Substantiation rules for charitable gifts.

EXECUTIVE SUMMARY

* Under the PPA '06, taxpayers must keep specific written records, such as a bank record or receipt, for all cash donations.

* The substantiation rules for property donations depend on the amount given.

* Under the AJCA changes and IRS guidance, special rules apply to vehicles if the deduction exceeds $500.

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The charitable contribution substantiation rules have become increasingly detailed and more complex in recent years. This article provides an overview of the current rules for cash, property and vehicle donations.

Sec. 170 allows taxpayers a deduction for contributions made to charitable organizations. Over recent years, the extent and complexity of the substantiation requirements for such deductions has increased. For example, the American Jobs Creation Act of 2004 (AJCA) added substantiation and valuation requirements that apply specifically to vehicles. Previously, the Revenue Reconciliation Act of 1993 increased the substantiation requirements for charitable contributions in general. In this article, the current substantiation requirements for charitable contributions, including cash, property and vehicle donations, are discussed.

Cash Contributions

For all cash contributions, including those by check, credit card or other monetary instrument, taxpayers should maintain records of the amount, name of the charitable organization and date of the donation.

PPA '06

Pension Protection Act of 2006 (PPA '06) Section 1217(a) modified the substantiation provisions for cash contributions. In particular, Sec. 170(f)(17) provides tougher substantiation provisions for cash contributions. This section provides that cash contributions are deductible only if the donor maintains either a bank record or a written communication from the donee showing the organization's name, and the contribution date and amount. Other written records, such as the taxpayer's diary or log, would not be sufficient. This new provision effectively toughens the substantiation requirements for the small contributions discussed below and is effective for tax years beginning after Aug. 17, 2006.

Less Than $250

According to Regs. Sec. 1.170A-13(a), proper substantiation for cash contributions of less than $250 includes a cancelled check or any of the following:

* A receipt (including a letter or other communication) from the donee charitable organization, showing the name of the donee, the date and the contribution amount.

* Other reliable written records showing the donee's name, the date and the amount. The burden of proof is on the taxpayer to establish reliability. Regs. Sec. 1.170A-13(a)(2)(i)(B) provides that a contemporaneous diary entry stating the amount, date and name of the donee organization made by a taxpayer who regularly makes such entries would generally be considered reliable.

* For small contributions, any written or other evidence received from the donee organization (including an emblem, button or other token traditionally associated with the organization).

IRS Pub. 526, Charitable Contributions, provides that any of the following account statements are acceptable substantiation, as long as they are legible:

* If payment was by check, the check number, amount, date posted and to whom paid.

* For an electronic funds transfer, the amount, date posted and to whom paid.

* If payment was by credit card, the amount, transaction date and to whom paid.

$250 or More

Special provisions apply when substantiating a cash contribution of $250 or more. According to Sec. 170(f)(8), there must be a contemporaneous written acknowledgment of the contribution by the donee organization, containing the following information:

* The amount of cash contributed.

* Whether the organization provided any goods or services in consideration (in whole or part) for the cash contributed.

* A description and good-faith estimate of the value of any goods or services provided by the donee organization, or if such goods or services consisted solely of intangible religious benefits, a statement to that effect.

Taxpayers should obtain the acknowledgment on or before the earlier of the date the tax return is filed for the year of the contribution or the due date (including extensions) for filing the tax return.

In most cases, taxpayers who make charitable contributions by way of payroll deductions do not need an acknowledgment from the donee organization. However, if $250 or more is deducted from a single paycheck, Sec. 170(f)(8)'s contemporaneous-written-acknowledgment requirement applies. Regs. Sec. 1.170A-13(f)(11) provides that the donor meets this requirement with:

* A pay stub, Form W-2 or other document furnished by the employer that sets forth the amount withheld for the purpose of payment to a donee organization.

* A pledge card or other document prepared by, or at the direction of, the donee organization. The card or document should include a statement to the effect that the donee does not provide goods or services in whole or partial consideration for any contribution.

