Consider the following scenario: a taxpayer enthusiastically informs his CPA that his old family car was donated. Upon further inquiry, the CPA is satisfied that the car was donated to a not-for-profit organization designated under Internal Revenue Code (IRC) section 501(c)(3), and that the value of the donated asset has been reasonably calculated within the prescribed manner set by the IRS. In return for this donation, the individual received a voucher for a weekend’s stay at one of several resorts. How should this transaction be reflected on the individual’s tax return?
This article covers the individual income tax issues surrounding vacation vouchers and other benefits received in exchange for noncash donations, assuming a reasonable calculation of the value of the donated asset has been made. The most significant issue for tax advisors regarding vacation voucher benefits is to ascertain the amount by which the charitable donation is reduced by acceptance of the vacation voucher.
Vacation Vouchers Emerge
In recent years, there has been a proliferation of incentive programs offered by not-for-profit organizations, most notably involving vacation vouchers, in exchange for noncash donations. While vehicles are a popular asset sought for donations, other noncash assets that may be donated include boats, jewelry, and artwork.
In general, the proper amount of the deduction for such a donation is to subtract the fair market value (FMV) of the benefit received from the charitable contribution. Vacation vouchers, however, pose some challenges; some notfor-profit organizations do not disclose to their donors how to treat the tax effects of noncash assets, often leading unsuspecting donors/taxpayers to believe that the tax deduction of their donated asset may be worth more than allowed. Depending on the valuation of the vacation voucher, it may have an offsetting tax effect on the value of the donated asset.
Insubstantial versus Substantial Benefit
The main issue is whether the vacation voucher benefit is considered insubstantial or substantial. Generally, if the vacation voucher benefit is insubstantial, it does not offset the value of the donation; if substantial, it does.
Vacation voucher benefits are considered insubstantial if the contribution occurs in the context of a fund-raising campaign in which the charity informs donors how much of their donation is a deductible contribution, and either—
- the FMV of all benefits received in connection with the FMV of the donated asset is not more than 2% of the payment or $50, whichever is less; or
- the FMV of the donation is more than $53.50 in tax year 2017 and the benefits received in connection with the donation are token items bearing the organization’s name or logo. Additionally, the inflation adjusted cost, not the FMV to the charity of all of the benefits received by a donor, must in the aggregate be within the limits established for “low cost articles” $10.70 in tax year 2017 under IRC section 513(h)(2).
If neither of the above two tests is met, the vacation voucher benefit received is substantial and, under IRC section 170, the deductible amount of a contribution is determined by taking into account the FMV of any benefits received in return. For example, in 2017, if the cost of the vacation voucher to the charity is more than $10.70, the FMV is the amount used to offset the value of the donated asset.
The main issue is whether the vacation voucher benefit is considered insubstantial or substantial.
Determining the Insubstantial Benefit Threshold
At times, it may be difficult for an individual to adequately communicate to the tax preparer whether or not the insubstantiality tests are met. How would one know the FMV of the vacation voucher, let alone how much it cost the charity? The IRS has required not-for-profit organizations to disclose the FMV of benefits; when a donation exceeds $75, not-for-profit organizations must provide written disclosure of a good faith estimate of the value of the benefits received. Under certain circumstances, however, such disclosure is not required (Scott N. Cairns, Diane A. Riordan, and Michael P. Riordan, “The Deductibility of Charitable Contributions after Rev. Proc. 90-12,” Tax Adviser, October 1990). Exhibit 1 provides examples of such circumstances. When a not-for-profit does not disclose a good faith estimate, determining the proper amounts to report on individual income tax returns becomes a challenge.
EXHIBIT 1
Exceptions to the Requirement to Disclose Value of a Received Benefit
The examples below are several suggestions to help CPAs assist taxpayers in determining whether a vacation voucher meets the threshold amounts to be treated as an insubstantial or substantial benefit.
Determine if the fund-raising campaign qualifies.
If the not-for-profit organization does not determine the FMV (or a reasonable value) of the vacation voucher or state in its materials how much is deductible under IRC section 170, then the fund-raising campaign does not qualify and any benefit received by the donor will be deemed substantial (Revenue Procedure 90-12, 1990, http://bit.ly/2opy3mO; Revenue Procedure 92-49, 1992, http://bit.ly/2nn0wba).
Look for specific disclosures stating the benefit is insubstantial.
If a not-for-profit organization is only offering benefits of insubstantial value, then it should disclose the following language: “Under IRS guidelines, the estimated value of the benefits received is not substantial; therefore, the full amount of your payment is a deductible contribution.”
Make a reasonable practical estimate of FMV.
For 2017, the cost of the vacation voucher cannot exceed $10.70. Using a reasonable practical estimate, how often does a one-night stay in a three-star hotel cost $10.70 or less? Is it likely that the vacation voucher cost the charity $10.70 or less?
Form 1098-C disclosure.
Not-for-profit organizations that receive motor vehicles, boats, or planes as donations are required to issue IRS Form 1098-C if the claimed vehicle exceeds $500 in value. (If Form 1098-C is not attached, the IRS can disallow the deduction of the donated asset. On line 6b of Form 1098-C, the not-for-profit organization should report a good faith estimate of the value of the vacation voucher. Although the IRS offers specific guidance if the client does not receive the Form 1098-C (that is, file an extension and wait until it is received, or forego the deduction if it is not received), it does not offer specific guidance if the value of the benefit is not provided.
