Any Red Flags on Clothing Donation?

[pstu24]

A very close friend of mine has been recently (the last few years) using a strategy of clothing donation to maximize his tax write-offs. I don't think he is wrong in what he does, but from what I gather it could still be a red flag and I wanted to get some more opinions before I follow suit!

If you can feel comfortable donating to the Salvation Army or Goodwill, then you can write off up to 50% of adjusted gross income. The trick he uses is that he will go to garage sales, rummage sales, and other events where you can get very cheap clothing (also other goods, but he focuses on clothing) - and in no time at all he can 'invest' a great deal into buying tax credits.

The key he uses is to be as cheap as possible. He will literally go pick up gently used stuff that can be as little as 4 t-shirts for a quarter. Total invested would only be $1.00 for the four shirts. Then, if you go look at the Salvation Army donation schedule (just one place to donate at) https://satruck.org/Home/DonationValueGuide .... you can see there is a value on Men's shirts between $2.50 and $12.00 apiece. In other words, he spent $1.00 (plus time and energy to get there of course), and in return will be able to receive back $10 to $48 in donations. Not to mention he doesn't just go and pick up 4 shirts ... he will go and grab 50 or 100 if possible. The best part is, he isn't looking for size, just cheap clothes. So he can grab men's, women's, and even children's clothing. Put it into bags when he buys it... never even take it home ... drive straight to salvation army and drop it off for tax credits.

Here's my question. While I know you need to itemize to write off charitable contributions ... are there any red flags he should keep in mind (or that I should be aware of if I were to use this strategy)?

Also, is he forgetting something, or for an individual who makes slightly over 70k a year, is he really writing off 35k right off of the bat and not being taxed on half of his income?

Because again, in order to generate that 35k of donations ... it wouldn't be THAT hard. If he could sustain making as much as $5.00 per T-shirt (which means he donates it at 5.25 if he purchases it for $.25 .... right in the middle of the $2.50-$12.00 spectrum), then you would STILL need 7,000 t-shirts. While that is very ambitious ... it's not unheard of. Going to a neighborhood where there is a block sale, going to a flea market, or doing something along that mindset would easily net countless shirts. Especially when you aren't even limited to Shirts AND you aren't even worried about the design or fashion - just quality of clothing.

Throw in the fact that you would be saving roughly $7,000 in the process (the taxes on the last $35,000 that would have been written off for a person in the 70k salary range ... which is 20% rate). And, while it is absolutely not a home run, you could pocket (or keep from paying in taxes) almost $7,000 just by taking a handful of Saturday mornings and filling up your van with old clothes and chauffering them all down to the Goodwill or Sal-Val!

Again - I think it works, but for meaningless work I also think it could be too good to be flawless...

[CareCPA]

I would not hesitate to say this falls under fraud.

From the IRS website:
https://www.irs.gov/uac/eight-tips-for-deducting-charitable-contributions
"4. Donations of stock or other non-cash property are usually valued at the fair market value of the property. Clothing and household items must generally be in good used condition or better to be deductible. Special rules apply to vehicle donations.

5. Fair market value is generally the price at which property would change hands between a willing buyer and a willing seller, neither having to buy or sell, and both having reasonable knowledge of all the relevant facts."

Which means fair market value is the price he paid, so he can't inflate it using another schedule. Those schedules are to be used in the absence of better information. Here we have the information from the actual transaction.

ETA: Additional info and examples: https://www.irs.gov/pub/irs-pdf/p561.pdf

[Captain FIRE]

Are you asking if you/he will be "caught" by the IRS in an audit, or if this is legal?

Legality:
You can deduct the FMV of the donated property.  If you bought it and donated it rapidly (same day, or even within weeks/months), the used price you bought it at is an extremely good indication of the FMV of that property.

https://www.irs.gov/publications/p561/ar02.html#d0e139

If you want to stay out of the grey audit-concern area, I'd suggest that you start ebaying these clothes rather than donating them and taking a higher value for them that you paid.

Practicality:
I have heard rumors that if you deduct more than the average amount that people in your similar income brackets deduct for charitable contributions, you are more likely to be audited.  While I have no idea if that is true, I can't help but think that deducting half of your income is bound to set up a red flag.

