Tax Tip 4: Generosity Pays: Turn Donations into Tax Deductions

For small businesses, making charitable contributions before year-end can help reduce taxable income, while also supporting causes that align with the company’s values. However, there are some rules and limits to keep in mind.

Eligibility for Deductions

• C Corporations: C Corps can directly deduct charitable contributions up to 25% of their taxable income. If the contribution exceeds this limit, the corporation can carry forward the excess for up to five years.
• Pass-Through Entities (LLCs, S Corps, Partnerships): Charitable contributions from pass-through entities aren’t deducted at the business level. Instead, the deduction passes through to individual owners’ tax returns, where they can claim it as an itemized deduction, subject to individual tax rules.
Types of Deductible Contributions
• Cash Donations: Cash contributions to qualified organizations are straightforward and often the easiest way to make a deductible donation. Cash donations are generally deductible at 100% of the amount given (up to the allowable limit).
• Non-Cash Donations: Businesses can donate assets like inventory, equipment, or property. Non-cash donations are deductible at fair market value (or cost basis for inventory), but there are special valuation rules depending on the type of asset.
• Volunteer Services and Time: While time and services donated aren’t deductible, out-of-pocket expenses incurred during volunteering (like travel or supplies) can be.

Qualified Charitable Organizations

To claim a deduction, donations must go to a qualified 501(c)(3) organization. Contributions to individuals, political groups, or foreign charities (without a U.S. status) aren’t deductible.

You can check the IRS’s Tax Exempt Organization Search to verify whether an organization qualifies.

Record Keeping Requirements

• Receipts: For cash donations, keep a bank record or receipt from the charity showing the donation date, amount, and organization’s name. Contributions over $250 require a written acknowledgment from the organization.
• Valuation of Non-Cash Donations: For non-cash contributions over $5,000, you’ll need a qualified appraisal to claim the deduction. For inventory or stock donations, make sure you document fair market value and any applicable reduction (like for inventory deduction limits).

Charitable Contributions and Limits

• Cash Contributions: Deductible up to 60% of adjusted gross income (AGI) for individuals (in pass-through entities). For C Corps, it’s limited to 25% of taxable income.
• Non-Cash Contributions: Usually capped at 30% of AGI for individuals, depending on the asset and organization.

Advantages of Year-End Charitable Giving

• Immediate Tax Savings: If your business is facing a higher-than-expected profit this year, donations can offset some of that taxable income.
• Improved Cash Flow Management: Charitable deductions can reduce tax liability, which can help with year-end cash flow planning.
• Strengthen Community Ties: Contributing to causes meaningful to the business or local community also strengthens the business’s reputation and relationships with customers and partners.

Example of How This Might Work

If a business owner expects $200,000 in taxable income, a $10,000 donation to a qualified charity could effectively lower taxable income (for C Corps directly, and for pass-through entities on the personal return). For the owner, this reduction might translate to substantial tax savings, depending on their tax rate.

In summary, charitable contributions are a valuable tool for both supporting causes and lowering tax liability, especially if planned and documented carefully.