How To Account For Business Deductions Of Charitable Donations From Inventory

I often get asked during the preparation of tax returns whether a company can get a deduction for the charitable contribution of goods from inventory.  The answer, as with everything else, “it depends”.

Typically, this occurs after the company has already either adjusted their inventory at year-end with an entry to cost of goods sold or, the company is a cash basis company and at the time the inventory was purchased it already was charged to Cost of Goods Sold.  If this is the case, then the Profit and Loss statement, in most cases, already records the reduction of the profit on the P&L. The only thing that may need to be done is to reclassify the cost from Cost of Goods Sold to Charitable Contributions.

Frankly, many of my clients are surprised to hear this advice. (They seem to think that the Government would allow you to deduct it twice!)  

Many businesses give away unused or unwanted inventory to charities for goodwill, or sometimes for recognition.  It is understandable that business owners get confused as the rules get complicated. As with many other tax laws, they were made complicated to prevent abuse, but still, allow businesses to get a benefit for donations.

First of all, you must give the inventory to a “qualified charitable organization”.  The organization must be a 501(c)(3). You can check whether the charitable organization qualifies as a charitable organization here: https://apps.irs.gov/app/eos/

The standard rule of thumb is that you can deduct as a charitable contribution of the inventory item(s) contributed at the lower of their cost or their fair market value.  

However, there is a difference based on the type of entity that you use.

C Corporations have an advantage here.  In some cases, they can take a deduction which is equal to the Fair Market Value (FMV) of the item donated, reduced by one-half of any amount by which the FMV exceeds the corporation’s cost basis in the item.  If this results in the item being twice the cost basis, then the allowable deduction is limited to twice the cost. In other words, twice the cost is the ceiling on the deduction. However, you must get a letter from the charity stating the following:

1. The donation is being used to care for the financially needy, ill or infants, and is used in a manner related to the donee’s exempt purpose.
2. A third party has not used the property unless that use is incidental to the primary use of caring for the ill, needy, or infants.
3. Donated property has not been transferred by the donee in exchange for money, other property, or services.

S Corporations are limited to the amount equal to the lesser of cost basis or the FMV of the inventory item.  This is bad for companies that have little or no cost basis in their inventory items. You will get very little benefit for donating since your cost is so low.  In addition, there is one further downside of S Corporation charitable contributions –  the charitable contribution gets put on the shareholder’s K-1 and gets passed through so it actually “passes through” to the shareholder’s personal tax return. The problem is made even worse if the shareholder does not itemize. In that case, the contribution is worth $0 to that shareholder. (NOTE: More shareholders do not itemize now with the new tax law.)

Need help with understanding the nuances of accounting for charitable donations from inventory? Call us at (925) 256-6321, or drop us a note here.