New Tax Law Changes the Rules for Donations of Automobiles

By Larry R. Garrison and Richard Cummings

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NOVEMBER 2005 - Due to the increasing number of programs that allow for the donation of used automobiles to charitable organizations, the IRS has become concerned about the misuse of this method of charitable giving. Citing a GAO study, the IRS noted that 733,000 tax returns took charitable contributions for vehicle donations, totaling about $2.5 billion. These deductions reduced the taxpayers’ combined tax liability by approximately $654 million (IR-2003-139; Dec. 15, 2003). The IRS is concerned about taxpayers deducting fair market values for used vehicles that do not represent the true fair market value of the donation as required by the tax laws. To address this concern, the IRS issued Publications 4302 and 4303, for the charity-donee and taxpayer-donor respectively. In addition, the American Jobs Creation Act of 2004 [P.L. 108-357; amended to IRC at section 170(f)(12)] limits the amount of the allowable deduction to the subsequent sale proceeds of the donated vehicle in certain situations.

Taxpayer-Donor Responsibilities

Donations “to” a charity. IRC section 170(a)(1) allows for taxpayers to deduct contributions to IRS-recognized charitable organizations. Section 170(c) states that a charitable contribution includes a contribution or gift to or for the use of:

  • A state or possession of the United States or any subdivisions thereof;
  • A corporation, trust, or community chest, fund, or foundation that is situated in the United States, and is organized and operated exclusively for religious, charitable, scientific, literary, or educational purposes, or for the prevention of cruelty to children or animals;
  • A veterans’ organization;
  • A fraternal organization operating under a lodge system; or
  • A cemetery company.

IRS Publication 78, Cumulative List of Organizations (2004), contains a list of organizations that have received tax-exempt status under IRC section 501. Although this publication does not include all qualified charities, particularly churches, synagogues, and other religious institutions, it can help taxpayers determine whether their donation is to a qualified charity.

Donations of used automobiles may seem to be a contribution “for the use of” a charitable organization. However, as noted in Davis v. United States [495 US 472 (1990)], a contribution is considered “for the use of” a qualified organization if the contribution is held in a legally enforceable trust or similar arrangement. Because the automobile donation will generally not fall under this definition, the donation must qualify under the term “to” the charity rather than “for the use of” the charity. Charitable contributions are generally made directly “to” the charitable organizations. Most used-car donations, however, are through an agent for the charitable organization. This use of agents to receive donations will satisfy the charitable contribution requirements of IRC section 170(c). [See IRC section 170(c)(2); Treasury Regulations section 1.170A-1(b); and Revenue Ruling 85-184, 1985-2 CB 84.]

Valuation of the donation. Treasury Regulations section 1.170A-1(c)(1) states that if a charitable contribution is in the form of property rather than cash, the amount of the donation is the fair market value of the property at the time of the contribution. [See also IRC section 170(e)(1) and (e)(3) and Treasury Regulations section 1.170A-4(a) and 1.l70A-4A(c) for possible reductions in value for certain property.] The general definition for 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 the relevant facts [Treasury Regulations section 1.170A-1(c)(2); see also IRS Publication 561, Determining the Value of Donated Property].

To determine the value of a used-car donation, common practice is to refer to a used-car pricing guide. The highest value in the pricing guide may not, however, be representative of the value of the taxpayer’s automobile. The value used must be the same make, model, year, and condition as the donated vehicle. According to IRS Revenue Ruling 2002-67 (2002-2 CB 873), the value must also be representative of the value of the vehicle if sold in the same area. Resources, including Kelley Blue Book (, can provide information based upon zip code.

Revenue Ruling 2002-67 addressed two donation situations. In the first, the taxpayer-donor donated an automobile of average condition to a qualified charity. An “established used car pricing guide” listed a current sales price of $3,000 for the same make, model, and year of automobile sold in the same area. The ruling allowed the taxpayer to use the $3,000 listed price as the amount of the charitable contribution. It stated that the donor could have valued the car using another “reasonable method.”

In the second situation, the facts were the same but the automobile was in poor condition. Because the established used-car pricing guide did not list a sales price for an automobile in poor condition, the ruling stated that the donor must use some other reasonable method to determine the fair market value for contribution purposes.