As can be seen, the substantiation requirements for contributions of $250 or more are more cumbersome than those for contributions of less than $250. What happens when multiple contributions, each below $250, are made to the same charity, if their combined total exceeds $250? According to Kegs. Sec. 1.170A-13(f)(1), separate contributions to the same charity, each less than $250, are not subject to Sec. 170(f)(8)(A)'s provisions, even though the total contribution may exceed $250. Presumably, multiple checks written to the same organization on the same date should be considered as one donation for purposes of determining whether the $250 threshold is met. (1)

Out-of-Pocket and Car Expenses

Certain out-of-pocket expenses related to the provision of services to a qualified charitable organization are deductible. If the deduction for such costs is $250 or more, Regs. Sec. 1.170A-13(f)(10) provides that the following will serve as a contemporaneous written acknowledgment:

* A description of the services provided by the taxpayer.

* A statement of whether the donee organization provided any goods or services in consideration for the unreimbursed expenses.

* If the donee organization provided any goods or services other than intangible religious benefits, a description and good-faith estimate of their value.

* If the donee organization provided any intangible religious benefits, a statement to that effect.

Car expenses related to the provision of services to a qualified organization are generally allowable as a charitable donation, but reliable records must be retained to substantiate the deduction. According to Pub. 526, records are deemed reliable if made regularly and near the time of the expense. The records should include the name of the donee organization and each date the car was used for charitable purposes. If the standard mileage method is used, the records should include the number of miles used for charitable purposes. (2) If the actual-expense method is used, the records must show the costs of operating the car directly related to charitable purposes.

Property Contributions

Substantiation requirements for property contributions depend on the amount contributed. Property contributions are divided into the following categories:

* Less than $250;

* From $250 to $500;

* Over $500 to $5,000; and

* Over $5,000.

The rules for combining property contributions for purposes of the $250 threshold are essentially the same as those for combining cash contributions. Accordingly, separate contributions should not be combined in determining if a contribution exceeds $250.

PPA '06 Section 1216 modified the rules for contributions of clothing and household items after Aug. 17, 2006. Specifically, under Section 1216, with one exception, no deduction is allowed for contributions of clothing and household items, unless they are in good used condition or better. The exception applies to contributions of clothing and household items for which a (1) deduction of more than $500 is claimed and (2) qualified appraisal is included with the return.

Under $250

Regs. Sec. 1.170A-13(b) provides that substantiation is adequate if a receipt, letter or other written communication is received from the donee organization and contains the following information:

* The name of the donee.

* The date and location of the contribution.

* A description of the property. The property's fair market value (FMV) need not be stated on the receipt.

In addition, the donor should also retain written records of:

* The FMV of the property as of the contribution date.

* The method used to determine the property's FMV. If an appraisal was used, a copy of the appraiser's signed report.

* For property to which Sec. 170(e) (3) applies, the property's adjusted basis, the amount of the adjustment required under Sec. 170(e) (4) and the manner in which the reduction was computed.

* The terms of any agreement or understanding entered into by or on behalf of the donor that relates to the use, sale or other disposition of the property by the donee.

A receipt is not required when it is impractical to obtain one. However, a taxpayer should maintain written records of contributions containing the above information.

Example 1: S dropped off used clothes for a charitable organization (G) in the parking lot of a local supermarket. The estimated value of the clothes is $175. Because it is impractical for S to obtain a receipt, she should simply document the date and location of the drop, along with a description of the clothing, its FMV and the fact that the donation was made to G.

From $250 to $500

The additional substantiation requirements for property contributions from $250-$500 are similar to the requirements for cash contributions exceeding $250 (i.e., a contemporaneous written acknowledgment is needed). This acknowledgment should include a description of the property donated. Further, the donee should document the contributed property's FMV, even though it is not required to provide information about FMV on the acknowledgment.

Over $500 to $5,000

For contributions of more than $500 to $5,000, the donee's written acknowledgment is required. Additionally, taxpayers are required to complete and file Form 8283, Noncash Charitable Contributions, with their returns. According to Regs. Sec. 1.170A-13(b)(3)(i), the following additional records are required:

* The manner of acquisition of the property by the taxpayer and the approximate acquisition date. If created, produced or manufactured by or for the taxpayer, the approximate date the property was substantially completed.

