Vehicle Donations

New Burdens and New Penalties for Charities

On several occasions, we have chronicled the frustration of the IRS and Congress over the disparity between the charitable deductions claimed by donors of motor vehicles and the amounts ultimately received by the donee charities. A General Accounting Office (GAO) report in 2004 estimated that taxpayers claimed $2.5 billion in deductions for contributions of vehicles in 2000. However, the GAO found that charities actually received 5% or less of the value donors claimed as deductions for two-thirds of 54 specific vehicle donations examined. This report probably was the most significant catalyst for Congressional action.

Congress Lowers the Boom

The American Jobs Creation Act of 2004 dramatically changed the rules governing charitable contributions of vehicles having a claimed value of more than $500 [IRC Sec. 170(f)(12)]. The new rules are effective for contributions after 2004 and generally apply to donations of autos, trucks, boats, and airplanes, but not inventory. The good news is the donor still gets a charitable deduction. But the bad news is the amount of the deduction may be considerably less than the vehicle’s fair market value (FMV).

Significant Use Is the Key

If the donee charity significantly uses the vehicle (or makes material improvements to it) prior to its sale or disposition, the donor’s deduction is equal to the vehicle’s FMV (as under pre-2005 rules) on the date donated. Any reasonable method can be used to determine FMV. For example, an established used car pricing guide can be used, provided, of course, that the vehicle being valued is comparable to the vehicle described in the price guide. However, the donor must also obtain a qualified appraisal if the claimed FMV is more than $5,000.

According to the Conference Committee Report, Congress intends that the IRS strictly construe the requirement of significant use or material improvement. To meet the significant use test, an organization must actually use the vehicle to substantially further its regularly conducted activities, and the use must be significant. A donee will not be considered to significantly use a qualified vehicle if, under the facts and circumstances, the use is incidental or not intended at the time of the contribution. Whether a use is significant also depends on the frequency and duration of use.

Congress further intends that a material improvement would include major repairs or other improvements that significantly increase the vehicle’s value. Cleaning, minor repairs, and routine maintenance will not be considered a material improvement. The Conference Committee Report illustrates the meaning of “significant use” with examples.

A Double Whammy for Charities

Charities typically sell the vehicles they receive immediately, without using or improving them. (Often, the entire donation-sale process is handled by an agent and the charities don’t take direct physical possession of the vehicles.) Charities that have built solicitation programs around vehicles necessarily have to sell them at auction (often in bulk) at prices significantly below car pricing guide values.

Under the new rules, the donor’s deduction is limited to the proceeds the charity receives when there is no significant use of, or material improvement to, a vehicle by the charity. The vehicle’s actual FMV is irrelevant! This dramatic reduction in a donor’s tax deduction will probably lead to an equally dramatic reduction in vehicles contributed. So charities’ receipts will suffer.

Adding insult to injury, the new rules significantly increase the charities’ bookkeeping obligations. A charity must provide a contemporaneous written acknowledgment to the donor in order for the donor to be entitled to a deduction for a contribution of $250 or more [IRC Sec. 170(f)(8)(A)]. But the prescribed contents for an acknowledgment of a vehicle with a claimed value of more than $500 are more burdensome than the acknowledgment for other property [IRC Sec. 170(f)(12)]. Such document must include the name and taxpayer identification number of the donor and the vehicle identification number (or similar number) of the vehicle. If the charity sells the vehicle without significant intervening use or material improvement, the acknowledgment must also:

• Certify that the vehicle was sold in an arm’s length transaction between unrelated parties
• Certify the amount of the gross sales proceeds; and
• Include a warning that the donor’s deduction is limited to the amount of the sales proceeds.

Providing this certification of the vehicle’s sales price will likely be a challenge for charities that use third parties to handle their sales. The third parties often sell the vehicles in bulk at wholesale. However, the new rules provide no guidance on how to allocate a bulk price to individual vehicles for purposes of the donor acknowledgment.

If, in the infrequent event that the charity intends to make significant use of the donated vehicle or make material improvements to it, the required acknowledgment must certify:

• The intended use and duration of the use or the intended material improvements to be made; and
• That the vehicle will not be transferred in exchange for money, other property, or services before completion of such use or improvements.

The charity must provide the acknowledgment to the donor within 30 days of the sale of the vehicle or within 30 days of the contribution if the charity retains the vehicle for its use. To the extent required by the IRS, charities must also disclose to the IRS information included in acknowledgments given to donors.

A donor is not entitled to any deduction for the vehicle until the acknowledgment is received. But, where there is no intervening use, the charity is not required to provide the acknowledgment until 30 days after the vehicle is sold, so acknowledgments for year-end contributions may not be received until after the April 15th filing deadline for individuals. In such case, the donor’s Form 1040 due date will need to be extended for the deduction to be allowed.

Now there are Penalties

Although charities should provide a written acknowledgment to donors, there previously has been no penalty for the failure to do so (other than perhaps the loss of donor goodwill). IRC Sec. 6720 imposes a penalty on a charity that fails to furnish the acknowledgment for a vehicle donation timely or provides a fraudulent acknowledgment. The penalty is the greater of the highest individual tax rate applied to the gross proceeds from the sale of the vehicle, or the sales price stated in the acknowledgment. If the organization does not sell the vehicle, the penalty is the greater of the highest individual tax rate applied to the claimed value of the vehicle, or $5,000. Currently, the highest individual tax rate is 35%, which means the penalty can be significant.

Practical Consideration

The IRS has promised guidance soon on vehicle donations. The guidance is expected to exempt certain vehicle sales from the rule that limits the donor’s deduction to the gross proceeds when the sale is in direct furtherance of the organization’s charitable purposes. For example, if an organization directly furthers its charitable purposes by selling automobiles to needy persons at a price significantly below FMV, the donor may be allowed to deduct the vehicle’s FMV even if it exceeds the gross proceeds from its sale.