New law on valuation of the donation. The American Jobs Creation Act of 2004 limits the charitable contribution of used motor vehicles (with a claimed value in excess of $500) to the gross sales price received by the charity for the subsequent sale of the donated vehicle, rather than the fair market value. (The limitation also applies to donated boats and airplanes with claimed value exceeding $500.) In addition, the donee organization must provide the donor with a contemporaneous written acknowledgement of the gross sales price, which the donee must attach to the income tax return. The new law, which applies to donations made after December 31, 2004, is intended to limit a taxpayer’s charitable contribution deduction to the actual cash amount received by the charity if the donated automobile is subsequently sold.

On June 3, 2005, the IRS issued Notice 2005-44 to provide interim guidance [2005-25 IRB 1 (June 3, 2005)] regarding new IRC sections 170(f)(12) and 6720(1). The notice highlights certain exceptions to the general rule limiting the deduction. For qualified vehicles sold by the charity without significant intervening use or material improvement, the deduction may not exceed the gross proceeds received from the sale or the fair market value, whichever is lower. If, however, the charity makes a significant intervening use or material improvement, then the gross proceeds limitation rule does not apply and the fair market value may be used to determine the deduction amount [Notice 2005-44, Sec. 3.02(1)].

Nor does the gross proceeds limitation rule apply if a donated qualified vehicle is sold at a price significantly below fair market value or gratuitously transferred to a needy individual in direct furtherance of the charitable purpose of the donee organization. The charitable purpose of the organization must relate to “relieving the poor and distressed or the underprivileged who are in need of a means of transportation” [Notice 2005-44, section 3.02(3), citing H.R. Conference Report No. 755, 108th Congress, 2d Session 750 (2004)]. Notice 2005-44, section 3.03(4), Example 3, found an acceptable charitable purpose for a charity that helped unemployed needy individuals develop new job skills and find jobs and also provided a means of transportation to jobs in areas not served by public transportation.

Substantiation and recordkeeping. According to IRC section 170(f)(8), no deduction is allowed for any individual contribution of $250 or more unless the taxpayer substantiates the contribution by contemporaneous written acknowledgement by the charitable organization. The acknowledgement must include the following:

  • The amount of cash and a description (but not value) of any property other than cash;
  • Whether the donee organization provided any goods or services in consideration, in whole or in part, for any property; and
  • A description and good-faith estimate of the value of any goods or services.

The acknowledgement is considered contemporaneous if the taxpayer obtains the acknowledgement on or before the earlier of the date on which the taxpayer files a return for the taxable year of the contribution or the due date, including extensions, for filing the return.

Under Treasury Regulations section 1.170A-13(b), taxpayers are required to maintain records of their charitable contributions. Generally, a taxpayer making a noncash contribution must retain a receipt that includes the following:

  • The name of the donee;
  • The date and location of the contribution; and
  • A sufficiently detailed description of the property.

The receipt does not need to list the fair market value of the item. The receipt may be in the form of a letter or other written communication from the donee organization. The letter from the donee should include the same information as a receipt listed above.

For noncash donations in excess of $500, the taxpayer is required to maintain a written record that includes the following:

  • Name of the donee;
  • Date and location of the contribution;
  • Sufficiently detailed description of the property;
  • Fair market value of the property at the time of contribution;
  • Method used to determine the fair market value;
  • Statement as to the method used to determine the fair market value, and, if applicable, a copy of a signed appraisal;
  • Date and manner of acquisition of the property by the taxpayer; and
  • Cost or other basis of the property to the taxpayer.

New law on substantiation and recordkeeping. As noted above, a contemporaneous written acknowledgement including the gross sales price must be received from the donee organization and attached to the taxpayer’s income tax return. Specifically, a 2005 charitable contribution of a qualified vehicle with a claimed value of more than $500 must meet the acknowledgement requirements for being contemporaneous and include the required content.

The acknowledgement will be contemporaneous if the donee organization provides it within 30 days of the sale of the qualified vehicle, or it meets one of the following circumstances:

  • If the donee organization decides to use the vehicle or make a material improvement to the vehicle, then, within 30 days of the contribution, it must provide certification of the intended use or material improvement of the vehicle and the duration of such use, as well as certification that the vehicle will not be transferred in exchange for money, property, or services before completion of the use or improvement.
  • If the donee organization intends to sell the vehicle to a needy individual at a price significantly below fair market value or by gratuitous transfer, then, within 30 days of the contribution, it must provide certification of this intent 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 in need of a means of transportation. [See IRC section 170(f)(12)(C)].

The acknowledgment’s required content includes the name and taxpayer identification number of the donor and the vehicle identification number.

