3-31-06
Course Correction Needed
Assorted, and sometimes odd, patterns appear before me during the course of income tax season. Some of them are mere statistical accidents, as when my appointment calendar develops daily themes. One day last week, I had three consecutive appointments involving long-time clients and their elderly mothers; another day might be four gay couples, or nothing but people with California tax problems.
But sometimes the patterns are significant. Recently, I have been seeing a pattern of wrong information involving charitable contributions. What I find disturbing is its source. If individuals have bad data because it was heard third-hand, or because they only half-remember something they read—that’s understandable and common. Here, though, the bad information is coming from the non-profit organizations themselves, telling their donors to take deductions to which the donors are not entitled.
What’s Going ’Round
The problematic pattern does not involve cash contributions. A transaction as simple as you forking over money is hard to screw up or misunderstand (though it is possible for a nonprofit organization to not follow IRS acknowledgment rules). Rather, I am seeing bad advice being given for non-cash contributions, particularly of services.
Some churches and theatre companies have been telling people in writing that they can take a tax deduction for the value of services they contribute, and even putting a dollar amount on the form.
This is wrong on several levels.
To start with, the person making the contribution is responsible for valuing it. Nonprofits are prohibited from assigning dollar values to contributions, whether it is professional services or a bag of old clothes. A university library would not even be allowed to pay for the appraisal of a rare book collection.
Why is this? Before these rules were put in place, bidding wars would sometimes break out. “Give us your art collection, and we’ll value it at $1 million” might get countered with, “Oh yeah, well, I’ll give you $1.2 million” and so on till the values were absurdly inflated.
A Is Not Equal to B
The deeper part of the problem involves an asymmetry between the way nonprofit organizations account for the contribution of services, and the way individuals and businesses do. The charity is allowed for tax purposes, and required for financial statement purposes, to recognize these in-kind contributions of services if (and only if) the services require specialized skills, are provided by persons possessing those skills, and would have to be purchased if not contributed. The idea is to distinguish, say, a lawyer providing pro bono legal services from the leader of a Boy Scout troop.
But the rules are different for donors. The deductible amount of a contribution is limited (with one important exception) to the lower of two amounts: what it cost the donor, or what it’s now worth. Your services cost you nothing, and that is what you can deduct: zero.
(Economists would note that there is an opportunity cost, since in theory you could have been earning money elsewhere for those services rather than contributing them. That’s a useful, if oversimplified, model for decision-making purposes. It is irrelevant for taxation.)
Not Quite the Same
Services are not the only in-kind contributions. You can give away tangibles (things you can touch) as well. Car donation programs are regularly advertised on the radio, and most of us routinely give away used clothes and household items to a charitable thrift shop. But the contribution need not be used items. For example, I’ve seen board members go out and personally purchase furniture for a theatre’s lobby, or a computer for its office.
Sometimes you may donate items that you did not buy. To address those situations, tax law uses the term “basis” rather than “cost.” If you bought something, your basis is its cost. If you inherited something, your basis is its value at the date of the person’s death. If it was a gift, your basis is whatever the donor’s basis was. Your deduction, strictly speaking, is the lower of a donated item’s basis or fair market value.
With, as noted above, one important exception: publicly traded stocks that have appreciated in value. People who give those can deduct the market value at the date of donation.
This is huge, because the donor can double dip. Suppose you had been so prescient as to buy $1,000 worth of Microsoft stock in 1986; that investment would now be worth roughly $350,000. You could sell that stock now, pay about $53,000 of tax on your capital gain, and make a deductible contribution of the remaining $297,000. Or you could contribute the stock, take a charitable contribution of $350,000 and pay no capital gains tax.
Now, if we could just find that time machine...
Law of Unintended Consequences?
The Internal Revenue Service may have inadvertently encouraged these churches and theatres to say too much when it set up acknowledgment and disclosure rules a few years ago. They were trying to address two related problems. A long-standing rule about benefits and similar events is that you can deduct only the excess of the ticket price over the value of the meal or entertainment or whatever was provided to the ticket buyer. Many people were just taking the entire amount. Others were using rather creative math to tally up their charitable contributions at tax time.
These rules require charities to issue receipts for any contribution of $250 or more ($75 if the donor receives something in return), and to provide the value of any goods or services provided to the donor with more than a trivial cost.
And that is all. But Americans tend to like more rather than less and to get enthusiastic. Admirable traits, often, but not when charities cross a legal line.
Not Too Late
The tax deadline is just a couple of weeks off, but you can still receive my “Checklist of Potentially Deductible Items for Persons in the Arts.” It’s free for the asking. Just write, call or e-mail me at my office.
Are there money or tax questions you would like to see discussed in this column? Let me know, at 2835 N. Sheffield, Suite 311, Chicago, IL 60657, or call 773/525-1778 (888/525-1778 toll-free outside the Chicago area) or e-mail greg@gregmermel.com.
Greg Mermel is a certified public accountant whose clients in the arts range from individual performers to major theatre companies and suppliers. He has also been known to produce theatre.