Tax Effects of a Business Making a Charitable Contribution

Tax Effects of a Business Making a Charitable Contribution

Article Highlights:

  • Charitable Contributions
  • Business-Related Charitable Contributions
  • Charitable Pass-Through Deductions
  • 20% Business Pass-Through Deduction

Charitable contributions are generally allowed as part of an individual’s itemized deductions on his or her income tax return, while a business expense deduction generally isn't allowable for a contribution made to a charitable organization.

However, the IRS recently issued proposed regulations saying that if a taxpayer’s trade or business makes a contribution to a charitable organization with a reasonable expectation of financial return commensurate with the payment amount, the contribution could constitute an allowable deduction for trade or business expenses, rather than a charitable contribution deduction.

Example: Joe, who is a sole proprietor and a dealer in musical instruments, contributes $500 to a nearby church with the understanding that, as a result of the contribution, he will have an advertisement in the church’s concert program. The advertisement includes his business URL from which he sells musical instruments. Joe reasonably believes the advertisement will attract customers; therefore, Joe can treat the $500 payment as an ordinary and necessary business expense.

If no business benefit is derived or if the contribution is excessive for the amount of business benefit, then the payment will be treated as a charitable contribution by the business owner and deducted on the owner’s individual 1040 return, provided the owner is itemizing deductions.

If the business is a partnership or an S corporation, a partner’s or a shareholder’s prorated share of the contribution will be passed through to the individual partner or shareholder on Schedule K-1, which also reports his or her share of income, deductions and credits from the business entity.

Making charitable contributions from a business entity has another negative side. Starting in 2018, most business entities (but not C corporations) enjoy a new tax deduction that is generally equal to 20% of the business’s qualified business income (QBI) and is passed through to the business owners for them to deduct on their personal 1040 returns.

Basically, QBI is the business’s profit with certain adjustments. One adjustment that reduces the QBI is charitable contributions made at the business level. This is true even when the charitable contributions aren’t deductible and are passed through to the business owners.

It makes far more sense for self-employed individuals to make contributions personally and for partnerships and S corporations to distribute the amount of the intended contribution through to the partners or stockholders, so that they can make the charitable contribution personally, in order to avoid reducing the QBI, which will reduce the 20% deduction.

Long story short, there is no benefit in making charitable contributions from a business; in fact, doing so can have a detrimental tax effect.  

If you have questions related to how this might impact you or your business, please give this office a call. 

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