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Supporting worthy causes through the enhanced deduction: examine the benefits in excess inventory.

This article presents the tax and accounting issues relating to charitable gifts of inventory. First discussed are the rules relating to the calculation of the tax deduction for charitable gifts of inventory. Relevant tax reporting requirements then are identified. Finally, the article examines the reporting requirements for charitable gifts of inventory under generally accepted accounting principles (GAAP).

Basic Tax Rules for Charitable Gifts of Property

In general, the amount of the deduction allowed for a charitable contribution of any property is its fair market value at the time of the gift reduced by the amount of ordinary income or short-term capital gain that would have been recognized if the property had been sold.|1~ Thus, if all the gain would have been ordinary income, as is the case with inventory, any deduction resulting from a contribution of the property is generally limited to its adjusted basis (carrying value).

For general tax purposes, fair market value is the price negotiated between a willing buyer and seller, neither being under a compulsion to sell or to buy. In the case of a contribution of inventory, the regulations under IRC 170 amplify this definition. If the charitable contribution consists of property that is customarily sold by the donor, fair market value is the price the donor would receive in the usual market in which it ordinarily sells at the time and place of the contribution.|2~ Under this definition, the donor will take seasonal and quantity discounts into consideration.|3~

Enhanced Deduction for Certain Gifts of Inventory

There are two exceptions to the general rule that a charitable contribution of inventory results in the deduction being limited to the basis of the inventory. The first is for certain gifts of inventory and other property.|4~ The second is for gifts of certain scientific property.|5~ Under limited circumstances, a corporation may take what will be referred to hereafter as an enhanced deduction. To be eligible, a regular corporation (hereafter referred to a C corporation) must make a gift of inventory or other ordinary income property and meet the following guidelines:

The recipient must be a public charity or a private operating foundation|6~ that uses the property for the care of the ill, the needy or infants.|7~ The donee in turn does not charge for the use of the property.|8~ Finally, the donee gives the donor a written certification indicating that the property will be used for the care of the ill, the needy or infants.|9~

This enhanced deduction is equal to the cost of the item plus one-half of any appreciation (inventory fair market value less its cost). Thus, the enhanced deduction for inventory offers the opportunity to deduct pre-tax dollars. That is, the dollars deducted have not been taxed, and, in this case, never will be taxed. Please note, however, the deduction is limited to 200% of the inventory's cost. The basic computational rules relating to the 200%-of-cost limit on the enhanced deduction for inventory are illustrated in the following example.
Market value $500,000
Cost basis 150,000
Determination of amount deductible:
(1) Market value $500,000
(2) Cost Basis 150,000
(3) Appreciation $350,000
(4) 50% of Appreciation $175,000
(5) Tentative Deduction:
Items (2) + (4) $325,000
(6) Limitation: 2 x item (2) $300,000
Permitted Deduction:
Smaller of Item (5) or (6) $300,000

The enhanced deduction for the inventory contributed is $300,000 because of the 200%-of-cost limit. The extent to which this limit constrains the deduction is directly related to the cost of the inventory donated (i.e., 200% of a larger cost figure results in a larger limit). Note that determining the cost of the donated inventory is to some extent left to the taxpayer's discretion.

Eligibility for the enhanced deduction is based on the charitable organization's use of the property meeting certain specific conditions. The statute provides the following regarding the use of the contributed property:

|T~he use of the property by the donee is related to the purpose or function constituting the basis for its exemption under Section 501 and the property is to be used by the donee solely for the care of the ill, the needy, or infants.|10~ (Emphasis added)

The regulations and rulings have clarified the statute. They make it clear that a donation to an intermediate conduit charitable organization for distribution to the ultimate charitable user is permissible, provided appropriate documentation is available.|11~ Ultimately, the property must be used for the care of the ill, the needy or infants.|12~ The phrase "used for the care of..." should be taken literally. No other person may use the contributed property, except as incidental to the primary use in the care of the ill, the needy or infants.|13~ Furthermore, if the ultimate donee does not put the inventory to the appropriate use, the donor will lose the benefit of the enhanced deduction, unless "at the time of the contribution, the donor reasonably anticipated that the property would be used in a manner consistent with those requirements...."|14~ The prudent attitude is one of donor beware.

