October 10, 2016
Charitable Deduction vs. Business Expense
By William Boiman, Supervisor, 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.