Three key amounts—retained earnings, the accumulated adjustments account, and shareholder stock basis—have distinct meanings but similar calculations. This can cause confusion among shareholders and their tax advisors on their importance for understanding the tax implications of S corporation transactions.

In this article, I provide working definitions for these three key amounts and offer a simplified comparison of their calculations to demonstrate the subtle yet critical distinctions among them. I close with a case study that demonstrates how these measures relate yet differ.

In general, these three measures answer three different questions: retained earnings shows what happened, AAA determines what kind, and basis determines how much.

Retained earnings shows accumulated profits over time

At the end of each accounting period—usually the calendar year for most taxpayers—net income from the profit and loss statement closes, or transfers and zeroes out, into retained earnings. Distributions also close to RE at the end of each period. So, RE represents the cumulative net income a company holds rather than distributes to shareholders.

RE can take any value, positive or negative. A company may distribute cash or property in excess of accumulated profit, for example, by funding expenses with debt.1 Negative RE might represent already-distributed future profits.

Positive RE may indicate a business that has been relatively profitable at a given point in time and could distribute those profits to shareholders, whereas negative RE could indicate a history of losses or debt in excess of profits. Like any balance sheet account, the best way to analyze RE is by its change over time and in context with other amounts, such as total liabilities.

The accumulated adjustments account displays undistributed passthrough profits

The accumulated adjustments account reflects the cumulative, undistributed passthrough income of an S corporation.2 An S corporation may have existed as a C corporation prior to making the S election. This means retained earnings includes both C corporation earnings and passthrough S corporation profits. AAA ensures that S corporation earnings are distributed before any C corporation earnings and profits are treated as dividends.

Although it seems similar to RE, AAA differs in two important ways: first, distributions do not reduce AAA below zero;3 second, tax-exempt income increases RE, but it does not increase AAA.4

Like positive RE, positive AAA indicates earnings that could be distributed tax-free from the corporation. If an entity has no history as a C corporation, then AAA may seem unimportant; however, it still provides a useful account of undistributed profits. Even in these cases, AAA reminds us of the original purpose of Subchapter S: to prevent corporate earnings from being taxed twice via passthrough treatment.

Stock basis tracks shareholders’ limitations on deductions and nontaxable distributions

Stock basis (and then debt basis) limits the aggregate amount of losses and deductions a shareholder can deduct5 and the amount of nontaxable distributions a shareholder can take.6

Contributions, income (including tax-exempt income), and gains increase stock basis; and distributions, losses, and nondeductible expenses decrease basis, but not below zero.7 Since tax year 2021, S corporation shareholders calculate and report basis using Form 7203, S Corporation Shareholder Stock and Debt Basis Limitations.

Note that contributions increase basis but not RE or AAA. Include contributions in Capital stock (Line 22) or Additional paid-in capital (Line 23) on Schedule L, Balance Sheets per Books.

Example distinguishing RE, AAA, and basis

Jessica registers Lighthouse LLC by filing articles of organization, with herself as the sole member, on January 2, 20X1. On that date, she opens a checking account in the name of Lighthouse LLC and funds it with $1,000 of her savings. She also timely and correctly files Form 2553, Election by a Small Business Corporation, effective January 2, 20X1.

At the end of December 31, 20X1, Lighthouse LLC has nonseparately computed income of $84,000, municipal bond interest income of $500, and nondeductible meals and entertainment expense totaling $4,000. Jessica also received cash distributions totaling $35,000.

The calculations for RE, AAA, and basis at the end of 20X1 are as follows:

• RE $84,000 + 500 – 4,000 – 35,000 = $45,500

• AAA $84,000 – 4,000 – 35,000 = $45,000

• Basis $1,000 + 84,000 + 500 – 35,000 – 4,000 = $46,500

NB The $500 of nontaxable interest does not increase AAA, but it would increase the Other Adjustments Account.

The following year, Lighthouse LLC makes significant investments in operations, mostly funded through debt. At the end of December 31, 20X2, Lighthouse LLC reports the following for the year: nonseparately computed loss of $17,000, municipal bond interest income of $500, and nondeductible meals and entertainment expense totaling $4,000. Jessica also received cash distributions totaling $35,000.

The calculations for RE, AAA, and basis at the end of 20X2 are as follows:

• RE $45,500 – 17,000 + 500 – 4,000 – 35,000 = –$10,000

• AAA $45,000 – 17,000 – 4,000 – 35,000 = $0

• Basis $46,500 + 500 – 35,000 – 4,000 – 17,000 = $0

NB AAA is $24,000 before subtracting distributions; however, distributions cannot reduce AAA below zero. Basis is $8,000 before subtracting the loss; however, basis cannot go below zero, so $9,000 of the loss would be suspended and carried over in the next year. Both AAA and basis are zero, but Jessica still has suspended losses, highlighting that AAA and basis track different limitations.

In the next year, Lighthouse LLC returns to profitability despite significantly increased operating costs. At the end of December 31, 20X3, Lighthouse LLC reports the following for the year: nonseparately computed income of $10,500, municipal bond interest income of $500, and nondeductible meals and entertainment expense totaling $4,000. Jessica also received cash distributions totaling $15,000, a lesser amount due to reduced profits and a shortage of funds.

• RE –$10,000 + 10,500 + 500 – 4,000 – 15,000 = –$18,000

• AAA $0 + 10,500 – 4,000 – 15,000 = $0

• Basis $0 + 10,500 + 500 – 15,000 – 4,000 – 9,000 = $0

NB Basis is $11,000 before subtracting distributions, resulting in $4,000 of capital gain income. The carried over loss from the prior year carries over into the subsequent year. The nondeductible expenses do not carry over unless Jessica makes an election under Reg. § 1.1367-1(g).

Conclusion

Although similarly computed, S corporation RE, AAA, and stock basis have important differences in their calculations and interpretations. Shareholders and their advisors should be familiar with the concept of basis, track it annually, and take it into consideration whenever running tax projections or considering distributions.

Put your car in your business so you can deduct it.

Fraudulent reporting of excess business usage of a vehicle aside, does it ever make sense to own and operate a vehicle in a business, and if so, when?

In general, I usually recommend against this approach, unless there is some compelling reason to follow it. In many small business situations I see—especially with S corporations—the shareholder owning the vehicle personally and being reimbursed by the business is often the cleaner and more defensible structure.

But, as with all things tax, the answer depends on the specific facts and circumstances of the situation. So, when I’m advising a client about the business use of a vehicle, I use a simple framework that helps me sort through these questions quickly.

The framework boils down to three questions:

• Who owns the vehicle?

• Who uses the vehicle and how?

• What percentage of use is for business, and how will that change over time?

These three variables determine almost every tax consequence involving business vehicles: deductions, depreciation, income inclusion, and sometimes recapture.

I’ll unpack this framework in more detail in an upcoming episode of Tax in Action. I’m also teaching a webinar for NAEA on the topic in June. But I’m curious how other practitioners think about these situations. So, if you have a way of handling clients who insist on treating their grocery haulers as if they’re company cars, I’d love to hear it!

Let’s look at a few real situations to see how the framework clarifies how I think about the tax treatment of a vehicle.

Occasional business use of a personally-owned vehicle

A typical situation for my practice looks like this: A service-based S corporation with a sole shareholder-employee who occasionally drives her personally-owned vehicle for business purposes, such as meeting clients.

Let’s break this down:

• The shareholder-employee owns the vehicle.

• She also exclusively uses the vehicle for both business and personal purposes.

• Business use percentage is relatively low and will likely remain low for the foreseeable future.

I generally recommend using an accountable plan in situations like this.1 The plan allows the business to provide a tax-free, deductible reimbursement to the shareholder-employee for the business use of her personal vehicle. I typically recommend reimbursing at the IRS standard mileage rate.

