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We were recently asked: can businesses deduct donations to charity?
It's a great questions and, of course, the answer is, "It depends," because corporate tax law around charitable deductions is a little weird, and thanks to the Tax Cuts and Jobs Act of 2017 (the "TCJA"), most business donations and sponsorships are ultimately non-deductible.
Individual taxpayers can deduct the non-commercial value of their contributions. So, for example, if a $500 donation comes with two tickets to a charity gala valued at $150 each ($300 total), the individual donor can deduct $200 of their contribution. The issue is that, beginning with 2018 under the TCJA, the IRS raised the standard deduction such that most people now do not have enough deductions to itemize anyway. As a result, fewer individuals are giving their money to charities. As individual donations to charities decline, non-profits are looking to businesses to bridge that gap.
The only business entities that can directly deduct charitable contributions and sponsorships as a business expense are C-Corps. Any in-kind services provided by a C-Corp (including reduced-cost services) are considered donations at their cash value. So basically, the corporation takes the tax deduction on its own corporate tax return.
Other non-profits can make donations to like-minded charities so long as it serves their charitable purposes. Cash contributions and sponsorships from one non-profit to another are regarded as grants, and in-kind services provided are regarded as direct support.
So here's where it gets weird:
Sole proprietorships, partnerships, LLCs and S-Corps (what the IRS calls "pass-through entities") that make cash donations or sponsor charities do not get a deduction at all. Instead, the deduction passes through to the business owner's individual tax return. The business owner gets to list the part of the cash donation or sponsorship that benefits their business (such as the value of advertising they receive) as an "ordinary and necessary business expense." The remainder of the donation that did not directly benefit the business is a "charitable deduction." The kicker is, the business owner only gets those deductions if they exceed the standard deduction and get to itemize deductions on their personal tax return. Weirder still, a pass-through entity that donates in-kind services to a 501(c)(3) gets no deduction whatsoever for the value of its services.
This weirdness makes a little more sense if you understand that pass-through entities are not taxed directly. Small businesses are typically pass-through entities, and a pass-through entity's income, losses, and deductions all get passed through to the owners of the business in proportion to their ownership interest. The end result is an unintended consequence of the TCJA: fewer donations will be itemized and deducted by small business owners, and their incentive to donate to and sponsor charities is getting thin.