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George F. Bearup, J.D. Senior Legal Trust Advisor

29-Jun-20

Charitable Gifts and the Quid Pro Quo Rule

Take-Away: Gifts to charities are tax deductible, less anything of value that the donor receives from the charity in exchange for the gift. The return of value to the donor, or quid quo pro, is usually found in charitable fundraising events and activities. Failure to adhere to the quid pro quo rules can result in the loss of the entire charitable income tax deduction to the donor.

Background: Over 50 years ago the IRS published guidelines on the deductibility of ‘admission payments’ for fundraising events, such as charity balls, bazaars, banquets, shows, and athletic events. [Revenue Ruling 67-246.] Those rules are still in effect today. Those rules have been periodically supplemented by legislation and Regulations over the years, including in 1990 a Charitable Solicitations Compliance Improvement study.

Tax Deduction Rules: A brief summary of those charitable tax deduction rules follows:

  • Unless an exception applies, a donor cannot receive anything of value from the charity.
  • If a donor receives something in return, the IRS will presume that payment or receipt is the ‘purchase price,’ and that no charitable gift was made by the donor.
  • In order to be eligible to claim a charitable tax deduction, the donor has the burden of proof to establish: (i) the amount paid by the donor exceeded the value of the benefits that the donor received; and (ii) the donor intended to make a charitable gift of the excess amount.
  • The donor’s intention to make a gift can be inferred from surrounding circumstances; therefore, proof of donative intent is not always required.
  • Proof of donative intent is, however, important when it is unclear whether the payment made by the donor was a ‘purchase’ or a charitable gift.
  • If the charity alerts the donor of the value of the premium/price ahead of time, the donor can then show that he/she intentionally made a gift by knowingly paying more than the fair market value of what is received by the donor.
  • Only the amount of the payment to the charity in excess of the fair market value of what the donor receives is a deductible charitable gift.

Exceptions: The IRS’s guidelines and Regulations create a safe harbor for charities that acknowledge contributions with token gift items.

  • Token Items: If the charity gives a donor a low-cost item, which cannot cost the charity more than $11.20 in 2020, the charity’s receipt provided to the donor does not have to mention the token gift. [IRC 513(h)(2).] This safe harbor covers small items like mugs, t-shirts, posters, etc. The dollar amount limit is adjusted annually by an inflation factor.
  • Example: Don, the donor, gives $300 to the local animal shelter, a 501(c)(3) tax exempt entity. The animal shelter gives Don a t-shirt worth $5.00 with the animal shelter’s logo. Because the t-shirt is a token item, it can be ignored for substantiation purposes, and the receipt that the animal shelter sends to Don does not have to mention the t-shirt, but the receipt must still say on its face that the animal shelter gave Don ‘nothing in return for his charitable contribution.’
  • Qualified Fundraising Campaign: A charity can advise a donor that his/her gift is fully deductible, if: (i) the donor’s payment is made in response to a qualified fundraising campaign in which the charity informs donors how much the donor can deduct; or (ii) the donor receives benefits having a fair market value of $112 or 2% of his/her payment, whichever is less; or (iii) the donor gives the charity at least $56 and receives a token item. That token item must carry the charity’s name or logo and must cost the charity no more than $11.20.
  • Unsolicited Gifts: If a donor receives  an unsolicited free item, the donor does not have to reduce his/her contribution to the charity, so long as the items are free, low cost, and part of a charity’s fundraising campaign. [Treasury Regulation 1.170A-13(f)(8)(i)(A.)]
  • Reasonable Estimate of Value: Even if the item given by the charity is a donated item, e.g. t-shirts are contributed to the charity by a t-shirt printing company to be used in the charity’s annual fundraising campaign, the charity must still make a reasonable estimate of what the item would cost if the item had been purchased.

Donor Tax Traps: Complying with these rules can present problems for the donor, and sometimes cause the donor the loss of their charitable income tax deduction.