Occasional personal use of a company-owned vehicle

A less common, but still plausible, situation involves some personal use of a company-owned car. This can make sense under the right conditions, as long as the business diligently tracks and correctly reports personal use.

What happens when the business owner-employee primarily uses the vehicle for business, but also drives it on weekends and vacations? Let’s take a look:

• The business owns the vehicle.

• The owner primarily uses the vehicle for business, with some limited personal use.

• Business use percentage is relatively high and will likely remain high for the foreseeable future.

The business use of the company provided-vehicle is a working condition fringe benefit.2 The owner must substantiate the use of the vehicle, such as with a mileage log.3

Any personal use of the vehicle results in the inclusion of the value of that usage in the owner’s taxable wages. This means coordinating the owner’s mileage log with payroll, introducing additional complexity.

Variable business use over time

Now consider a vehicle initially treated as a company-owned vehicle. The business claimed accelerated depreciation because business use exceeded 50 percent.

Two years later, both the business and the owner’s personal life have changed, and business use falls below 50 percent.

This can trigger recapture of the “excess depreciation” claimed in prior years, which could have significant tax and financial consequences.4

Exceptions to the general recommendation

To be clear, I’m not saying the business should never own the vehicle. There are situations where corporate ownership may make sense.

But, in my experience, too many vehicle structures are chosen without thinking through the interaction between ownership, use, and business-use percentage.

I want to know how you think about these situations.

When a client asks about a “business vehicle,” what factors do you look at first?

What mistakes have you seen recently?

What’s the strangest vehicle deduction you’ve seen recently?

What’s the best—or worst—business vehicle story from your practice?

Section 199A allows a deduction for taxpayers of up to 20% of qualified business income (QBI) from passthrough entities. The Petitioners co-owned three cannabis businesses taxed as S corporations. This case involves two of them and hinges on whether a cannabis business subject to § 280E can use the total W-2 wages paid, or only the deductible portion of those wages paid, for the calculation of the § 199A qualified business income deduction (QBID).

In calculating their § 199A deductions, the Petitioners used total W-2 wages paid by the two businesses to determine their QBID. The IRS disagreed, arguing that W-2 wages nondeductible under § 280E cannot be considered under § 199A.

In the majority opinion, agreeing with the IRS, Judge Toro writes that Congress provides an exception to the general rule that a taxpayer uses total W-2 wages paid for the calculation. Section 199A(b)(4)(B) states that, for purposes of the section, the “term [W-2 wages] shall not include any amount which is not properly allocable to qualified business income…” (emphasis added).

The Court then examines the meaning of “properly allocable,” connecting it to the statutory definition of QBI in § 199A(c). Section 199A(c)(3)(A)(ii) limits the definition of QBI to items “included or allowed in determining taxable income for the taxable year.” The Court works backward to decide that, because § 280E makes a portion of the W-2 wages nondeductible, then that portion does not qualify for inclusion in the definition of QBI and therefore cannot be used in the calculation of the deduction.

In a dissent, Judge Jenkins considers the policy intent of § 199A, which was to encourage the creation of jobs for Americans. Also, Congress did not include drug trafficking businesses in its list of ineligible trades or businesses in § 199A(d).

It’s an interesting case for a few reasons: first, it shows how different sections of the IRC can interact in unexpected ways; second, Jenkins’ dissent highlights the contention between desired policy outcomes and strict interpretations of the law; and third, it is the sole significant discussion of § 199A I can find in a court case.

NB The Petitioners have filed an appeal in the 9th Circuit.

I’m recording an upcoming episode of Tax in Action on QBID. I’m also teaching a 2 CE course on QBID at the National Association of Enrolled Agents 2026 Tax Summit. (Let me know if you’re attending!)

If you have questions about QBID, let me know by posting a comment here!

Do you agree with Toro’s opinion? Or does Jenkins’ dissent make more sense? Let me know!

I’ll also discuss QBID in my three-hour practical, hands-on workshop on S corporations at the New York State Society of Enrolled Agents Annual Conference in October.

He set up his firm’s calendar for 2026, marked deadlines, and blocked off unavailable days. This resulted in a maximum capacity of about 66 returns. Initially, he said, that number seemed low; however, he then compared it to this year’s production of about 90 returns, with several of them amended or prior year returns.

He realized the calendar wasn’t wrong. It was honest.

And that is the main benefit of intentionally managing your firm’s workflow and capacity. A calendar-based capacity plan doesn’t tell you what you wish you could do. It tells you what you can actually deliver without overworking yourself and your staff.

The reader then asked a series of follow-up questions that I’ll summarize as follows:

Once you start giving clients structured dates instead of loose promises, how do you manage what happens next?

This question deserves more than a quick email reply, so let’s go deeper.

The two-way bargain of calendar-based capacity

Scheduling your tax return workflow is really an agreement between two parties:

You agree to reserve time for the client, and the client agrees to provide you with everything necessary to complete the job.

That’s the bargain. But if you’re used to a reactive, “send it when you send it” model, shifting toward structure is a culture change for you and for your clients.

The reader’s estimate of 66 returns seems perfectly reasonable for a solo preparer who wants a humane tax season. Could he squeeze in 10–15 more? Sure. But capacity isn’t just about how many 1040s you can grind through. It’s about the combination of that with amended returns, notices, prior-year cleanup, advisory work, and the inevitable handful of “life happened, help me” moments that march in unannounced.

Scheduling protects the space for all of it.

Anticipating schedule-based workflow issues

The reader asked about three scenarios and how my firm approaches them: missed review deadlines, early submitters, and new clients admitted during tax season.

Let’s take a look at each of the three scenarios in turn.

1. A client fails to submit information and documents on time

Every firm that implements a scheduling workflow hits this wall, and the solution is painfully simple:

That is the rule at Steadfast. There are occasional exceptions—life is weird, and tax practice is even weirder—but the baseline expectation is this: Your date on the calendar is contingent on your documents being ready.

But the key is not enforcement. It is communication. Steadfast has client success managers (CSMs) who send reminders, complete initial document review, and compare uploaded documents to the prior year. We try to use review weeks to help (as much as possible) clients meet their obligations.

You may not have a CSM role in your firm yet, but you can still follow our procedures to help clients avoid an automatic rescheduling:

• Tell clients upfront that their scheduled date assumes timely documents.

• Remind them a week before.

• Make the reschedule a neutral, automatic outcome, not a judgment.

Good clients do not push back when they know the rules clearly and ahead of time.

2. A client submits everything early

This is the delightful opposite problem. And the answer is equally simple:

At Steadfast, we also move clients up on the calendar for a real need, such as a mortgage application, FAFSA request, offboarding, or other similar reasons to expedite. But this only works if the schedule has intentional slack. If you plan yourself to the minute, you remove your ability to respond to reality without significant stress.

3. A client onboards during tax season

Here is my honest advice: Avoid onboarding new clients during tax season unless there’s no alternative.

Onboarding is slow. Tax season is fast. The two do not mix well.

But if you choose to accept new clients during the season, set realistic expectations, not aspirational ones. Avoid overpromising during discovery and onboarding, and then having to choose between fulfilling your promise to this new client or your responsibilities to your existing clients.

Always build in at least a month for proper onboarding. Then, make it clear that the filing turnaround is typically 6–8 weeks from signup, assuming their documents are complete.

If a prospective client says, “I’ll go somewhere else if it takes that long,” that is not a scheduling problem. That is a differentiation problem. Your messaging, value proposition, and intake process should make it evident that your firm is not interchangeable with the one-hour pop-up booth in the strip mall.

When prospects see the firm as a commodity, any delay feels like friction. When they see you as a specialist, delay feels like quality control.

