The popularity of donating used cars to charity has increased in recent years, to the point of creating a subculture of companies that do nothing but collect and distribute old cars. Billboards, radio ads, flyers in the mail - they all attempt to encourage people to donate vehicles to charitable organizations in return for hefty tax deductions.

Nowhere is this more pervasive than on the Internet, where a search for "used car donations" on Google returned 1.64 million entries, with online donation centers topping the list.

But despite the visibility of donation centers and the way they make the donation process sound so easy and enticing, 2005 will go down in history as the year that charitable deductions for automobiles got really confusing.

First there was the new tax law enacted last year as part of the American Jobs Creation Act of 2004. Effective for used-car donations after Dec. 31, 2004, the law limits tax deductions to the amount that a charity realizes when selling the vehicle.

Prior to 2005, the amount of a deduction for a used-car donation was left up to the donor, and although the donor was instructed to deduct fair market value, you could pretty much deduct whatever your conscience would allow. You could take an old clunker that had been used as a planter in the backyard, get it towed to a charity, then look up the Kelley Blue Book value of the car and pick a deduction. How was the Internal Revenue Service to know whether or not the car was drivable?

"I'd say people overstate the value of donated cars up to 20 percent to 30 percent," said Russell D. Francis, a Tigard, Ore.-based CPA.

In June, the IRS issued more rules, offering detailed guidance and making the whole car donation business more complex. The IRS expects to pocket $2.4 billion over the next 10 years with these new rules. One thing is certain - from now on, if you want to take a tax deduction for giving a car to charity, you should expect to develop a relationship with the charitable organization, because you're going to need to stay in touch.

Effective for cars and other vehicles donated after June 5, 2005, here are the rules that must now be observed.

Cars (as well as trucks, boats and airplanes) that are donated to a charity and subsequently sold by the charity without being used in any meaningful way generate a tax deduction for the donor of the actual selling price. The charity is to report this price to the donor within 30 days of the sale. This applies to cars with a fair market value of more than $500.

The charity is required to provide the donor with a written acknowledgment of the sale, containing the name and taxpayer identification number of the donor; the vehicle identification number; the date of the contribution and the date on which the car was sold; the amount received in the sale; a statement indicating that the sale was conducted in an arm's-length transaction between two unrelated parties; and a statement that the amount of the sales proceeds is the maximum amount that can be deducted by the donor for this vehicle.

The donor must attach this statement to his tax return for the year in which the tax deduction is taken. The deduction will be denied if this documentation is not attached to the tax return.

Christine Bragale, director of media relations for Goodwill Industries, reported that car donations have dropped considerably for Goodwill. "Many of our agencies report drops of as high as 40 percent from the same time period last year," she said. "It's a significant hit. Goodwill does not rely heavily on car revenues, but the new law is hurting us."

Other nonprofit agencies reported similar downturns in vehicle donations. Volunteers of America has reported a 46 percent drop in donations. The Military Order of the Purple Heart in southeast Michigan conducted a survey in which more than half of respondents indicated that they would no longer consider donating cars specifically because of the new tax laws.

The IRS has set up a stringent penalty structure. Note that these are penalties on the charitable organizations, not the donors.

The penalty for falsifying statements or knowingly failing to provide timely statements to donors regarding a car worth more than $500 that is sold by the charitable organization is the greater of the amount of the sales price of the car or the fair market value stated on the statement provided to the donor times the highest current federal income tax rate (presently 35 pecent).

For example, a car that sells for $2,000 in an arm's-length transaction, and for which the charity provided a donor statement indicating that the fair market value is $8,000, would incur a penalty of $2,800 (the higher of $2,000 or 35 percent times $8,000).

Whether the IRS would actually take the time to identify specific cars by their VIN numbers, track down the cars, and try to determine what shape they might have been in when donated remains to be seen.

However, the changes to the auto deduction rules may be just the first of a one-two punch to nonprofit organizations.

Looming on the tax deduction horizon is the possibility of limiting the total amount of deduction that can be claimed in any year for clothing and other material goods to $500 per tax return.

"The Joint Committee on Taxation recommended a limit to the deductions on clothing and other goods, limiting how much property can be donated when people clean out their closets or empty their home after a death in the family," said Bragale. "We're really concerned."

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