[pstu24]

VERY eye opening to hear! As I said, I believed it may have been too good to be true and that is not my level of risk. Also - I wasn't aware of the needing to donate at fair value over the suggested schedules. Thanks for letting me know and I will forward information to my buddy as well!

[SeattleCPA]

I would not hesitate to say this falls under fraud.

From the IRS website:
https://www.irs.gov/uac/eight-tips-for-deducting-charitable-contributions
"4. Donations of stock or other non-cash property are usually valued at the fair market value of the property. Clothing and household items must generally be in good used condition or better to be deductible. Special rules apply to vehicle donations.

5. Fair market value is generally the price at which property would change hands between a willing buyer and a willing seller, neither having to buy or sell, and both having reasonable knowledge of all the relevant facts."

Which means fair market value is the price he paid, so he can't inflate it using another schedule. Those schedules are to be used in the absence of better information. Here we have the information from the actual transaction.

ETA: Additional info and examples: https://www.irs.gov/pub/irs-pdf/p561.pdf

I don't think it's necessarily fraud. Not an attorney obviously, but I think criminal intent is pretty hard to prove.

However, I agree with everything else FrugalGrad says. Stuff someone buys for a quarter isn't worth $10 or whatever...

BTW, at the level your friend is operating, I think the statute of limitations is probably six years. So if he or she is examined, IRS can (and should) go back six years, calculate the taxes evaded, assess the 25% penalty, and then charge interest on the taxes and the penalty.

[CareCPA]

I would not hesitate to say this falls under fraud.

From the IRS website:
https://www.irs.gov/uac/eight-tips-for-deducting-charitable-contributions
"4. Donations of stock or other non-cash property are usually valued at the fair market value of the property. Clothing and household items must generally be in good used condition or better to be deductible. Special rules apply to vehicle donations.

5. Fair market value is generally the price at which property would change hands between a willing buyer and a willing seller, neither having to buy or sell, and both having reasonable knowledge of all the relevant facts."

Which means fair market value is the price he paid, so he can't inflate it using another schedule. Those schedules are to be used in the absence of better information. Here we have the information from the actual transaction.

ETA: Additional info and examples: https://www.irs.gov/pub/irs-pdf/p561.pdf

I don't think it's necessarily fraud. Not an attorney obviously, but I think criminal intent is pretty hard to prove.

However, I agree with everything else FrugalGrad says. Stuff someone buys for a quarter isn't worth $10 or whatever...

BTW, at the level your friend is operating, I think the statute of limitations is probably six years. So if he or she is examined, IRS can (and should) go back six years, calculate the taxes evaded, assess the 25% penalty, and then charge interest on the taxes and the penalty.

Fraud may be hard to prove, but I would have trouble believing an "ignorance of the rules" defense at that dollar level. But I've been wrong before, and I'll be wrong again...
Either way, it will be expensive if/when the IRS catches on.

[couponvan]

I think your friend has gone overboard - our family has a strategy to buy high quality items on super sales, wear for 1 year and donate and take a tax credit of FMV and buy more for the tax credits. Of course our spending/donations are way less than 10% of our income.

[jwright]

If you donate an item or one group of similar items valued at over $5,000 you have to have the donee organization sign off and an appraisal.  That's on Page 2 of the Form 8283.  I suppose he could get around that by limiting each donation to less than $5,000 and splitting them up around donation sites around town. 

The valuation would be suspect.  If I buy a shirt for 25 cents; why would I argue that the fair market value is $12? The FMV is what a reasonable person would pay.  Why is garage sale value so much less than thrift store value? 

Finally I do think it would be a red flag to have a large charitable contribution compared to income; especially without an appraisal.  But that is just an opinion.

[With This Herring]

I would not hesitate to say this falls under fraud.

From the IRS website:
https://www.irs.gov/uac/eight-tips-for-deducting-charitable-contributions
"4. Donations of stock or other non-cash property are usually valued at the fair market value of the property. Clothing and household items must generally be in good used condition or better to be deductible. Special rules apply to vehicle donations.