A front-of-the-line fee is also a legitimate option. Concierge service is a service.

Introducing multiple changes at once

The reader also admitted his firm is in early-stage growth mode and expressed nervousness about rolling out upfront pricing, scheduled slots, onboarding structure, and deadlines all at the same time.

Here’s some encouragement for him and you, especally if you’re in a similar position:

Good clients handle change extremely well when the benefits are clear and the communication is confident.

You do not need lengthy explanations of your business model. You need a short, simple message, such as the following:

We’re making a few improvements this year to streamline your experience. Here’s what will be different and how it benefits you:…

Clients do not care about features. They care about reducing friction and maximizing peace of mind.

The irony is that earlier in a firm’s life is often the best time to set expectations. Later on, when your roster is full and your processes are cemented, clients will resist change more than they do now.

Scheduling is business design

The reader’s questions show what happens when you move from a reactive approach to a designed workflow: everything becomes a system problem instead of a willpower problem.

Scheduling forces clarity on multiple critical aspects of your business:

• Capacity

• Boundaries

• Pricing logic

• Workflow steps

• Client expectations

• Communication rhythms

Most firms do not have performance issues. They have design issues.

And scheduling—done honestly—reveals the truth of your practice’s economics. You can only do what you can do. And that is not a defect. It is the first step toward building a firm that supports your life instead of consuming it.

A final note to the reader

If you’re reading this, know that your instinct was right. The calendar did not expose your weakness. It exposed your reality.

And you can build a beautiful tax season on reality.

This is exactly how you grow from “I hope this works out” into “I know exactly what I can promise, and I know exactly how to deliver it.”

Thanks for reading!

Giving property to nonprofit organizations provides a great example of the potential complexity and pitfalls of tax-deductible charity. A recent U.S. Tax Court case demonstrates how a seemingly minor technicality can negate a deduction—meaning a good deed is only as good as the documentation substantiating it.

Background of Besaw v. Commissioner

In Besaw v. Commissioner, T.C. Summ. 2025-7, the taxpayers—John Henry Besaw and his spouse—claimed a deduction for noncash charitable contributions totaling $6,760 on their timely filed 2019 joint federal income tax return. They included Form 8283, Noncash Charitable Contributions, along with worksheets identifying the names and addresses of the donee organizations and short descriptions of the donated property.

However, the return lacked two key pieces of information regarding the contributions: the dates of the donations and the values of the donated items. The IRS examined the return. In response, Besaw reconstructed the information from Form 8283 and submitted it to the IRS in 2022.

The IRS issued a Notice of Deficiency on August 10, 2022. The Notice explained that Besaw failed to substantiate the contributions adequately. Importantly, the government did not challenge the generosity; instead, it challenged the substantiation, and that proved fatal for the taxpayer.

Valuing and substantiating noncash charitable contributions

The amount of a noncash charitable contribution is generally the fair market value of the property at the time of the contribution, reduced as determined under IRC §170(e).1 This generally limits the potentially deductible value of the contribution to the lower of FMV or the taxpayer’s basis in the property.

Any noncash contribution over $250 requires a contemporaneous written acknowledgment from the donee organization, which must include a description (but not the value) of the property.2 Contemporaneous means the taxpayer obtains the acknowledgment on or before the earlier of the date the taxpayer files a return for the tax year of the contribution or the due date (including extensions) of that return.3

Treas. Reg. §1.170A-13 provides recordkeeping and return requirements for deductions for charitable contributions. Specifically for noncash donations under $5,000, a taxpayer must keep a receipt (or letter) from the donee organization showing the following information:

• The name of the organization;

• The date and location of the contribution; and

• A description of the property in reasonably sufficient detail.4

If it is impractical to obtain a receipt—such as at a remote drop-off location—the taxpayer must maintain a reliable written record that includes the following information for each item donated:

• The name and address of the organization;

• The date and location of the contribution;

• A description of the property in reasonably sufficient detail;

• The FMV of the property at the time of the contribution; and

• The cost or other basis of the property.5

For property valued over $500, the taxpayer also must record the date and manner of acquisition of the property.6

Besaw’s failure to substantiate adequately

Despite reporting noncash contributions on Form 8283 and attached statements, Besaw failed to substantiate the contributions adequately on several points:

• First, the return did not include values or dates of the donations.7

• Next, the receipts Besaw provided during examination, although containing dates and signatures, did not identify the property donated.

• Finally, the reconstructed documents submitted in 2022 were not contemporaneous.

Given these failures, the Court held that Besaw did not adequately satisfy the substantiation requirements of IRC §170(e)(1) and Treas. Reg. §1.170A-13. The primary issue was the lack of property descriptions on the donation receipts.

Lessons learned from Besaw

The key takeaway from the Besaw case is the necessity of adequate documentation for noncash charitable contributions. That means obtaining receipts that include dates, locations, and descriptions of the donated property.

Taxpayers often rely on donee organizations to provide proper documentation; however, many preparers sort through (mostly blank) Goodwill receipts each year. Proactively communicating the requirements can help clients understand what they need to record their donations sufficiently. Here’s a helpful checklist:

1. Get a contemporaneous receipt that includes the organization’s name and address, the date and location of the donation, and a reasonably detailed description of each item donated. “Household goods” may not suffice if the taxpayer claims a significant deduction.

2. Maintain a separate list of the items donated, including acquisition date (or a reasonable estimate), cost, condition, and value. Photos can help.

3. Be careful as the claimed value of the donation approaches $5,000. Crossing this threshold requires a qualified appraisal.

4. Prepare Form 8283 when total noncash contributions exceed $500. Make sure the appraiser and donee organization sign it, if necessary.

Charitable contributions are a great way to support organizations and communities in need. They can also provide a benefit for taxpayers, but only if they follow the rules.

Thanks for reading! This post is part of a Giving Tuesday collaboration with other great tax experts writing on Substack. Please check out their publications if you haven’t already:

• Tom Talks Taxes by Thomas Gorczynski, EA, USTCP

• Josh & Taxes by Josh Youngblood, EA

• Matt’s Tax Firm Insights by Matt Gaylor, EA

• Financial Guardians by Brad Messner, EA

• The Buzz about Taxes by Manasa Nadig, EA

• Tiffany Huntington, EA

1. Clarify the question

2. Consult appropriate sources

3. Confirm the findings

4. Conclude with confidence

As promised at the end of that article, I recorded an application of that framework, showing how I find an answer to what I think is a good tax research question (with an interesting answer, to me, at least) using Parker Tax Pro Library:

If you’re interested, here’s the text I use in my notes in Markdown format:

Tax research project 2025-11-21 16:37

## Clarify the question

### Client’s question

### Legal question

## Consult

### IRC

§{}

### Regulation

### Court case(s)

### IRS guidance

### Secondary sources

## Confirm

- Do the facts in the authority align with the client’s facts?

- Does the controlling authority actually support the interpretation?

- Is the source still current? Has any new law, guidance, or court opinion superseded it?

## Conclude

### Legal position

### Client response

## Contribute

Can I write off the cost of repainting my rental property?

Twenty minutes later, you have twelve browser tabs open, posts in a few tax professional Facebook groups with contradictory comments (and a few insults), you’re halfway through a podcast episode, and something about a 2010 Tax Court memo…

Federal tax law is complex and complicated, even for tax professionals. And clients always find ways to bring questions we’ve never quite dealt with, leading us to question what we think we know.

Today’s technology—search engines, social media, online communities, continuing education webinars, and, of course, artificial intelligence—provides more opportunities to get responses to questions. Replies can range from one-word answers to long treatises full of citations, with a few snide remarks about how basic your question is and unhelpful suggestions to “do your own research.”

