Charitable giving is a many-splendored thing. It is also one of the largest categories of tax deductions every filing season.


In recent years, the IRS has seen a dramatic increase in fundraising programs involving the sale of donated cars. The General Accounting Office estimates that 733,000 (of 125 million) individual returns for the 2000 tax year claimed a tax deduction for a vehicle donation. These donations were valued at about $2.5 billion and reduced taxpayer liability by an estimated $654 million. This would seem like a great deal for both the taxpayers and the charities involved.


Unfortunately, charitable car donation programs provide a fertile ground for abuse and donation scams are widespread. Otherwise law-abiding taxpayers can become indignant when they learn their vehicle donations are limited after they've seen ads on the internet or in print promising them big deductions for their old cars and trucks. Those donating a vehicle to charity may also be shocked to learn that their charity ends up with pennies on the dollar after a fundraiser deducts administrative and advertising costs related to selling the vehicle.


Meanwhile, the IRS is generally caught between a rock and a hard place when reviewing such non-cash donations. The IRS cannot afford to look miserly and opposed to charitable endeavors by making audits so disagreeable that no one wants to donate property. At the same time, it lacks the audit resources to police the valuation rules in even a fraction of the claimed contributions. In cases where charitable contributions are finally audited, however, most taxpayers should expect the IRS examiner to be looking for a compromise value (i.e., more money from the taxpayer) unless the taxpayer's value for the car donation is airtight. As of 2005, taxpayers face even greater challenges when claiming this type of deduction.


Tax Laws of 2005
Under laws that went into effect back in 2005 as a result of the American Jobs Creation Act of 2004, if the claimed value of a donated motor vehicle, boat, or plane exceeds $500, and the item is sold by the charity, the taxpayer's deduction is limited to the gross proceeds from the sale. The charity must provide an acknowledgment to the donor stating the amount of the gross proceeds within 30 days of the sale.


Also, under the new rules, the charity must provide an acknowledgment to the donor within 30 days of the contribution if the charity will significantly use or materially improve the motor vehicle. In that case, the donor generally may deduct the market value of the vehicle.

A donee organization that knowingly provides a false or fraudulent acknowledgement, or that fails to provide a written acknowledgement containing the required information within the prescribed time frame, will be penalized for each such act or failure. If the donee organization sells the qualified vehicle without any significant intervening use or material improvement, the penalty is the greater of: (a) the product of the highest rate of tax and the sales price stated on the acknowledgement, or (b) the gross proceeds from the sale of the qualified vehicle. With respect to any other qualified vehicle, the penalty is the greater of: (a) the product of the highest rate of tax specified and the claimed value of the vehicle, or (b) $5,000.

Follow up:

If this weren’t complicated enough, the IRS issued interim guidance on June, 3, 2005, that adds an additional twist to the deductibility and substantiation requirements for donated vehicles. For a qualified vehicle that the donee organization intends to sell to a needy individual at significantly below fair market value (FMV) (or gratuitously transferred to such a person), the acknowledgment must include a certification that the donee organization will make such a transfer of the vehicle and that the sale or transfer will be in direct furtherance of the donee organization's charitable purpose of relieving the poor and distressed or the underprivileged who are in need of a means of transportation.


Also, if the qualified vehicle is either given to a needy individual or sold to such a person at a price significantly below FMV in direct furtherance of the organization's purpose to relieve the poor, distressed or underprivileged who are in need of a means of transportation, the gross proceeds limitation enacted by the American Jobs Creation Act of 2004 does not apply. Again, the donor must instead substantiate the fair market value of the vehicle.


For contributions made since June 5, 2005, the acceptable measure of the FMV of a vehicle is limited to amounts not in excess of the price listed in a used vehicle pricing guide for private party sales of similar vehicles. If the deduction is not limited to the gross proceeds from the sale of the vehicle, the donor is required to provide a qualified appraisal as substantiation for any deductions in excess of $5,000.


IRS Offers Help

To assist individual taxpayers and charities in complying with the new tax laws, the IRS is currently revising two publications on car donations it originally released in August of 2004: Publication 4302, A Charity's Guide to Car Donations, and Publication 4303, A Donor's Guide to Car Donations.


"We want people and the charities to make sure they are taking the proper steps involving vehicle donations," said IRS Commissioner Mark W. Everson. "Supporting charitable activities through tax deductible contributions is an important element of tax law and serves the national interest. But we encourage people to proceed carefully when donating vehicles."


Taxpayers Beware
Despite the IRS’s offer of help, however, this area of the tax law is a potential minefield of tax compliance problems. The situation is complicated by the fact that the IRS is only now starting to issue some guidance on the tax law changes despite the laws being in effect for over half a year. Meanwhile, many organizations continue to aggressively market vehicle donation programs urging donations in exchange for potential tax deductions that may never materialize.


What’s a poor altruistic taxpayer to do? If you’ve read this far, you’ve already taken the first step, which is realizing that donating a vehicle to charity is not as lucrative as charitable organizations would have you believe. In addition to lower deduction amounts, the IRS is likely to look very closely next year at returns that claim such a deduction. Although there is still some financial incentive attached, don’t expect a huge payoff for your generosity.


Next, choose a charity wisely. The charity you select to donate a vehicle must be on top of all the associated requirements to make sure you get the full value of the tax deduction.

Also, given a choice, you are better off donating your vehicle to an organization that falls under the new exception provided in the interim IRS guidance. For example, donating a vehicle with a FMV of $1,000 to an organization that then provides it to a needy individual yields a potential tax deduction of $1,000. With another type of charitable organization that merely sells the vehicle for $100, however, the tax deduction would be limited to only the $100. This may favor one type of charity over others, but those are the rules as they stand now.


Finally, review the IRS vehicle donation publications when they finally get updated later this year. If you are still unsure of what to do, consult a tax professional before proceeding with a donation.


Following the above simple suggestions can make it better to both give and receive where charitable vehicle donations are concerned.


By Paul N. Gada, CCH Financial Planning Toolkit