5. Fair market value is generally the price at which property would change hands between a willing buyer and a willing seller, neither having to buy or sell, and both having reasonable knowledge of all the relevant facts."

Which means fair market value is the price he paid, so he can't inflate it using another schedule. Those schedules are to be used in the absence of better information. Here we have the information from the actual transaction.

ETA: Additional info and examples: https://www.irs.gov/pub/irs-pdf/p561.pdf

I don't think it's necessarily fraud. Not an attorney obviously, but I think criminal intent is pretty hard to prove.

However, I agree with everything else FrugalGrad says. Stuff someone buys for a quarter isn't worth $10 or whatever...

BTW, at the level your friend is operating, I think the statute of limitations is probably six years. So if he or she is examined, IRS can (and should) go back six years, calculate the taxes evaded, assess the 25% penalty, and then charge interest on the taxes and the penalty.

Fraud may be hard to prove, but I would have trouble believing an "ignorance of the rules" defense at that dollar level. But I've been wrong before, and I'll be wrong again...
Either way, it will be expensive if/when the IRS catches on.

This smells like fraud to me.

With charitable clothing donations, the general idea is that one buys clothing at market value, wears it for a few years, then donates it when the value has already dropped significantly.

From Publication 526:

Giving Property That Has Increased in Value
If  you  contribute  property  with  a  fair  market value that is more than your basis in it, you may have  to  reduce  the  fair  market  value  by  the amount  of  appreciation  (increase  in  value) when you figure your deduction.  Your basis in property is generally what you paid for it. If you need more information about basis, see Pub. 551.  Different rules apply to figuring your deduc­tion, depending on whether the property is:

• Ordinary income property, or
• Capital gain property.

Ordinary Income Property

Property is ordinary income property if you would have recognized ordinary income or short-term capital gain had you sold it at fair market value on the date it was contributed. Examples of ordinary income property are inventory, works of art created by the donor, manuscripts prepared by the donor, and capital assets (defined later, under Capital Gain Property ) held 1 year or less.

Property used in a trade or business.   Property used in a trade or business is considered ordinary income property to the extent of any gain that would have been treated as ordinary income because of depreciation had the property been sold at its fair market value at the time of contribution. See chapter 3 of Pub. 544, Sales and Other Dispositions of Assets, for the kinds of property to which this rule applies.

Amount of deduction.   The amount you can deduct for a contribution of ordinary income property is its fair market value minus the amount that would be ordinary income or short-term capital gain if you sold the property for its fair market value. Generally, this rule limits the deduction to your basis in the property.

Example.

You donate stock you held for 5 months to your church. The fair market value of the stock on the day you donate it is $1,000, but you paid only $800 (your basis). Because the $200 of appreciation would be short-term capital gain if you sold the stock, your deduction is limited to $800 (fair market value minus the appreciation).

Exception.   Don't reduce your charitable contribution if you include the ordinary or capital gain income in your gross income in the same year as the contribution. See Ordinary or capital gain income included in gross income under Capital Gain Property, later, if you need more information.

Red coloring added by me for emphasis.  I would worry that, with this guy's very specific scheme and rapid clothing turnover, the IRS might look at this as the guy failing to report income (the profit on these contributions).  It is very obvious that the guy's intent is to "pull a fast one" over on the IRS, which will not be looked upon kindly.

[SeattleCPA]

This smells like fraud to me.

I share this not to disagree or argue, but to add color and hopefully provide some useful insight.

In graduate tax school, one of the professors was a well-known tax attorney and former tax court judge. I remember this professor telling us that whenever he took on a client the IRS was targeting for criminality, it was basically impossible for IRS to prevail as long as the taxpayer hadn't talked with the IRS agents. The point was it's really hard in tax law to prove criminal intent.

Please take this as a general comment. The only real take-away is that if you are ever contacted by an IRS special agent as part of a criminal investigation, you would not want to say anything. Not a word, according to the former tax court judge. Rather, you'd want to immediately have a tax attorney represent you.

