Calling All Car Donors: IRS to Set Up Roadblock Against Deduction Padding

Seymour Lauretz knows only too well how taxpayers have abused auto donation programs sponsored by charities.

A certified public accountant and longtime auto enthusiast, Lauretz recalled recently that he had several clients who had tried to pad deductions related to giving away their junkers.

“One of my ex-clients tried to convince me that the very old Toyota that he gave to charity was worth $9,000,” he said. “That was the last straw. I told him to prove it.”

Lauretz figures the deduction padding -- at least as far as car donations go -- will come to a halt in January, when new federal tax rules go into effect and dramatically tighten write-offs for donated cars, boats and airplanes.

The rules, part of the American Jobs Creation Act passed by Congress, were spurred by widespread abuses. Taxpayers claimed $654 million in write-offs from car donations in the 2000 tax year, but charities reported getting just $32.7 million from sales of those donated cars after expenses, a study by the Government Accountability Office found late last year.

Although some of that difference had to do with the costs of selling the cars, the wide disparity was a clear indication that many taxpayers grossly overstated their deductions, accountants said.

“The abuse is obvious,” said Lauretz, who works in Beverly Hills. “Legislation was definitely needed.”

The rules aim to curb deduction padding by changing how donated cars are valued. (Donations of boats and airplanes will be affected too, but those are less common.)

Currently, taxpayers are simply expected to make a good-faith effort to value the donated car themselves. If the car is worth more than $5,000, however, they may need an appraisal to substantiate the deduction, if they’re audited.

Starting Jan. 1, the burden falls to the charity, which will have to tell the donor what it plans to do with the car: use it or sell it. If the answer is “sell,” the charity also will be required to tell the donor how much it received when the car was sold.

This notice must be sent to the donor within 30 days of the gift; a duplicate copy will be sent to the Internal Revenue Service. The taxpayer’s deduction will be limited to the gross sales price on the notice.

There are only three exceptions to that rule: If the car is worth less than $500, the donor can write off that value without obtaining further proof of value from the charity; the donor also uses today’s valuation rules if the charity is using the car in its operations, rather than immediately selling it, or if it substantially improves the car before its sale.

The new rules are worrisome to charities for a couple of reasons, said Paula Skuratowicz, executive director of the Polly Klaas Foundation in Petaluma, Calif. One is practical: Cars are often not sold within 30 days, so it would be impossible to tell donors that quickly what they’re worth. Most often, cars donated in December aren’t sold until March.

Skuratowicz, whose organization receives 85% of its annual revenue from auto donations, said the foundation was talking with the IRS to work out kinks such as the 30-day rule. There are often technical corrections that follow major tax changes.

Even if changes are made, charities fear car donations will slow, and accountants say they might.

Honest taxpayers might want to think twice before giving a car to a charity under the new rules, said Mark Luscombe, principal tax analyst with CCH Inc., a Riverwoods, Ill.-based publisher of tax information. Frequently, automobiles donated to charity are sold at auction, where they might go for bargain-basement prices. The donor is stuck with the charity’s sales price to value his write-off, even if the car was legitimately worth more, he noted.

And, of course, a tax write-off is only worth about 30 cents in tax savings for every dollar donated.

The donor may be willing to forgo the more lucrative sales price in order to fund a favorite cause. But it adds insult to injury when the value of the deduction is diminished by a fire sale of the car, Luscombe said.

“After January, you might want to shop around to see what the charity does and go out of your way to look for a charity that will use the car,” said Martin Nissenbaum, tax partner at the national accounting firm of Ernst & Young in New York. “You might look for charities that deliver meals to the poor and the homebound. Or you could donate the car to the neighborhood security patrol.”

Or, Lauretz suggested, people could sell the cars themselves and give the proceeds to charity.

Although the allure of giving a car to charity is partly to avoid the trouble of having to sell it, few charities are set up to sell the cars themselves, he said. As a result, they give the job to a for-profit middleman, which often siphons off a substantial portion of the car’s value.

In the case of the Polly Klaas Foundation, the auto donation program brought in $5.2 million worth of cars in 2002. The cost of selling the cars amounted to nearly $3.9 million, including a $1-million fee paid to a Monrovia firm that handles the sale.

After expenses, the foundation’s net income from all of those donations was $1.26 million.

Skuratowicz said the foundation didn’t plan to change the way it handled donated cars, but some experts said other charities might.

Bob Ottenhoff, president and chief executive of GuideStar, a charity information service in Washington, said some charities might receive fewer cars -- and some auto donation programs might face increased scrutiny by donors and the IRS alike. He figures, however, that it will prove a positive change in the long run.

“There may be some people who cannot take the same kind of deduction that they once did, and there may not be as many cars that go to nonprofits,” he said. “But I think this is a good realigning of priorities. What this should be about is making a cheerful and voluntary contribution to a worthwhile cause. I hope that remains the driving motivation for what people do.”