In the early years of the income tax, private philanthropy was encouraged by the inclusion of a charitable contribution deduction in the Internal Revenue Code. The original charitable contribution deduction was enacted in the War Revenue Act of 1917, P.L. 65-50. The present Code provides a deduction for charitable contributions made within the tax year (Sec. 170(a)(1)).
A corporation reporting taxable income on the accrual method is allowed to elect a charitable contribution deduction if the board of directors authorizes the contribution during the year and the contribution is made on or before the 15th day of the fourth month following the close of the year (Sec. 170(a)(2)).
Charitable contributions of food are given special treatment in the Code (Sec. 170(e)(3)(C)). And a recent change in the law makes it easier for taxpayers to claim charitable deductions for food products donated to charity (Section 113 of the Protecting Americans From Tax Hikes Act (PATH), P.L. 114-113).
Charitable deduction basics
No charitable deduction is allowed for the contribution of services, although unreimbursed expenditures made in the course of performing services for a charitable organization may constitute deductible contributions (Regs. Sec. 1.170A-1(g)).
Charitable contributions of property require additional computations to calculate the deductible amount. The first step is to determine the fair market value (FMV) of the property. The charitable contribution deduction for property is reduced by the gain that would not have been long-term capital gain had the property been sold at its FMV (Sec. 170(e)(1)(A)). For this purpose, depreciable property and real property used in a trade or business are treated as a capital asset, except for that portion of the gain that is treated as ordinary income under certain recharacterization provisions (Regs. Sec. 1.170A-4(b)(4)).
Charitable deductions for food
While generally only C corporations may claim a deduction for charitable contributions of nonfood inventory items, any form of entity is entitled to the charitable deduction for contributing food (Sec. 170(e)(3)(C)(i)(I)).
Under Sec. 170(e)(3)(C)(i)(II), the food must be apparently wholesome food, the FMV of which is determined without regard to the taxpayer's internal standards, a lack of market or similar circumstances, or by reason of being produced by the taxpayer exclusively for the purpose of transferring the food to a qualified charity (Sec. 170(e)(3)(C)(v)). The FMV considers the price at which food items of the same or substantially the same type and quality are sold by the taxpayer at the time of the contribution or, if no sales were made at that time, in the recent past (Sec. 170(e)(3)(C)(v)(I)).
"Apparently wholesome food" is defined in 42 U.S.C. Section 1791(b)(2), which states:
The term "apparently wholesome food" means food that meets 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.
Note: The food's "pull date" or "sell-by date" is therefore irrelevant in determining FMV as long as the quality and labeling standards are otherwise met.
Contributions of food inventory are based on the food's FMV but reduced under a specific provision. For zero-basis inventory of a cash-method taxpayer not required to maintain inventories (e.g., a cash-method farmer), the charitable deduction under this provision is 50% of FMV. The PATH Act liberalized the deduction for cash-method taxpayers not required to account for inventories (e.g., farmers) by deeming the tax basis of the apparently wholesome food to be 25% of its FMV. In this manner, the deduction amount is FMV, reduced by one-half of the ordinary income that would have been recognized had the property been sold, and also reduced by an additional amount to the extent that the deduction would exceed twice the tax basis of the property (Secs. 170(e)(3)(B)(i) and (ii)). By deeming the tax basis to be 25% of the FMV of the food, this second clause (i.e., Sec. 170(e)(3)(B)(ii)) has no effect.
Note: This provision applies to tax years beginning after 2015. Before the addition of this special provision for contributions of food, a taxpayer holding zero-basis inventory received no deduction for the charitable contribution.
The use of the donated food
The charity must use the donated food inventory in furtherance of its purpose or function constituting the basis for its exemption as a charitable organization. The food inventory must be used by the organization solely for the care of the ill, needy, or infants. No goods or services may be received in exchange for the donation, and the taxpayer must receive from the donee a written statement representing that its use and disposition of the property will be in accordance with these provisions. The food must satisfy the requirements of the Federal Food, Drug, and Cosmetic Act (Sec. 170(e)(3)(A)).
Example 1: A cash-method farmer raises fruits and vegetables on his five-acre farm. He harvests seasonal products to take to local farmers' markets, held on different days of the week in the nearby metropolitan area. At the end of the day, he delivers any unsold fruits and vegetables to the local food bank. Because he is not required to maintain inventories for tax purposes, he has no tax basis in the produce. He may deduct a charitable contribution deduction equal to one-half of his normal sales price, assuming he meets the documentation requirements, including receiving a written acknowledgment from the charity.
Limitation on the deduction
This charitable contribution is subject to special limitations. For a taxpayer other than a C corporation, the limitation is 15% of the taxpayer's aggregate net income for the year from the trades or businesses from which the contributions were made (determined without regard to this charitable contribution) (Sec. 170(e)(3)(C)(ii)(I)). For example, if the only business generating the food to be contributed is the taxpayer's farm business reported on Schedule F, Profit or Loss From Farming, the limitation is 15% of the Schedule F net income. The taxpayer's other income, reported on Schedule B, Interest and Ordinary Dividends, Schedule C, Profit or Loss From Business, and Schedule E, Supplemental Income and Loss, is not considered. Presumably, if a sale of a Schedule F depreciable asset is reported on Form 4797, Sales of Business Property, the gain (or loss) from the sale is considered as part of the Schedule F business income for purposes of this limitation.
The limitation for a C corporation is 15% of taxable income determined without regard to the deductions for charitable contributions (Sec. 170(e)(3)(C)(ii)(II)). For other corporate charitable contributions, the 10%-of-taxable-income limitation is reduced (not below zero) by the contributions subject to the 15% limitation (Sec. 170(e)(3)(C)(iii)(I)). Excess contributions may be carried over for each of the five succeeding tax years (Sec. 170(e)(3)(C)(iii)(II)).
Example 2: A Inc., a C corporation, raises apples on part of its 2,000-acre farm and ships its apples throughout the United States and to other countries. It donates several boxes of its apples a week to the local mission for the homeless. A determines the FMV of the donated boxes based on its sales prices for the grades of apples donated. Even though it has no tax basis in the apples (under its cash method of accounting, A is allowed to deduct all of the cost of raising the apples (Regs. Sec. 1.162-12(a); Regs. Sec. 1.471-6(a)), it may deduct as a charitable contribution one-half of the FMV of the apples donated, limited to 15% of its taxable income (determined before the charitable contribution). Any excess charitable deduction is carried over to the succeeding five years.
The charitable contribution deduction for apparently wholesome food may be claimed by any type of taxpayer. Owners of fresh product packed for shipping may benefit from this provision, as well as other cash-method owners of food inventory, even if that inventory is in excess of the market demand for the perishable commodity for that day.
Cash-method farms, including community supported agriculture programs that allow individuals to join a cooperative with other individuals to receive fresh fruits and vegetables from local farmers, now may receive the benefit of a charitable contribution deduction for donating excess inventory to the local food bank or homeless shelter. This includes the unsold product from the day's local farmers' market. A cash-method grower/packer/shipper of fresh fruit or vegetables may also receive an "above basis" charitable contribution deduction.
Accrual-method taxpayers, including taxpayers required to maintain inventories (e.g., grocery stores), should review the computation to calculate the reduction from FMV to determine the charitable contribution deduction.
Christopher W. Hesse, CPA, is a principal in the National Tax Office of CliftonLarsonAllen LLP in Minneapolis. He is also a Member of the AICPA Tax Executive Committee and former chair of the AICPA S Corporation Technical Resource Panel and the AICPA National Agriculture Conference.
A version of this article appeared in the Washburn Agricultural Law & Tax Report (July 6, 2016).