The Business of Charity
Worth Magazine, December 2014 - January 2013
MAKING CHARITABLE CONTRIBUTIONS TAXDEDUCTIBLE AS A BUSINESS EXPENSE IS LEGAL BUT COMPLICATED. HERE’S HOW TO DO IT RIGHT.
Charitable deductions are subject to various limitations under the Internal Revenue Code. For example, contributions to public charities may be deducted up to 50 percent of a taxpayer’s adjusted gross income, while contributions to certain private foundations are limited to 30 percent. Plus, since charitable contributions are treated as itemized deductions, they are also subject to the general limitation on itemized deductions.
But with proper planning, you can mitigate the effect of the limitation on charitable contributions. Here’s how: The above discussion was predicated on the assumption that a gift to a charity is treated as a charitable contribution for federal income tax purposes. If, however, the payment is not a gift, but rather a trade or business expense, the amount might be deductible as a business expense—without the aforementioned limitations.
What is a charitable contribution? The term “contribution or gift” is not defined in the Internal Revenue Code but the generally accepted test for evaluating whether a payment is a charitable contribution looks at the receipt of consideration and the intention of the payment. In other words, if the payer intended to make a gift and did not receive a quid pro quo, the payment will likely qualify as charitable. If a taxpayer makes a payment in consideration for goods or services, it cannot be treated as a gift. A payment to a charity made with a reasonable expectation of a commensurate financial return and bearing a direct relationship to the taxpayer’s trade or business is not a charitable contribution.
If a payment is not a gift, is it a deductible business expense? Possibly. The business expense deduction has three major components. First, the taxpayer must be carrying on a “trade or business.” Second, there must be a connection between the expenses and the business activity. Finally, the deduction is limited to “ordinary and necessary” expenses incurred in carrying on the trade or business.
The precedents establishing when a charitable contribution can be treated as a business expense date from the 1970s. In a 1972 IRS ruling, the taxpayer, a corporation, was engaged in a stock brokerage business and paid an amount equal to 6 percent of its brokerage commissions to a charity. The purpose: to reduce neighborhood tensions and combat physical deterioration in the neighborhood in which the taxpayer had its office. The taxpayer used these payments as an inducement to its clients to remain clients and as advertisement for new business. The IRS pointed out that whether payments are “contribution or gift” or ordinary and necessary business expenses depends on whether such payments were gratuitous or they bore a direct relationship to the taxpayer’s business and were made with a reasonable expectation of a financial return. The latter payments were held to be deductible as business expenses.
In a ruling one year later, the IRS concluded that contributions to a city’s oil pollution control fund, used to fund cleanup costs tied to improving the city’s tourist trade following an oil spill, were deductible as business expenses. The reasoning? The taxpayer had suffered a loss of business as a result of the spill, the payments were calculated to improve the taxpayer’s future business, and the payments were commensurate with the amount of financial return expected. Based on these precedents, taxpayers who make payments to charities may be able to characterize them as business expenses.