Certain pharmaceutical companies might be able to enjoy improved cash flow through an enhanced tax deduction for the charitable donation of inventory. Guidance for enhanced tax deductions related to the contributions of inventory for the care of the ill, needy, or infants by a corporation to a charitable organization is provided under Internal Revenue Code (IRC) Section 170(e)(3).
A taxpayer’s deduction for charitable contributions of inventory generally is limited to the income tax basis in the inventory, given that IRC Section 170(e)(1)(A) requires that the charitable contribution deduction otherwise based on fair market value be reduced by the amount of ordinary income that would be realized on the sale of such property. IRC Section 170(e)(3) provides a special rule whereby a corporation may claim an enhanced deduction for certain contributions of inventory in an amount equal to the lesser of (1) the basis of the contributed property plus one half of the ordinary income that would be realized if the property were sold for fair market value (FMV), or (2) twice the tax basis of the contributed property.
The following are examples of how this enhanced deduction of certain contributed inventory is applied:
1) Assume the cost of the product is $50 and the FMV is $100. The difference between the cost and FMV is $50 and half of the difference is $25. The allowed deduction would be $75 ($50+$25=$75) since this is less than twice the cost basis ($50*2=$100)
2) Assume the cost of the product is $100 and the FMV is $500. The difference between cost and FMV is $400 and half of the difference is $200. The allowed deduction would be $200 ($100*2=$200) since this is less than the cost plus half the difference between cost and FMV ($100+$200 = $300)
Listed below are some basic conditions that pharmaceutical companies need to meet in order to qualify for the enhanced deduction:
- the donated product is used solely for the care of the ill, needy or infants
- taxpayer must obtain a written statement by the donee stating that the donation is to be used for qualified purposes
- the donee organization must be a US 501(c)(3) charitable organization
- the donation must be made by a C corporation
For pharmaceutical companies weighing the benefits of donating rather than disposing inventory, the aforementioned enhanced deduction creates a tax incentive to choose the charitable option. If a company were to destroy, rather than donate a product, the company would not be entitled to the tax ‘step-up’ provided under section 170(e)(3) and the company could incur significant disposal costs. Hence, participation in a donation program could result in a positive financial impact for pharmaceutical companies.