The regulations very broadly define those who are in the special classes. An ill person is one who requires medical care, the expense of which would qualify for a deduction under the provisions of |sec~213 of the Code.|15~ Care of the ill means an alleviation or cure of an existing illness and includes care of the physical, mental or emotional needs of the ill.|16~

A needy person is a person who lacks for the necessities of life involving physical, mental or emotional well-being as a result of poverty or distress.|17~ The care of such person must result in the alleviation or satisfaction of the specific need that causes the person to fall into this particular category.|18~

An infant is a minor child (as determined under the laws of the jurisdiction in which the child resides).|19~ The care of an infant means performance of a parental function and the provision for physical, mental and emotional needs of the infant.|20~

Requirements Illustrated

To illustrate the application of these rules, four hypothetical gifts to a charitable hospital from C corporation donors are presented, followed by the authors' opinion as to justifiable results based on the above regulations. The four hypothetical gifts are as follows: (1) a pharmaceutical company gives drugs, (2) a hospital supply company gives hypodermic syringes, (3) a surgical goods manufacturer gives rubber surgical gloves and (4) a pencil manufacturer gives pencils for the doctors to use in making patient notes.

Because the regulations are concerned with the ultimate use by or for the benefit of a particular disadvantaged person, we believe that the following results would be obtained for the stated reasons.

(1) The drugs would qualify for the enhanced deduction. They are directly and exclusively used by an ill person for the alleviation of an existing illness.

(2) The hypodermic syringes, while literally used by a third party, would also qualify for the enhanced deduction. The use of the syringe by a third party is incidental to the primary purpose of the delivery of a medication to an ill person.

(3) The surgical gloves also should qualify for the enhanced deduction based on the same rationale. Although the ill person does not ever use the surgical gloves, their use in the operating room is essential in the process of alleviating illness.

(4) The pencils do not qualify for the enhanced deduction. They are not used by the ill person and their use is incidental rather than essential to the alleviation of illness. Although the IRS has not ruled on these issues, the authors find this argument meritorious.

If the ultimate charitable recipient was changed from a hospital to a high school and the same mix of items were donated, the results would be different. The pencils would most certainly be deductible if given to minor-aged students (i.e., infants under the Code) to assist them in their schoolwork. The surgical gloves and even the syringes would be deductible if used by the students in connection with, perhaps, a science class. The drugs probably would not qualify.|21~ Medical supplies used in the school infirmary probably would not qualify because of the requirement that the use of the property be "related to the purpose or function constituting the basis for |the organization's tax~ exemption...."|22~ A school's justification for its tax exemption is related to education objectives, not the rendering of medical care.

Treatment of Charitable Gifts Under GAAP

The accounting treatment of charitable gifts of property in general differs significantly from the tax treatment. However, since the distinction between different types of charitable organizations (e.g., public charities versus private nonoperating foundations) is not relevant for purposes of GAAP, the reporting requirements are quite straightforward. The basic authority regarding nonmonetary transactions--of which a charitable gift of property is but a single example--is Accounting Principles Board Opinion Number 29 (APB 29).|23~

The basic principle applicable to nonmonetary transactions is contained in 18 of the Opinion and, in pertinent part, reads as follows:

A transfer of a nonmonetary asset to...another entity in a nonreciprocal transfer should be recorded at the fair value of the asset transferred, and a gain or loss should be recognized on the disposition of the asset. The only exception to this principle is the practical concession that if fair value is not determinable, it can hardly be used as the basis of measurement.|24~

The primary concern, from the perspective of GAAP, is the proper disclosure of the results of the enterprise's activities for the period. With respect to charitable gifts of inventory, the issues that must be addressed are the practical points involved in: (1) assuring that the cost of the contributed property not be misclassified (e.g., buried in cost of goods sold); (2) reflecting its fair market value as a nonoperating expense on the income statement; and (3) recognizing any gain or loss associated with the disposition of the contributed property.

The classification issue acknowledges that the cost of inventory contributed to charity was not sold and therefore should not be included in the cost of goods sold on the income statement. A charitable contribution is an expense that is within the discretionary purview of management. Burying the cost of donated inventory in cost of goods sold places such contributions at the heart of the firm's income-producing activities rather than as a discretionary, peripheral transaction. If significant in amount, the resulting increase in cost of goods sold (which results in lowered operating income) may adversely affect users' perceptions of the uncertainty of future cash flows and results of central operations.|25~

APB 29 requires that the expense item for the contribution of inventory (or any other property) be recorded at its fair market value. Recognition of gain or loss is an automatic by-product resulting from the need to reconcile the difference between the cost of the contributed inventory and the fair market value recorded for the contribution expense. Just as is the selection of the inventory valuation method, the determination of the cost of the contributed inventory is a matter to be addressed by internal accounting policy. The following simplified example illustrates how all three issues of concern under GAAP might be addressed in a single adjusting entry.
Fair market value of
contributed inventory $100
Cost basis of contributed
inventory 55
Adjusting entry:
 Dr. Cr.
Charitable contribution expense 100
Cost of goods sold 55
Gain on donation of inventory 45

Again, the charitable contribution expense as well as the gain or loss associated with the donation of the inventory are to be reported on the donor's income statement in a manner that clearly reflects the nature of the event (i.e., peripheral to central operations).

