Enhanced Deduction for Charitable Contributions of Inventory: Is Your Company Taking Advantage of This Cash Tax Savings?

The CARES Act temporarily increased the deduction limitation for charitable contributions of food inventory for contributions made during calendar year 2020 to provide increased deduction opportunities for businesses that are increasing their charitable activity in response to COVID-19. A significant cash tax benefit may be derived from certain philanthropic donations of inventory to qualified charitable organizations. Section 170(e)(3) provides taxpayers with an enhanced deduction in excess of the tax basis in the inventory for donations of inventory meeting certain requirements. The enhanced deduction is limited to donations of food inventory for non-corporate taxpayers. C corporations are entitled to an enhanced deduction for qualifying charitable contribution of all types of inventory.

Background

Under the general rule, a deduction for a charitable donation of property other than money is equal to the fair market value (FMV) of the property at the time of the contribution. However, for taxpayers who contribute ordinary income property, such as inventory, the tax deduction for charitable contributions of inventory is generally limited to the taxpayer’s cost basis in the contributed property. However, certain contributions of inventory are eligible for an exception to this general rule. When a qualifying charitable donation is made, the enhanced deduction allows a taxpayer to take a deduction on its tax return equal to the tax basis in the donated inventory plus half of the gain that would have been recognized had it been sold, limited to twice tax basis.

What Contributions Qualify for the Enhanced Deduction?

All taxpayers, regardless of form of entity, are eligible for the enhanced deduction on qualifying contributions of apparently wholesome food inventory. Apparently wholesome food generally means the food must meet all federal, state and local quality and labeling laws and regulations, even though it may not be readily marketable due to appearance, age, freshness, grade, size, surplus or other conditions. Corporate taxpayers are eligible for the enhanced deduction on all qualifying contributions of inventory (i.e., not limited to food inventory donations). For a contribution of inventory to be eligible for the enhanced deduction contained in Sec. 170(e)(3), the following requirements must be met:

• Donation must be made to a Sec. 501(c)(3) organization, other than a private foundation that is not an operating foundation
• The charitable organization must use the donated property for the purpose for which the charitable organization is constituted and be used for the care of the ill, the needy or children
• The donated property may not be transferred in exchange for money, other property, or services
• If donated property is subject to regulation under the Federal Food, Drug and Cosmetic Act, it must satisfy the requirements of this act both on the date of transfer and for the immediately preceding 180 days
• Taxpayer must receive a written statement from the donee to substantiate the enhanced deduction

How is the Enhanced Deduction Computed?

Generally, if a qualifying donation is made, a taxpayer can deduct its tax basis in the donated inventory plus half of the gain that would have been recognized in income if the inventory had been sold at its FMV on the date of contribution, limited to twice tax basis. Below is an example of the calculation for illustration purposes. 

Data

Calculation

1. Compute enhanced deduction before limitations

2. Limited to Twice Basis in Inventory

*The illustration assumes taxpayer is not limited by taxable or net income

Special Rules Applicable to Food Inventory Donations

Special rules related to donations of food inventory simplify the calculation of the enhanced deduction in certain circumstances. First, if a taxpayer donates apparently wholesome food that the taxpayer would not otherwise sell by reason of its own internal standards, lack of market or similar circumstances the FMV of the food can be determined by taking into account the price at which the same or substantially the same food items (as to both type and quality) are sold by the taxpayer at the time of contribution (or if not sold at such time, in the recent past). This modification makes it clear that the FMV of wholesome food which is unsaleable or unmarketable in its traditional outlet, such as past-date food, packaged food which is damaged, mislabeled or missing a label, is still worth its original FMV. The FMV is not required to be decreased as a result of these defects for purposes of computing the enhanced deduction. Second, taxpayers that are not required to account for inventories under Sec. 471 or capitalize costs under Sec. 263A may elect to treat the tax basis in its donated food inventory as 25 percent of the FMV of the apparently wholesome food.

Inventory Contribution Percentage Limitations

For C corporations, the enhanced deduction allowed with respect to the contribution of non-food inventory property is limited to 10% of the taxable income of the C corporation. Any unused charitable contribution may be carried forward five years. 

For food inventory, the enhanced deduction is generally limited to 15% of taxable income for C corporations and in the case of any other taxpayer, 15% of the taxpayer's aggregate net income for such taxable year from all trades or businesses from which such contributions were made for such year. Any unused charitable contribution deduction may be carried forward five years. However, as part of the CARES Act, Congress incentivized taxpayers to assist in fighting the pandemic by temporarily increasing this percentage limitation for donations of food inventory to 25% for contributions made during calendar year 2020 for both corporate and non-corporate taxpayers.

The Takeaway

With the current economic environment, taxpayers who expect to make charitable donations of inventory should consider the tax benefits of the enhanced deduction under Sec. 170(e)(3). The temporary increase in the percentage limitations for food inventory contributions as a result of the CARES Act provides taxpayers with an increased tax incentive to make these donations during the 2020 calendar year.