Structuring advertising expenditures to avoid reclassification as charitable contributions.

• Author: Weld, Leonard G.

For a business, advertising is essential. A marketing strategy is implemented through advertising programs, sales promotions and distribution programs. Advertising expense is an allowable deduction under Sec. 162(a). However, some advertising promotions may involve payments to charitable or civic organizations. Unless properly structured, these expenditures may be reclassified as charitable contributions and may be limited by Sec. 170(b), rather than being fully deductible under Sec. 162(a). This reclassification is particularly critical for businesses that anticipate losses or minimal amounts of income.

Limitation of deductions

Depending on the product or service offered, organizations that are listed in Sec. 170(c) (e.g., community chests, churches or schools) could be involved in marketing strategy. Sec. 162(b) specifically addresses the deduction of charitable contributions and gifts: "No deduction shall be allowed under subsection (a) for any contribution or gift which would be allowable as a deduction under section 170 were it not for the percentage limitations . . . . " As a further limitation, Regs. