Corporate philanthropy doesn’t have to be limited to just writing checks. Charities also appreciate donations of time, skills, inventory and capacity. Of these alternative options, the IRS has given “in-kind” donations of inventory a few complicating wrinkles, so we’ll try to smooth those out for you today.
First of all, what’s “in-kind”? Generally, we mean that it’s a payment in a non-monetary form. In Latin, it was “a kind of payment,” or in specie. That means that there are lots of forms that gifts in-kind can take, including things like inventory or companies. In most cases, in-kind will just refer to donations of inventory, from raw materials to finished goods.
For more alternative ways to donate to charity, check out CSR Best Practices for Small Business, our free whitepaper.
From a deduction perspective, the IRS treats in-kind donations of inventory differently than other donations of non-publicly traded assets, such as stock in private companies. Partly, this is in response to the existence of organizations who fraudulently solicit contributions of food, clothing or other property, and then either sell it, or use the contributions to mask the unlawful enrichment of the managers of these charities.
Overcoats for Orphans solicits manufacturers and retailers for used or damaged clothing. They also send out a direct mail appeal for cash donations from the general public. They report the fair market value of donated coats at $5 million, and 100% of the cash donations ($250,000) are used to pay the managers. The typical efficiency ratio shows that >95% of donations are dedicated to program activities. Unfortunately, all the coats are going to a landfill, and the “managers” are really just one guy running a charity scam.
Overcoats for Orphans highlights two areas that make in-kind donations tricky:
- The valuation of the contribution
- Proof that the contributions are actually reaching people in need
The Treasury Department has instituted a couple of provisions that help prevent the above scenario, all of which can be found in IRC 170.
While donations of property can generally be deducted at fair market value, that amount is reduced by “the amount of gain that would not be long-term capital gain”. What that usually means for donations of inventory is that when fair market value is higher than cost basis, you only get to deduct cost basis.
Example 1: Stardew Manufacturing donates 100 widgets to charity. The fair market value of the widgets is $1000, and the cost basis is $100. There is no long-term capital gain on the widgets, so the deduction is:
Example 2: Stardew Manufacturing donates 100 solid gold widgets to charity. The fair market value of the widgets is $1000 and the cost basis is $100. The price of gold has risen over the last two years that they’ve been in inventory so there is $250 of long-term capital gain. The deduction is:
There is an exception to the above rule, usually referred to as the enhanced deduction. Donations of inventory directly to a public charity or private operating foundation that distributes to the needy can be deducted the lower of two alternative calculations.
In order to receive the enhanced deduction, several pieces of documentation are required to be produced, including
- a description of the property and the date it was donated,
- a statement that the property will be used in compliance with IRC 170(e)(3) and 1.170A-4A(b)(2) and (3),
- a statement that the recipient organization is exempt under IRC 501(c)(3),
- a statement that adequate books and records will be kept and made available to the IRS on request, and
- when the value exceeds $5,000, filing of Form 8283.
Example 3: Stardew Manufacturing donates 100 widgets to charity. The fair market value of the widgets is $1000, and the cost basis is $100. Their donation meets the criteria for the enhanced deduction, so their deduction is the lower of
Why is this so complicated?
These provisions were put into tax law back in 1969, when it was possible to make more money by donating inventory to charity than by selling it, simply by avoiding the high taxes on sales. That would be much harder to do now since we don’t have a 70% tax bracket, but the regulations remain in place anyway.
Despite the complicated rules, in-kind donations are a great way to make tax-deductible contributions to charity, especially when you can take advantage of the enhanced deduction.