Charitable Contribution or Business Expense?

Staff members administering a company’s charitable giving program are sometimes asked whether payments to a charity may be deducted as a charitable contribution or a business expense by the company. Although business expense deductions have fewer limitations than charitable contribution deductions, a company does not have complete discretion in choosing whether to deduct a payment as a business expense or a charitable contribution.

Charitable Contribution Deduction

The federal tax code allows a U.S. company to deduct charitable contributions up to 10 percent of net taxable income. Most companies give away less than 2 percent of their taxable income and will not reach this threshold. If a company happens to reach the contribution deduction limit, any excess payments can be carried over to the next five years.

Charitable gifts can take many forms, including cash, appreciated property, products, or inventory and volunteer time. The simplest gifts are gifts of cash that are fully deductible within the 10 percent deduction limit. Gifts of appreciated property to public charities are deductible at fair market value—appreciated property other than publicly traded stock requires a qualified appraisal. Gifts of products or inventory may qualify for a charitable deduction, but special limitations and rules exist on what and how much can be deducted. Finally, the value of staff or personal time (gifts of services) donated to a charitable organization is not deductible, although unreimbursed out-of-pocket expenses incurred in carrying out such work may be deductible. The company must substantiate its gift, usually by securing a gift acknowledgment from the charity, to claim a charitable contribution deduction.

The federal tax code does not allow a company (or an individual) to claim a charitable contribution deduction for gifts to charities formed or created outside the United States. A gift may be made to a U.S. charity that will use the funds internationally. However, if the charity uses the funds to provide services in other countries, the company must make sure that the charity is organized as a corporation—as opposed to a trust or an unincorporated association—for the gift to be deductible.

Business Expense Deduction

Under the federal tax code, a company may deduct ordinary and necessary business expenses from gross revenues for tax purposes. These are expenses that a company generally incurs in the production of revenue.

Unlike the charitable contribution deduction, there is no ceiling on the amount that can be deducted as ordinary and necessary business expenses (although special limits may apply for certain expenses). In addition, excess business expense deductions may be carried back as net operating losses and may produce a tax refund.

Business expenses can be deducted on an accrual basis, that is, at the time when the expense is incurred, rather than when the payment is made. A charitable contribution must be claimed in the year in which it is paid (although a company that is on an accrual basis of accounting may deduct contributions prior to payment if an election is made and payment is completed before the 15th day of the third month of the year following the year in which it is authorized).

Charitable Contribution or Business Expense

Whether a payment is to be treated as a charitable contribution or a business expense is determined by whether there is a reasonable expectation of financial return commensurate with the amount of the payment. Put simply, a business expense is one for which the company expects a return benefit commensurate in value to the expense. A charitable contribution, on the other hand, is a gratuitous payment for which there is no expectation of a financial benefit.

Moreover, the federal tax code specifically disallows any business deduction for a payment that qualifies as a charitable contribution. In other words, a company cannot circumvent the limitations for charitable contribution deductions by deducting excess charitable contributions as a business expense.

Examples

As discussed above, a company cannot claim a payment for which there is an expectation of a financial return as a charitable contribution. A good example is in the area of corporate sponsorship payments. In general, corporate sponsorships may be treated as charitable contributions as long as the company does not receive a substantial return benefit, such as advertising of services or products that is expected to generate new business for the company. When in doubt about whether there is a chance of receiving a substantial economic benefit from corporate sponsorship, a company should generally deduct the cost as a business expense.

Some companies also face questions about the deductibility of donations of volunteer time, hotel rooms by a hotel chain, or seats on an airplane by an airline. The federal tax code does not allow a charitable contribution deduction for gifts of services. Volunteer time is considered to be a donation of services, and therefore deductible as a business expense rather than a charitable contribution. Deductions for other types of contributions will depend on a careful analysis of complex tax rules to determine whether they are treated as services, rather than as inventory (which may be deductible as charitable contributions).