  • Raffles and Door Prizes: The IRS will disallow in full a charitable tax deduction for a donor who receives a chance to win something as a quid pro quo. [IRS Publication 526.] Payments made to a charity for raffle tickets are not deductible as charitable contributions because the donor-purchaser is deemed to have received full consideration by receiving a chance to win a valuable prize, regardless of the odds of the donor actually winning the prize. [Goldman v Commissioner, 26 Tax Court, 136 (1966).]
  • Example #1: Doris pays $500 to attend a fundraising banquet sponsored by her favorite charity. The value of the dinner and entertainment is $100.00. Therefore, Doris will be able to deduct $400.00 as a charitable contribution (her $500 payment less the $100 quid pro quo dinner and entertainment value that she receives.) However, in addition to the meal and entertainment, this charitable event also entitles all donors a chance to win the title to a new automobile as a door-prize. According to the IRS, Doris’ charitable deduction would be $0.00 because as a purchaser of the ticket to the charity’s fundraiser, Doris acquired something of value as a result of her ticket purchase- the opportunity to win the prize automobile in addition to the value of her dinner and entertainment. The IRS will ignore the probability of Doris winning the door-prize raffle to value her gift to the charity. Note that Doris will lose her entire charitable deduction, regardless of how much the raffle item is worth., e.g. it could be a lithograph print worth $150.00.  It is immaterial how much, if anything, in excess of the value of the meal and entertainment may have been paid by Doris. The purchase of the banquet ticket of $500 by Doris cannot be deducted.
  • Example #2: Same facts as in Example #1, only Doris decides to not attend the banquet. She bought the ticket, but she decided not to attend the banquet (its January in Michigan!). Doris still cannot deduct the price paid for her ticket to the charity’s banquet. The test of tax deductibility is not whether Doris’ right to admission to the banquet is exercised. Rather, it is whether Doris accepts, or rejects the right to attend. [Revenue Ruling 67-246.] In order to preserve her charitable income tax deduction, Doris needed to affirmatively refused to accept participating in the door-prize raffle, as opposed to simply not use her banquet ticket.
  • Formal Rejection: This potential  loss of a charitable income tax deduction is why a charity that plans a raffle or offers a door-prize as part of their fundraising activities should give donors an option to decline to participate, e.g. a check-the-box on a charity-provided form that expressly rejects the benefit offered by the charity. I confess that I have never been furnished a ‘check-the-box’ form from a charity for any fundraisers that I have ever attended over the last 50 years, even though that is what IRS Publication 526 tells us. [Nor have I ever won a door-prize in those same 50+ years either, for what its worth!]
  • Dual Character Payments: When a donor receives a benefit from a charity but the amount of the donor’s payment or contribution is out of proportion to the benefit, the payment has a duel character. This means that it is a part non-deductible ‘purchase’ and part tax deductible contribution. [United States v American Bar Endowment, 477 U.S. 105 (1986.)] A duel character payment is deductible (i) to the extent that it exceeds the fair market value of the benefit received; and (ii) if the donor intends the excess payment to be a gift. Even when an excess payment is made by the donor, it is not tax deductible if the donor only realized that fact after making the gift or contribution. As noted earlier, when a donor receives a privilege or benefit in return for his/her payment, the presumption is that the payment is not a gift. The burden is on the donor to prove the contribution isn’t the purchase price of the benefit and that part of the payment does, in fact, qualify as a charitable contribution. None of the payment is deductible unless the donor can overcome the presumption that it does not exceed the value of the benefits he/she expects in return.

Conclusion: These rules are intended to prevent abuse or collusion when claiming charitable income tax deductions. Some of these appear to harshly punish a donor. However, more likely is the case where these rules are pretty much ignored by donors who proceed to claim a charitable tax deduction when technically the deduction is disallowed. Perhaps even more germane is the reality that only about 10% of taxpayers now itemize their tax deductions in light of the doubled standard deduction amounts under the 2017 Tax Act. So why even mention these quid pro quo rules? Because the qualified charitable distribution (QCD) opportunity used to satisfy a taxpayer’s required minimum distribution for the year, also makes it clear that there can be no quid pro quo benefit when a direct QCD is made from the donor’s IRA to a charity. Consequently, a working knowledge of the quid pro quo rules is important, both to the donor, and to the charity and for those who make qualified charitable distributions from their IRAs each year.