market value (FMV) of stock in a medical PSC that was donated to a charitable professional service corporation. Parties in 20 related but nonconsolidated cases agreed to be bound by the stock valuation determination in this case and the penalties if the Court’s holding on the penalties was the same for all parties.
From ’94 to 2001, the five doctors practiced medicine as employees of and as stockholders in University Anesthesiologists, P.C. (UA), a medical PSC specializing in anesthesiology. From ’94 to 2001 the accountant was the chief executive officer of and a stockholder in UA.
Through UA, the doctors provided medical services to patients of the Oregon Health & Science University Hospital (OHSU), a public teaching and research hospital in Portland, Oregon. UA was the exclusive provider of anesthesiology medical services to all OHSU hospitals and clinics.
Before the stock donation at issue, the doctors and the accountant each held 100 shares of UA’s voting common stock which they purchased in ’94 at $1 per share. In addition to UA, approximately 30 other medical practice specialty groups were affiliated with OHSU in a similar manner through separate medical professional service corporations.
In the late ’90s and after careful consideration and discussion, because of perceived risks and management concerns associated with the many separate medical practice specialty groups that were providing (through their respective professional service corporations) medical services to OHSU hospitals and clinics, OHSU’s executive management concluded that the consolidation into a single medical practice group, controlled and managed by a single PSC which in turn would be under OHSU’s direct management and administration, would be required of all the different medical practice specialty groups that wished to continue to be affiliated with OHSU (the consolidation).
In ’98 OHSU management formed the OHSU Medical Group (OHSUMG) as a Code Sec. 501(c)(3) tax-exempt professional service corporation to serve as the single consolidated medical group into which all of the then-extant 30 different medical practice specialty groups whose doctors were affiliated with OHSU would be consolidated.
A plan was hatched to reap large tax benefits by having the doctors donate their UA stock to OHSUMG.
In or around April 2001, an attorney for UA informed each UA stockholder of the steps to be taken to make the donation to OHSUMG of his or her UA stock and to claim a charitable contribution deduction for the donation. Under the plan outlined by the UA attorney, a new class of nonvoting UA stock would be issued through the distribution of a UA stock dividend. The attorney believed that this step was necessary to comply with Oregon law under which a majority of voting stock in a medical professional service corporation was required to be held by licensed Oregon doctors.
The attorney’s plan then called for UA stockholders to donate their UA stock to OHSUMG in two stages. Before the consolidation they would donate to OHSUMG their newly created UA nonvoting stock and claim substantial charitable contribution deductions. After the consolidation they would donate to OHSUMG their UA voting stock and possibly claim additional charitable contribution deductions.
On their respective 2001 Federal income tax returns, using an appraisal-based per-share value of $401.79 for both the voting and the nonvoting shares, 26 of the 28 UA stockholders claimed charitable contribution deductions for the donation of their UA stock. The remaining two UA stockholders claimed no charitable contribution deduction for the donation of UA stock.
Before taking into account charitable contribution limitations, the doctors generally claimed charitable contribution deductions of $176,788 on their 2001 Federal income tax returns for their UA stock donations. Because of the limitations, a number claimed carryovers to subsequent years.
On audit of the various returns, IRS, determining that on the Sept. 14, 2001 donation date, the UA stock had no value and disallowed in their entirety the claimed charitable contribution deductions relating to the donation of UA stock.
Before trial and on the basis of an expert appraisal, IRS agreed that the UA stock had a value of $37 per voting share and $35 per nonvoting share and that charitable contribution deductions were allowable to that extent.
Court sides with IRS. The Tax Court observed that the dramatic difference between the doctors’ experts’ and IRS’s expert’s appraised value for the UA stock stemmed largely from the experts’ respective conclusions as to the proper valuation premise–whether to value UA as a going concern. The Tax Court sided with IRS and concluded that as of the Sept. 14, UA should not be valued as a going concern. The donation of UA stock was driven by the imminent consolidation of UA (along with the other medical groups) into OHSUMG.
The Court then went on to analyze how the IRS expert arrived at the $37 and $35 values. Because the doctors did not show and the Court did not find flaw in IRS’s expert’s analysis, the Court concluded that the UA voting and nonvoting stock had a per-share value of $37 and $35, respectively, on the date in issue.
It also found that each doctor could be socked with a 40% undervaluation penalty under Code Sec. 6662(h) if his or her underpayment exceeded $5,000.
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