10th Circuit: Donation of Discovery Materials in Bombing Trial Worth $.3M Not Tax Deductible

Holding:

The U.S. Court of Appeals for the Tenth Circuit has turned down a $0.3 million charitable tax deduction by Leslie Stephen Jones, defense counsel of Oklahoma City bomber Timothy McVeigh, for the attorney’s donation of discovery materials in the bombing trial to the University of Texas. Specifically, the Tenth Circuit rejected Jones’ contention that the discovery materials, made up of FBI statements, memoranda, lab reports, computer discs, and photographs, does not fall under the Internal Revenue Code’s (“IRC”) definition of a “capital asset” because these were prepared or produced for him. The Tenth Circuit noted that that the discovery material was provided to petitioner only because of his position as lead counsel for McVeigh, and it was the type of material typically produced for defense counsel in the course of a criminal trial. Accordingly, the Tenth Circuit held that the discovery material donated by petitioner falls within the plain language of 26 U.S.C. § 1221(a)(3)(B) -- thereby limiting the charitable deduction amount to petitioner’s basis in the property. Because petitioner had no basis in the discovery material, the Tenth Circuit ruled that petitioner is precluded from claiming any income tax deduction for his charitable donation. On the basis of the foregoing, the Tenth Circuit affirmed the Tax Court’s judgment.

Detailed Summary:

In July 2004 the Commissioner issued a notice of deficiency to petitioners for the years 2000 and 2001 in the amount of $14,784.99. The basis for the deficiency was the Commissioner’s determination that petitioners improperly claimed a large income tax deduction for a charitable contribution of discovery material that Leslie Stephen Jones acquired while serving as lead defense counsel in the Oklahoma City Bombing trial. Petitioners contested the deficiency notice in U.S. Tax Court, and then appealed the tax court’s judgment upholding the Commissioner’s determination.

Petitioner Jones was lead defense counsel for McVeigh in the Oklahoma City bombing trial. During the course of his representation, the government provided petitioner with voluminous discovery material related to the prosecution of McVeigh. The same discovery material was furnished to the Oklahoma State Bureau of Investigation, the Oklahoma County District Attorney’s Office, and counsel for McVeigh’s co-defendant, Terry Nichols.

Subsequently, in December 1997, petitioner donated the discovery material to the Center for American History at the University of Texas. Prior to the donation, petitioner had the discovery material appraised by an expert at a value of $294,877.00. Petitioner claimed a deduction for the material on his 1997 income tax return. The excess amount of the deduction was carried over to subsequent tax years.

In 2004 the Commissioner noticed petitioner for income tax return deficiencies of $3,675.00 in 2000 and $11,109.99 in 2001. The Commissioner informed petitioner that he did not “own” the donated material and, therefore, could not claim a charitable contribution deduction.

Relying on precedent from jurisdictions outside Oklahoma, and the Oklahoma Rules of Professional Conduct, the tax court held that primary ownership in an attorney’s case file lies with the client and not the attorney. Thus, petitioner did not own the donated discovery material.

The Tax Court also ruled, in the alternative, that if petitioner owned the discovery material, it was not a “capital asset,” and, therefore, the amount petitioner could claim as a deduction was equal to his basis in the donated material.

The Tenth Circuit noted the Tax Court’s ruling that if petitioner owned the discovery material, it was excluded under the IRC’s definition of capital asset pursuant to 26 U.S.C. § 1221(a)(3)(A). Specifically, the Tax Court held that the discovery material qualified as “letters, memoranda, or similar property created by the taxpayer’s own efforts.” Opinion, p. 7, citing Jones v. Comm’r, 129 T.C. 146, 159 (2007).

The Tenth Circuit however noted that the property which petitioner claimed as a charitable contribution was not created by his own personal efforts. Thus, the Tenth Circuit held that the Tax Court incorrectly applied § 1221(a)(3)(A) to the discovery material.

According to the Tenth Circuit, under § 1221(a)(3)(B) of the IRC, property described as a “letter, memorandum, or similar property” that is “prepared or produced” for a taxpayer, is excluded from the IRC’s definition of “capital asset.” Id., p. 8, citing 26 U.S.C. § 1221(a)(3)(B).

Thus, the hypothetical sale of such property provides only ordinary income—meaning the allowable income tax deduction for donating the item to charity is limited to the taxpayer’s basis in the property. Id., citing Maniscalco v. Comm’r, 632 F.2d 6, 8 (6th Cir. 1980).

The Tenth Circuit concluded that the discovery material, consisting of FBI memoranda, lab reports, computer discs, and photographs,  is properly characterized as “letter(s), memorand(a), or similar property.” Id., p. 9, citing 26 U.S.C. § 1221(a)(3)(B).

Admittedly, the discovery material was not originally created for petitioner’s benefit. Rather, the government first compiled the material to assist in its investigation and prosecution of McVeigh.  The government then produced the discovery material for petitioner. The Tenth Circuit noted that that the discovery material was provided to petitioner only because of his position as lead counsel for McVeigh, and it was the type of material typically produced for defense counsel in the course of a criminal trial. Id., p. 10, citing Morrison v. Comm’r, 71 T.C. 683, 689 (1979). The Tenth Circuit held that these letters and memoranda should be excluded from the IRC’s definition of capital asset.

Accordingly, the Tenth Circuit held that the discovery material donated by petitioner falls within the plain language of 26 U.S.C. § 1221(a)(3)(B)—thereby limiting the charitable deduction amount to petitioner’s basis in the property. Id., p. 11, citing Morrison, 71 T.C. at 689. Because petitioner had no basis in the discovery material, the Tenth Circuit ruled that petitioner is precluded from claiming any income tax deduction for his charitable donation.

On the basis of the foregoing, the Tenth Circuit affirmed the Tax Court’s judgment.

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