* The donor's adjusted basis for property (other than publicly traded securities) held for a period of less than 12 months immediately preceding the donation date. The donor's adjusted basis for property (other than publicly traded securities) held for a period of 12 months or more preceding the donation date, if the information is available.

If information on the acquisition date and/or adjusted basis is not available, a taxpayer will not be denied a charitable deduction if an explanatory note is attached to his or her return.

Over $5,000

In addition to the donee's written acknowledgment and other records described above (for donations over $500 to $5,000), Regs. Sec. 1.170A-13(c) requires a qualified appraisal if the property contribution exceeds $5,000 and is not publicly traded stock. Further, the donor must attach a fully completed appraisal summary to the return on which the deduction is first claimed. The summary is made on Form 8283 and is signed and dated by both the donee and a qualified appraiser. There are special rules (not discussed here) for privately held securities and artwork.

Qualified Appraisal

When required, a qualified appraisal should be obtained no earlier than 60 days prior to a property contribution. Under Regs. Sec. 1.170A-13(c)(3), the appraisal should contain a description of the property in sufficient detail for a person not generally familiar with it to ascertain that the property appraised was the property contributed. Additionally, the appraisal should provide the following:

* A description of the property's physical condition.

* The contribution date.

* The terms of any agreement or understanding entered into (or expected to be entered into) by or on behalf of the donor or donee that relates to the use, sale or other disposition of the property.

* The name, address and identifying number of the qualified appraiser.

* The qualifications of the signing appraiser, including his or her background, experience, education and membership (if any) in professional associations.

* A statement that the appraisal was prepared for income tax purposes.

* The date(s) of the appraisal.

* The appraised FMV of the property on the date (or expected date) of contribution.

* The method and specific basis for valuation.

FMV

Generally, the charitable deduction for a property contribution is the property's FMV. (5) According to Regs. Sec. 1.170A-1(c)(2), FMV is:

... the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell and both having reasonable knowledge of relevant facts.

The Code and regulations provide little additional guidance on the determination of FMV. Guidance is available in IRS rulings and publications, as well as various court decisions. Various factors that can be used in determining FMV are provided in the exhibit on p. 728.

Exhibit: Determining FMV *

When using this factor:         Consider these questions:

Cost or selling price           Was the purchase or sale of the
                                property reasonably close to the
                                contribution date?

                                Was any increase or decrease in value,
                                as compared to its cost, at a
                                reasonable rate?

                                Do the terms of purchase or sale limit
                                what can be done with the property?

                                Was there an arm's-length offer to buy
                                the property close to the valuation
                                date?

Sales of comparable properties  How similar is the property sold to
                                the property donated?

                                How close is the sale date to the
                                valuation date?

                                Was the sale at arm's length?

                                What was the condition of the market
                                at the time of sale?

Replacement cost                What would it cost to replace the
                                donated property?

                                Is there a reasonable relationship
                                between replacement cost and FMV?

                                Is the supply of the donated property
                                more or less than the demand for it?

Opinions of experts             Is the expert knowledgeable and
                                competent?

                                Is the opinion thorough and supported
                                by facts and experience?

* Adapted from IRS Pub. 561, Determining the Value of Donated Property

Comparable sales: A common allowable method of valuation is comparable sales. (6) However, this method is most appropriate when a large number of comparable sales are available. The physical characteristics between the comparable sales and the contributed property should be considered, as well as the proximity of the contribution date to the comparable sales date.

The use of comparable sales is common when valuing the contribution of an automobile. According to Rev. Rul. 2002-67, (7) using an established car pricing guide is acceptable for determining FMV. However, the ruling indicates that such a guide is appropriate only if it lists the sales price for a car that is the same make, model and year, and sold in the same area and in the same condition, as the donated car.

Other methods: Although comparable sales is a common valuation method, it cannot always be used. In Cooley, (8) the Tax Court held that FMV must be determined as to a particular property at the time of contribution, subject to any conditions or restrictions on marketability. Thus, for example, reproduction or replacement cost can be relevant for unique property or for property for which comparable sales are not available. In Est. of Palmer, (9) the Eighth Circuit held that the reproduction costs of a mansion contributed to a college and used for events and storage had to be considered, because the property was unique, had a limited market and there was no evidence of comparable sales. In using the reproduction or replacement cost to value property, any observed depreciation or obsolescence should be considered.

