If you’re holding an auction, are you in compliance?

Charitable auctions have long been lucrative fundraising and stakeholder engagement events. And the option of cost-effectively conducting online auctions has only made these activities more popular. But auctions also come with some tax compliance responsibilities, largely related to substantiating donations.

Acknowledging donations of auction items

Charity auctions (silent or live) typically sell merchandise or services which are donated to the organization. Thus, the first requirement for the organization is to acknowledge the donation of the item to be auctioned. Often this step is missed as the organization is more concerned about reporting to the purchaser and not the donor.

If the donated item may have a $250 or higher fair market value (FMV), then the organization should be sending out acknowledgement letters with certain required language, including that no goods or services were received in exchange for the donation. This acknowledgement is required if the donor is going to take a tax deduction for the donation. For these donated items, the organization should not put the value of the item on the acknowledgement letter, even though the donor may have provided it. The donor is responsible for valuing the donated item on his/her tax return and the rules can vary significantly here. For example, if the donation is from the donor’s inventory, the donor’s deduction may be different than if the donation is from the donor’s art collection. Also, if the appraised value of the gift is greater than $5,000, the donor may be giving the charity a Form 8283 to sign. If this is the case, when the item is sold at the auction, the charity will be required to file Form 8282 with the IRS indicating that the donated item has been sold and the price at which it had been sold.

Similarly, if you receive an item for auction valued at greater than $500 — and within three years sell the property — you must file Form 8282, “Donee Information Return.” You also must provide a copy of the form to the donor of the item. Form 8282 must be filed within 125 days of the sale. If you fail to file the form, penalties may apply.

If you receive a motor vehicle as a donation, you must provide Form 1098-C to the donor reporting the actual amount received for the vehicle within 30 days of the sale. The donor’s charitable deduction is limited to this amount.

Related acknowledgement rules apply to the purchasers at the auction when they spend $250 or more on an item. The organization should send them an acknowledgement for the purchase, but in this case the letter should tell them how much of the purchase price is for the goods and services received (not deductible) and how much is in excess of that amount (deductible). For examples of acknowledgement letters and for fairly complete information on gift acknowledgements of all kinds, see IRS Publication 1771: http://www.irs.gov/pub/irs-pdf/p1771.pdf.

Remember, it’s the donor’s responsibility to substantiate the value of a donated auction item.

Other rules for auction item donors

Donors of services (for example, legal, beauty or personal chef services) may be surprised to learn that their donations aren’t tax-deductible. So make sure you alert them to this in advance. The same goes for the donation of the use of a vacation home or other property, including goods, equipment and facilities.

You also may want to inform donors of property, such as artwork or fine jewelry, that tax law generally limits their deduction to their tax basis in the property (typically what they paid for it) — they can’t deduct the current fair market value (FMV) of the donated property if it’s higher.

“Quid Pro Quo Rules”

There is another rule requiring the organization to inform the donor of tax deductibility for event tickets or purchases of $75 or more (IRC Section 6115(a)). Failure to do this can result in penalties to the organization and disclosure of compliance is one of the questions on the Form 990. Under these “quid pro quo rules” for event tickets or purchases of $75 or more the organization is responsible for informing the purchaser as to how much of the purchase price is a donation and how much is for goods and services. In other words, any excess over the FMV of an item is a donation. If the purchase price does not exceed the FMV, then there is no donation by the purchaser (which is often the case). The easiest way to inform auction purchasers of fair market value is to provide the information in the program. The value of each item should be listed and there should be prominent language saying that only the amount paid in excess of value is allowable as a charitable deduction. It is important that the retail value of the item be used on this listing—not simply the cost of it, as it may have been purchased at a discount or produced by the donor. Often, the donor of the item can provide this information; if not, the organization will have to do some research. The valuation can be a good faith estimate.

The failure to provide the written disclosures can result in penalties of $10 per contribution, not to exceed $5,000 per auction. You can avoid the penalty if you can show your failure was due to “reasonable cause.”

Sales tax

Another area often ignored with charitable auctions is sales or local tax. Most states (and some localities) tax sales of merchandise by charitable organizations; having an exemption from paying sales tax is not an exemption from collecting it. Many organizations already are engaged in the sale of merchandise and are already registered with the state where the auction is occurring. However, when an organization does not ordinarily engage in merchandise sales or is conducting an auction in another state, it may be required to register and collect sales tax even for a one-time event. Some states have exclusions from registration and collection of tax for “occasional” sales and for charitable fundraising. Clearly, it is important to research sales tax issues well before the planned auction date.

990 reporting

Lastly, for the Form 990, charitable auctions will be reported as a fundraising activity on the revenue section (Part VIII) and, if above certain thresholds, on Schedule G. The donation portion of the receipts is reported on Line 1c for Part VIII as donations, while the value of purchased items (the FMV) goes on line 8a of Part VIII as gross income. Schedule G requires a listing of all fundraising events with a little more detail. The net income of the fundraising event will generally be shown in the “excluded” column of Part VIII as it usually fits an exclusion from unrelated business income: either because of selling donated merchandise, use of primarily donated merchandise in the activity or because the activity is not regularly carried on (once a year or less in frequency).

In conclusion, it is important to remember that there are a number of rules that an organization must be mindful of when conducting a charitable auction, from donor acknowledgement to sales tax and 990 reporting, to remain complaint with the various taxing authorities. Due to the complexity of these regulations, it is always a good idea to consult your tax adviser to ensure that the event is successful and without compliance setbacks. Contact author Bob Moreland, CPA via e-mail or phone (502.882.4658) for more information.