BTW, final comment: The sort of funny postscript to this story was that this tax attorney would say that people always told him they hadn't talked with the IRS agent... and then they'd later say, "well, it wasn't very long... probably less than an hour..." and that was enough sometimes to really undermine any defense.

[pstu24]

So I continued to watch this thread go by (thank you all for comments and input!!) And while I don't pretend to agree ... I guess the major question I personally have has to deal with the underlying idea of fair market value.

Please keep in mind this is purely for understanding and not trying to "debate" anyone on the concept!

But... if the idea is to mark this off at fair market value, with clothing wouldn't it be slightly different? I guess the hard part is wrapping my brain around the idea branding / quality / etc. What I mean is if I donated a house, there is a fairly good way to evaluate housing based upon neighborhoods, market value, condition, etc. The same could be said with Cars (by using Blue Book value). But with a T-Shirt, for example, there's a lot of variability.

If you go to a store in your local mall with name brands, you could find a plain T-shirt without labels, and the price tag may list as much as $20 (or if you want high end ... add a zero to the end :) ). If you go to a store with quality but known for sales (I'm thinking Marshall's where my wife loves) - you could find essentially the same shirt, same design, and even the same tag but they are just trying to empty shelves of inventory for half the price. Then you could go to a place like Walmart, and while the designer isn't the same, the functionality of t-shirt that looks almost identical could be had at a price of 3 for $5.00 ...

If I went to a yard sale because someone was spring cleaning and wanted to get rid of the clothing that their teen who just hit puberty is growing out of, who's to say there isn't a t-shirt they got for Christmas with the tag still on it, never worn, and suggested retail price of $50.00, but is now only for sale for 50 cents because that's better than throwing it out?

Plus, if the idea is you should be recording some sort of appreciation on the asset, couldn't you then theoretically record everything you did in the process to acquire including washing them to be sure they aren't dirty, record the mileage, and even start writing off meals you eat while conducting the activity?

Again, not trying to go TOO far off the deep end. Just looking to better understand the FMV.

Thanks!

[CareCPA]

I think it all comes back to the definition of Fair Market Value from my earlier post:
"Fair market value is generally the price at which property would change hands between a willing buyer and a willing seller, neither having to buy or sell, and both having reasonable knowledge of all the relevant facts"

The KBB value of a car is an approximation usually based on relevant transactions (the online KBB even purports to search nearby transactions, narrowing it down by geographic location). This uses historic data to approximate FMV.
The same for a house, similar transactions are used to approximate FMV. The actual FMV of the house becomes what was actually paid.

With clothing, the guides (and MSRP) are the same philosophy. They try to approximate FMV. If shirts are on clearance at a store, it means they can't sell for what they were originally marked in a reasonable time, so the clearance price becomes the FMV based on the most recent transactions.

At the end of the day, actual transactions between a willing buyer and seller are going to be the best valuation of FMV. In this specific case, the yard sale is such a transaction - thus it becomes the FMV of the article.

[Captain FIRE]

So I continued to watch this thread go by (thank you all for comments and input!!) And while I don't pretend to agree ... I guess the major question I personally have has to deal with the underlying idea of fair market value.

Please keep in mind this is purely for understanding and not trying to "debate" anyone on the concept!

But... if the idea is to mark this off at fair market value, with clothing wouldn't it be slightly different? I guess the hard part is wrapping my brain around the idea branding / quality / etc. What I mean is if I donated a house, there is a fairly good way to evaluate housing based upon neighborhoods, market value, condition, etc. The same could be said with Cars (by using Blue Book value). But with a T-Shirt, for example, there's a lot of variability.

If you go to a store in your local mall with name brands, you could find a plain T-shirt without labels, and the price tag may list as much as $20 (or if you want high end ... add a zero to the end :) ). If you go to a store with quality but known for sales (I'm thinking Marshall's where my wife loves) - you could find essentially the same shirt, same design, and even the same tag but they are just trying to empty shelves of inventory for half the price. Then you could go to a place like Walmart, and while the designer isn't the same, the functionality of t-shirt that looks almost identical could be had at a price of 3 for $5.00 ...