Post-AJCA Automobile Contributions

The AJCA added Sec. 170(f)(12), which contains special provisions for contributions of qualified vehicles. Sec. 170(f)(12) defines vehicles to include motor vehicles manufactured primarily' for use on streets and highways, boats and airplanes. Most importantly, Sec. 170(f)(12)(A)(ii) provides that if a donee organization sells a contributed vehicle without any significant use or material improvement to it, the charitable deduction is limited to the gross proceeds from the sale. These rules apply when the claimed value of the deduction exceeds $500. Additionally, Form 1098-C, Contributions of Motor Vehicles, Boats and Airplanes, should be attached to a donor's return if the deduction exceeds $500. If the claimed deduction is $500 or less, the substantiation requirements discussed above for property contributions apply. Additionally, Sec. 170(f)(12) does not apply to property described in Sec. 1221(a)(1), which is property held for sale to customers (e.g., inventory).

The AJCA also granted Treasury the authority to prescribe regulations or other guidance to carry out Sec. 170(f)(12). Notice 2005-44 (10) provides guidance until regulations are effective.

The notice provides that the charitable deduction limit (i.e., the gross proceeds from selling the vehicle) will not apply if the charity sells or gives it to a needy individual at a price significantly below FMV. This exception applies if the donation is in direct furtherance of the organization's charitable purpose of aiding the poor, distressed or underprivileged who need transportation. In this case, the charitable deduction equals the vehicle's FMV.

Example 2: D contributes a used car ($20,000 adjusted basis and $2,000 FMV) to charity O. Shortly thereafter, O sells the car for $1,900. Ordinarily, D's charitable deduction would be $2,000 (FMV of the car at time of donation). According to Sec. 170(f) (12) (A) (ii), however, D's deduction is limited to $1,900 (gross proceeds from O's sale).

Example 3: The facts are the same as in Example 2, except O sells the car for $100 to an underprivileged person who needs transportation. Because O sold the car to a needy person at a price significantly below FMV, the general rule does not apply, and D' s deduction is $2,000.

The meaning of "significantly below FMV" is not clear from reading either the Code or the notice.

Example 4: The facts are the same as in Example 3, except O sells the car for $1,800 to an underprivileged person who needs transportation. It is not clear if this selling price is "significantly below" FMV. If it is, then D's charitable deduction is $2,000. However, if the price is not significantly below FMV, D's deduction is $1,800.

In summary, a donor can deduct the vehicle's FMV when the:

* Claimed deduction is $500 or less;

* Donee organization has a significant intervening use of the vehicle;

* Charity makes a material improvement to the vehicle;

* Donee organization sells the vehicle at a price significantly below FMV to a needy individual in direct furtherance of its charitable purpose.

If none of these situations applies, and the donee sells the vehicle contributed, the donor's deduction is limited to the lesser of the gross proceeds received by the donee organization from the sale or the vehicle's FMV.

Substantiation

For vehicle contributions for which the donor claims a deduction of $500 or less, the general substantiation requirements for property contributions (discussed above) need to be followed. For vehicle contributions exceeding $500, according to Sec. 170(f)(12), the donor must receive a contemporaneous written acknowledgment from the donee. The donor must include this statement with the return for the tax year of the deduction. Sec. 170(f)(12)(B) provides that the acknowledgment must include the (1) donor's name and taxpayer identification number and (2) vehicle identification number or similar number.

In addition, the notice indicates that the acknowledgment must include the contribution date. Any additional information required depends on the details of the donee's intentions as to the vehicle. The three different possibilities discussed in the notice are presented below.

Sale without significant use or improvement: If the donee organization sells the vehicle without any significant use or material improvement, it must provide an acknowledgment within 30 days of the sale. It should contain:

* A certification that the vehicle was sold in an arm's-length transaction between unrelated parties.

* A statement of the gross proceeds.

* A statement that the deductible amount may not exceed the gross proceeds.

