Why Use Donations on Church or Charity? You Should Use Your Business
As a result of The Tax Cuts and Jobs Act (TCJA), it is now harder to benefit from your donations.
Imagine you donate $10,000 to a church, school, or other 501(c)(3) charity:
1. Will you get a tax deduction—in other words, will you itemize?
2. Will you benefit from the entire $10,000 as an itemized deduction? In other words, did the $10,000 simply put you over the hump that beat the standard deduction?
3. Say you can deduct all $10,000 as an itemized deduction. Would making it a business deduction increase the tax benefit value to you?
There are two big changes that make it less likely that you will itemize. First, the TCJA set a $10,000 limit on your state and local income and property tax deductions.
And Secondly, it increases the 2020 standard deductions to:
· $12,400 for individuals, and
· $24,800 for married couples filing jointly.
Even with larger donations, there are larger problem this creates—let’s say you are married and donate $17,000 to charity. If this is your only itemized deduction, your donation is not a good investment because it’s less than $24,800.
Fortunately for your generous self, there’s a much more tax smart way to give.
Being a business owner allows you to make a few modifications and convert your church, school, and other 501(c)(3) donations to a different type of deduction—an ordinary business expense—which, as you’ll see below, increases the tax savings that land in your pocket year after year.
Choosing the Business Deduction Is Better
When you deduct a contribution to charity as a business expense, the deduction goes on your Form 1040, Schedule C, or corporate tax return (if you operate your business as a corporation).
Let’s say you operate as a Schedule C taxpayer and the business expense goes on your Form 1040, Schedule C. This is nice because:
· It reduces both (a) self-employment and (b) income taxes. (If you itemize, personal charitable deductions reduce only income tax.)
· It reduces your adjusted gross income (AGI). This is important because the more you reduce your AGI, the more you benefit from other non-business tax deductions and credits you might be able to utilize.
Here’s an Example
Suppose you earn $115,000 and you give $10,000 to charity as a business deduction. This reduces both your
· self-employment tax, and
· income tax.
In addition, the reduction in your AGI could increase your tax savings for other deductions and credits, depending on your family size and investment strategies.
You also achieve superior results if you operate as a C corporation or an S corporation and claim a business deduction for the money given to charity.
Business Deductions for Charitable Contributions
Now that you’ve had a glimpse at the tax savings you can generate through this strategy, it’s time to find out how it works.
You convert a charitable contribution into a business expense by making the contribution a promotion or advertisement for your business.
You might think—wait, that sounds a little tacky. Don’t worry. If you would prefer not to call attention to yourself when you give to charity, there are ways you can use this strategy and still donate fairly discreetly.
Here’s how tax law states the rule: Treat a contribution to a charitable organization as a business expense if the contribution is both
1. directly related to your business, and
2. made with a reasonable expectation of a commensurate economic return. In other words, if you contribute $10,000 to a charity, you expect to generate at least $10,000 of business because of this contribution.
A Quick Note: Donations to charity don’t have to actually generate that much revenue—but you must have a reasonable expectation that they will generate that much revenue for you.
Strategy 1—Use the Donation as an Advertisement
One strategy is to use your donation as a way to attract customers to come to your business in the future.
For example, in the Marcell case, the owner of a trucking company contributed cash to a hospital because he wanted to impress the chairman of the charity drive, who was a potential customer. The court found that Philip Marcell had a reasonable expectation for a commensurate return on his donation and treated the contribution as a business expense.
Example.You hold a fundraiser for a charity. You pay for the location, food, and print materials.
During the event, you make it known that you are a sponsor and you give a short talk about how your services can benefit the attendees of the event. This is a business expense and you can deduct the costs of holding the fundraiser.
Strategy 2—Give a Portion of the Sales Proceeds to Charity
A second strategy is to tell customers that you will donate a portion of your sales proceeds to charity. This encourages customers to buy your products because they know they are supporting a good cause.
Example.ABC Company attaches rebate slips to some of its products that it sells to customers.
The customers can then present the rebate slips to the charity, at which point ABC Company pays the charity the amount listed on the slip.
In a revenue ruling, the IRS held that the payments from ABC Company to the charities in this
example are business expenses.
Strategy 3—Follow the Stockbroker Strategy
In Revenue Ruling 72-314, the IRS ruled that the stockbroker corporation that paid 6 percent of its brokerage commissions to the neighborhood charity could deduct the payments as business expenses because
· its office was located in the neighborhood;
· it made the payments to promote its brokerage, which was located in the neighborhood; and
· it made the payments to separate itself from and compete with brokerage firms located in more established financial neighborhoods of the city.
The neighborhood charity’s purpose was to reduce neighborhood tensions and combat neighborhood deterioration.