Whether a reply is a comment in an online forum for practitioners or an AI-generated answer, quality is always a concern. Sometimes a response is excellent, others it’s half-true, and many times it’s a confident, well-formatted sentence that somehow manages to be wrong in three different ways.

None of this is meant as an insult to anyone. I’ve been both the provider and recipient of a lot of responses of varying quality and helpfulness. Federal tax law is enormous, scattered across statutes, regulations, case law, rulings, notices, procedures, and form instructions. No one knows everything. But we all have the same duty:

Don’t rely on an answer until you’ve verified it.

It’s critical for every tax professional—regardless of the credentials you have, role in your firm, or kind of client you serve—to understand how to handle tax questions and find answers to them. Our professional status requires us to develop the ability to conduct independent research. Circular 230 §10.33 includes in its Best practices for tax advisors the following:

Establishing the facts, determining which facts are relevant, evaluating the reasonableness of any assumptions or representations, relating the applicable law (including potentially applicable judicial doctrines) to the relevant facts, and arriving at a conclusion supported by the law and the facts.

I was a teacher and researcher in academia before working in accounting. Planning, conducting, and publishing research was part of my core responsibilities. As a tax practitioner, I use a similar process, albeit with different topics and goals.

Over time, I’ve settled into a simple, repeatable structure that I use for every question, whether it comes from a client message, someone in my firm’s staff, or a colleague. I call it the Four Cs:

1. Clarify the question

2. Consult appropriate sources

3. Confirm the findings

4. Conclude with confidence

This process helps ensure I determine the real issue at stake, focus only on relevant material, and provide a helpful answer supported by authoritative tax law.

Depending on the question and how close it is to my typical client work, going through this process can take anywhere from a few minutes to a few hours. But even for more complicated questions with lengthier research sessions, the process keeps me focused on the specific question, avoiding time wasted going down rabbit holes or confusion generated by conflicting responses.

Let’s walk through the Four Cs and see how they work:

Clarify the question

Before diving into my research tools, I have to know what the issue is, from both the perspectives of the person asking (usually a client or a colleague’s client) and the law itself. So, I start by writing the question in two forms:

1. Plain English What is the client asking? What happened that led to asking this question? When did it happen? Who else was involved? How much money1 was involved?

2. Legal What is the specific transaction? What Code section most closely covers this topic?

Note that these two versions of the question usually do not match. When a client asks, “Can I deduct the cost of repainting my rental property?” (Plain), your research question might be “Is repainting part of routine maintenance (deductible under §162) or is it an improvement (capitalized under §263)?”

Clarifying the real research question as early as possible prevents wasting time searching for the wrong things. It also helps other practitioners know precisely what you’re asking, avoiding nonsensical replies and harsh rebukes.

Consult appropriate sources

Once I’ve clarified the research question, then—and only then—do I consult sources. There are two kinds of research sources: primary, secondary, and tertiary:

1. Primary sources The first primary source for any tax research question is the relevant section of the Internal Revenue Code. But for a lot of questions, the Code merely provides the general rule, so I also look at the related Treasury Regulations for that Code section.2 Then, the IRS may provide additional authoritative guidance in Revenue Rulings or Revenue Procedures.3 Finally, federal courts interpret the law, including the Code, Regulations, and other courts’ opinions.4

2. Secondary sources Explanations, essays, and other non-legal sources can provide excellent starting points for research on unfamiliar topics. In these cases, I often start with a *Treatise* from my research service.5 A treatise is a summary in essay format, organized by subject. I also search for recent articles published in professional journals, such as the AICPA’s The Tax Adviser, which offers many of its articles for free. These articles go through an editorial process to ensure quality and usually feature rich citations to authoritative sources. Regardless of how you conduct your secondary research, always look for citations to authoritative primary sources to indicate the quality of the source.

3. Tertiary sources Sources that rely on and convey a blend of primary and secondary sources can be helpful, but they also require corroboration. Typical examples include dictionaries, encyclopedias, and textbooks, but in this context, I also include continuing education6 and tradition. I’m a lifelong learner, so I love good CE. But there’s a lot of bad or hastily written education out there, too.7 I avoid any CE that does not provide citations to authoritative primary sources or that includes a sales pitch for a product or service. As for tradition, “That’s how we’ve always done it” or SALY8 are red flags for me, especially when they contradict established guidance or best practices.

Whether you start with primary sources or with secondary sources, the key point remains: Understand what the law says, not what someone remembers it saying.

Confirm the findings

Once you have concluded your research, you need to do extra work to confirm your findings. I often see practitioners skip this confirmation step. I’m a bit ashamed to admit that I’ve missed it too many times myself, and when I have, I’ve always regretted it.

Finding a plausible answer, especially for a complex question or a drawn-out research project, can cause a rush. It’s essential to stop and evaluate the answer to ensure it actually fits all the facts and circumstances of your case.

Like all tax work, tax research requires due diligence. Finding an answer is one thing, but confirming it is another. Here are a few questions to ask yourself:

• Do the facts in the source align with your client’s facts?

• Does the controlling authority actually support your interpretation?

• Is the source still current? Has any new law, guidance, or court opinion superseded it?

This is the verify part of trust, but verify.

Online groups are great for getting feedback or confirmation from colleagues, who can often point me to an authoritative source or a rephrasing of the initial research question I hadn’t considered.

This step helps prevent embarrassing (and potentially costly!) errors and increases your confidence when reaching your conclusion.

Conclude with confidence

Once I’ve clearly phrased the research question, found an answer based on my reading of actual law, and confirmed my findings, the final step comes full circle: I summarize the result in two parts:

1. Plain English I explain the conclusion in layperson terms, using as much of the client’s original phrasing as possible. Then I transmit the message to the client (or colleague, with the caveat that the colleague should independently verify my conclusion).

2. Legal I also document my research in my private files, along with citations and direct quotations from authoritative sources. This gives me a quick reference if I come across a similar question again later.

The goal is a clear, defensible position well-supported by relevant authority.

A position is not “my opinion.” It is never “Here’s what I’d do if I wrote the law…” or “Here’s how I’ve done it, and it survived an audit.” Too often, I see statements like these as the totality of support for an otherwise indefensible position. This, to me, is malpractice.

The fifth C: Contribute your newfound knowledge

Those four steps—Clarify, Consult, Confirm, and Conclude—are sufficient to keep your clients satisfied and stay in business. However, as professionals, we have a higher duty, not just to our own firms and careers, but to our colleagues and our posterity.

So the Fifth C is to contribute your newfound knowledge to your community. That may look like sharing your findings with the junior tax staff in your office. It could look like a post to your firm’s website, your independent blog, or your YouTube channel. Maybe you discuss the case (anonymously, of course) as a guest on a podcast. Or you write up a summary of the law, your interpretation, and your application for publication in a professional journal.9

Regardless of how you share your learning, you should share it with at least one other person who can use it to help others. Keeping that learning private hinders the profession, potentially robbing colleagues and young professionals of potentially invaluable insight. Sharing is how we advance collectively, making us all better off.

A note about getting answers in groups

I spend a lot of time in online groups for tax professionals. When I meet other practitioners in real life for the first time, they usually recognize me from these online groups.

I’ve gotten a lot of great help from these groups. I’ve also met some great colleagues, friends, and mentors in them.

But we have to be honest, the quality of advice varies dramatically:

• Some people cite authority.

• Some cite what they remember from five years ago.

• Some cite something their software used to do.

• Some cite something their software still does (incorrectly).

• Some cite something a marketing influencer told them.

That all creates noise. Your due diligence cuts through the noise to get to the signal.

The best approach is simple:

Trust, but verify.

If someone posts a good answer, thank them, and then check the Code section, the Regulation section, the court opinion, or the ruling yourself. If someone gives a confident but unsupported answer, treat it as a starting point, not an end point.

