A Little-Known Tax Benefit: The Gift of Inventory

By Robert Ford, CPA, and Irwin Leib, CPA, Washington, DC

Charitable Deductions

Tax incentives are available for contributions of inventory for the care of the ill, needy, or infants, but many taxpayers may be unaware of them. This item outlines the current rules for an increased deduction and analyzes events leading up to the current rules.

For many years, no tax incentive existed for businesses to donate ordinary income property, such as inventory, to a qualified charity. Donors of appreciated ordinary income property were only permitted to deduct their basis in the property, generally cost, rather than the full fair market value (FMV).

For example, pharmaceutical manufacturers or retail stores may have a “do not sell after” designation for their merchandise, meaning that a manufacturer generally will not distribute the property after a certain date, nor will any retailer sell the items after the expiration date. However, the property could have a useful life for some time after this date. In many instances, destroying the property would provide a greater tax benefit to the owner than contributing it to a charity. Upon destruction, the owner of the outdated property would be entitled to deduct the entire basis of the property as a loss under Sec. 165 or as a deduction through cost of goods sold—clearly, not an incentive to make a donation to a worthy charity.

Various industries and charities have recommended modification of the deduction rules for ordinary income property to Treasury and IRS officials. In 1984, Treasury amended the Sec. 170 regulations to provide a deduction for the contribution of inventory to certain qualified charities equal to the cost of the donated inventory plus one-half the gross profit the property would have generated if sold at its FMV.

Today, incentives are available for contributions of inventory for the care of the ill, needy, or infants, and many taxpayers may be unaware of the increased deduction. Following is an analysis of events leading up to the current rules.


A statutory change enacted in 1962 provided a deduction for contributions of property to a charitable organization equal to the FMV of the property (Sec. 170(e)(1)), providing the sale of such property would have produced long-term capital gain to the donor. An increased deduction was not originally allowed for the contribution of property producing ordinary income because taxpayers in high marginal brackets could possibly receive a greater tax benefit for contributing substantially appreciated property to a charity than for selling the property.

The rule disallowing an increased deduction for ordinary income property eliminated certain abuses related to the contribution of property to charities. However, at the same time it also noticeably reduced contributions of certain types of property such as food, clothing, and medical supplies for the needy and disaster victims. Therefore, the Tax Reform Act of 1976, P.L. 94-455, permitted a deduction for contributions of certain ordinary income property (Sec. 170(e)(3)). Under this exception, the Code permitted an increased deduction, albeit reduced, for the contribution of certain qualified inventory.

By applying the new rules, a pharmaceutical company, for example, could receive an increased deduction for donating “outdated” drugs to a qualified charity. While these drugs would not be sold through normal retail outlets, presumably they will have medical value to the recipients. Similarly, the increased deduction would be available to a grocery store donating outdated milk or other dairy products to a food bank. Although the store may no longer sell the expired dairy products, the products may still be fit for human consumption.

Originally, the regulations promulgated by Treasury in 1982 for Sec. 170(e)(3) required a taxpayer to reduce the cost of goods sold by the cost of the contributed inventory. Subsequently, regulations permitted a deduction equal to the FMV of the property plus one-half the difference between the FMV and cost. However, if the inventory had an FMV less than cost, the rules essentially penalized taxpayers. A taxpayer would have received a larger deduction by simply destroying the property and taking a loss through Sec. 165 or through cost of goods sold. Therefore, in 1984 Treasury amended the regulations so that a deduction for the contribution of inventory would not be lower than the cost of the property.

Qualified Charitable Contribution

Generally, current law qualifies the donation of an inventory item to a charitable organization as an increased deduction if the donee uses the property for the care of the ill, the needy, or infants. In addition, the inventory must meet the following seven requirements:

  • The property must be given by a C corporation;
  • It must be inventory as described in Secs. 1221(a)(1) and (2);
  • It must not be transferred by the donee for money, other property, or services;
  • The donee must represent in writing given to the donor that the property will be used to care for the ill, the needy, or infants and that it will not be transferred for money, other property, or services;
  • If subject to the Federal Food, Drug, and Cosmetic Act, the property must satisfy the act’s requirements and the requirements of the regulations promulgated thereunder on the date of transfer and for the prior 180 days;
  • The donee must be a public charity or private operating foundation (not a private foundation); and
  • The use of the property by the donee must be related to the exempt function of the donee, and the property may not be used to produce unrelated business taxable income under Sec. 512.

