Tax options for handling obsolete inventories

Nation's Business, Dec, 1997 by Gloria Gibbs Marullo

If you have excess or obsolete inventory, you have two ways to turn it into a tax deduction: write it down or give it away. For many small businesses, the best option might be to give it away.

Inventories of any type can be donated to charity, but not all companies get the same deduction for donating the same types of goods, says Gary L. Rodgers, a partner with accounting firm Kennedy and Coe in Englewood, Colo.

If your company is an S corporation, a partnership, or a sole proprietorship, and if you donate inventory to a charity that uses the goods to help people who are ill or needy or to help children, you generally can take a tax deduction for your cost of producing the inventory.

For C corporations, the deduction increases to the cost of the inventory plus half the difference between that cost and the fair market value of the goods--not to exceed twice the cost of the inventory.

Once you have mastered the math, your next hurdle is to find a nonprofit organization that can use your old inventory. United Way and Goodwill Industries, two of the nation's largest charitable organizations, typically accept donations of food, clothing, and furniture.

Many churches also receive and distribute donated items, but they may not be able to accept all the types of products you want to donate. That's where organizations such as Gifts In Kind International and the National Association for the Exchange of Industrial Resources (NAEIR) enter the picture.

Redistribution Channels

Gifts In Kind International in Alexandria, Va., (703) 836-2121, has a list of about 50,000 charities to which it can channel donated goods; it gave away over $230 million worth of goods last year.

The NAEIR is a charity clearinghouse with warehouses in Galesburg, Ill., and Porterville, Calif., and can be reached at 1-800-562-0955. It collects donated goods and distributes them to more than 10,000 nonprofit members such as hospitals, schools, churches, and homeless shelters. These nonprofits pay annual dues of $275 to $575 and most receive more than $10,000 in goods each year.

"Our fastest-moving items are office supplies, toys, clothing, power tools, electrical and plumbing supplies, and janitorial supplies," says Jack Zavada, director of communications, "but it's amazing what organizations can use."

His favorite example: a donation of 10 gallon tins of pickled sharks used for high-school biology classes. They were gone in less than a week, he says.

Another unusual donation: 200,000 arrows from True Flight Arrow Co. in Monticello, Ind., the world's largest arrow assembler. "We average between 50 and 80 employees a year who [collectively] produce between 20,000 and 50,000 arrows a day," says John Gooding, the firm's president.

"We sell to large retailers like Wal-Mart and Kmart, so we have to keep a certain level of inventory on hand. What typically happens is a [retailer] will start ordering a different stock number, which leaves us with an inventory of obsolete arrows."

The NAEIR was Gooding's fourth choice for disposing of the arrows. "We first offered the arrows to the c customer at a discount," he says. "The following year we tried a deeper discount. After that we looked at what liquidators were willing to pay. When the liquidator's price was too low, we decided to donate the inventory." The NAEIR targeted the arrows to high-school archery programs.

The Write-Down Option

If you prefer not to give away inventory, try writing down its value to get a tax deduction. It's not too late to get a deduction for the current tax year, but you need to move fast, says Harry Cohen, a partner with Stonefield Josephson, an accounting firm in San Francisco.

Inventory items that cannot be sold at regular prices may be valued at the net realizable value (selling price less direct costs of disposition) if the items are actually offered for sale within 30 days after the inventory date.

That means if you take an inventory at the end of December and offer the items for sale (to establish the lower price) before the end of January 1998, you can deduct the decline in value on your 1997 business tax return.

Congress this year made it somewhat easier to take a deduction for inventory shrinkage resulting from theft, breakage, and bookkeeping errors, says Rodgers. Under a provision of the Taxpayer Relief Act of 1997, passed in August, "if you took a physical inventory during 1997, you can now take a deduction for shrinkage based on a year-end estimate rather than an actual December inventory," says Rodgers. While there are some exceptions, the new rule generally applies to companies with tax years ending after Aug. 5, 1997.

Under prior law, companies were required to take actual inventories at year's end to establish shrinkage.

The Need For Forecasting

For florists, grocers, and other businesses, dealing with perishable inventories, the best way to avoid excess inventory is to develop a nose for forecasting the exact amount needed to meet customer demand, says Ron Lies, owner of Ehninger Florist in South Bend, Ind. "I've been a florist for 14 years," says Lies, "and you have to be 1,000 times better today at forecasting sales and inventory. Shrinkage--in our case, old flowers--can kill you."