Tax Effects of a Business Making a Charitable Contribution
- Learn more about the tax treatment of charitable contributions by businesses.
- Find out how business-related charitable contributions could lead to an unexpected tax deduction.
- Learn more about charitable pass-through deductions.
- Discover the 20% business pass-through deduction and how charitable contributions for businesses can negatively affect your QBI.
Charitable contributions are generally allowed as part of an individual’s itemized deductions on his or her income tax return. However, the IRS generally doesn’t allow a business expense deduction 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. Fiducial offers you a breakdown of the different ways charitable contributions can affect your business.
Contribution as deduction for trade or business expenses
An example: Joe, who is a sole proprietor and a dealer in musical instruments, contributes $500 to a nearby church. He contributes 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.
What happens if a business derives no benefit from a charitable contribution?
If a business derives no benefit or if the IRS deems the contribution excessive for the amount of business benefit, then by IRS rules, the payment becomes a charitable contribution by the business owner. The owner may deduct this on their individual 1040 return, provided the owner itemizes deductions.
If the business is a partnership or an S corporation, a partner’s or a shareholder’s prorated share of the contribution passes 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.
The downside of charitable deductions for businesses
Making charitable contributions from a business entity has another negative side. Starting in 2018, most business entities (but not C corporations) enjoyed a new tax deduction that generally equals 20% of the business’s qualified business income (QBI). This passes through to the business owners for them to deduct on their personal 1040 returns.
Basically, QBI is the business’s profit with certain adjustments. For instance, charitable contributions made at the business level reduces the QBI. 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. In this way, they can make the charitable contribution personally and 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. Have questions related to how this might impact you or your business? Call Fiducial at 1-866-FIDUCIAL or make an appointment at one of our office locations. Ready to book an appointment now? Click here. Know someone who might need our services? We love referrals!
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