Up next

In my next post, I’m going to show you exactly how I use Parker Tax Research to work through a question in real time: scrolling, clicking, searching, cross-referencing, and taking notes. It’ll be messy, honest, and practical.

Let me know if you have something specific you’d like me to demonstrate or look up.

We accomplished this with our existing software (no need for any separate apps!), and with a few refinements, we’re looking forward to implementing this approach again next year.

Why We Tried Scheduling This Year

The start of tax season can feel like a floodgate: once returns start coming in, it’s hard to manage priorities, staff capacity, and client expectations. Clients understandably want to know when their returns will be completed, but when everything comes in at once, the only honest answer is “as soon as possible.”

It’s also tricky to know when to start working on a return. For the first couple of months of the year, documents and information can trickle in. Missing forms suddenly appear, along with corrected forms and revelations of new investments, businesses, even marriages and recently born children! Rechecking files and revising returns and estimates can deplete capacity and ratchet up stress.

And what if the client submits the questionnaire, uploads a few documents, and immediately requests updates? What if she has a mortgage application that needs to be finalized, or refuses to file an extension?

Many firms, including ours, usually shift workloads, rearrange schedules, and make costly exceptions for requests like these. But this year, we wanted something different:

• A way to smooth out the workflow so our staff didn’t feel overwhelmed,

• A system that would reduce the endless stream of “What’s the status of my return?” messages, and

• Space to plan around real life—vacations, breaks, even paternity leave!—without feeling like we were letting clients down.

How Scheduling Worked for Steadfast

We asked each of our individual (1040) clients to choose a week by scheduling an “appointment.” During that week, our team committed to reviewing their documents and beginning return preparation. If we were still missing documents or information, we informed the client of what we needed and that they would need to reschedule their review.

If we determine we have what we need during the document review, we committed to a two-week turnaround, beginning with the following week. That means a client should expect to have the return ready to review and sign within three weeks of the start of their document review week.

We allowed a predetermined number of signups each week, based on the number of returns we expected to do and the number of weeks we offered. We included “blackout” periods to account for breaks and to give us opportunities to catch up.

And, of course, we filed extensions for all returns, without exception. We filed proper extensions with genuine estimates of each client’s tax liability based on our projections and information available at the time of filing.

Here’s what changed for us:

• Less stress We controlled the pace, rather than letting the season control us.

• Better planning We had visibility into workload weeks in advance and could block off periods for deadlines, vacations, and family time.

• Fewer status requests Clients knew exactly when their documents were scheduled for review, if we needed more information, and an estimated timeframe for completing the return.

Clients generally found it easy to use. A few were confused because they thought they were scheduling a meeting (not just a review window), and some wondered why they couldn’t pick a week before April 15. Both were simple messaging issues we’ll refine for next year.

Implementing Scheduling in Your Firm

A simple scheduling system can yield major benefits. By adding structure, we reduced stress, gave clients clarity, and allowed our team to balance heavy workloads with real life.

Of course, you probably have questions, even doubts, about implementing a system like this in your firm. (We did too!) Thinking through your firm’s workflows and your clients' needs can help alleviate fears.

First, implementing scheduling helps maintain healthy boundaries for you and reasonable expectations for clients. Telling them to pick a review week, then making exceptions, accepting late submissions, or tolerating nonresponsiveness defeats the purpose. You have to clearly communicate the consequences of not scheduling a document review or not providing all the necessary documents and information by that date.

Next, the timeframes and number of reviews per week we used may not be appropriate for your firm. You could do more than one round per week, or even daily reviews, depending on your capacity and workflows. Just keep in mind that the more reviews you commit to doing each week, the greater the need to add in blackout periods to prevent overloading yourself and your staff.

Also, you may feel like setting this system up would be more trouble than it’s worth. However, you likely have what you need already. Our system worked well with our existing technological infrastructure. We didn’t need special software, and neither do you! You probably have someone in your firm already who could set this up for you, or if not, I’m happy to help!

💡 The rest of this post is for paid subscribers. I’ll walk through the exact setup, including the tools, calendar scheduling, and workflow details so that you can replicate this in your own practice.

Read more

Taxpayers now have relatively short windows to either acquire or place into service certain green energy property if they want to qualify for these tax provisions before they expire within the 12 months.

Tax professionals should clearly communicate these changes to their clients as soon as possible. See below for a taxpayer-friendly message available to paid subscribers.

Clean vehicles

The credits for clean vehicles (EVs) now terminate for property acquired after September 30, 2025. This includes the following:

• §30D clean vehicle credit,

• §25E previously owned clean vehicle credit, and

• §45W qualified commercial clean vehicles credit.

A taxpayer looking to purchase an EV should so so as soon as possible to qualify for one of these credits.

Clean buildings

The following clean building provisions now terminate for property placed in service after December 31, 2025:

• §25C energy efficient home improvement, and

• §25D residential clean energy credit.

A taxpayer making energy-producing or energy-efficient home improvements should do so as soon as possible. Note that this property must be placed in service by December 31, 2025, and there is no special transition rule for binding contracts in effect prior to the above dates (hat tip to for pointing this out).

If you have questions about the §25D residential clean energy credit, listen to Episode 1 of my Tax in Action podcast. (You can also qualify for CE by completing the course on Earmark CPE.) I cover the necessary criteria to claim this credit.

Taxpayer-friendly message (for paid subscribers)

Read more

🎙️ In this episode of Tax in Action, I break down why joint filing is not actually the default, despite how it’s treated in practice. I also walk through how to properly compare filing statuses, review the disadvantages of separate returns, and explain why some clients might still be better off filing separately, whether because of student loans, mistrust, or financial protection.

In this episode, you’ll learn the following:

1. 🏛️ Why joint filing isn’t the default status for married taxpayers under the Internal Revenue Code;

2. 🔎 How to use your tax software to compare joint vs. separate returns accurately and spot common data entry mistakes; and

3. 💸 When it makes sense for a married couple to file separately, even if it increases their overall tax liability.

Earn CPE for listening to this podcast!

Filing status can make a big difference for taxpayers, in terms of both tax and personal finance. Make sure you’re taking all of the taxpayers’ needs into account when you prepare those joint returns!

In this episode, you’ll learn the following:

• 🏠 When you can (and can’t) do a §1031 exchange;

• 🏛️ Rules and exceptions discussed in relevant Tax Court cases; and

• 📑 The necessary people and paperwork to make sure your §1031 exchange is legitimate.

Earn CPE for listening to this podcast!

§1031 exchanges provide a substantial wealth-building tax benefit for real estate investors, as long as they follow the rules. Tax advisors can help owners make sure their transactions are handled and reported properly.

In this episode, you’ll learn the following:

• 📊 How debt-heavy balance sheets can trigger taxable events during an election;

• 😱 Ensuring LLC operating agreement provisions don’t violate S corporation rules and lead to unintended terminations;

• 💼 Equity structures that don't work with single-class stock requirements; and

• 💸 State taxes that can completely wipe out tax savings.

Earn CPE for listening to this podcast!

Partnerships and sole proprietorships often serve business owners better than the hyped S corporation structure. Before you recommend that next S-election, make sure you're considering the full picture, not just the self-employment tax savings.

In this episode, you’ll learn the following:

• ☑ The four-part test for qualified research activities;

• 💸 Identifying eligible expenses, including wages, supplies, and contract research;

• 🧮 Calculating the credit using the Regular and Alternative Simplified Credit methods;

• 💻 Special considerations for internal-use software and the “High Threshold of Innovation” test;

• 📈 How startups can apply the credit against payroll taxes; and

• 🛑 Common myths and pitfalls to avoid.

