All-wheel drive: IRS approves car donations. (Taxing Issues).

We have all been deluged with radio and television pleas from various organizations asking for donations of used cars, boats, trailers and other items. Typically, the ads talk in terms of claiming a deduction for the "full market value" of the vehicle. The ads promise free towing, so the car doesn't even have to be in operating condition.

This flood of advertising has not gone unnoticed by the Internal Revenue Service (IRS). They have issued a number of warnings in recent years, both to charities and to potential donors. The IRS is concerned that the charities are implying that a donor can deduct the "blue book" value, even if the car isn't running. The IRS is also concerned that in some programs, the vehicles go directly to a car dealer and the charity doesn't really take title or bear any risk of loss. While many organizations have started car donation programs, others may have shied away from the idea due to the IRS concerns.

If your organization has considered starting a car donation program, the IRS has finally told you how to do it. In April, 2002, a private letter ruling was issued for the structure of a charity's vehicle donation program. The ruling, PLR 200230005, which was made public in August, deals with a public charity (Charity) whose purpose is "to find a cure for certain illnesses." Charity operates through local chapters, but the program is in the name of the parent organization.

The program's structure

Charity proposed to sign an agency agreement with a limited liability corporation that was a registered charitable fundraiser (LLC). LLC's business is to buy, store, maintain, dismantle and sell used motor vehicles, vessels and other personal property.

An individual and his controlled corporation own LLC. Charity has no other connection to these parties. The agreement appoints LLC as Charity's agent to act in Charity's name. The agreement is for the purposes of advertising for car donations; picking up the donated items; arranging for qualified appraisals if needed; processing, repairing and selling the vehicles and doing any other necessary acts to accomplish the transactions.

LLC agrees to pay all costs of the program, including repairing or maintaining the vehicles and selling or otherwise disposing of them. LLC has discretion to determine how to dispose of each vehicle received; i.e. whether to scrap it or sell it at auction.

LLC will receive a percentage fee from the sales proceeds. Charity is the equitable owner of the vehicles until they were sold, and bears the risk of accidental loss, damage or destruction. LLC handles advertising of the program, subject to Charity's review and approval, including establishing a toil-free telephone number.

LLC will provide the donor with a blue book printout, along with a disclosure that "the printout does not in any way represent the opinion of LLC or Charity" as to fair market value. Donors sign a Certificate of Donation and other paperwork needed to transfer title. LLC provides a thank you letter and. an official receipt from Charity for each donation.

LLC also processes all required Department of Motor Vehicles paperwork under a power of attorney from Charity. If a donor needs an appraisal (i.e., if the value of the vehicle is more than $5,000), LIC will arrange for an unaffiliated appraiser at donor's expense. LLC will sign Form 8283 acknowledging receipt of the property.

IRS analysis

The IRS considered three issues:

1. Did the donations qualify as charitable contributions?

2. Did this program affect Charity's Section 501(c)(3) status?

3. Was the income subject to unrelated business income tax?

They answered each question favorably. The donations did qualify as charitable contributions by the donors. LLC was clearly acting as Charity's agent in connection with the program. The agreement provided that Charity directed and controlled LLC in its conduct. Charity will be the owner of the property until LLC disposes of it. LLC will provide regular reports to Charity on finances and advertising, and Charity has the right to audit and inspect LLC's records.

Therefore, assuming the program operates in accordance with the agreement, the donations will be made to Charity and qualify as contributions.

The IRS went on to review the thank you letter and determined it complied with the tax rules for substantiation of charitable contributions, subject to some minor revisions. IRS also held that LLC could properly sign Form 8283 on behalf of Charity.

The ruling also indicates that operation of the program will not jeopardize Charity's Section 501(c)(3) status. The issue here is whether the contingent compensation to LLC "inured to the benefit of a private individual or shareholder" or constituted a substantial private benefit. Violation of either of these rules can cost Charity its exemption.

The IRS noted that contingent compensation can create a conflict of interest between the organization and the service provider. However, in this case, the agreement was negotiated at arm's length. It serves a real and discernable business for Charity. The compensation depends on accomplishment of the objectives of the agreement, and not on Charity's other incoming revenues.

Finally, there was no evidence of abuse or unwarranted benefits to LLC or its owners. Therefore, the IRS found that there was no inurement to LLC. With regard to private benefit, the IRS focused again on the arm's length negotiations and the fact that there were no other relationships between the parties. Therefore, they held that any private benefit was incidental.

The ruling concludes that the program will not represent an unrelated trade or business. Under Code Section 513(a)(3), a business that consists of selling merchandise that has been received as gifts is excluded from the definition of trade or business. As all of the vehicles sold will be donated to Charity, the sales program will not generate unrelated business income.

Conclusion and comments

This ruling, while not precedential, should provide great comfort to you if your organization already operates a vehicle donation program or is thinking of starting one. The IRS has issued numerous threatening comments in recent years about these programs.

While the approved structure is not terribly surprising, it is good to see that the IRS has instructed on how to do it. If your organization already operates a program, you should review its mechanics to see how close you come to the facts in this ruling. If there are significant differences, you should see if you can change your program.

The IRS has been particularly concerned about programs where a dealer pays the charity a fixed amount per vehicle, regardless of the sales proceeds. In this type of program, the IRS believes that the gift of the car is not to the charity but to the dealer, who then makes a payment to the charity for the use of its name. It is noteworthy that, in the case in this ruling, Charity remains the equitable owner, bears the risk of loss, and receives more or less money depending on the sales price.

Another interesting point is that the IRS didn't really comment on the valuation of the cars. The ruling does mention the disclaimer that Charity includes when it provides the "blue book" valuation. Such a valuation assumes the vehicle is in good operating condition. If it is damaged or otherwise doesn't function well, the valuation should be less than the blue book value.

It is good that the IRS did not impose any requirement on Charity or its agent to validate the valuation claimed. However, if you receive a donation valued at more than $5,000, and you acknowledge it on Form 8283, you are required to file Form 8282 if you dispose of the property within two years.

This will always be the case with vehicle donation programs. You have to file Form 8282 within 125 days of disposing of the property. You send copies to IRS in Ogden, Utah and to the original donor.

Therefore, the IRS will know how much you received for a car that was originally valued at more than $5,000. If the donor valued the car at less than $5,000, and thus did not need an appraisal, there is apparently no burden on you to notify the donor of the sale price when you dispose of it.

Harvey Berger is a partner and national director of not-for-profit tax services in Vienna, Va., for the accounting and management consulting firm Grant Thornton LIP. His email address is: [e-mail].