If I went to a yard sale because someone was spring cleaning and wanted to get rid of the clothing that their teen who just hit puberty is growing out of, who's to say there isn't a t-shirt they got for Christmas with the tag still on it, never worn, and suggested retail price of $50.00, but is now only for sale for 50 cents because that's better than throwing it out?

Plus, if the idea is you should be recording some sort of appreciation on the asset, couldn't you then theoretically record everything you did in the process to acquire including washing them to be sure they aren't dirty, record the mileage, and even start writing off meals you eat while conducting the activity?

Again, not trying to go TOO far off the deep end. Just looking to better understand the FMV.

Thanks!

Re the bold, I think you are starting to confusion a business expense with a charitable deduction.  Mileage and meals have absolutely nothing to do with the donation, so let's put that aside.

FrugalGrad puts it well, but for another explanation, look at it from the IRS' perspective, since they would be the ones auditing you:
On Day 1 you bought Item X for $1.
On Day 2 you donated Item X for $5*.
The IRS/you need to establish the FMV.  As the item was so recently bought & sold, it's easy!  Absent other factors (e.g. you are a famous person who signed the item making it a collectible, you are a famous artist who painted the item raising its value considerably), it's the price you recently paid for it.  Note that for this whole scheme to even work, you'd need to collect a much high value deduction than you paid for the item, by at least 3-4x, depending on your tax bracket.  Your logic seems to be that you washed the item (which may have already been washed and may be washed again by the charity) so that adds 5x the value.  I think that's a considerable stretch, and believe the IRS would take an even dimmer view of it.

You could probably easily get away (as in, not have your activity be noticed) with some arbitrage between the posted schedules of prices by various organizations (which note, the IRS does not actually endorse - they are created by other organizations), however, a systematic attempt to capture that value is likely to be flagged and objected to based on the above reasoning.

[SeattleCPA]

ere's a lot of variability.
Note that for this whole scheme to even work, you'd need to collect a much high value deduction than you paid for the item, by at least 3-4x, depending on your tax bracket.

The above is a really good point. If you buy something for a dollar and then take a five dollar deduction, you lose a $.50 if your tax rate is 10%, you lose $.25 if your tax rate is 15%, and you make $.25 if your tax rate is 25%.

The other thing is, no one who understands the law thinks you can buy something for a dollar and then a little while later claim the FMV equals $5 or $10.

[Cowardly Toaster]

It seems very sketchy to me, but how would the IRS go about proving what he did? Start tailing him when he goes to garage sales? Federal law enforcement is pretty busy and I doubt they would mess around with a case like this.

So it really comes down to whether your friend is being ethical or not, and I guess that comes down to what you think about paying taxes.

[SeattleCPA]

It seems very sketchy to me, but how would the IRS go about proving what he did? Start tailing him when he goes to garage sales? Federal law enforcement is pretty busy and I doubt they would mess around with a case like this.

So it really comes down to whether your friend is being ethical or not, and I guess that comes down to what you think about paying taxes.

IRS doesn't need to prove FMV, taxpayer will need to do that with documentation. Without documentation, IRS gets to assume what they want.

BTW, when a taxpayer loses in an audit, the reason (typically) is that they can't support via good documentation the stuff they've claimed or reported within their tax return. (Note: This statement reflects my own professional experience representing taxpayers before IRS and it's also conclusion of Fred Daily, the tax attorney who wrote "Stand  up to the IRS"...)

FWIW, you're right that IRS won't do a field audit on something like this. But they might do a correspondence audit if the numbers were extreme. That'd be relatively easy for them.  And in that case, taxpayer will need to send in their documentation and a cover letter explaining their accounting.

[pstu24]

It's a very interesting topic and I'm not even arguing for or against it... im just still tying to wrap my head around fair market value. One specific example - I live by a church that is across the street from a local college of over 5k students. At the end of the year they take donations from students who don't want to take things home with them. This church will sell the items in thier sale and donated all of the money warned. A few months ago I came across between 5- 6 hooded sweatshirts with college sports logos and etc that STILL HAD THE STICKERS on them. As in these goodies probably went for 40- 60 bucks a pop. They were most likely never worn. The church wanted either 5 per or 7.50 per... I can't remember. Could you argue arbitrage? Because in that scenario I dont get how fair market value for a single item is at a deal when the going rate is much higher? It's more of the exception I think. Just clarifying!