* The date the qualified vehicle was sold.

The donor's charitable contribution is limited to the lower of the gross proceeds received by the donee from the sale or the FMV at the time of the donation. Accordingly, the donor may still need to determine (and substantiate with adequate records) the vehicle's FMV at the time of the donation.

Sale below FMV to needy individual: If the sale by the donee organization is (or will be) at a price significantly below FMV to a needy individual, and is in furtherance of its charitable purpose, the additional acknowledgment should be furnished no later than 30 days after the contribution date. Additionally, the acknowledgment should certify that the:

* Donee organization sold (or will sell) the qualified vehicle to a needy individual at a price significantly below FMV.

* Sale (or transfer) will be in direct furtherance of the donee organization's charitable purpose of aiding the poor, distressed or underprivileged who need transportation.

Significant intervening use or material improvement: If the donee organization intends a significant intervening use or material improvement, it must provide the acknowledgment within 30 days of the contribution. It should include:

* A certification and detailed description of either the intended (1) intervening use and intended duration of the use or (2) material improvement.

* A certification that the vehicle will not be transferred in exchange for money, other property or services before completion of such use or improvement.

Whenever a donor's deduction for a vehicle contribution is the FMV, the provisions discussed earlier in this article (under "Property Contributions") apply. The donor must still be able to substantiate the vehicle's FMV. Additionally, a qualified appraisal is required if the deduction exceeds $5,000.

Transition Rules

The provisions of both Sec. 170(f)(12) and Notice 2005-44 apply to vehicle contributions after 2004. The notice provides that a contemporaneous written acknowledgment obtained before July 4, 2005, will be considered acceptable, even if it does not include the date the vehicle is sold or a detailed description of the intended significant intervening use or material improvement by the donee organization.

Special transition rules apply to contributions of vehicles sold by a donee organization at a price significantly below FMV to needy individuals (as described above). For contributions made before Sept. 2, 2005, the acknowledgment must have been obtained by the donor before Oct. 2, 2005.

Conclusion

Taxpayers who fail to receive and maintain adequate substantiation of their charitable contributions face the prospect of being unable to receive the tax savings from their generosity. Additionally, taxpayers who deduct amounts not properly substantiated or valued may be subject to various penalties. For example, Sec. 6662 imposes a 20% penalty on certain tax underpayments. This penalty applies when there is a substantial valuation misstatement, negligence or a disregard of the rules and regulations. Taxpayers and tax advisers need to be aware of the detailed requirements for the substantiation of charitable contributions.

For more information about this article, contact Dr. Krumwiede at [e-mail].

(1) See H Rep't No. 103-213, 103d Cong., 1st Sess (1993), p. 67, n. 9.

(2) The Katrina Emergency Tax Relief Act of 2005 (KETRA), Section 303, provided that a taxpayer who uses a vehicle in providing donated services to a charity, solely for the provision of relief related to Hurricane Katrina, can compute a charitable mileage deduction using a rate 70% of the business mileage rate in effect on the date of the contribution, rather than the charitable standard mileage rate generally in effect under Sec. 170(i). This provision applies to services contributed between Aug. 25, 2095 and Dec. 31, 2006. The KETRA temporarily increased the 50% contribution base to 100% (for contributions made from Aug. 28, 2005-Dec. 31, 2005).

(3) This is donated property that, if sold by the donor, would have resulted in ordinary income or short-term capital gain.

(4) This is the amount of gain that would have been ordinary income or short-term capital gain; see note 1, supra.

(5) See notes 1 and 2, supra, and the discussion in the text below on the contribution of automobiles.

(6) See Rev. Proc. 79-24, 1979-1 CB 565.

(7) See Rev. Rul. 2002-67, 2002-2 CB 873.

(8) Jacob J. Cooley, 33 TC 223 (1959).

(9) Est. of D.D. Palmer, 839 F2d 420 (8th Cir. 1988).

(10) Notice 2005-44, IRB 2005-25, 1287.

Tim Krumwiede, Ph.D., CPA

Associate Professor

Bryant University

Smithfield, RI

Larry Witner, LL.M., CPA

Associate Professor

Bryant University

Smithfield, RI