CPAs should use professional skepticism when a not-for-profit organization informs a taxpayer that the value of a vacation voucher is minimal or insubstantial. Furthermore, any refusal by the not-for-profit organization to disclose such value should raise a red flag. If the value turns out to be substantial upon IRS audit, it could result in a full or partial disallowance of the charitable deduction. Under current law, the ultimate burden of proof resides with the taxpayer claiming the benefit (Revenue Ruling 67-246, 1967, http://bit.ly/2nr52Gu). From practice, however, CPAs know that the blame for any discrepancies or tax audit questions arising from these situations is usually passed on to the preparer. CPAs should inform clients that appropriate documentation is essential during year-end tax planning meetings. It may also become necessary to conduct research to ascertain a reasonable FMV for the vacation voucher.
Making a Reasonable FMV Estimate for a Vacation Voucher
If insubstantiality cannot be ascertained and the FMV of the donated asset must be determined, using government per diem rates for lodging, taxes, meals, and incidental expenses is one good strategy for reasonably valuing a vacation voucher. The General Services Administration (GSA) establishes the rate in the continental United States (see “Factors Influencing Lodging Rates,” http://bit.ly/2nHIcwN), the Department of Defense establishes rates for Alaska, Hawaii, and territories outside the continental United States (see “Per Diem Rates Query,” http://bit.ly/2opJ8UQ), and the State Department establishes rates for international destinations (see “Per Diem Rates,” http://bit.ly/2oHcEow).
CPAs should use professional skepticism when a not-for-profit organization informs a taxpayer that the value of a vacation voucher is minimal or insubstantial.
In some cases, an individual may receive a voucher but never use it. The intention to use the benefit does not determine whether or not a taxpayer will have to reduce a charitable contribution; rather, the deciding factor is acceptance or rejection. Therefore, a taxpayer is not entitled to a full deduction of the noncash asset if the benefit received is deemed substantial, even if the voucher was not used.
Hypothetical Scenarios
Below are some scenarios designed to help a tax professional understand the application issues surrounding vacation vouchers. Exhibit 2 provides a flowchart to help determine whether the value of a vacation voucher offsets the value of the donated asset. Exhibit 3 provides suggestions of questions to ask taxpayers.
EXHIBIT 2
Steps to Ascertaining Substantiality or Insubstantiality of a Benefit
EXHIBIT 3
Client Interview Questions for Tax Preparers
Scenario 1.
In 2016, Liam donates a vehicle with a determined FMV of $700. As an incentive to donate the vehicle, an IRC section 501(c)(3) not-for-profit organization offers a three-night stay vacation voucher at a three-star hotel in a select city. The organization claims that the value of the vacation voucher is “minimal” and does not provide further details. Since the not-for-profit did not disclose how much of the vacation voucher might be deductible from the donated asset, the fundraising campaign is not qualifying, and the value of the vacation voucher is deemed substantial. Therefore, the FMV of the vacation voucher must offset the value of the donated asset. One approach for Liam to determine the FMV of a weekend in the select city would be to visit a travel aggregator website, such as Expedia or Kayak, and check the pricing for three-star hotels during the weekend he used (or will use) the voucher. If the FMV was, for example, $300, that will have to be deducted from the $700 vehicle donation value, for a net tax-deductible donation of $400.
Scenario 2.
Camila donates a vehicle with the same value as Liam’s ($700), but her not-for-profit organization meets the disclosure test by informing the public that the value of the vacation voucher is $150. The vacation voucher also bears the organization’s name or logo, and the organization claims the benefit is of token value [$150 is more than 2% of $700 ($14)]. Furthermore, the name or logo is of the organization inconsequential, as the value of the vacation voucher is greater than $10.70 and therefore not of token value. Thus, the benefit cannot be considered insubstantial, and the FMV of the vacation voucher must offset the value of the donated asset, resulting in a net tax-deductible donation of $550.
Scenario 3.
Nilza donated a piece of jewelry to a not-for-profit organization and accepted a vacation voucher for a one-night stay at a three-star hotel at an off-peak time in a relatively low-cost city. The value of the vacation voucher was disclosed as $40. A local jeweler appraised the jewelry at a FMV of $2,200. In this case, the FMV of the benefit ($40) is less than 2% of the FMV of the asset ($44) or $50 (whichever is less). Therefore, the value of the vacation voucher is insubstantial and the entire $2,200 FMV of the donated jewelry is deductible. No offset is required.
Conscientious tax preparers should question their clients as to the nature and valuation of all donations, especially noncash donations.
Getting the Right Answer
Noncash donations to a charity can present issues for tax preparers. Numerous questions must be asked and answered to determine the proper deduction. CPAs should ascertain whether the taxpayer has the proper documentation to support the valuation of a donated asset, as well as the valuation of any vacation voucher or other benefit received in return. Asking the right questions and ensuring that the donor has such information from the charity may help reduce confusion when determining whether the insubstantiality tests are met. There are also implications for the not-for-profit organization receiving these donations. If a charity promises or implies a full deduction for the value of the asset and the donor is unable to take that full deduction, it may lead to ill will or even lead to government investigations. The not-for-profit should be careful in how it reaches out to potential donors in its marketing materials and receipts.
Charitable contributions have always been complex area for preparers and taxpayers. Complexity increases when the contribution is a noncash item and the charity gives a benefit to the donor. Conscientious tax preparers should question their clients as to the nature and valuation of all donations, especially noncash donations, as well as asking about benefits received and their valuation.
