Tax Information: copied from the Internal Revenue Manual

4.43.1.4.19.4 (01-01-2002) Contributions of Inventory

1. As inventory merchandize becomes old (i.e., shelf life expiration, new product introductions fashion trend changes, seasonal changes, technical obsolescence, etc.), the retailer must exercise disposal options. Inventory that remains unsold after all markdowns must either be scrapped, sold in any available after markets (i.e., jobbers or discounters), or donated to charities.

2. An exception to the general rule limiting charitable contribution deductions to inventory basis is provided by IRC section 170(e)(3)(A). If certain requirements are met, a C corporation that contributes property (i.e., inventory used in a trade or business) may deduct an amount in excess of the property's basis. Primarily, the property must be used by the donee solely for the care of the ill, the needy, or infants, and in a manner related to the donee's exempt purpose. If all requirements are met, the starting point for calculating the amount of a corporation's charitable contribution deduction is the fair market value (FMV) of the donated inventory less one half the amount of gain that would not have been long-term capital gain if the contributed property had been sold at its FMV (i.e., the unrealized appreciation in most cases). The resulting amount must be reduced by any amount in excess of twice the property's basis. That portion of the contribution in excess of cost will be reflected on Schedule M-1 of the Form 1120.

3. To establish FMV, the examiner must determine the composition, nature, character, and condition of such inventory immediately before donation. Whether such inventory has marketability to a retailer's customers has a definite bearing on the worth of such merchandise for donation purposes when applying the guidelines of Treas. Reg. 1.170A-1(c)(2) and (30).

A. A retailer may attempt to claim the last retail price, before close-out (including all permanent markdowns), as its FMV for contribution purposes. Treas. Reg. 1.170A-1(c)(2) states that if the contribution is made in property of type which the retailer sells in the course of his business, the fair market value is the price which the retailer would have received if he had sold the contributed property in the usual market in which he customarily sells, at the time and place of the contribution, and, in the case of a contribution of goods in quantity, in the quantity contributed.

B. Treas. Reg. 1.170A-1(c)(3) states that, "If a donor makes a charitable contribution of property, such as stock in trade, at a time when he could not reasonably have expected to realize its usual selling price, the value of the gift is not the usual selling price but is the amount for which the quantity of property contributed would have been sold by the donor at the time of the contribution."

C. The Senate Finance Committee relative to P.L. 97-34, in regards to Section 222 of the bill and the IRC section 170(E), commented [in explaining the 1976 enactment of the IRC section 170(e)(3)(B)] that, "At the same time, the Congress also determined that the deduction so allowed, should not be such that the donor could be in a better after-tax situation by donating the property than by selling it."

4. The examiner must look to the pattern of giving to help establish donative intent. The retailer may be motivated to give its merchandise to charities because it is truly benevolent as a donor to the ill and needy. However, the retailer's actions may be primarily business motivated, and the deduction for such disposal actions limited to inventory basis (i.e., an IRC section 162 ordinary and necessary expense).

A. Periodic donations of highly saleable inventory (items still being offered to its retail customers) may meet the donative intent test.

B. Regular, routine, and recurring inventory reductions and donations of no longer saleable items may be an ordinary and necessary business practice. Technically obsolete inventory such as computers may have limited after markets. Damaged or refund merchandise may not be returned to the retail floor. Perishable products with limited shelf life may be sold in "day old" shops.

5. The condition and quality of contributed inventory should be verified.

A. The examiner should review all written company policy on inventory contribution procedures. Business versus benevolent practices may limit the deduction to basis. After market sales of similar inventory to vendors may establish FMV.

B. The examiner should interview company employees who have "hands on" knowledge of the donation process.

C. Third party discussions with donees may establish the condition and value of donated inventory.

6. Verifying the retailer's FMV and donative intent actions should not overshadow the examiner's requirements to substantiate the basis of contributed property.

A. LIFO or FIFO cost records should identify donated items.

B. Substantiation for inventory maintained on the retail method should include retention of the price tags or price lists for donated items.