Payments to charities by business enterprises: Sec. 162 vs. Sec. 170.

• Author: Harrison, Robert E.

Whenever a business enterprise makes a payment to a charitable organization, it is often beneficial to ascertain whether the expense can be classified as an ordinary and necessary business expense (deductible under Sec. 162) rather than a charitable deduction (under Sec. 170).

While the proper classification could be beneficial for C corporations, it is frequently more important for S corporations, limited liability companies, partnerships and sole proprietorships. For many businesses not operating as C corporations, the tax deduction will ultimately be taken on individual income tax returns, where it is usually more advantageous to have a deduction in computing adjusted gross income (AGI) (Sec. 162) instead of a deduction from AGI (Sec. 170). This "above-the-line" deduction would be even more valuable to a taxpayer in states like New York, which reduces otherwise allowable itemized deductions of higher income taxpayers, or New Jersey, which provides no itemized deduction for charitable contributions.

Regs. Sec. 1.170A-1(c)(5) states that "[t]ransfers of property to [a charitable organization] which bear a direct relationship to the taxpayer's trade or business and which are made with a reasonable expectation of financial return commensurate with the amount of the transfer may constitute allowable deductions as trade or business expenses rather than as charitable contributions." It should be noted that Secs. 162 and 170 are mutually exclusive. An expense properly classified as a charitable deduction cannot be deducted as an ordinary and necessary business expense, even when part (or all) of the amount could not be deducted because of the charitable deduction percentage limitations, substantiation/appraisal requirements, or reductions for certain types of charitable contributions of property (Sec. 162(b)).

Whenever a business enterprise makes material payments to charitable or governmental entities, inquiries should be made to determine the motivation behind the payments. In many instances, the expectation of a financial return will be sufficiently direct to permit (or require) classification of the payment as an ordinary and necessary business expense. While such classification may not be beneficial in all cases, in many situations it will lower the business owners' tax liabilities.

Many types of charitable payments have been held to have a sufficiently direct relationship to an expectation of commensurate financial return so as to permit...