As the holidays approach, many businesses consider how they can play a part in ensuring no one in our communities goes hungry during this celebratory time of year. In addition, the recent hurricanes and other natural disasters have created a great need for donations of non-cash items, including food. An often-missed tax incentive is an increased deduction for qualified donations of food inventory, which was created to encourage taxpayers that hold food as part of their regular inventory to contribute excess or unsaleable wholesome food to people in need. Recent changes to the tax law created by the Protecting Americans from Tax Hikes (PATH) Act, P.L. 114-113, have enhanced this deduction and removed the sunset provisions, effectively making the incentive permanent until or unless it is modified by future legislation.
Timing of deduction
Charitable contributions are generally deductible in the year actually paid. However, in the case of a corporation using an accrual method of accounting, a deduction is also allowed if the board of directors authorizes the contribution during the taxable year, and payment is made within 3.5 months of year-end (Internal Revenue Code (IRC) Sec. 170(a)(2)).
Charitable contributions are generally deductible at fair market value, subject to certain reductions. In the case of inventory donations, this reduction is ordinarily equal to the amount of gain which would have been recognized as ordinary income if the property had been sold (Sec. 170(e)(1)(A)), resulting in a deduction equal to:
- Cost basis of the inventory or fair market value, whichever is lower
- Limited to 50% of an individual’s or 10% of a corporation’s taxable income, calculated without regard to certain items (Sec. 170(b)(1) and (2))
- Five year carryforward of contributions exceeding the percentage limitation (Sec. 170(d))
A corresponding adjustment must be made to cost of goods sold for the cost basis of the donated inventory (Treas. Reg. Sec. 1.170A-4A(c)(3)).
Exception for property acquired or produced in the year of contribution
Under Treasury Regulation Sec. 1.170A-1(c)(4), when contributed property was not reflected in opening inventory but is rather acquired or produced in the year of contribution, the property is to be treated as part of cost of goods sold for the year. No charitable contribution deduction is taken, and thus the deduction is not subject to the individual 50% or corporate 10% limitation. However, if these rules are applied, the total amount deducted is limited to the taxpayer’s cost of the property. Therefore, if the donation qualifies, the taxpayer may instead choose to apply on a per-contribution basis the rules for the enhanced deduction under IRC Sec. 170(e)(3). This section of the tax law allows for a general increased deduction for C corporations that donate inventory for the care of the ill, needy, or infants, a special deduction for the donation of book inventory to public schools, and the enhanced deduction for certain contributions of food inventory that is the subject of this article.
Special rules for contributions of food inventory
As noted earlier, a deduction for donated inventory is generally limited to the cost basis of the inventory, even if the fair market value, or the price for which the taxpayer could have sold the inventory to a third party, is higher. A taxpayer would be entitled to the same deduction for the cost basis of the property if they were to simply destroy or discard the property. Clearly, this could create a preference to destroy unsaleable inventory instead of donating it, especially since donating the property often involves some additional cost and effort on behalf of the contributing entity. Therefore, this incentive was developed to encourage and reward taxpayers for taking the extra steps to identify and transfer such inventory to worthy causes.
The IRC Sec. 170(e)(3)(C) enhanced deduction is available for certain qualified contributions of food inventory, as follows:
- The property will be used for the care of the ill, needy, or infants
- The donation is of food that is apparently wholesome food
- The donee must be a tax-exempt IRC Sec. 501(c)(3) organization (other than a private foundation)
- Donee’s use of the property must be related to the organization’s tax-exempt purpose or function
- Donee may not require or receive money, property, or services for the transfer of the property to the ultimate needy recipients
- Donee must furnish to the taxpayer a written statement certifying that the property will be used in the care of the ill, needy, or infants, and that it will not be transferred for money, property, or services
- If the property is regulated by the Federal Food, Drug and Cosmetic Act, it must meet all standards under that act as of the date of transfer and for the 180 days prior
- The deduction is limited to 15% of the donating entities’ taxable income in the year of the contribution, calculated without regard to certain items.
Importantly, the enhanced deduction for food inventory is not limited to corporate donors, but rather is available to all types of entities. The entity must hold the food as part of its trade or business inventory; for example, farms, cooperatives, grocery stores, or restaurants (Sec. 170(e)(3)(A)).
Treasury Regulations Sec. 1.170A-4A(b)(d)(ii) provide guidance on the definition of care for the ill, needy, and infants. In part, these regulations provide examples of needy persons including the impoverished, the homeless, victims of natural disasters, crime victims, refugees, immigrants, and more. Many common recipients of food donations such as food banks or homeless shelters serve such qualified individuals.