The stockbroker operated as a corporation and wanted to avoid the 5 percent limit on corporate charitable deductions. With this ruling, the IRS declared all of the stockbroker’s payments to the charity were deductible as advertising expenses.
In this ruling, the IRS emphasized the promotion aspects of the payments, including the following:
· The brokerage got the charity to agree to advertise the arrangement.
· The advertisements told prospects that doing business with the brokerage put money into the neighborhood at no cost to the customer.
· There was a reasonable expectation that the arrangement with the charity would direct new business to the brokerage and help retain existing business.
Strategy 4—Coupons
The strategy here is different from Strategy 2 but along the same lines.
To stimulate business, the sole owner of a corporation attached a coupon to his corporation’s products. The coupon stipulated that the customer could trigger a contribution to one of the listed charities by buying the product and sending the coupon to the charity.
When the charity received the coupon, it contacted the owner, who then wrote a check to the charity to redeem the coupon.
In Revenue Ruling 55-514, the IRS ruled that this owner could deduct as business expenses the monies he paid to charities to redeem the coupons issued by his corporation on the sale of its products.
Planning note.Make sure that the business is writing the checks directly to the charities.
Building better records.If you operate your business as a proprietorship, you should have a separate business checking account for the proprietorship. You are best served with the separate account even when you operate the proprietorship in your personal name.
Consider the IRS.A separate checking account makes your business feel and look like a separate entity from you, the individual.
Strategy 5—Rebate Strategy
Sarah Marquis, a sole-proprietor travel agent, made payments to charities on the basis of business they did with her. She had 30 charities as clients, and those 30 charities accounted for 57 percent of her business.
Rather than promote the business using salespeople, as her competitors did, Marquis used a cash rebate that she arranged either in person or over the phone. The rebate was tied to the business or expected business from the charity. In deciding on the amount of the rebate, Marquis considered
· the type and amount of travel business from the client;
· the nature of the recipient (i.e., group, conference, referral source);
· the profitability of the business; and
· the likelihood of ongoing business with the recipient.
Marquis wrote the check from her business account and enclosed a message to the effect that the payment was in lieu of a salesperson’s visit and that Marquis appreciated the business.
With one exception, the religious organizations were denominations different than Marquis’ own. Further, Marquis made charitable-deduction payments to her church separate and apart from the business payments.
In this case, the court ruled that Marquis could deduct the payments that she made to the religious organizations as business expenses.
More Things to Know
The IRS says that you can deduct payments to charity as
· charitable contributionsif they are completely gratuitous, or
· business expensesif they bear a direct relationship to your business and you make them with a reasonable expectation of financial return commensurate with the amount paid.
Definition of charitable contribution.According to the IRS, a “charitable contribution” is a voluntary transfer of money or property made by the transferor without receipt or expectation of financial or economic benefit.
If the transferor receives, or can reasonably expect to receive, sufficiently substantial financial or economic benefits in excess of those that would accrue to the general public, the transfer is not a charitable deduction.
Be Overt
Here’s a failure.
Closely held Hartless Linen Service Co. sent checks to 86 Christian Science churches with a note that stated the following:
· Use this money to give more lectures.
· We advertise in the Christian Science Monitor.
· We would appreciate being informed of any prospects in your area who would be interested in our services.
In court, Robert B. Hartless, the sole owner of the corporation, testified that he could not demonstrate that his new Christian Science customers were the result of his donation letter or that they came to his corporation as a result of the advertisements in the Christian Science Monitor. On the basis of this testimony, the court ruled that the payments to the 86 churches were charitable contributions and not business expenses.
Hartless Linen failed to qualify the payments as business expenses for two reasons. First, the corporation did not make clear to the churches that it wanted business. Second, the corporation got business but could not prove where the business came from.
Hartless may have fared better had it used the coupon strategy and reimbursed the 86 churches for each referral. The coupon would help prove commercial intent and would allow tracking to the referring church and perhaps even the name of the church member who made the referral.
If you decide to make business contributions to charity, make sure your proof will stand up to scrutiny. With the knowledge you have gained here, you know how to do this and you know it’s not difficult.
Takeaways
It’s a win-win situation when you qualify to treat your monies paid to a church, school, or other 501(c)(3) charity as a business expense: the charity gets the money and you increase your tax savings over what you achieve with a personal, itemized charitable deduction.
The additional tax breaks give you a bigger incentive to help the church, school, or other 501(c)(3) charity. In fact, you can contribute more to such institutions without hurting yourself financially.
To turn a charitable donation into a business expense, you have to promote your business. In one way or another, you need to prove that your strategy has as its purpose attracting customers and revenue for your business.
The tax law rule is that your donation must
· have a direct relationship to your business, and
· create a reasonable expectation for a commensurate economic return.
Make a record that shows the activity and monies spent, and document why you expect the expenditures to create and sustain business. For good measure, include dollar estimates that show your estimated return on investment.