Earn CPE for listening to this podcast!

Whether you’re advising startups, tech firms, or traditional businesses exploring innovation, this episode provides practical insights to navigate the R&D credit landscape effectively.

🎧 Check out the episode now!

☀️ The Residential Clean Energy Credit under IRC §25D.

In this episode, you’ll learn the following:

• ⚖️ The legal background of §25D, including what kinds of home energy improvements qualify, and which don’t.

• 🗣️ The intake questions you should be asking clients when they install solar panels or other clean energy-producing property.

• 📝 How to report the credit correctly on Form 5695, Residential Energy Credits, and avoid common errors.

• 🏠 What ancillary costs, like roof upgrades, count for the credit.

I start with a real-world example, walk through the legal authority, then apply it all in a way that’s practical for everyday tax work.

Earn CPE for listening to this podcast!

If you prepare 1040s, advise homeowners, or just want a better grasp of clean energy tax incentives, this episode is worth a listen.

🎧 Check out the episode now!

I’m excited to share a brand-new podcast I’m hosting, brought to you by Earmark CPE: Tax in Action: Practical Strategy for Tax Pros! This show brings tax law to life through real-world cases and down-to-earth conversations for working tax professionals.

The first episode launches soon, but the feed is live and ready for subscribers. That means you can be the first to listen when we release Episode 1.

👉 Click here to subscribe!

Anyone can listen to the episodes. But, if you’re an Earmark subscriber, you’ll be able to earn CE/CPE without sitting through boring webinars or in stuffy hotel ballrooms!

And if you have any questions or cases you'd like covered on the show, please let me know!

Thanks for supporting JWellsTax and Tax in Action!

We’ll be diving into books that challenge the way we think about tax, business, and advising clients, all while building a community of like-minded professionals. If you’ve ever wanted to read more but needed a little accountability (or just a good discussion), this is for you.

🔗 Join the book club by clicking here.

📖 Our first book is The Logic of Subchapter K by Cunningham and Cunningham.

I’ll keep signups open through the end of the week. Then, we’ll set our first meeting date and time. I hope to see you in the club!

Get more from Jeremy Wells, EA, CPA in the Substack app

Available for iOS and Android

Get the app

Partnerships—especially smaller, “simpler” ones—tend to gloss over (or outright omit) the centralized partnership audit regime (CPAR) in their operating or partnership agreements (OAs). However, ignoring CPAR or failing to update OAs to include relevant provisions and decision-making procedures can lead to big headaches if the IRS audits a partnership return.

The evolution of the centralized partnership audit regime

The current CPAR seeks to streamline partnership audits through a single, powerful individual. This approach has its roots in the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA), P.L. 97–248, which sought to facilitate IRS audits of partnerships. Before TEFRA, the IRS audited partnership activity at the partner level, leading to inconsistent treatment of partners. Under TEFRA, IRS audited partnerships, made adjustments to “partnership items,” and assessed additional tax at the partner level if necessary. Each partnership designated a tax matters partner (TMP) to coordinate the audit or judicial proceedings. Still, each partner received audit notices, retained the right to participate in the audit or proceedings, and could negotiate separately with the IRS.

In 2014, the U.S. Government Accountability Office (GAO) reported that the IRS audited a significantly smaller proportion of large partnerships than comparably large corporations.1 Passing partnership adjustments to partners, especially in large partnerships and multi-tiered structures, was costly and inefficient. Moreover, the statute of limitations on partners’ returns continued to run while the IRS audited the partnership. Despite attempting to simplify partnership audits, the TEFRA CPAR ultimately resulted in administrative burdens on the IRS, partnerships, and partners.

Congress responded to the GAO report by entirely replacing the TEFRA CPAR with a new one in the Bipartisan Budget Act of 2015 (BBA), P.L. 114–74. The BBA made two critical changes:

1. First, the BBA replaced the TMP with a partnership representative (PR). Only the PR (or a designated individual [DI], if the PR is an entity) receives notices, participates in the audit or judicial proceedings, and makes decisions on behalf of the partnership regarding an audit. The PR (and DI) need not be a partner but must be substantially present in the US.2

2. Second, the BBA simplified tax assessment and collection by imposing an imputed underpayment (IU) at the partnership level, following all adjustments to income, gains, losses, deductions, or credits. The IU uses the highest marginal tax rate—corporate or individual—of the reviewed tax year.3 The PR (or DI) can elect to “push out” the adjustments to partners; however, they pay an additional 2 percent interest rate on the underpayment.4 The PR (or DI) ultimately has the final, irrevocable say.

Congress resolved the flaws of the TEFRA CPAR by replacing the TMP with a fully empowered PR, which can decide whether to bind the partnership to pay additional tax after an audit or to push the adjustments to individual partners. Given this potential power, partnerships should carefully consider the role when crafting their foundational agreements and designating a PR.

Operating agreement issues for managing partnership representatives and audits

The U.S. Small Business Administration recommends each LLC have an operating agreement (OA). An OA “outlines the business’ financial and functional decisions including rules, regulations and provisions” by “govern[ing] the internal operations of the business in a way that suits the specific needs of the business owners.” They usually include, at minimum, a breakdown of members’ ownership percentages, voting rights, and duties; guidelines regarding distributions of profits and losses; and procedures for transferring interests or in the event of a member’s death.

Most OAs I have seen discuss tax issues minimally, usually focusing on a few provisions in the Internal Revenue Code’s (IRC) Subchapter K of Chapter 1, which covers partnership tax rules. I have yet to see an OA that mentions CPAR rules, found in Chapter 63 of the IRC.5 This is a significant oversight with severe potential ramifications for the partnership and its partners.

Tax advisors should explain the importance of CPAR to their partnership clients and encourage them to add language to their OAs regarding CPAR when possible. To help guide the discussion, partners should answer the following questions:6

• Should the operating agreement include a requirement to elect out of CPAR (if eligible) or establish a procedure for the partnership to decide whether to elect out of CPAR each year? Eligible partnerships may elect out of CPAR each tax year.7 Partners should establish a clear rule for making the election (or not) or mandate that the partnership automatically elects out (or not) if it qualifies.

• Should the operating agreement prohibit transfers of partnership interests to persons who would terminate or prohibit an election out of CPAR? As a follow-up to the prior question, it must maintain its eligibility if the partnership mandates electing out of CPAR. Bringing on a partner or transferring a partner’s interest to another individual or entity may disqualify the partnership from electing out of CPAR. The partnership should anticipate this possibility in its OA.

• Should the operating agreement include a procedure for designating a partnership representative? If the partnership does not elect out of CPAR, it must name a PR on its Form 1065, U.S. Return of Partnership Income, or risk letting the IRS designate one in an audit. Partners should protect their ability to assign a PR of their choosing whom they trust to make decisions in their best interests. A partnership should also include a provision for revoking its designated PR.8

• Should the operating agreement describe how and when the partnership will elect to push out the burden of a positive adjustment to the partners? The PR ultimately decides whether the partnership elects to push out the tax burden of positive adjustments to partners; however, the partners should establish a procedure for determining whether to instruct the PR to make that election.

• Should the operating agreement establish whether or not partners who did not own an interest during a reviewed year are liable for tax paid by the partnership for that year? If the partners have changed since the reviewed year, current partners perhaps should have some clear recourse if the PR chooses to have the partnership pay the imputed underpayment.

Partnerships should provide written answers to these questions, preferably in an operating agreement or contract with the PR (and DI) and with the advice of a qualified attorney and tax advisor.

Caveat socius: Limits on partners’ ability to constrain a partnership representative

Given a PR’s relatively immense and unchecked power during an audit, partnerships should consider contractual limits on them. At a minimum, the OA should answer the questions posed above.

