Charitable Deduction

Charitable Deduction

News story posted in Field Service Advice on 13 September 2000| comments
audience: National Publication | last updated: 18 May 2011
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Summary

In Field Service Advice 1995-4, released today, the Service advised that a grocery chain could not take a charitable income tax deduction equal to the full retail price of fresh bread for donations of four-day old bread to food banks.

FSA 1995-4

PGDC SUMMARY:

In Field Service Advice 1995-4, released today, a grocery chain had been donating four-day old, unsold bread to food banks, which are qualified charitable organizations. In general, the four-day old bread was taken off the shelf when the grocery chain received fresh bread each day and the four-day old bread was boxed up for delivery to the food banks. However, because bread was not delivered on Sunday, the grocery chain sold some four-day old bread at full retail price. The grocery chain claimed charitable income tax deductions for the donated bread equal to the full retail price of fresh bread. Based on industry practices and other information, the IRS argued that the fair market value of the four-day old bread was equal to 50% of its retail price.

Citing Treasury Regulation Sections 1.170A-1(c)(2) and (3) and Revenue Ruling 85-8, 1985-1 C.B. 59, the IRS advised that the four-day old bread could not be valued at the full retail value of fresh bread. The IRS noted (i) the large quantities of four-day old bread donated by the grocery chain caused the value of such bread to be lower under the laws of supply and demand; (ii) the fact that the grocery chain could not dispose of all of its four-day old bread on Sunday was evidence that such bread is not worth that much; (iii) the IRS expected its expert to show that such bread is generally sold from grocery store discount racks or thrift stores at half price, so half price is the fair market value; (iv) the IRS expert should be directed towards customer knowledge of the bread dating system because most Sunday customers probably were not aware that some of the bread was four days old and so did not have knowledge of all the relevant facts; and (v) property that is "otherwise intrinsically more valuable that is encumbered by some condition limiting its marketability must be valued in light of such limitation." The IRS did not recommend pursuing the grocery chain's possible lack of charitable intent as an argument against the charitable deduction because the IRS noted that the standard for a corporate donor would likely be whether the corporation received some quid pro quo and the grocery chain would find it easy to show that it did not.

POINTS TO PONDER:

How might a donor counter the potential arguments raised by the IRS in this Field Service Advice?

FULL TEXT:

Date: January 19, 1995
Refer Reply to: CC:TL-N-11627-94
INTERNAL REVENUE SERVICE MEMORANDUM
TO:
District Counsel, Portland CC:W:POR
ATTN:
Alan Summers
FROM:
Assistant Chief Counsel (Field Service) CC: DOM: FS
SUBJECT:
* * *


This responds to your request for field service advice dated December 13, 1994, as well as that of Kevin Croke (of District Counsel, San Francisco), dated December 2, 1994.

DISCLOSURE STATEMENT

This document may contain taxpayer information subject to section 6103. This document may also contain confidential information subject to the attorney-client and deliberative process privileges, and may also have been prepared in anticipation of litigation. Therefore, this document shall not be disclosed beyond the office or individual(s) to whom it is addressed and in no event shall it be disclosed to taxpayers or their representatives.

Specifically, if this memorandum is addressed to a District Counsel, then only office personnel working the specific case or subject matter may use this document. If this memorandum is addressed to a District Director, then only office personnel working the specific case or subject matter may use this document. This memorandum shall not be disclosed or circulated beyond such office personnel having the requisite "need to know."

ISSUE

Whether, for purposes of determining the allowable charitable contribution deduction under I.R.C. section 170 for the contribution of four-day old bread by a grocery chain, four-day old bread is properly valued at the full retail price of fresh bread.

CONCLUSION

We do not believe that four-day old bread can be properly valued at the full retail price of fresh bread for I.R.C. section 170 purposes. The actual fair market value of four-day old bread is a question of fact which is ready for trial.

FACTS

During the years at issue, petitioner * * *, a grocery chain, contributed unsold four-day old bread to food bank programs. These contributions were made to qualifying organizations. The only question is the fair market value of the four-day old bread.

* * * claims that the fair market value of the four-day old bread is equal to its full retail price. This argument is based on the following.

During the years at issue, * * * delivered freshly baked bread to its stores on every day of the week except Sundays. The delivery persons placed the new bread to the back of the shelves and the older bread to the front. On the bread delivery days, * * * removed any unsold bread that had been on the shelves three days. For example, bread that was placed on the shelves in the early morning of Tuesdays would be removed in the early morning of Fridays. The bread that was removed was boxed up and contributed to the food banks.

* * * did not make bread deliveries on Sundays. Therefore, * * * did not remove three-day old bread from its shelves on Sunday mornings. Therefore, * * * in essence, sold some four-day old bread from its shelves at full retail price on Sundays. Since * * * sold some four-day old bread at full retail Since price on Sundays, * * * argues that the four-day old bread which it contributed on other days was worth full retail price.