According to IRC section 170(f)(12)(B), when the donee sells the qualified vehicle, the acknowledgement must include the following:

  • A certification that the vehicle was sold in an arm’s-length transaction between related parties;
  • The gross proceeds from the sale; and
  • A statement that the deductible amount cannot exceed such gross proceeds.

Other requirements. Form 8283, Noncash Charitable Contributions, section A, must be completed and attached to Form 1040 for noncash contributions of more than $500 but less than $5,000. For noncash contributions in excess of $5,000, Form 8283, Noncash Charitable Contributions, section B, must be completed, along with a qualified appraisal. According to Treasury Regulations section 1.170A-13(c)(2), the appraisal must be completed no more than 60 days before the property contribution. The act [IRC section 170(f)(11)(C)] provides that for charitable contributions greater than $5,000 made after June 3, 2004, an appraisal is required to be attached to the return for the year the contribution is made.

Generally, the total charitable contribution deductions for an individual taxpayer made to a public charity may not exceed 50% of the taxpayer’s adjusted gross income. Charitable contributions are reported on Form 1040, Schedule A [IRC section 170(a)(1); also IRS Publication 526, Charitable Contributions]. Limitation percentages of 20% and 30% apply to certain donations to private foundations.

The taxpayer-donor should contact the charity or the appropriate state motor vehicle registration office with regard to the transfer of the vehicle’s title from the taxpayer to the donee organization.

Donee and Agent Responsibilities

IRC section 501(c)(3) states that for an organization to qualify for tax-exempt status, it must be organized and operated exclusively for charitable purposes. This standard is met if the organization engages in activities that accomplish one or more of the exempt purposes defined in the tax code.

Prohibition against personal benefit. As provided for by IRC section 501(c)(6) and Treasury Regulations section 1.501(c)(3)-1(c)(2), tax-exempt organizations may not use their earnings to benefit any private shareholder or individual. According to Treasury Regulations section 1.501(a)-1(c), a private shareholder or individual is a person having a personal and private interest in the activities of the organization. The courts have determined that inurement occurs when the earnings of the tax-exempt organization are paid to insiders, but this does not include reasonable compensation [see U.S. v. Dykema, 666 F2d 1096 (7th Cir. 1981); also Unitary Mission Church v. Commissioner, 74 TC 507 (1980)].

Many charities use a third-party agent to receive and sell donated automobile vehicles while transferring part of the proceeds to the charity. The agent receives a percentage of the sales price as a commission or transaction fee. The agency relationship makes the agent a personal or private interest. The agency relationship between the third party and the charity would not generally be considered to benefit any private shareholder or individual. Revenue Ruling 69-383 [1969-2 CB 113] identifies the major factors to consider in determining if an agreement constitutes private inurement:

  • Whether the agreement was negotiated at arm’s length;
  • Whether the agent does not participate in management or otherwise have control of the organization;
  • Whether the agreement serves a bona fide business purpose; and
  • Whether the amount received by the agent is reasonable given the services provided.

Charitable organizations should be aware that using third-party agents might increase the possibility of abuses such as excessive commissions or other conflicts of interest.

Unrelated trade or business income. IRC section 511 imposes a tax on income unrelated to an organization’s exempt purpose. IRC section 513(a) defines an “unrelated trade or business” as any trade or business that is not substantially related (aside from the need of the organization for the income or use it makes from the profits) to the exercise or performance of the organization’s charitable, educational, or other purpose or function that is the basis for the organization’s exemption. According to IRC section 513(a)(3) and Treasury Regulations section 1.513-1(e)(3), a tax-exempt organization may sell merchandise, such as vehicles, donated to the charity as gifts or contributions and not be considered to have an unrelated trade or business.

New IRS publications. Two IRS publications alert both donees and donors to their responsibilities when donating or receiving used cars. The donee’s guide is Publication 4302, A Charity’s Guide to Car Donations (IR-2004-84, June 29, 2004; see also PLR 200230005, April 11, 2002). The donor’s guide is Publication 4303, A Donor’s Guide to Car Donations (IR-2004-84, June 29, 2004; see also PLR 200230007, April 11, 2002).

