Pending tax reform legislation has put a renewed focus on charitable contributions. As part of the “Tax Reform Act of 2014,” House Ways and Means Committee Chairman David Camp has proposed in the section on charitable contributions that a taxpayer would have to donate at least 2% of his income to a charity in order to claim a charitable deduction. The provision would also extend the deadline for making tax deductible donations for a given tax year to April 15 of the following year (instead of December 31 of that tax year). With the proposal looming, we provide below a review of charitable contributions and relevant valuation considerations.
Requirements for Charitable Contributions
A charitable contribution is defined as a contribution or gift to a governmental entity for a public purpose, or to a domestic organization in accordance with U.S. Code Section 501(c)(3). There must be donative intent behind the charitable contribution; the Supreme Court has indicated that the gift must be given with “detached and disinterested generosity.” In addition, there must be a conscious desire to make a gift, i.e. the gift cannot be given by mistake or under pressure.
The deduction is allowed in the tax year in which the payment is made, when delivery of the gift is effected. The deduction is premature if the taxpayer has only made a pledge or given the charity a postdated check. For a corporation, the deduction cannot exceed 10% of the corporation’s taxable income. Excess contributions can be carried over for the next five years. For individuals, the deduction is limited to 50% of adjusted gross income (AGI) for donations to public charities and private operating foundations, or 30% of AGI for donations to entities classified as private foundations. For estates and trusts, all qualifying distributions to charity are deductible to the extent of gross income.
The IRS requires donors and donee organizations to supply certain information to prove a taxpayer’s right to deduct charitable contributions. If you donate an item (or a group of similar items) of property worth more than $5,000, certain appraisal requirements apply. You must obtain a “qualified appraisal,” attach an “appraisal summary” to the first tax return on which the deduction is claimed, include supplemental information with the return, and maintain certain records. The appraisal report should include the appraiser’s qualifications, a statement of value, the underlying facts that support the value, the date of the valuation, and the appraiser’s signature. The appraisal must be made by an appraiser no earlier than 60 days prior to the contribution. The type of asset being donated will present certain valuation considerations. The following is an overview of key considerations.
For real property, the deduction equals the fair market value (FMV) at the time of the contribution. FMV is defined as the “price at which the property would change hands at the time of the gift between a willing buyer and a willing seller who are not compelled to buy or sell.” If the real property is inventory, FMV is the price the donor would normally receive in the course of business. The gift is deductible in the year the taxpayer delivers the deed to the charity.
The value of securities is equal to the average of the high and low prices in reported sales on the date of contribution. If no sales occurred on the contribution date, the value is the weighted average between the highest and lowest sales on the dates closest to the contribution date.
For closely held and unmarketable stock there are a number of factors to consider in the valuation including the nature of the business and history since inception, the economic outlook and condition of the specific industry, the book value and financial condition, dividend-paying capacity, and anticipated public offering.
A conservation or “facade” easement preserves a historical structure by restricting changes to the structure. To qualify as a deductible contribution, the easement must be on a “certified historic structure” as defined by IRC Section 170. A certified historic structure is a building, structure or land area listed in the National Register or certified by the Secretary of the Interior. For the valuation of the easement, the underlying property is valued before the grant of the easement and after the grant of the easement. The difference between the two is the value of the easement.
Under the Jobs Act of 2004, if a taxpayer contributes a patent or other intellectual property (other than certain copyrights or inventory) to a charitable organization, the taxpayer’s initial charitable deduction is limited to the lesser of the taxpayer’s basis in the contributed property or its fair market value. “Partial interest” donations are not deductible. For example, donating the right to use the patent, but not ownership, is a donation of partial interest and is not deductible.
While the income, market, and cost approaches are the methods commonly used to value intellectual property for tax purposes, the income approach is the most prevalent method and the one most supported by Tax Court.
To avoid penalties, it is important to engage an experienced valuation professional who knows the requirements for a qualified appraisal. For more information on valuations of charitable contributions, contact your VRC representative.