The Service argues, based upon industry practice and other available information, that the four-day old bread had a fair market value equal to 50% of its retail price. Industry practice is to pull bread after three days. This bread is then sold at steep discounts from in-house discount racks or at thrift stores.

DISCUSSION

We do not believe that four-day old bread can be properly valued at the full retail price of fresh bread. This conclusion is supported by several published Service positions, which are discussed below.

Treas. Reg. section 1.17OA-1(c)(2) provides as follows with respect to the fair market value of contributed property:

The fair market value is the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell and both having reasonable knowledge of relevant facts. If a contribution is made in property of a type which the taxpayer sells in the course of his business, the fair market value is the price which the taxpayer would have received if he had sold the contributed property in the usual market in which he customarily sells, at the time and place of the contribution and, in the case of a contribution of goods in quantity, in the quantity contributed.

This regulation is instructive in several ways. First, it is clear that * * * contributed large quantities of four-day old bread. Treas. Reg. section 1.17OA-1(c)(2) requires that the quantity of the goods contributed be considered in determining value. Under the law of supply and demand, the larger the quantity, the lower the value. Thus, the government can argue that the value of * * *'s four- day old bread should be discounted accordingly.

A second related argument can be advanced as follows. Presumably, * * * should be denied a full retail price deduction unless * * * would have been able to dispose of all of its four- day old bread at full retail price. The fact that * * * is unable to dispose of all four-day old bread it offers on Sundays at full retail price is strong evidence that its four-day old bread is not worth that much.

Third, Treas. Reg. section 1.17OA-1(c)(2) provides that, with respect to inventory sold in the normal course of business, fair market value is the price the taxpayer would have received if they had sold the contributed property in the usual market in which they customarily sell, at the time and place of contribution. As you point out in your request for field service advice, in Lio v. Commissioner, 85 T.C. 56 (1985), aff'd, sub. nom. Orth v. Commissioner, 813 F.2d 837 (7th Cir. 1987), the Tax Court stated that the determination of the proper market for valuation purposes is a question of fact. 85 T.C. at 66-67. Furthermore, the Tax Court stated that the fair market value of an item of property is to be determined in the market where the item is most commonly sold to the public. Since we expect our expert to show that four-day old bread is most commonly sold from in- house discount racks or from the shelves of thrift stores, this is the relevant market. And since four-day old bread sold in this market typically sells at half price, this represents its fair market value.

Fourth, Treas. Reg. section 1.170A-1(c)(2) states that reasonable knowledge of relevant facts is necessary before the price paid will be considered to be the fair market value. The government may be able to use this language to counter * * *'s argument that its Sunday sales are indicative of fair market value. The government may be able to argue that Sunday customers who purchase four-day old bread do not have reasonable knowledge that the bread they are purchasing is four days old. Admittedly, the bread is marked in such a way to enable store workers to recognize its relative freshness. Whether the average customer is cognizant of this system is subject to doubt. In fact, a 1993 Trends survey of U.S. grocery shoppers by the Food Marketing Institute found that only three (3) percent of grocery shoppers say they check the expiration dates when purchasing food.1 Further evidence that the average customer may not be cognizant of the bread dating system exists in the fact that not all of the fresher bread of each type which is offered for sale on Sundays is purchased on Sunday while some of the four-day old bread is purchased. Presumably, a large percentage of customers, if truly aware of the dating system, would choose the fresher bread, even if it was placed in the back of the rack. We believe that you should consider engaging your marketing expert on this point.

Additional support for the government's position in the instant case can be found in another regulation, Treas. Reg. section 1.170A-1(c)(3), which provides as follows:

If the donor makes a charitable contribution of property, such as stock in trade, at a time when he could not reasonably have been expected to realize its usual selling price, the value of the gift is not the usual selling price but is the amount for which the quantity of property contributed would have been sold by the donor at the time of the contribution.

We believe that Treas. Reg. section 1.170A-1(c)(3) was intended to limit taxpayers (such as * * *) from claiming full retail price deductions for goods encumbered by some temporal condition affecting marketability. Therefore, the regulatory scheme supports the government's position in the instant case.

Rev. Rul. 85-8, 1985-1 C.B. 59 (clarifying and superseding Rev. Rul. 83-29, 1983-1 C.B. 65) also supports the government's position in the instant case. In Rev. Rul. 85-8, Corporation X is a pharmaceutical manufacturer. X manufactures products that are subject to an expiration date. The products may not be legally sold after the expiration date. Shortly before the expiration date, X made a qualified contribution of a quantity of certain products which were about to expire. X claimed a deduction for this contribution based on the normal price the products would be sold for in the usual market in which the products are sold. However, since the expiration date was almost at hand, if X had sold the products in its usual market, X would only be able to sell these products for half price.

The question in Rev. Rul 85-8 is whether X can obtain a contribution deduction based on the normal price or whether X's contribution deduction is limited to the half price figure. Rev. Rul. 85-8 holds that the fair market value of the products for the purpose of determining X's deduction is limited to the half price figure. 2

Thus, Rev. Rul. 85-8 states that property otherwise intrinsically more valuable that is encumbered by some condition limiting its marketability must be valued in light of such limitation. See also Cooley v. Commissioner, 33 T.C. 223 (1959), aff'd per curiam, 283 F.2d 945 (2d Cir. 1960).