[Captain FIRE]

You say that you don't wish to argue, yet you keep presenting the same argument seemingly in the hopes of a different answer. 

It doesn't make a difference if you buy & donate t-shirts, sweatshirts, widgets or gizmos.  The advice remains the same:
- The IRS would likely take the recent price you bought it as an indication of the FMV.  If audited, you would need to prove how you arrived at the FMV and satisfy them.
- You'd need to buy/donate at a considerable discrepancy to make money, as your tax bracket at the $70k mentioned above would be 15 or 25% (so you'd need to claim a value 5 to 7 times what you paid for it to make any money at all).  At higher tax rates it might drop to 3-4 times.
- A small scale operation would likely fly under the radar.
- That doesn't make it right or legal.

I'll also add:
- There are probably easier ways to cheat on your taxes.

In the case you present, if there really is an arbitrage opportunity, then sell it on ebay or a similar site.  You'll collect all of the money for your time rather than just a percentage and avoid any potential audit issues.

And with that, I'm out of this thread.  Based on your repetition of the same situation/argument over and over, I can't tell if you just trolling and I have no desire to further waste my time repeating myself.

[pstu24]

Sorry if you believe I am trolling. Again, I'm not trying to argue. I dont understand the idea of fair market in this scenario. Teo exact same items sit next to each other. One is bought at retail full value. Another is bought at a discount. The amounts do not matter.  The discounts do not matter.  The items do not matter. I am just confused as to how you can only write something off at the value you acquired it for instead of it's its actual potential market value.

Again, I hope you can see my point. I am not trying to cheat on my taxes despite the fact I think you were implying that... perhaps I was wrong or perhaps I didn't emphasize that enough...

I just can't wrap my head around the idea that "Fair Market Value" has nothing to do with market value.. but rather it appears this value is actually more along the lines of "purchase price" or "acquisition cost" under these terms.

I get it that otherwise things could be opened up to additional tax fraud or what have you... but if I bought an item that i was willing to pay a given amount for say 100 dollars... and if the going rate was 100 dollars... and if every other like item of that kind was 100 dollars... I just am getting stuck on the fact that if I obtained the item at a discount - the item's value is instantly reduced to the acquisition cost and not the market cost.

Sorry for offending!

[TomTX]

If you donate an item or one group of similar items valued at over $5,000 you have to have the donee organization sign off and an appraisal.  That's on Page 2 of the Form 8283.  I suppose he could get around that by limiting each donation to less than $5,000 and splitting them up around donation sites around town. 

The valuation would be suspect.  If I buy a shirt for 25 cents; why would I argue that the fair market value is $12? The FMV is what a reasonable person would pay.  Why is garage sale value so much less than thrift store value? 

Three points from a different perspective:

The FMV is $12, because that's what Goodwill/Salvation Army sells it for in their store. That's why they have the value list available. It's documentation of the value for a willing buyer and seller.  Donator just prints out the list and takes it to the audit.

Garage sale prices can be FAR below FMV because the vast pool of buyers has no idea that the item they want is available.

There is likely no documentation of the garage sale purchase price.

Note: Not something I would do myself. I have too much bought-full-price crap to get out of my house as it is.

[Mezzie]

Legally fraud or not, it is entirely unethical.

[MoseyingAlong]

ETA Sorry, looks like you do understand this restriction, just don't like it. That's the tax code for us.

With This Herring already brought up the key point you and your buddy seem to be missing or ignoring. It's not just the FMV to consider, it's also your basis or what you paid for the items, i.e. the garage sale price. You are basically limited to deducting the lower of the two and in this scheme, it's the garage sale price.

I don't think this should be used to decide what to do (just do the right thing) but I can see a way to prove this was fraud. Get the bank records for the last few years. He makes $70K and claims a donation of $35K. Does cash flow support this? i.e. does all his other spending, saving, investing and taxes leave $35K to spend on clothes? Probably not.