Deductions for the fair market value (FMV) of contributions made to qualified charities are limited by the taxpayer, type of property donated, and the charitable organization. In the case of an individual taxpayer, the deduction is limited by various percentages based on the type of property contributed and the organization receiving the property. Likewise, the donation of ordinary income property, such as inventory by a business, is limited to the adjusted basis (usually cost) of the donated property.
Section 113 of the Protecting Americans from Tax Hikes (PATH) Act of 2015 reinstates and makes permanent the deduction for charitable contributions of “apparently wholesome food” from any trade or business of the taxpayer under IRC §170(e)(3)(C) made after December 31, 2014. PATH increases the deduction limit from 10% to 15% for contributions made after December 31, 2015, and makes it available to all corporate and noncorporate businesses. But as one might suspect, there are a few issues associated with this deduction.
The meaning of the term “apparently wholesome food” is provided in the Internal Revenue Code to have the same meaning as under §22(b)(2) of the Bill Emerson Good Samaritan Food Donation Act (42 U.S.C. 1791(b)(2)). Liability for damages from donated food and grocery products is limited by §1791(c)—thus, the reason for “Good Samaritan” in the name of the law. As the Joint Committee on Taxation states in the technical explanation of the PATH Act (JCX-144-15), “apparently wholesome food” is food intended for human consumption 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. Finally, the contribution must be made to qualifying organizations.
ENHANCED FOOD DEDUCTION
Beginning in 2016, the charitable deduction for donating apparently wholesome food by a noncorporation business is limited to 15% of the taxpayer’s aggregate net income for all the taxpayer’s businesses that make such a contribution. In other words, if a taxpayer is a sole proprietor, a shareholder in an S corporation, and a partner in a partnership, and each of those businesses makes charitable contributions of food inventory, the taxpayer’s deduction for donations of food inventory is limited to 15% of the combined net income from the sole proprietorship and the taxpayer’s interests in the S corporation and partnership. But if only the sole proprietorship and the S corporation made charitable contributions of food inventory, the taxpayer’s deduction would be limited to 15% of the net income from the trade or business of the sole proprietorship and the taxpayer’s interest in the S corporation. The taxpayer’s interest in the partnership wouldn’t be involved in the calculation. The aggregate net income is determined without regard to charitable contributions per IRC §170(e)(3)(C)(ii).
Qualifying food inventory contributions exceeding the 15% annual limit are carried forward for each of the succeeding five years and are absorbed on a first-in, first-out basis if additional contributions are made in those succeeding years. In addition, the other charitable deduction limitations by a non-C corporation taxpayer aren’t affected by the 15% food inventory contribution limitation. If the allowable contribution amount of the food inventory exceeds 50% of the taxpayer’s contribution base, the deduction is limited to 50% for the taxable year, and the excess is carried forward in each of the succeeding five years.
The general rule is that the contributed property must be inventory of the taxpayer and must be donated to a charitable organization described under IRC §501(c)(3), except for private nonoperating foundations (which principally provide grants to other exempt organizations instead of actively conducting their own exempt activities). More importantly, the qualifying organization must satisfy three criteria: (1) The use of the property must be consistent with the organization’s exempt purpose solely for the care of the ill, the needy, or infants. (2) The organization can’t transfer the property in exchange for money, other property, or services. (3) The organization must provide a written statement attesting to the fact that the property will be used in accordance with these regulations.
VALUATION OF CONTRIBUTED PROPERTY
To determine the charitable contribution deduction amount, the taxpayer needs to establish the value of the contributed inventory property. For qualified inventory, there’s an “enhanced” deduction that’s equal to the lesser of (1) the cost of the property plus half the difference between its FMV and cost or (2) two times its cost. For example, the enhanced deduction for a taxpayer’s donated food that has a cost of $400 and a FMV of $1,000 would be $700, which is the lesser of $700 [$400 + (($1,000 - $400)/2)] or $800 (2 ✕ $400). Without this exception for valuation, a taxpayer’s deduction for charitable contributions of inventory would generally be limited to the taxpayer’s cost, which is why it’s called an “enhanced” deduction.
For taxpayers without an established cost, such as farmers who grow their food, no enhanced deduction would be possible since the lesser of the enhanced deduction would be zero—twice the inventory’s cost of zero is still zero. Section 113 of the PATH Act remedies this situation by adding IRC §170(e)(3)(C)(iv), which provides that, for purposes of the enhanced deduction only, a taxpayer may pretend that the “cost” of any apparently wholesome food is equal to 25% of its FMV. Therefore, the taxpayer would be permitted to take an enhanced deduction equal to 50% of the inventory’s FMV. Following similar calculations as above, the 50% is computed as the lesser of 62.5% (“cost” of 25% plus one half of the increase to its FMV of 37.5% (50% of (100% - 25%)) or 50% (two times the “cost” of 25%). For example, the enhanced deduction would be $500 if a taxpayer donated food with a FMV of $1,000 and a “cost” of $250 ($1,000 ✕ 25%), which is the lesser of $625 [$250 + (($1,000-250)/2)] or $500 (2 ✕ $250).
Section 113 of the PATH Act also clarifies and broadens the determination of FMV in situations where apparently wholesome food can’t or won’t be sold solely because it doesn’t meet the taxpayer’s internal standards, there’s a lack of market, or similar circumstances or because the food was produced by the taxpayer exclusively for the purposes of being transferred to a qualifying organization. In these cases, the FMV is determined by taking into account the price at which the same or substantially same food items (in terms of both type and quality) are sold by the taxpayer at the time of the contribution (or, if no similar items are sold at that time, in the recent past). In these situations, the taxpayer may be able to use historical pricing records to establish the FMV.
Overall, this provision provides clarification for this enhanced deduction. Better yet, it increases the deduction’s annual limit beginning in 2016. Many qualified organizations will be pleased with these changes to the enhanced deduction rules.
December 2016
