All too often we see businesses who write checks to 501(c)(3) tax-exempt organizations automatically lump those deductions into charitable contributions expense. The question business owners should be asking before doing this is: “Did I get something in return for my donation?” If the donation was for a specific event then the business logo may be printed on media materials and tickets received in return for the donation which could be considered advertising. In this blog we will discuss the different tax treatments and how to properly account for those deductions.
Why it Matters
A business expense is not always fully deductible against business income. Charitable contributions are one example of this. Whether you are a sole proprietor, partner in a partnership, or shareholder in a S Corporation charitable contributions are reported as an itemized deduction on your individual income tax return. This deduction’s tax benefit could be limited for the following reasons:
1. Charitable contribution deductions are limited to 50% of adjusted gross income and in some cases 20% or 30%. While this limitation does not affect a lot of taxpayers, it is something to note.
2. The business owner does not itemize deductions on his or her tax return. If the total of itemized deductions (state income taxes, real estate and personal property taxes, mortgage interest, and charitable contributions to name the main few) does not exceed $6,200 for single files and $12,400 for married filers for 2014 then that deduction is lost due to the standard deduction being taken.
3. The business owner is a sole proprietor or partner in a partnership. Sole proprietors and partners are subject to self-employment tax (15.3%) on their net business income in addition to regular income tax. Charitable contributions are only a deduction against taxable income that reduces income tax, not self-employment tax. Therefore, the business owner is not getting the deduction against business income that is taxed at an additional 15.3%.
4. The business owner’s itemized deductions are limited due to income. For 2014 tax returns itemized deductions start to be limited when taxpayer’s income hits $254,200 for single filers and $305,050 for married couples filing jointly. They are reduced by 3% of every dollar over those thresholds.
How to Account for it
If the donor receives advertising, tickets, etc. valued at more than 2% of the value of the donation then the IRS requires the charitable contribution to be reduced. The fair market value of what the business owner receives in return for the donation reduces the charitable contribution deduction. The value of what is received has to be reclassified to sponsorship, entertainment, or advertising depending on the item. The expense is still deductible, but cannot be claimed as a charitable contribution. This reduction requirement by the IRS typically is not tax advantageous for individuals who donates personally, but can be for the business owner who otherwise would have the donation limited or not used to its full tax benefit potential in the scenarios described above.