New Law Restricts Tangible Asset Donations
What Your Clients Need to Know to Comply
The Internal Revenue Service (IRS) has long been relaxed in its policies toward noncash charitable donations. Individuals and corporations alike have pushed the law to its limits (and, in some cases, beyond), deducting the highest possible amounts for donations of automobiles, boats, airplanes—even patents and works of art. But last June, the IRS decided it had had enough.
Going before the Senate Finance Committee, IRS Commissioner Mark W. Everson referenced a recent General Accounting Office (GAO) study that estimated there are about 4,300 charities with vehicle donation programs. Based on returns for the 2000 tax year, Everson said the GAO estimated that about 733,000 taxpayers claimed deductions for donated vehicles they valued at $500 or more. Everson said that the GAO found a disturbing number of cases where the charity received less than 10% of the value claimed on the donor's return. This disparity was a sure sign that some unscrupulous donors were inflating the value of vehicles in order to take a healthy deduction for themselves.
"It was perceived as 'free money,'" says Sophie Beckmann, tax and financial planning specialist for A.G. Edwards. "People were taking junk cars, contributing them to a charity, which in turn would sell them. The donor, meanwhile, would assign market value to the donation regardless of what the car brought at auction. The IRS saw this as abuse."
But abuses didn't stop there. The reforms that Everson's testimony generated extend not just to donations of vehicles such as cars, boats, and airplanes, but also cover gifts of patents and other intellectual property. The tougher laws were rolled into the American Jobs Creation Act of 2004, which was signed by the President in October. Congress says the new law, aimed mainly at curbing abuses, will save the government $2.4 billion over the next 10 years.
Starting January 1, 2005, most donors contributing vehicles to a charity will be allowed to deduct only the amount the item actually sells for. Because most charities dispose of these gifts at wholesale auctions, the allowable deduction will often be very small and may not represent the vehicle’s retail value. The new rules do not apply when the claimed deduction is less than $500 and a more generous deduction is possible if the charity keeps the vehicle and uses it in carrying out its activities or if the charity makes substantial repairs prior to sale. Donations with a claimed value of $5,000 and over require an independent appraisal.
Donations of intellectual property, such as patents, will earn the taxpayer an initial deduction equal to the costs involved in creating the work or the fair market value—whichever is less. However, donors may gain additional deductions in future years if the contributed property produces income for the charity.
What Your Client Needs to Know
Taxpayers can deduct the "fair market value" of any vehicle, boat, or aircraft donated before January 1, 2005, but keep in mind that it is the rather loose definition of fair market value that led to the change in law. Therefore, if your client made a 2004 donation, make sure he or she is aware that valuation depends on a number of factors including the age of the item, wear and tear, accessories, etc.
Even before that, your client needs to know whether he or she qualifies for the deduction.
"Make sure that they're itemizing," says Beckmann. "After that, remember that deductions are limited to 30% of adjusted gross income and can carry over for five years."
The new law treats patents somewhat differently. In the past, most donors could deduct the fair market value of the donated patent, an amount which often included potential income that the patent might generate. It doesn't take much imagination to see how a dishonest donor might abuse this kind of 'blank check.'
The new law restricts taxpayers to writing off the lesser of their basis—or costs—associated with the donated patent or the patent’s fair market value. To prevent a year-end rush to donate patents with inflated values, Congress made the intellectual property provisions effective retroactive to June 3, 2004. Lawmakers did, however, allow donors to benefit if the charity receiving the patent generates income from the gift. Donors can write off up to 100% of the income in the first two years, and a gradually decreasing amount over the 10 years that follow. But there is a catch—donors may not claim any additional deduction until income from the property exceeds the amount of their initial deduction.
Is This The End, My Friend?
Some pundits have decried the new law as the death knell for tangible asset donations. But Ani F. Hurwitz, director of communications at The New York Community Trust, says it's all part of a continuing cycle.
"This happens periodically—usually when there's a budget shortfall," Hurwitz says. "Charities can appear like an easy target."
She added that the booming donor advised fund market has helped thrust charities into the spotlight. "It's huge and it captures a lot of attention as others get into the charity business," she says.
But Hurwitz reserves judgment on how the new law will ultimately affect tangible asset donations. She's waiting to see what the panel convened by Independent Sector—a coalition of charitable organizations and chaired by Senator Charles Grassley (R-IA)—comes up with. The panel is charged with recommending "actions that will strengthen good governance, ethical conduct and effective practice of public charities and private foundations." The panel will report to the Senate Finance Committee in February.
In the meantime, advisors should encourage their clients to act on their charitable impulses, claim only the deductions that are allowed by law, and be extra careful in valuating noncash donations.
Kenneth Heaton is a freelance writer based in Maplewood, New Jersey.
Copyright 2004, Council on Foundations and Community Foundations of America
Used with permission