Tuesday April 23, 2024
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4.5.1 Inventory and Income Tax Deductions
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Inventory and Income Tax Deductions
What is Inventory? Inventory is property that a person or business entity offers for sale to customers in the ordinary course of trade or business.
Charitable Deduction: Generally, gifts of inventory to charitable organizations are not treated as favorably as gifts of other types of appreciated property.
Cost of Goods Sold: Normally, a business will deduct the cost of inventory as a cost of goods sold.
State Use Tax: Another consideration for gifts of inventory is state sales and use tax.
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Permanent Charitable Tax Extenders
In December of 2015, both the Senate and House passed the Protecting Americans From Tax Hikes Act of 2015 (H.R. 2029). The bill makes permanent four charitable tax extenders.
The four permanent charitable provisions include the following:
1. Conservation Gift Limits – Gifts of property for conservation purposes benefit from increased deduction limits. The normal 30% limit for appreciated property gifts is increased to 50% and the carry-forward limit is extended from five years to 15 years.
2. Food Inventory Gifts – An enhanced deduction for contributions of "apparently wholesome" food will be available for all donors. The deduction is the lesser of twice the basis or basis plus one-half of the appreciation.
3. IRA Charitable Rollover – Each IRA owner may make a transfer of up to $100,000 per year to a qualified charity. The IRA charitable rollovers are tax-free and not included in adjusted gross income.
4. S Corporation Appreciated Gifts – A Subchapter S corporation may give appreciated stock or land to charity. Only the basis of the S corporation in the donated asset will be used to reduce the shareholder basis, even though the full fair market value deduction is claimed by the shareholder.
What is Inventory?
Inventory is property that a person or business entity offers for sale to customers in the ordinary course of trade or business. Thus, if an art dealer donates artwork from her store to a local museum, that artwork is a gift of inventory because it is an item that the donor offers for sale to her customers in the ordinary course of her business.
The category of inventory may also apply to certain earmarked gifts. If a donor acquires large numbers of books, artwork, gemstones or other items at bargain prices and holds them for one year to obtain long-term capital gains status, followed by an immediate gift to charity, then the Service may consider the individual a dealer. Rev. Rul. 79-256, 1979-2 C. B. 105, Rev. Rul. 80-233, 1980-2 C. B. 69 and Rev. Rul. 80-329, 1980-2 C. B. 70.
Charitable Deduction
Generally, gifts of inventory to charitable organizations are not treated as favorably as gifts of other types of appreciated property. The main difference between treatment of gifts of appreciated property, such as stock or real property, and gifts of inventory is the amount of the charitable deduction for the gift.
Unlike typical appreciated property gifts such as stock, the charitable deduction for the gift of an inventory item is limited to the cost basis of the item. For example, the art dealer above who contributed art to a local museum may claim a deduction for only the cost basis of the artwork (i.e., what she paid for the artwork) rather than for the fair market value at which she could sell the artwork to her customers. This is true even if the museum plans to use the art in furtherance of its charitable purpose (for a related use). Because only the cost basis of inventory is deductible, a donor's deduction may be used in an amount up to 50% of his AGI in the year of the gift.
Generally, when tangible personal property is given to a charity for a related use, the donor is able to claim a deduction for the fair market value of the property. Note that even if there is a related use, a gift of inventory is treated differently and does not get a fair market value deduction.
There are exceptions to the general rule that gifts of inventory receive less favorable treatment than other gifts. The exceptions, however, pertain only to C corporations and apply only in narrow circumstances. For example, there is an exception for gifts that have a use related to the charity's exempt purpose and are solely for the care of the ill, the needy or infants. There is also an exception for gifts of certain scientific equipment to educational institutions or scientific research organizations.
Example 4.5.1
Colin Coincollector owns a shop where he buys and sells rare coins. Colin recently purchased an extremely rare coin collection at an estate sale. Colin purchased the collection for a fraction of its fair market value.
Colin would like to donate this coin collection to the State College Museum. The museum has agreed to display the coin collection.
Because Colin buys and sells coins in his ordinary course of business, the deduction he is allowed for the gift of coins to the State Museum will be limited to his cost basis in the coin collection. This is true even though the coins have a related use to the museum's exempt function.
Other Considerations
Cost of Goods Sold
Normally a business will deduct the cost of inventory as a cost of goods sold. If a C corporation makes a gift of inventory to a charity and claims a charitable deduction, it cannot also deduct that same inventory as a cost of goods sold. The corporation is permitted only one deduction for each item of inventory.
Generally, taking a deduction as a cost of goods sold is more advantageous for the corporation because a charitable deduction is limited to 10% of the corporation's taxable income. The IRS, however, has specific rules for what type of deduction the corporation is allowed to take.
The distinction between what type of deduction is allowed depends on when the inventory is acquired. If the inventory was acquired prior to the year of the gift and is included in the corporation's beginning inventory in the year of the gift, the corporation will receive a charitable deduction for gifts of the inventory items. However, if the inventory was acquired during the year of contribution, a cost of goods sold deduction is allowed and a charitable deduction is not.
State Use Tax
Another consideration for gifts of inventory is state sales and use tax. When a corporation purchases inventory or parts to be used for the construction of inventory, it does not normally pay sales or use tax on those components. This is because sales tax is paid when the corporation sells the finished items. When inventory is contributed to charity those items are never sold and thus, no sales tax is ever paid. Some states allow an exemption from sales and use tax for gifts of inventory to a charity. The exception does not require the corporation to pay sales or use tax on the gifted inventory. However, some states do not have such an exemption and therefore consider gifts of inventory to have been "used" by the corporation, thus requiring use tax to be paid by the charity at the time of the inventory gift.
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Case Studies on Inventory and Income Tax Deductions
Greenco Inventory Gift I:
Bill and Clara Green consider themselves very fortunate. Bill was born in Estonia. While he was an infant, his parents immigrated to America. He attended high school and State College on the East Coast. After he received an engineering degree, Bill worked for two different companies on the East Coast. He met Clara, married and has two children, Susan and Harry.
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