Charitable contributions of inventory.

Under Sec. 170(e) (3) (A), a corporation is allowed a deduction in excess of its cost basis if it donates inventory to qualified charitable organizations and the property is used for the care of the ill, needy or infants by that charity in carrying out its exempt purpose. Contributions of inventory by a corporation to public charities to be used for the care of the ill, needy or infants are reduced by only one-half of the gain that would have been ordinary income had the property been sold. This is an exception to the general rule that limits inventory contributions to the corporation's cost. One of the major issues between the IRS and corporate contributors in connection with such donations is the fair market value (FMV) of inventory that is no longer "new" merchandise.

The Tax Court recently held that a taxpayer's contributions of bakery products to qualified charitable organizations were "qualified contributions" of inventory under Sec. 170(e) (3) (A) (Lucky Stores, Inc., 105 TC No. 28 (1995)).

At issue was whether bakery products that had been pulled from the retail shelves after three days should be valued at full retail price or at a reduced value (as suggested by the Service). The Tax Court held that donations should be valued at full retail prices.

The taxpayer sold assorted bread products at its stores by having the products delivered to its retail outlets each morning except for Wednesdays and Sundays. Supplies delivered to each store were loosely calculated to provide 5% more inventory than was normally required (to guarantee there would not be a shortage). The taxpayer would remove any unsold bread on the fourth day after delivery.

The pulled bread products would be donated to charitable organizations for their use in caring for the needy. The taxpayer did not sell the pulled bread products at a discount to the public.

The IRS contended that the four-day-old inventory could not be sold at full retail prices and argued for a 50% reduction in FMV. The taxpayer countered with evidence that four-day-old bread did sell at full retail price, so full retail price should be the value used in determining its Sec. 170(e) deduction.

The Tax Court determined that the Service's position limiting excess inventory to 50% of full retail value would be unfair to Lucky Stores since it purposefully overproduced bread products. The court felt it would be inappropriate to penalize the taxpayer for doing so. Finally, since the taxpayer did in fact sell four-day-old bread at the usual retail price, it should be entitled to a deduction based on that retail price. The Tax Court felt it was inappropriate to find a valuation somewhere between the IRS approach and the full retail value argued by the taxpayer.

The donation of inventory and the accompanying deduction is a common exam issue between retailers and the Service. This case indicates the Tax Court's willingness to accept the taxpayer's valuation of donations of inventory, and provides favorable authority to assist taxpayers in defending administrative challenges.