The OA, or a separate contract with the PR (and DI, if applicable), should ensure the partners maintain as much decision-making authority as possible. It should also include provisions for revocation or restitution if the PR (or DI) acts incompetently or contrary to the partnership's interests or desires.

But the partners must keep the following two points in mind as they plan for constraining a PR:9

1. Contractual restrictions on a PR (or DI) do not bind the IRS. Partners may have a cause of action against a PR who settles an audit in violation of the OA or a contract, but they cannot contest the adjustment or assessment of tax with the IRS after it has been stipulated by a PR (or DI).

2. Seeking damages from a PR may produce a limited benefit. An entity PR may have little or no assets against which the partners could collect a judgment. Also, an external PR could require indemnity from the partnership in its contract.

Any partnership can wind up in an IRS audit. One can find itself in a difficult situation without taking necessary precautions in preparing an annual tax return, especially including either an intentional election out of CPAR or properly designating a qualified, trustworthy PR. As tax advisors, we should push our small business clients to ensure they have the necessary discussions and written provisions with their partners and legal advisors to mitigate stress and harm during an audit.

Individuals can claim an itemized deduction for charitable contributions to qualified organizations.1 Tax law limits the deductible amount and requires substantiation depending on the value and type of the contribution. (C corporations can generally deduct charitable contributions, up to 10 percent of taxable income.2)

To determine the deductibility of a charitable contribution, a tax professional needs to know the following:

• The recipient organization

• The type of contribution

• The donor’s adjusted gross income and total itemized deductions

Depending on these facts, the tax professional may need additional information about the contribution, such as substantiation or a valuation.

Qualifying charitable organizations

IRC §170(c) defines a charitable contribution as a donation or gift to, or for the use of, a qualified organization. Qualified organization include the following:

• A state, possession, or political subdivision of the United States, if the contribution is for exclusively public purposes;

• A corporation, trust, community chest, fund, or foundation created or organized in the United States or a U.S. possession, which is “organized and operated exclusively for religious, charitable, scientific, literary, or educational purposes, or to foster national or international amateur sports competition (but only if no part of its activities involve the provision of athletic facilities or equipment), or for the prevention of cruelty to children or animals,” provides no benefit to any private shareholder or individual from net earnings, and is not disqualified for tax exemption under IRC §501(c)(3);

• A post or organization of war veterans organized in the United States that provides no benefit to any private shareholder or individual from net earnings;

• A domestic fraternal society, order, or association, operating under the lodge system, using the contribution or gift from individuals exclusively for religious, charitable, scientific, literary, or educational purposes, or for the prevention of cruelty to children or animals (college fraternities and sororities do not qualify)3; and

• A cemetery company owned and operated exclusively for the benefit of its members, not operated for profit and provides no benefit to any private shareholder or individual from net earnings.

Most religious organizations (churches, temples, synagogues, mosques), nonprofit charitable organizations, colleges, museums, nonprofit hospitals and medical research organizations, and public parks and recreation facilities qualify. Contributions or membership dues paid to civic and business organizations, such as chambers of commerce, civic leagues, country clubs, homeowners associations, labor unions, and political organizations usually do not qualify as charitable contributions.

NB Contributions to political campaigns do not qualify as charitable organizations. With this year’s political activity, tax professionals and advisors should communicate this to their clients proactively.

Contributions to foreign charitable organizations generally do not qualify as deductible; however, if a qualifying organization carries on charitable activities outside the U.S., a taxpayer may deduct contributions to the organization.4

The IRS provides a free tax exempt organization search tool to help confirm whether an organization qualifies. However, the search tool may not include qualifying organizations exempt from filing, such as religious organizations.5

Qualifying charitable contributions

To qualify as a deductible charitable contribution, the taxpayer must voluntarily transfer money or her entire interest in property to a qualifying organization without receiving or expecting a substantial financial or economic benefit.6 If a taxpayer receives a benefit in exchange for a contribution, she may deduct the amount of the contribution in excess of the value of the benefit received, as long as she made the remaining contribution with the intention of a gift.7 Small benefits of token value, or sent to the taxpayer in connection with a fundraising campaign, are deemed to have insubstantial fair market value (FMV).8

If a taxpayer makes a gift to a specific individual, or earmarked for the benefit of a specific individual, including a disaster victim or a needy person, the taxpayer cannot deduct the gift as a charitable contribution.9 This includes crowdfunded giving, such as GoFundMe.

A taxpayer may not deduct the value of her time or services. This includes lost wages and blood donations.10 However, unreimbursed out-of-pocket expenses incident to performing services for a qualified organization — such as mileage at the charitable rate, parking, tolls, or required uniforms with no general utility — are deductible. Reasonable meals and lodging are deductible only when the volunteer must be away from home overnight and the trip is primarily for charitable services, not personal pleasure.11

Valuing charitable contributions

Generally, a taxpayer may deduct the FMV of property contributed to a qualified organization.12 IRC §6662(h)(1) imposes a 40 percent gross valuation misstatement penalty, effectively doubling the accuracy-related penalty of IRC §6662(a).13

A taxpayer may need to reduce the FMV of appreciated property when calculating the deduction.14 The FMV of ordinary income property, such as inventory, works of art or manuscripts created by the donor, and short-term capital assets, must be reduced by the amount of ordinary income or short-term capital gain if the taxpayer sold it for FMV.15 This generally limits the value of the deduction to the lower of FMV or the taxpayer’s basis in the property. However, the taxpayer may deduct the FMV of appreciated property if she includes the ordinary or capital gain in gross income in the same year as the contribution.16 A taxpayer may deduct the FMV of certain long-term capital gain property, including qualified appreciated stock.17

A gift of property subject to a liability results in a bargain sale: if the FMV exceeds liability, the difference is a charitable contribution; however, if the liability exceeds the FMV, the taxpayer recognizes a gain.18

Contributions of clothing and household goods must be in good used condition or better to qualify for a deduction, unless the taxpayer includes a qualified appraisal with her return.19 Household goods include furniture, furnishings, electronics, appliances, and linens, but not food, antiques, artwork, jewelry, gems, or collections.20

If a taxpayer contributes a motor vehicle, boat, or airplane with a claimed value of more than $500, she may deduct the lesser of the gross proceeds from the sale of property by the organization or the FMV or the property on the contribution date.21 If the organization significantly uses or materially improves the vehicle, or transfers it to a needy individual at a price well below FMV, the taxpayer can deduct the FMV of the vehicle on the contribution date.22

For businesses contributing inventory, the business reduces the FMV of the inventory by the ordinary gain had the business sold the inventory. Thus, the deductible value of donated inventory is the lesser of FMV or cost, and inventory is reduced by the contribution’s cost (to avoid double counting as cost of goods sold).23

Substantiating and reporting charitable contributions

Taxpayers should keep records of all monetary charitable contributions, including bank statements or written acknowledgments from the donee showing the name of the organization, date(s) of the contribution(s), and amount(s) given.24 The taxpayer may rely on a paystub or Form W-2 for contributions made by payroll if she also receives a document prepared by the donee showing the required information.25

For noncash charitable contributions over $500, the taxpayer must file Form 8283, Noncash Charitable Contributions. She must also substantiate the donation, depending on the value of the contribution:

• Less than $250 A receipt showing the name and address of the donee, the date of the contribution, a description of the property, and in the case of securities, the name of the issuer and type of security.26 When the taxpayer cannot practically obtain a receipt, such as deposits at a donee’s unattended drop site, she can satisfy the recordkeeping requirement by maintaining reliable written records.27

• Between $250 and $500 A contemporaneous written acknowledgment from the donee including a description (but not value) of property donated, whether the donee provided any goods or services to the donor in consideration for the property donated, and if so a good faith estimate of the value of those goods or services or a statement they consist solely of intangible religious benefits.