The Internal Revenue Code points to the Bill Emerson Good Samaritan Food Donation Act, which provides the following definition of apparently wholesome food: “food that meets all quality and labeling standards imposed by Federal, State, and local laws and regulations even though the food may not be readily marketable due to appearance, age, freshness, grade, size, surplus, or other conditions.” (42 U.S.C. 1791(b)(2)). IRC Sec. 170(e)(3)(C)(v) further provides that the fair market value of the donated property should be determined by taking into account the price at which the same or substantially similar items are sold by the taxpayer, without regard to the taxpayer’s internal standards, the lack of a market for the items, or even whether the taxpayer produced the specific items with the sole intent of ultimately donating them. Notably, this means that foods that the taxpayer would not otherwise sell due to mislabeled packaging, abnormal appearance, items that are nearing or have exceeded their “sell-by” date, or unintentional overstocks can still be donated and valued with reference to their retail price. All facts and circumstances should be considered, however – for example, it is likely not reasonable to assign a fair market value equal to full retail price to products that no longer fall under legal regulations for sale (e.g. expired products).
The provision limiting the deduction to 15% of the donor’s taxable income is an increase from the 10% limitation under prior law. This is one of the enhancements made under the recently-enacted PATH Act (P.L. 114-113, Section 113). As with other contributions, amounts in excess of the limitation can be carried forward for up to five taxable years (Sec. 170(e)(3)(C)(iii)(I)). For taxpayers other than C corporations, this limitation specifically applies to 15% of net income for the taxable year from the trades or businesses from which the contributions were made (Sec. 170(e)(3)(C)(ii)(I)). For example, if the contributing entity is a trade or business reported on the individual’s Schedule C, the 15% limitation is applied based on the income from that Schedule C alone. Other income such as bank interest, dividends or a spouse’s wages from an outside employer cannot be considered for purposes of the limitation. Because of this, an individual taxpayer may find it more beneficial in certain situations to waive the enhanced deduction and simply deduct the cost basis of the donated property under the regular rules, applying the limitation of 50% of the taxpayer’s entire contribution base under IRC Sec. 170(b)(1)(A). On the other hand, for a donor that is a C corporation, the 15% limitation must be coordinated with the lower 10% overall limitation on corporate contributions. In this case, IRC Sec. 170(e)(3)(C)(iii)(II) specifies that food donations subject to the 15% ceiling should be deducted first, and the 10% limitation reduced accordingly (but not below zero).
Amount of the deduction
The amount of the enhanced deduction is generally equal to the tax basis of the property plus one-half of the gain which would have been recognized as ordinary income if the property had been sold (see example A, below). However, the deduction may not exceed twice the basis of the contributed property (example B). In addition, as with all charitable contributions, the deduction generally may not exceed the fair market value of the property (example C). The PATH Act created a notable exception to the basis limitation, which addresses cash-basis taxpayers not required to maintain inventory accounts. For such taxpayers, like certain family farms that raise crops and deduct all expenses currently, their basis in the donated property is $0. Therefore, the basis limitation would have prevented them from taking any deduction under the old rules. The new exception allows such taxpayers to treat the basis of the donated food to be 25% of fair market value for purposes of the basis limitation only, effectively allowing a deduction of 50% of fair market value (example D) (Sec. 170(e)(3)(C)(iv)).
|Example A||Example B||Example C||Example D|
|Fair Market Value||150,000||350,000||80,000||100,000|
|Basis Plus One-half of Appreciation||125,000||225,000||100,000||50,000|
*Presumed basis of 25% FMV applies only to cash basis taxpayer not required to maintain an inventory
An adjustment must be made to cost of goods sold for the lesser of the fair market value or cost basis of the donated inventory. Note that in cases where cost basis exceeds fair market value, the Sec. 170(e)(3) rules thus allow the taxpayer to recover any built-in loss as part of the cost of goods sold deduction.
Substantiation and recordkeeping requirements
A written statement must be furnished by donee and attached to the donor’s tax return, containing a description of the property, the date of receipt, a statement that the property will be used in the care of the ill, needy, or infants, a statement that the property will not be transferred for money, property, or services, and a representation that adequate books and records are maintained, and will be made available to the Internal Revenue Service (IRS) upon request. This statement should be obtained no later than the due date (including extensions) of the donor’s tax returns (Treas. Reg. Sec. 1.170A-4A(b)(4)). A computation of the amount claimed as an increased charitable deduction should also be attached.
If the enhanced deduction exceeds $500 ($5,000 for certain C corporations), IRS Form 8283 Noncash Charitable Contributions should be filed with the taxpayer’s income tax returns. When the increased deduction is less than $5,000, Section A of the form should be used. If the amount of the increased deduction exceeds $5,000, Section B, Part I of the form should be completed, and an authorized representative of the donee organization should sign Section B, Part IV verifying the donation received. A formal appraisal of the property is not required. This is because IRC Sec. 170(f)(11)(A)(ii) specifically exempts trade or business inventories from the appraisal requirement. However, the taxpayer should retain for their records thorough documentation of the fair market value used.
For taxpayers who regularly donate unused food inventory to food banks or similar charities, this enhanced deduction is an opportunity to obtain additional tax deductions for their business with just a few extra administrative steps. For taxpayers who are weighing the benefits of donating rather than disposing of their stock, this statute creates an incentive to choose the charitable option.
Please contact our offices if you would like more information or assistance in claiming this deduction.
Adena Thomson is a manager based out of our East Aurora, NY office.
This material has been prepared for general, informational purposes only and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. Should you require any such advice, please contact us directly. The information contained herein does not create, and your review or use of the information does not constitute, an accountant-client relationship.