By Darden Bell, Tax Senior Manager
Internal Revenue Code (IRC) Section 170 and the regulations thereunder govern the deduction for payments to a charitable organization.
One of the provisions under IRC Section 170 states that if a payment to a charitable organization is made by a business, then the payment bears a direct relationship to the business and the business expects a reasonable expectation of financial return. Ultimately, the payment is deducted as a Section 162 business expense and not a charitable contribution.
The IRS recently issued Proposed Regulation 1.162-15 stating “a payment or transfer to or for the use of a tax-exempt charitable organization that bears a direct relationship to the taxpayer’s trade or business and that is made with a reasonable expectation of financial return commensurate with the amount of the payment or transfer may constitute an allowable deduction as a trade or business expense rather than a charitable contribution deduction.”
The proposed regulation contained the following two examples to help illustrate this concept:
Example (1). A, an individual, is a sole proprietor who manufactures musical instruments and sells them through a website. A makes a $1,000 payment to a local church (which is a charitable organization described in section 170(c)) for a half-page advertisement in the church’s program for a concert. In the program, the church thanks its concert sponsors, including A. A’s advertisement includes the URL for the website through which A sells its instruments. A reasonably expects that the advertisement will attract new customers to A’s website and will help A to sell more musical instruments. A may treat the $1,000 payment as an expense of carrying on a trade or business under section 162.
Example (2). P, a partnership, operates a chain of supermarkets, some of which are located in State N. P operates a promotional program in which it sets aside the proceeds from one percent of its sales each year, which it pays to one or more charities described in section 170(c). The funds are earmarked for use in projects that improve conditions in State N. P makes the final determination on which charities receive payments. P advertises the program. P reasonably believes the program will generate a significant degree of name recognition and goodwill in the communities where it operates and thereby increase its revenue. As part of the program, P makes a $1,000 payment to a charity described in section 170(c). P may treat the $1,000 payment as an expense of carrying on a trade or business under section 162. This result is unchanged if, under State N’s tax credit program, P expects to receive a $1,000 income tax credit on account of P’s payment, and under State N law, the credit can be passed through to P’s partners.
Impact of IRC Section 170
The impact of this regulation is that pass-through entities like partnerships and S corporations, farmers, and sole proprietors should consider using this regulation to take Section 162 business deductions for payments to charitable organizations rather than a contribution deduction. With the increase in the standard deduction made by the Tax Cuts and Jobs Act, many taxpayers are not able to take full advantage of their contribution deductions. In addition, a section 162 deduction reduces income subject to the self-employment tax whereas contribution deductions made by a business do not reduce self-employment income. Section 162 deductions also reduce Adjusted Gross Income (AGI) which can have other income tax benefits.
Many of the payments that businesses make to exempt organizations are sponsorship fees for fund-raising events put on by the exempt organization such as galas and golf tournaments. Where the business expects to receive reasonable advertising/goodwill from the sponsorship, the payment can be deducted as a business expense rather than a charitable contribution
The regulation goes on to state that if the business receives a state or local tax credit in return for the payment, the section 162 deduction is not reduced by the amount of the credit.
However, the regulation goes on to state that this provision does not apply to any credit received by a pass-through entity or sole proprietor if the credit reduces a state or local income tax. As a result, it appears that these taxpayers would have to reduce the amount of the section 162 deduction by the amount of the state or local income tax credit.
The regulation states that taxpayers may rely on this proposed regulation for payment to charitable organizations made after 2017.
Additional Tax Resources
- State Income Tax Changes for Businesses
- How Nonprofits Can Pursue Refunds from Repealed “Parking Tax”
- New Virginia Taxpayer Changes
- Individual Tax Provisions Extended by the Taxpayer Certainty and Disaster Relief Act
- IRA and Retirement Plan Changes in the 2019 Budget Act
- 2019/2020 Tax Planning Guide
Source: Thomson Reuters
About the Author
The information contained within this article is provided for informational purposes only and is current as of the date published. Online readers are advised not to act upon this information without seeking the service of a professional accountant, as this article is not a substitute for obtaining accounting, tax, or financial advice from a professional accountant.