Although beyond the scope of this article, a brief comment on interperiod tax allocation is in order.|26~ In most cases, the differences between reporting the charitable contribution expense in accordance with GAAP versus tax rules will not raise the issue of interperiod tax allocation. Differences between the two authorities usually are permanent in nature rather than a matter of timing. If, however, the deduction of a charitable contribution is deferred due to the 10%-of-taxable-income limit, the issue of interperiod tax allocation becomes relevant. The interested reader is referred to Statement of Financial Accounting Standards No. 96, "Accounting for Income Taxes."

Tax Treatment of a Charitable Gift of Inventory Under Different Situations

This section will examine the treatment of a charitable contribution of inventory from a tax compliance perspective. The two principal tax compliance issues are: (1) reporting the charitable contribution on the corporation's tax return (Form 1120); and (2) deciding if Form 8283, Noncash Charitable Contributions, needs to be attached to the return.

Reporting on Form 1120

If a C corporation donates inventory or certain other ordinary income property to charity, it is allowed to deduct the lesser of the property's fair market value or cost, or the previously discussed enhanced deduction. The issues that distinguish the tax reporting of charitable contributions of inventory are: (1) whether the contribution qualifies for the enhanced deduction, and (2) whether the cost of the contributed inventory was incurred during the current taxable year or during a prior taxable year. This classification gives us four basic situations:

* The gift is made out of prior year's inventory and qualifies for the enhanced deduction;

* The gift is made out of currently acquired inventory and qualifies for the enhanced deduction;

* The gift is made out of prior year's inventory but does not qualify for the enhanced deduction; and

* The gift is made out of currently acquired inventory but does not qualify for the enhanced deduction.

If the donation falls into one of the first three categories, it is treated as a charitable contribution on Form 1120, U.S. Corporation Income Tax Return, and adjustments are made to the appropriate component(s) of costs of goods sold. Failure to make these adjustments to cost of goods sold would result in a double deduction of the cost of the donated inventory: once in cost of goods sold and again as a charitable contribution. If the contribution falls into the fourth category, it is not treated as a charitable contribution. Rather, for tax purposes, the cost of the item is recovered through cost of goods sold.|27~

Filing Form 8283

Another aspect of tax compliance involves the filing of Form 8283, Noncash Charitable Contributions, or a statement in lieu thereof. In general, C corporations (other than personal service corporations and closely-held corporations) are required to file a Form 8283, Noncash Charitable Contributions, along with their Form 1120 if the amount claimed as a deduction from the charitable contribution of property is in excess of $5,000.|28~ However, a special rule applies for deductions taken by C corporations making gifts that qualify for the enhanced deduction under 170(e)(3) (inventory) or 170(e)(4) (scientific property). Under this special rule, the corporation must file the Form 8283 only if the amount claimed as a charitable deduction for the gift of inventory exceeds the amount that would have been deducted as cost of goods sold by more than $5,000.|29~ If because of this exception Form 8283 need not be filed, a statement in lieu thereof is included in the return. This statement merely discloses that inventory was donated and, per Reg. 1.170A-13(c)(1)(ii), Form 8283 need not be attached to the return.

Summary of Tax Compliance Issues

Using the four-category classification described above, Figure 1 presents an algorithm for determining the tax treatment of contributions of inventory to charity.

Comparison of Tax and GAAP Treatments

In Figure 2, a matrix is presented comparing the treatment of a contribution of inventory for tax purposes with the treatment required by GAAP.

The one point of similarity between GAAP and tax reporting is that the carrying value (cost) of the inventory must be removed from cost of goods sold (in all cases for GAAP and in all but Category 4 above for tax reporting). However, this is where the similarity between the two treatments ends. No gain or loss is recognized for tax purposes. The amount of the charitable contribution deduction will either be equal to the cost of the inventory or cost plus one-half the appreciation (subject to the 200%-of-cost limit) on the inventory, depending on whether the contribution qualifies for the enhanced deduction. However, the contribution expense under GAAP will always be the fair market value of the inventory contributed.


To encourage corporate charitable activities, Congress made a special provision for corporations giving inventory and certain other property to charity. The corporations may be eligible for an enhanced deduction equal to the cost of the property plus one-half of any appreciation in the event that the fair market value of the property is higher than cost. This enhanced deduction is limited to no more than two times the cost of the property.