• Between $500 and $5,000 A contemporaneous written acknowledgment (see above) and completion of Form 8283, Section A. For vehicle contributions, the taxpayer must also attach a copy of the acknowledgment.

• Over $5,000 A contemporaneous written acknowledgment (see above), a qualified appraisal, and completion of Form 8283, Section B, unless the property is a publicly traded security, certain intellectual property, a qualified vehicle, or inventory for sale. The appraiser must provide a declaration including the statement found in Treas. Reg. §1.170A-16(d)(4).28 Note that Form 8283, Section B requires a signature of an official authorized to sign for the donee. A taxpayer who donates a vehicle, boat, or airplane must attach Form 1098-C, Contributions of Motor Vehicles, Boats, and Airplanes, Copy B or a similar statement received from the organization and, if the claimed value exceeds $500, also complete Form 8283. If the claimed deduction for non-publicly-traded property exceeds $500,000, the taxpayer must also attach the qualified appraisal to the return.

Passthrough entities (partnerships and S corporations) must abide by reporting, substantiation, and valuation rules at the entity level; however, deductions are denied at the partner or shareholder level.29

NB Communicate the recordkeeping requirements for noncash contributions to clients before you receive the stack of blank Goodwill forms! Back-and-forth communication about these contributions slows down return preparation and reduces efficiency. If you prepare returns, clarify for clients how they should report charitable contributions to you and how they should substantiate those contributions.

Taxpayer limitations on deducting charitable contributions

A taxpayer must deduct a charitable contribution in the year made (or in a succeeding carryover year), regardless of whether the taxpayer uses the cash or accrual method.30 A contribution is considered made when delivered or mailed.31

An individual taxpayer’s deduction for charitable contributions is generally limited to 50 percent (60 percent for tax years 2018, 2019, 2021–2025; 100 percent for 2020) of the taxpayer’s adjusted gross income (AGI) without regard to any net operating loss (NOL) carryback to that tax year.32 Gifts to certain organizations, of capital gain property to certain organizations, or “for the use of” rather than “to” a qualified organization are limited to 30 percent of AGI.33 Gifts of capital gain property to certain organizations are limited to 20 percent of AGI.34 A taxpayer may carryover charitable contributions in excess of the AGI limit for up to five years.

NB Deductible charitable contributions only benefit the taxpayer if they itemize! Discuss charitable giving, especially for tithers and philanthropists, if you offer year-end planning. The taxpayer may receive a greater tax benefit by accelerating contributions in the current year, “bunching” contributions in alternate years, or contributing appreciated long-term assets. A retiree may also consider a qualified charitable distribution (QCD) from an individual retirement arrangement (IRA), especially if she is required to take a minimum distribution (RMD).35

A taxpayer contributing food inventory may not deduct more than 15 percent of the taxpayer’s net income from all trades or businesses contributing food inventory.

But I want to make sure it’s helpful for you. So I’d love it if you could do the following:

1. Click here and read the draft article.

2. Reply to this email with any comments, questions, or suggestions. Let me know what would make it more helpful for you.

I’ll leave the link open until tomorrow morning (Friday, Eastern time).

As a thank you, I’ll give a free one-year subscription to the most helpful reply I get.

By the way, this will probably be my last “Thursday thoughts” article. I’ll still publish articles, and I’m working on a more consistent publishing schedule, but I found that the need to publish something weekly tuned into publishing anything weekly, and that’s not good for anyone.

In the order, the judge stated that the Court could not find three of the four cases cited in the memorandum. For those three, the names of the cases cited were real, but they were not at the locations given, and the actual cases were unrelated to the petitioner’s issue. And the locations of the hallucinated cases cited pointed to different cases that were also unrelated to the current case.

The judge found the memorandum violated the Court’s Rule 33, which requires counsel’s signatures on submissions to the Court. The US Tax Court Rules of Practice and Procedure require that counsel sign every pleading, and the effect of that signature is the following:

Counsel or a party signing a pleading certifies that the signer has read the pleading; that, to the best of the signer’s knowledge, information, and belief formed after reasonable inquiry, it is well grounded in fact and is warranted by existing law or by a nonfrivolous argument for extending, modifying, or reversing existing law or for establishing new law; and that it is not presented for any improper purpose, such as to harass, cause unnecessary delay, or needlessly increase the cost of litigation. (Rule 33, emphasis added.)

“In short,” the judge summarized, “it is the attorney who signs a pleading who is responsible for its content.”

In a hearing to address the erroneous citations, counsel admitted to the Court that she had recently joined a new firm and relied on a paralegal to draft the memorandum. Neither counsel nor the Court could confirm whether AI generated the memorandum; however, according to the judge, it “has the hallmarks of a document prepared with the assistance of a large language model.”

The judge then took advantage of the opportunity to discuss the use of AI, despite admitting “it is unclear whether, or to what extent, some form of AI may have been used to assist in preparing petitioner’s Pretrial Memorandum.”

Generative AI and the risk of hallucinations

Generative AI, which could have produced the memorandum at issue, is an extension of machine learning (ML). ML applies algorithms–a “model”–to relatively large sets of data to observe patterns and then classify new data based on those patterns. The classic example involves inputting thousands of images of dogs to train a model and then asking it whether or not a new image contains a dog.

Where ML stops at classifying data, generative AI goes a step further by producing new content. Back to the example using cats and dogs: a generative AI model can take what it knows and produce a unique image of dog.

But complications can arise. For example, often in images of living creatures, for example, models will include an unrealistic number of arms, legs, fingers, eyes, or other appendages. Newer models have fixed some of these issues, but an image of a person with six fingers on each hand or two knees in one leg was a tell-tale sign of an AI-generated image.

We call these unrealistic features in AI-generated content hallucinations. The term gives us an anthropomorphic metaphor for what happens when a model produces an erroneous output.

Models that produce written output also generate hallucinations the form of nonsensical or false statements, such as the incorrect court case citations in the memorandum. Generative AI models produce output that appears accurate, but an informed reader can quickly discover hallucinations.

It is nearly impossible to predict when and how often a model will hallucinate. And attempts to prevent hallucinations, such as through prompt engineering, cannot guarantee complete accuracy. So although AI models can speed up the process of producing technical written content, someone with subject matter expertise should review the output before sharing it.

Using AI in tax practice

The issue in this case was not the use of AI to generate the memorandum; rather, it was counsel’s failure to review it before signing and submitting it to the Court. The paralegal who generated the memorandum could have easily made up the cases and citations herself.

Discussing the use of AI, the judge wrote “The Court is not in the business of dictating to attorneys the extent to which they can or should rely on advancing technology to assist them in representing their clients.” In fact, the Court makes the case that AI can help those who lack the financial resources to retain legal counsel avail themselves of the judicial system on a near equal footing.

AI provides a potentially useful tool for reviewing, summarizing, and producing content for tax professionals as well. But we must remain vigilant in our use of it. Circular 230 §10.22(a) requires that practitioners “must exercise due diligence… In determining the correctness of oral or written representations made by the practitioner to the Department of the Treasury; and… In determining the correctness of oral or written representations made by the practitioner to clients with reference to any matter administered by the Internal Revenue Service.” This requirement predates widespread use of AI, and applies to all of our work.

Now your thoughts…

How are you using AI in your practice? What safeguards do you have in place around using AI? If you haven’t started using it, why not?

To read the Court’s order, see “Order that petitioner’s Pretrial Memorandum is deemed stricken.” Gary Thomas v. Commissioner, Docket No. 10795–22 (USTC).

Hat tip to David Fazio, EA, USTCP for sharing the case and order with the InCite community. If you aren’t a member of InCite yet, I can’t recommend it enough!