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By Peter Barton, MBA, CPA, JD, professor of accounting and Clayton Sager, PhD, associate professor of accounting, University of Wisconsin-Whitewater

In Lucky Stores v. Commissioner, a case of first impression, the Tax Court ruled that four-day-old bread could be valued at full retail price in determining the charitable contribution deduction for donated inventory. Enacted in 1976, Sec. 170(e)(3) allows C corporations to deduct basis plus one-half of the appreciation for donations for the care of the ill, needy, or infants. (Only basis can be deducted for discarded inventory.) Qualifying inventory includes food, clothing, medicine, medical and recreational equipment, books, etc. Lucky Stores affects all donations made under the broad provisions of this statute.

Deductions for contributions of ordinary income property are limited to basis by Sec. 170(e)(1)(A). However, Sec. 170(e)(3) allows C corporations to deduct basis plus one-half of the appreciation if the donation of inventory is for the care of the ill, needy, or infants. The deduction cannot exceed twice the basis. The appreciation is the fair market value (selling price) minus the basis. (Other entities can deduct only basis for these donations.) Regs. Sec. 1.170A-4A(b)(2)(ii) broadly defines "ill," "needy," and "infants."

Regs. Sec. 1.170A-1(c)(2) defines "fair market value" (FMV) as the selling price of the property "in the usual market in which [the donor] customarily sells ... in the quantity contributed." If the donor could not reasonably expect to receive the usual selling price, Regs. Sec. 1.170A-1(c)(3) requires that the gift be valued at "the amount for which the quantity of property contributed would have been sold by the donor at the time of the contribution."

Lucky Stores makes and sells bread. During the years at issue, it oversupplied its stores by about six percent to prevent the possibility of empty shelves and routinely donated the excess bread to food banks. In 1985, it donated four-day-old bread with a basis of $1,753,485 and FMV of $3,081,204. In 1986, the basis and FMV were $3,471,236 and $6,072,353, respectively. On its tax returns, Lucky Stores deducted basis plus 50% of the appreciation for these donations.

Lucky Stores delivered bread to their supermarkets on day 1. Bread unsold on day 4 was removed on the morning of day 4 and immediately donated to food banks. Thus, the donated bread was four-day-old bread. However, bread delivered to stores on Thursday was not removed until Monday (day 5). Therefore, Sunday sales of Thursday deliveries provided a measure of the value of four-day-old bread.

Unrefrigerated bread is edible for two weeks after it is made. Also, four-day-old bread loses neither nutritional value nor taste, but does lose moisture and "squeezeability." However, three-day-old bread is indistinguishable from four-day-old bread. Although Lucky Stores fastened its bread bags with a plastic disc containing the fifth day's date in small print, there were no other words, such as "sell by," on the disc.

The IRS disallowed the deduction in excess of basis, claiming that the FMV of the four-day-old donated bread was only 50% of the full retail price, reducing the bread's FMV to less than basis. Citing Regs. Sec. 1.170A-1(c)(2), the IRS argued that Lucky Stores did not sell any significant quantity of four-day-old bread because on Sundays the stores primarily sold bread delivered on Fridays and Saturdays. The IRS also pointed to the practice of major bakers who sold four-day-old bread at bakery thrift shops at a 50% discount.

The Tax Court rejected these arguments and ruled that the FMV of the donated four-day-old bread was the full retail price. Concerning the Sunday sales, the court ruled that the crucial point was that Lucky Stores sold four-day-old bread at full retail price, not the quantity of such sales. This ruling appears to contradict the quantity aspect of the regulation. Also, the court ruled that the "industry practice" argument did not prove the FMV of four-day-old bread, but only that Lucky Stores could have sold it at a discount. Finally, the court emphasized that Congress enacted Sec. 170(e)(3) to encourage donations.

Lucky Stores is an important precedent for the donation of appreciated inventory for the care of the ill, needy, or infants by C corporations. The Tax Court's liberal interpretation of the regulations in Lucky Stores makes it easier for donors to obtain the maximum deduction allowed by Sec. 170(e)(3). However, the IRS may appeal Lucky Stores, which would be to the 9th Circuit. *

Source: Lucky Stores v. Commissioner, 105 T.C., No. 28 (December 19, 1995).

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