Case Study Problem – Mal Manley

A client, Mal Manley, fills out his client questionnaire for the previous year and on it provides information for the preparation of his individual income tax return. The IRS has never audited Mal’s returns. Mal reports that he made over 100 relatively small cash contributions totaling $24,785 to charitable organizations. In the last few years, Mal’s charitable contributions have averaged about $15,000 per year. For the previous year, Mal’s adjusted gross income was roughly $350,000, about a 10% increase from the year before.

Required: According to the Statements on Standards for Tax Services, may you accept at face value Mal’s information concerning his charitable contributions? Now assume that the IRS recently audited Mal’s tax return for two years ago and denied 75% of that year’s charitable contribution deduction because the deduction was not substantiated. Assume also that Mal indicates that, in the previous year, he contributed $25,000 (instead of $24,785). How do these changes of fact affect your earlier decision?

According to the Statements on Standards for Tax Services one may accept at face value information about claimed contributions unless it appears incorrect, incomplete, or inconsistent. One should also be sure to make inquiries about the information supplied by the taxpayer if it seems to be conflicting or exaggerated. In Mal’s case, the information that he has claimed to have contributed is inconsistent with his charitable contributions from years past. In the previous year, Mal reported 100 small charitable contributions totaling $24,785, whereas in the two prior years, Mal only averaged $15,000 in charitable donations per year. In addition, the 60 percent increase in the previous year’s charitable contribution does not accurately reflect Mal’s 10 percent increase in adjusted gross income.

With the assumption of the denial of 75 percent of Mal’s prior reported contributions by the IRS, the situation changes into one where further documentation backing up the charitable contribution claim should be requested. The past denial of such an overwhelmingly large portion of the claimed contributions allows for the reasonable assumption that this year’s claims may also be over exaggerated. In this type of situation, especially considering the recent increase in contribution claims, one should not hesitate in requesting receipts or any other possible documentation of the majority of the claimed contributions.

Under the assumption that Mal indicates he contributed $25,000 and not $24,785 in the previous year, this would not affect earlier decisions based on Mal’s charitable contributions.