General rule

A business that donates inventory to charity generally deducts the basis of the donated property (generally cost), not its fair market value. This avoids the double-benefit of deducting an item the business never had to recognize as income. The donation reduces inventory and produces a charitable deduction equal to basis — the same net effect as selling at zero.

Enhanced deduction for food

Section 170(e)(3) provides an enhanced deduction for food inventory donated to qualifying charities (food banks, soup kitchens) for use in feeding the needy: basis plus half of the appreciation, capped at twice the basis. This helps grocery stores, restaurants, and food producers recover more of the value of donated food.

Books, computer equipment, scientific property

Several categories of inventory have their own enhanced-deduction rules: books donated to public schools, computer equipment donated to schools and libraries (rules narrowed substantially after 2011), scientific property donated to universities for research. Each has its own substantiation requirements.

Substantiation

Donations of $250 or more require a written acknowledgment from the charity. Donations of $5,000 or more (other than publicly traded securities) generally require a qualified appraisal — not practical for most inventory donations, which is one reason the basis-only rule is the dominant outcome.

Where it goes

A sole proprietor takes the charitable deduction on Schedule A as a personal itemized deduction (subject to AGI limits) — NOT on Schedule C. The business simply reduces inventory by the basis of the donated goods. An S-corp or partnership reports the contribution on Schedule K and passes it through to owners.

Common mistakes that disallow the deduction

The recurring ways this deduction gets disallowed in examination cluster in four categories: (1) personal-use expenses bundled with business (the deduction is disallowed entirely or apportioned downward); (2) inadequate substantiation (no receipt, no invoice, no business-purpose note); (3) the wrong line on Schedule C (not fatal, but it weakens audit defense); and (4) double-counting with another line (for example, deducting an expense on Schedule C and also on Form 8829, or as a personal itemized deduction on Schedule A). The fix in every case is contemporaneous bookkeeping and a clean chart of accounts.