While the above provisions are limited to contributions by C corporations, the Code permits taxpayers other than C corporations to receive an increased deduction for the contribution of food that is “apparently wholesome food” under Section 22(b) of the Bill Emerson Good Samaritan Food Donation Act, P.L. 104-210. The product must meet all quality and labeling standards imposed by federal, state, and local laws and regulations even though the food may not be readily marketable due to appearance, age, freshness, grade, size, surplus, or other conditions.

An increased deduction under Sec. 170(e)(3)(C) may not exceed 10% of a taxpayer’s aggregate net income for the year of the contribution. Because of this limitation, certain taxpayers may receive a greater benefit by applying the provisions of Sec. 170(e)(1) instead of Sec. 170(e)(3). In Notice 2008-90, the IRS announced it would not challenge a position taken by a taxpayer to deduct charitable contributions of food inventory under Sec. 170(e)(1) instead of Sec. 170(e)(3).

The Code also permits an increased deduction for contributions of book inventory to public schools where the school provides elementary or secondary education (kindergarten through 12th grade). The Code points out that the receiver of the books does not need to use the property for the care of the ill, the needy, or infants. The public school must certify in writing that the books are suitable, in terms of currency, content, and quantity, for use in its educational programs and must then use the books in its educational programs.

Enhancement of Deduction

The increased deduction for long-term capital gain property is equal to the FMV of the property given to a charitable organization. The increased deduction for contributions of inventory, however, is the cost of the inventory plus one-half the gain if the property were sold for its FMV. The deduction is limited to twice the cost of the inventory. The taxpayer’s method of accounting determines the cost. In addition, the taxpayer should consider all the facts to determine the property’s FMV on the date of the contribution.

In Lucky Stores, Inc., 105 T.C. 420 (1995), the Tax Court ruled that a bakery could take a deduction for charitable contributions of bread and other bakery products given to care for the needy using the full retail price of the products. The bread was given away after four days on the grocer’s shelves. Although the bread was too old for the grocer to sell, the court held that the retail price was the appropriate price for the store to use to determine the FMV of the goods.

In Rev. Rul. 85-8, a pharmaceutical company donated drugs for the care of the ill, and the IRS concluded that the proper FMV was not the retail price of the products, which was $10 each in the ruling. Because the drugs were approaching their expiration dates, after which they would not be sold, the appropriate value of the drugs was half the retail value, or $5 each. Despite the decrease in the FMV, under current law the drugs would have received an increased deduction of twice the cost of the products because the cost of the product was $1 each. The Tax Court distinguished the Lucky case from this ruling because the bread did not have an expiration date and could still be legally sold when it was contributed to a charity.

Procedural Aspects of Increased Deduction

The IRS requires special documentation for certain charitable contributions. Typical requirements include disclosure on the taxpayer’s tax returns, documentation of FMV, and documentation of receipt of property by the charity.

For charitable contributions of inventory with more than $500 of increased deduction, the IRS requires the taxpayer to file Form 8283, Noncash Charitable Contributions, with its income tax return. Section A of the form should be completed for contributions for which the taxpayer claims less than $5,000 of increased deduction and Section B for contributions for which the taxpayer claims more than $5,000 of increased deduction. If the increased deduction is greater than $5,000, an authorized representative of the donee should sign Form 8283 acknowledging the receipt of the property. In addition, a statement should be attached computing the amount of increased deduction for the inventory.

Unlike other property, Sec. 170(f)(11)(A)(ii) does not require an appraisal for contributions of inventory because inventory is generally valued annually by the taxpayer. The FMV of inventory contributed to a charity should be documented by the donor based upon the facts and circumstances at the time of the contribution.

For contributions of inventory, the Code requires the donee to provide a representation that the property will be used to care for the ill, the needy, or infants and that it will not be transferred for money, other property, or services. In addition, the representation should contain a description of the property, acknowledgment of the receipt of the property, and whether the donee provided any goods or services to the donor for the property.


It should be noted that as of the date this item was written, Secs. 170(e)(3)(C) and (D) sunset on December 31, 2009. However, it is expected that Congress will extend the statute with the Tax Extenders Act of 2009, H.R. 4213, or similar legislation.

Editor: Mary Van Leuven, J.D., LL.M.


Mary Van Leuven is Senior Manager, Washington National Tax, at KPMG LLP in Washington, DC.

For additional information about these items, contact Ms. Van Leuven at (202) 533-4750 or mvanleuven@kpmg.com.

Unless otherwise noted, contributors are members of or associated with KPMG LLP.

This article represents the views of the author or authors only and does not necessarily represent the views or professional advice of KPMG LLP. The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser.

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