Another possible argument for the government would center on the lack of true donative intent on the part of * * *. This argument has problems, however, as illustrated below.

The test for donative intent has been articulated in various ways. In Commissioner v. Duberstein, 363 U.S. 278 (1960), the Supreme Court held that, in order for a transfer to be excludable from gross income as a gift, the transfer must be 'motivated by "detached and disinterested generosity" or by charitable motives rather than expected economic benefit. The Tax Court has applied the Duberstein "detached and disinterested generosity" test in the past in the context of charitable contributions. See, e.g., Howard v. Commissioner, 39 T.C. 833 (1963).

This application of the Duberstein test (i.e., likening the definition of a gift for exclusion purposes with the definition of a charitable contribution for deduction purposes) was affirmed by the Ninth Circuit in DeJong v. Commissioner, 36 T.C. 896 (1961), aff'd, 309 F.2d 373 (1962). In DeJong, the Ninth Circuit stated that charitable contributions by individuals must stem from detached and disinterested generosity.

Six years after their opinion in DeJong, however, the Ninth Circuit declined to apply the Duberstein detached and disinterested generosity test to a corporate taxpayer in a section 170 case. United States v. Transamerica Corp., 392 F.2d 522, 524 (9th Cir. 1968). In Transamerica Corp., the Ninth Circuit distinguished Dejong, noting that DeJonq involved individual taxpayers. The Ninth Circuit stated that an absolute requirement of detached and disinterested generosity or lack of business purpose with respect to corporations would render ultra vires substantially all corporate charitable contributions.

Based on the opinion in Transamerica Corp., it is apparent that the Ninth Circuit prefers the quid pro quo test in analyzing whether donative intent should be deemed to exist in the context of corporate charitable contributions. Under the quid pro quo test, donative intent may be deemed to exist to the extent that the corporation does not receive full value in return for its transfers to exempt organizations. The quid pro quo test is easier to apply since it examines the external features of the transaction, as opposed to attempting to examine subjective intent.

Therefore, we do not recommend raising a "lack of donative intent" argument in the instant case. Since * * * is a corporate taxpayer, the Tax Court will only require the lack of a quid pro quo in order for * * * to establish donative intent. * * * will have no problem establishing the lack of a quid pro quo under the facts present in the instant case.

It is important to note that, in litigation, the Commissioner's audit determination of fair market value will be presumed to be correct and the taxpayer bears the burden of proving that the Commissioner's determination is either arbitrary or erroneous. Helvering v. Tavlor, 293 U.S. 507, 515 (1935); Welch v. Helvering, 290 U.S. 111, 115 (1933); Orth v. Commissioner, supra, 813 F.2d at 841; Laurel Hill Cemetery Association v. United States, 427 F. Supp. 679, 686 (E. D. Mo. 1977), aff'd, 566 F.2d 630 (8th Cir. 1977). To rebut the presumption of correctness that attaches to the Commissioner's determination, the taxpayer must introduce substantial evidence which overcomes the presumption. see, e.g., Toledano v. Commissioner, 362 F.2d 243 (5th Cir. 1966).

We acknowledge that there are litigation hazards to the government's position3 and that a loss on this issue would be somewhat detrimental to the public fisc.4 Nevertheless, we believe the governmentt's position to be correct as a matter of law and as a matter of economic reality. Therefore, we are reasonably confident that the government will prevail and that the benefits of going forward with this case outweigh the costs of concession or settlement on an unreasonable basis.

We agree with the litigating strategy you have outlined in your request for field service advice dated December 13, 1994. If you have any questions, please call Dan Cassano at (202) 622-7920.

DANIEL J. WILES
By: GERALD M. HORAN
Senior Technician Reviewer
Income Tax & Accounting Branch
Field Service Division

cc: District Counsel, San Francisco
Attn: Kevin Croke


Footnotes


  1. NUTRITION FLASH, Self Magazine, May 1994, at 123. Although this low percentage may be due to the fact that busy consumers assume grocery products offered for sale in normal (non-discount) stores to be fresh, we realize that * * * could use this statistic to argue that consumers don't really care about expiration dates. Based on this, * * * could argue that the fair market value of four-day old bread is equal to the full retail price of fresh bread.back

  2. Rev. Rul. 85-5 states that the price at which a product may be sold depends on all the facts and circumstances at the time of the sale. Rev. Rul. 85-5 provides that the purpose of the ruling is to illustrate the method of calculating the amount of the deduction allowable for a charitable contribution of inventory. Rev. Rul. 85-8 states that no inference is intended regarding the fair market value of any products donated by any corporation shortly before the expiration date of the products.back

  3. The fact that * * * is supporting worthy charities may affect the court's anlysis to some extent.back

  4. Note, however, that the mission of the Service is not to collect the maximum amount of tax, but only the correct amount.back

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