Publication 4302 discusses four types of car-donation programs:

  • The charity uses or distributes cars. In this type of program, the charity uses donated vehicles for their own charitable activities or gives donated vehicles to needy individuals. Such an arrangement should not adversely impact the organization’s tax-exempt status.
  • The charity sells donated cars. In this case, the charity receives donated cars and then sells them, using the proceeds to fund its charitable activities. The IRS does not consider this reselling activity to be detrimental to the organization’s tax-exempt status.
  • The charity hires agent. Some tax-exempt organizations may find it easier to contract with an outside third party to receive donated cars, sell them, and forward the proceeds (minus a transaction fee) to the charity. As discussed above, a valid principal-agent relationship must be established. The agent performs its duties on behalf of the charitable organization and the charity must maintain oversight (see PLR 200243057, July 2, 2002). The tax-exempt status of the organization should not be jeopardized if the principal-agent is contracted properly under state law. (Revenue Ruling 2002-67, 2002-2 CB 873 provides an example.)
  • Use of a for-profit entity. Unlike the previous three arrangements, the use of a for-profit entity to receive and sell donated cars in the charity’s name can result in the donor’s being unable to claim a charitable contribution for the donated property. While the charity receives a transaction fee from the for-profit entity and uses the fee to support its charitable activities, if the charity does not control the for-profit entity that pays the transaction fee, no valid principal-agent relationship exists. The IRS cautions that the for-profit entity and the charity may not mislead the public by either stating or inferring that a donation of a used car may be deductible for tax purposes.

Substantiation and recordkeeping. Because the donor is required to retain a contemporaneous written acknowledgement of any contribution valued at $250 or more, the donee should provide such an acknowledgement to the donor. In the case of a principal-agent relationship, the agent may satisfy the substantiation requirements of IRC section 170(f)(8)(B) by providing the written acknowledgement to the donor. (See Revenue Ruling 2002-67, 2002-2 CB 873.)

The new law requires the donee-organization to make a contemporaneous acknowledgement of the qualifying vehicle charitable contribution. Donee-organizations are required to make acknowledgments to donor-taxpayers within 30 days of sale of the qualifying vehicles. If the donee-organization uses or makes a material improvement to the qualifying vehicle, then additional certification on the use or improvements of the vehicle accompanied by the duration of use and the donee’s intent not to exchange the vehicle for money, property, or services before the completion of the improvement or use must be provided to the donor-taxpayer [see American Jobs Creation Act section 170(f)(12); see also Notice 2005-44, section 7].

Penalties. The new law provides for significant penalties on the donee-organization for false or fraudulent acknowledgements or for failure to timely provide to the donor-taxpayer an acknowledgment showing the required information related to the qualified vehicle donation. An acknowledgement is considered to be false or fraudulent if the donee does not sell or transfer the vehicle to a needy individual by the date specified. An acknowledgement is considered to be false or fraudulent if the donee sells the vehicle without a significant intervening use or material improvement when the acknowledgement states the intention to do so (See IRC section 6720).

In the above two exceptions allowing for a fair-market-value deduction (rather than the gross proceeds limitation), the penalty for a false or fraudulent acknowledgement would be the greater of the claimed value of the qualified vehicle multiplied by the highest individual tax rate, or $5,000. In other cases, the penalty for a false or fraudulent acknowledgement is the greater of the sales price stated in the acknowledgement multiplied by the highest individual tax rate, or the gross proceeds from the sale of the qualified vehicle.

Transition rules. While the new rules are generally effective for contributions made on or after January 1, 2005, certain transition rules are provided for acknowledgement and penalty purposes. A contemporaneous written acknowledgement obtained on or before July 3, 2005, is treated as meeting the requirements of IRC section 170(f)(12)(A) and the information requirements of section 170(f)(12)(B), if the requirements are met except for the omission of the date the vehicle is sold or the omission of a detailed description of the donee’s intended significant intervening use or material improvement of the vehicle (see Notice 2005-44, section 8.01).

According to Notice 2005-44, section 8.02, an extension is allowed to obtain acknowledgements for contributions made on or before September 1, 2005. For these contributions, a written acknowledgement will be considered contemporaneous if it is obtained on or before October 1, 2005.

While a donee-organization may determine the format of the acknowledgement (as long as it includes all the required information), the IRS provides Form 1098-C as a contemporaneous written acknowledgement to the donor.

Larry R. Garrison, PhD, CPA, is a professor of taxation in the department of accountancy at the Bloch School of the University of Missouri—Kansas City.
Richard Cummings, PhD, CPA, is an assistant professor of accounting in the accounting department of the University of Wisconsin—Whitewater.













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