October 10, 2016
By William Boiman, Manager, Tax & Business
A majority of businesses and business owners make charitable donations to qualified charities. Most taxpayers assume that these contributions result in a charitable deduction and report them as such on their tax returns. However, some taxpayers who make the effort to determine the actual business purpose for the contribution may realize a much more beneficial deduction.
The Internal Revenue Service (IRS) has released various guidance stating that a charitable payment which bears a direct relationship to the taxpayer’s business, and is made with a “reasonable expectation of financial return commensurate with” the amount of the transfer, is not a charitable contribution. Instead, the transfer or payment may be deducted as an ordinary business expense (unless it is an expenditure that must be capitalized).
This can be extremely advantageous to some taxpayers due to the various limitations associated with charitable contributions. Charitable deductions are limited to 50% (30% in some cases) of the taxpayer’s Adjusted Gross Income. They can also be phased out as an itemized deduction on Schedule A due to the amount of the taxpayer’s income. In contrast, an ordinary business expense will reduce a taxpayer’s income dollar-for-dollar.
The IRS has also ruled that a strictly contractual obligation on the part of a charity isn’t required, as long as the consideration justifies a “reasonable expectation” of financial return. To entitle the taxpayer to a business expense deduction, the expected return must be:
- Of a financial nature; and
- More than nominal, “commensurate with” the payment or other transfer.
Taxpayers must remember that a payment to a charitable organization won’t be deductible as a business expense unless it’s clearly shown that the contribution was made in the furtherance of business purposes, and was not a mere gift. For example, if a business makes gratuitous contributions with the intention of deducting them from its income as a business expense, a clear intention to increase the volume of business should be evident. Some examples of these could include:
- A contribution to a charity to please a potential customer who is head of the fund-raising drive. The actual purpose of the gift is to influence the customer.
- Payments made to 30 or so charitable organizations that regularly made bookings with the taxpayer’s travel agency. About 57% of total billings come from these organizations, and payments were geared to the amount of business and its profitability.
However, cash payments to a hospital by a seller of surgical and office supplies are considered contributions as no additional business was expected in return. The contribution was simply a gift for the betterment of the hospital.
Our small business clients are generous people, contributing thousands of dollars this year to charities, churches and other organizations. While the charitable deduction in the tax code encourages people of financial means to help their fellow citizens - most simply do it for the goodwill of helping others. But, our SMB (Small and Midsize Business) clients can save even more money on their taxes by turning their charitable contributions into a business expense.
What qualifies for the charitable contribution tax deduction?
First, a charitable contribution is when you donate money (including securities or business ownership interests), property or services to a qualified organization and deduct the market value of the contribution on your personal tax return. Qualified organization include churches, employee beneficiary associations,
social and recreational clubs, veteran organizations and financial cooperatives, among others. The IRS maintains a detailed list of every type of eligible organization on their website. You can check a charity's tax exempt status at //www.irs.gov/app/pub-78/
When is a charitable contribution a deductible business expense?
The IRS says that you can deduct a payment to a charity as a business expense when
the payment to the charity bears direct relationship to your business and you make the payment with the reasonable expectation of financial return to commensurate the amount paid.
For example, Fisher CPA Firm decides to advertise that 10% of the sales to new customers in the month of December will be donated to Toys For Tot's. We run an email and print advertising campaign heading into December highlighting the virtues of doing business with Fisher CPA Firm because we support Toys for Tots and other charities in our community. Since we ran the campaign with the reasonable expectation that we will earn more money than the cost of the ad, we can deduct the 10% donation as advertising expense.
Another example, Fisher CPA Firm is asked to sponsor a small business conference put on by the local chamber of commerce (a 501c3 charity). We agree and pay a sponsorship fee because we believe the exposure from our
position as a supporter of small business will land us new clients
that will earn us more than the cost of the sponsorship fee.
Why would I want to turn my charitable contribution into a business expense?
Business expense are not subject to limitations. Charitable contributions are subject to limitations and can be eliminated (called a "phase out") as a deduction if you earn more than $300,000 as a married tax payer. Whenever you have the choice between a business or personal deduction - always go for the business deduction.
If you have any questions about the deductibility of business expenses versus charitable expenses, please call us. A short phone call could save you a big headache later.
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