Donation of Discounted Goods Cannot Get List-Price Deduction Grainger, TCM 2018-117
In Grainger1, the Tax Court disallowed most of the charitable deduction claimed by a taxpayer who purchased clothing at discounted prices and, after donating the clothing to charity, claimed a charitable contribution deduction equal to the original retail price.
Grainger was a retiree and grandmother who was fond of shopping. Seeking to combine her love of shopping with a desire for a tax cut, she developed what she described at trial as her personal tax shelter. It was her understanding that a taxpayer was allowed to claim a charitable contribution deduction equal to the fair market value of donated property, and she assumed that the fair market value of a retail item is the dollar amount shown on the price tag when the retailer first offers the item for sale. Grainger thought she saw an opportunity if she could find items that had been heavily discounted from the amounts shown on their original price tags, then she could achieve a net tax benefit simply by buying and immediately donating those items.
Virtually all of the property for which Grainger claimed charitable contribution deductions consisted of clothing she had purchased at Talbots. She would look for clothing that had been heavily discounted and purchase dozens or hundreds of these items over the course of a year. As a valued Talbots customer, she would become entitled to points, which she could then use to obtain further discounts. As a result of successive markdowns and use of points, she was able to purchase an item for $10 that had an original retail price of $99. She would then donate that item to Goodwill Industries and claim a charitable contribution deduction of $99 on her federal income tax return.
On Grainger's 2012 federal income tax return, she reported noncash charitable contributions of $34,401, corresponding to the original retail prices of discounted items she had purchased at Talbots. She acquired these items by making an outlay of $6,047 ($2,520 in cash and $3,527 in points).
Grainger attached to her return six Forms 8283, Noncash Charitable Contributions. She described her donations as dresses, jackets, and other items of clothing, and she listed the donees as various Goodwill donation centers. None of the Forms 8283 were executed by a Goodwill official, as the forms explicitly require.
The IRS selected Grainger's 2012 return for examination. Concluding that she had not used a qualified method to establish the fair market value of the donated items, the IRS reduced Grainger's allowable deduction to $2,520, her actual cash outlay. She filed a protest with the IRS Appeals Office, which increased her allowable deduction to $6,117, primarily by revising her cost basis upward to include the points as well as the cash she had used to acquire the items. The IRS issued her a timely notice of deficiency setting forth this adjustment and the late-filing addition to tax. She timely petitioned the Tax Court for a redetermination.
Section 170 allows a taxpayer a deduction for any contribution made within the tax year to a charitable organization. Such deductions are allowable only if the taxpayer satisfies statutory and regulatory substantiation requirements. The nature of the required substantiation depends on the size of the contribution and on whether it is a gift of cash or property.
For all contributions of property (other than money), the taxpayer must maintain reliable written records that include the name and address of the donee, the date and location of the contribution, and a description of the property in detail reasonable under the circumstances. The taxpayer must also maintain records to establish the fair market value of the property at the time the contribution was made and the method used in determining the fair market value.
For all contributions valued at $250 or more, the taxpayer must obtain a contemporaneous written acknowledgment from the donee. The contemporaneous written acknowledgment must include (among other things) a description of any property other than cash contributed. In the absence of a contemporaneous written acknowledgment meeting the statute's requirements, no deduction is allowed.
Additional substantiation requirements are imposed for contributions of property with a claimed value exceeding $500. Still more rigorous substantiation requirements are imposed for contributions of property with a claimed value exceeding $5,000. In determining whether donations of property exceed these thresholds, similar items of property (other than cash and publicly traded securities) must be aggregated. The term similar items of property is defined to mean property of the same generic category or type (such as clothing or toys).
If property or similar items of property are valued in excess of $5,000, the taxpayer must substantiate the value of the property with a qualified appraisal of such property. The taxpayer must also attach to her return a fully completed appraisal summary on Form 8283.
To substantiate her contributions, Grainger produced receipts from Talbots, marked-down price tags of purchased items, and receipts from Goodwill. On each of the latter receipts, a Goodwill employee had marked the date and location of the donation, the general types of items donated (e.g., clothing), and his signature. Grainger also supplied a spreadsheet she had prepared, which the court found to lack any evidentiary value.
The court found that Grainger had fallen far short of substantiating noncash charitable contributions in excess of the amount the IRS had allowed her as a deduction. Because all of her donations were of similar items of property (i.e., clothing), the court held that they must be grouped together for purposes of determining whether the $5,000 substantiation threshold has been reached. Although Grainger claimed that the value of the clothing was $34,401, she did not obtain a qualified appraisal.
The court noted that although she had attached several Forms 8283 to her return, they were not executed by an official of Goodwill, as the Form 8283 explicitly requires. The court found that Grainger likewise failed to secure a valid contemporaneous written acknowledgment as required. The receipts from Goodwill merely stated that she donated clothing. However, the court noted that they did not indicate what specific items of clothing she donated or the number of items she donated on any particular visit.
Furthermore, the court held that even if Grainger had satisfied the substantiation requirements discussed above, the court would still sustain the disallowance made by the IRS because she failed to employ a legitimate methodology to determine the fair market value of the donated clothing. Fair market value is the price at which 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. The court rejected Grainger's position that the fair market value of an item is the price at which a hopeful retailer initially lists that item for sale. The court noted that by the time she purchased the clothing, Talbots had marked down the prices of those items three or four times, and therefore she purchased each item for a small fraction of its original list price.
The court found that no rational buyer having knowledge of the relevant facts would have paid for these items a price higher than the price Talbots was then charging Grainger. The court therefore concluded that Grainger had failed to establish a fair market value for the donated items higher than her acquisition cost.
Additionally, the court pointed out in a footnote that even if Grainger had been able to prove that the fair market value of the donated clothing exceeded her acquisition cost, she would not have been able to deduct more than her acquisition cost. Section 170(e)(1)(A) reduces the allowable deduction by the gain which would not have been long-term capital gain if the property contributed had been sold by the taxpayer at its fair market value. Because Grainger donated all the clothing to Goodwill shortly after she purchased it, any gain she would have realized by selling the clothing would have been short-term gain, which would have reduced her charitable deduction for the clothing to her cost basis.
Frank Baldino is an estates and trusts attorney who helps people throughout the greater Washington, DC area protect assets for their families and future generations through careful estate tax planning. For more information, contact Frank at (301) 657-0175 or firstname.lastname@example.org.
This article originally appeared in the December 2018 edition of Estate Planning, a monthly periodical directed to estate planning professionals that offers readers the newest and most innovative strategies for saving taxes, building wealth, and managing assets.