Because of the manner in which the Internal Revenue Service chose to have these charitable gifts reported, the tax compliance and accounting under generally accepted accounting principles is different from the situation where the donor gives cash or cash equivalent. However, the additional paperwork is not burdensome. It involves filing one additional form or an additional statement with the corporate income tax return. And in some instances it requires additional bookkeeping entries.

Compared to the sale of inventory, the contribution of inventory will never benefit the corporation from a cash-on-cash point of view. Nevertheless, by properly targeting donees, a corporation can benefit in tangible ways from a charitable gift more than from an abandonment. Furthermore, by giving away property the corporation benefits from the goodwill generated and the fact that it was not perceived as disposing its inventory under fire sale conditions.


1 IRC 170(e)(3) and Reg. 1.170A-1(c)(1).

2 Reg. 1.170A-1(c)(2) and (3).

3 Reg. 1.170A-1(c)(3).

4 IRC 170(e)(3). Inventory and other property is defined as property described in IRC 1221(1) and (2).

5 IRC 170(e)(4).

6 IRC 170(e)(3)(A).

7 IRC 170(e)(3)(A)(i).

8 IRC 170(e)(3)(A)(ii). Here the Code is referring to charging the ill, the needy, or infants who are benefiting from the contribution. For example, a hospital that is the recipient of drugs donated for the use of the ill, the needy, or infants cannot charge those charitable recipients for those drugs.

9 IRC 170(e)(3)(A)(iii).

10 IRC 170(e)(3)(A)(i).

11 Reg. 1.170A-4A(b)(2).

12 Reg. 1.170A-4A(b)(2)(ii).

13 Reg. 1.170A-4A(b)(2)(ii)(A).

14 Id.

15 Reg. 1.170A-4A(b)(2)(ii)(B).

16 Reg. 1.170A-4A(b)(2)(ii)(C).

17 Reg. 1.170A-4A(b)(2)(ii)(D).

18 Reg. 1.170A-4A(b)(2)(ii)(E).

19 Reg. 1.170A-4A(b)(2)(ii)(F).

20 Reg. 1.170A-4A(b)(2)(ii)(G).

21 Although the regulations provide general interpretation of the statute, there have been virtually no Revenue Rulings or Private Letter Rulings offering specific guidance on this point. However, the regulations seem to place paramount emphasis on the characteristics of the donee.

22 IRC 170(e)(3)(A)(i).

23 Accounting Principles Board (APB), Opinion No. 29, "Accounting for Non-monetary Transactions" (New York: AICPA, 1973). Although it does not affect the treatment of the donor of a charitable gift of inventory, the Financial Accounting Standards Board (FASB) has released an Exposure Draft (ED) on the subject of contributions. The ED is entitled Proposed Statement of Financial Accounting Standards, "Accounting for Contributions Received and Contributions Made and Capitalization of Works of Art, Historical Treasures, and Similar Assets" (Stamford, Conn.: FASB, October 31, 1990).

24 APB 29, 20.

25 This discussion is based on the conceptual principles presented in FASB's Statements of Financial Accounting Concepts Nos. 1 and 5. Statements of Financial Accounting Concepts No. 1, "Objectives of Financial Reporting by Business Enterprises" (Stamford, FASB, 1978) and Statement of Financial Accounting Concepts No. 5, "Recognition and Measurement in Financial Statements of Business Enterprises" (Stamford, FASB, 1984).

26 The issue of interperiod tax allocation is addressed in Statement of Financial Accounting Standards No. 96, "Accounting for Income Taxes" (Stamford, Conn.: FASB, 1988).

27 Reg. 1.170A-1(c)(4).

28 Reg. 1.170A-13(c)(1)(i).

29 Reg. 1.170A-13(c)(1)(ii).

Michael J.R. Hoffman is an associate professor of taxation in the School of Accounting at Florida Atlantic University. He earned his DBA at Indiana University.

Karen S. McKenzie is an assistant professor of accounting in the School of Accounting at Florida Atlantic University. She earned her PhD at Louisiana State University and is a CPA licensed in Florida.

S. Theodore Reiner, is a member of the Legislative and Regulatory Services Group, Ernst & Young's National Tax Department. A member of NSPA, he was formerly associate dean of the SMU School of Law and professor of taxation at New York University.
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Author:Hoffman, Michael J.R.; McKenzie, Karen S.; Reiner, S. Theodore
Publication:The National Public Accountant
Date:Jun 1, 1993
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