How to Cut Taxes Using Your Excess Inventory

By Gary C. Smith
June 2013

Excess, nonmoving toy inventory is a common business problem that, fortunately, contains its own solution.

By donating new, idle toys to charity, your business can earn a federal income tax deduction under Section 170 ( e )(3) of the U.S. Internal Revenue Code.

The IRS Code says that regular C corporations may deduct the cost of the inventory donated, plus half the difference between cost and fair market value. Deductions may be up to twice-cost.

Let’s say you’re a retailer of office products and you buy a desktop stapler for $2.00. Your price to the home office consumer is $4.50. Your deduction is $3.25. If the markup is considerably higher, deductions are limited to twice cost.

If you’re an S corporation, partnership, LLC or sole proprietorship, you qualify for a straight cost deduction.

Even if your business realizes only the straight cost deduction, it may be to your advantage to donate your stagnant inventory rather than clear it through a liquidator. Since liquidators look for the lowest price they can get, their offer may be less than your cost – substantially less.

Investigate donating inventory before negotiating with a liquidator, however, to be able to justify the product’s fair market value with the IRS. Using a gifts-in-kind organization like www.naeir.org makes the process simple.

Besides the tax deduction, your company can realize other benefits by donating excess inventory:

Free up needed warehouse space. Whether you own your warehouse or are renting space, storing product can be expensive. Insurance, utilities, labor, and damage all factor in. It doesn’t pay to hold stagnant inventory that isn’t earning its keep.

Get down to Just-in-Time inventory. If your business is a supplier trying to trim your inventory levels enough to achieve Just-in-Time delivery, these non-movers may be one of your biggest obstacles. Donating clears them out quickly.

Put your marketing focus where it should be: on your top sellers. Non-moving inventory can consume a disproportionate amount of your business’s money, time and effort to clear it. By donating those items to charity, your company can put your advertising and promotional dollars where they’ll do the most good, on your star performers.

Avoid problems involved with liquidating those overstocks. Liquidators tend to pick and choose. They may not want to buy all of your non-movers, leaving you with the problem of what to do with the leftovers. Donating can often clear all of your problem products at once.

Help deserving nonprofits, schools and church organizations. This good deed can translate into good will. You might ask the recipient group to call the local newspaper to publicize the donation. While a “grip and grin” photo of you presenting the donation might bring in additional business, keep in mind that it also may produce requests from other groups for donations, too. If you decide to go ahead with publicity, have a diplomatic answer prepared in case other groups call.

After you’ve consulted with your accountant or tax adviser and he has recommended that donating inventory would be the right move for your business, how do you identify which merchandise to clear? Here are some types of products to consider:

Unneeded supplies. As new products are introduced into your industry, you may be caught with quantities of equipment or supplies that simply aren’t up to date. They may not work as well as more current products for a particular sector of the economy, or are no longer part of what’s being offered in the mainstream market; be that the office products industry or the school supplies sector. But they might still be useful to nonprofits, schools or churches with limited funds.

Slow-selling or non-moving SKUs (stock keeping units). Just as it is dangerous to fall in love with a stock or mutual fund and be reluctant to unload it when it is not performing, it is equally unwise to fall in love with stagnant inventory. Businesses need to be continually aware of the need to constantly review their offerings, weed out the slow-movers, and concentrate on top-selling items.

Unsuccessful product introductions. Some new products simply do not move. By donating them, instead of selling them to a liquidator, your business will do better on the bottom line and will keep them from competing against you at cut-rate prices.

Discontinued models, styles, colors. As an example, the manufacturer with more efficient, high-tech versions may supersede older models of certain product lines. Inventory of those earlier generations of items can be donated instead of scrapped.

To earn this deduction, make sure that the nonprofit recipient is a 501( c )(3), since only that IRS classification of nonprofits qualifies. Public or private (nonprofit) schools may also qualify to receive these goods.

Have your accountant or tax adviser instruct the recipient group as to what information it needs to include in the documentation it furnishes you as proof of the donation.

You will need to include the recipient’s letter on your corporate tax forms as support for claiming the deduction.

If your business has a small quantity of merchandise to donate, select the recipient(s) carefully to avoid the appearance of favoritism. By the same token, if you have a large quantity of product (a semi-trailer or more), instruct the recipient groups that under IRS regulations, donated merchandise may not be bartered, traded or sold. Charities, schools or churches may not auction or sell donated merchandise to raise cash.

Bottom line: you can do something good for your community and your business.