What is the tax incentive for businesses donating inventory to our non-profit organization for distribution to our clients? 

ANSWER #1

Congress creates the tax law and incorporates provisions into the Internal Revenue Code. Section 170e3 of this code creates an enhanced deduction for businesses that donate appreciated property. Before the enhanced deduction was put in place, companies could only deduct an amount equal to their cost for an item donated to an IRS 501c3 public charity (if the charity did not resell the item). However, the inventory or other property may have a fair market value higher than its cost. Under 170e3, an enhanced deduction allows the donor to take a deduction up to twice the cost/basis of the item if the value is higher than the cost.

QUESTION #2

If items are donated under 170e3, how must the materials be distributed?

ANSWER #2

Donated property under 170e3 must be used for the ill, needy or infant (using IRS definitions). Equipment used by a facility providing service to the needy also qualifies. The same acknowledgement requirements that apply for any donations still applies under 170e3 donations. Though materials that are donated under 170e3 cannot be resold, organizations may charge a "user fee, handling fee, or donation fee" to recoup their expenses. The occasional or rare sale to the general public to reduce excess inventory would also not disqualify the enhanced deduction for the donor. 

QUESTION #3

Are there incentives to encourage a company to make donation of inventory before marking down the items? 

ANSWER #3

Yes. Contact the company and tell them that they might save money by donating slow-moving items prior to marking down the price. In addition, the donor can save the cost of other expenses related to maintaining the inventory, including the cost of warehousing, handling, and/or disposing of the items. Create a computation sheet (such as the one below) to show the donor how the enhanced deduction under 170e3 can benefit them. Your tax advisor can help with this solicitation.

Sample Computation  

Fair Market Value (Selling Price) = $1,000

Basis (Cost to Company) = $ 200

Gain = (Difference between FMV and Basis, 

or "mark up") = $ 800

Step 1: Determine the Gain

FMV $1000 - Basis $200 = $ 800

Step 2: Reduce the deduction to not more than 1/2 the gain

Gain $800 x 1/2 = $ 400

FMV $1000 - 1/2 Gain $400 = $ 600

Step 3: The deduction cannot exceed twice the basis or cost

$600 - 2 x Basis (2 x $200 = $400) = $ 200

Step 4: Add the limitation in Step 1 to the limit in Step 2 and subtract from the fair market value to determine the deduction

$1000 - Gain ($400 + $200) = $ 400

Deduction = Twice the Cost

The IRS allows a company to take up to half the gain (mark-up) on an item, but not more than twice what the company paid for it.

What Non-Profits Don't Know CAN Hurt Them
By Stuart Sobel

QUESTION #1

I have heard that the Internal Revenue Service (IRS) is putting our organization’s tax returns on the Internet. Can you explain why and the new procedure for accessing this information?

ANSWER #1

The IRS, in cooperation with the Philanthropic Research Inc., has created a website (www.guidestar.org) which has information from Forms 990, IRS Exempt Organization Tax Return, of organizations throughout the United States. Before, requests for information were time-consuming and costly. The 1997 forms are on-line and the 1998 information will be added shortly. The IRS will scan the forms when received at its Ogden, Utah, Service Center and make the information available to the website provider on CD-ROM.

QUESTION #2

Our organization recently changed treasurers and our tax return was filed late. The IRS sent us a notice with a significant penalty. Should we just pay the penalty or can the IRS be charitable to a charity?

ANSWER #2

The IRS will send out certain notices automatically, based on specific criteria. When an organization has made a mistake and it is unintentional, it is worthy to write a letter to the IRS asking them to abate the penalty. Under the Internal Revenue Manual, Part 20, Penalties Handbook, it states that when there is a "reasonable cause" a penalty may be abated. Reasonable cause could be substantiated by showing that you are operating with a volunteer board, and during the transition the error was made. Tell the IRS what has happened. Make sure that you correct the systemic problem and tell the IRS why the mistake should not happen again. The IRS will review the history of the organization and most probably see that the event was an aberration. Do not be afraid to describe the situation and ask for forgiveness. In most cases the IRS will demonstrate its compassionate side. However, do not make a habit of being late.

QUESTION #3

Our organization has a newsletter. To fund the document and to provide some financial support for the organization, we are considering accepting advertising. We will keep the advertising relevant to our mission of distributing donated materials and not accept inappropriate items. Can the IRS tax us on the revenue earned, and will we jeopardize our tax-exempt status? 

ANSWER #3

The IRS has prepared a very worthwhile publication entitled "Publication 598 Tax on Unrelated Business Income of Exempt Organizations". Order the publication by calling 800/829-3676 or see the IRS website at www.IRS.gov An organization is subject to tax on unrelated business income if the income is from a trade or business which is regularly carried on by the organization and which is not substantially related to the exempt purpose, except that the profits are needed from the activity to fund the exempt purpose. "Regularly carried on" means frequent and continuous and conducted in a manner similar to a commercial activity. Once a year is not regularly carried on, but once a month may be.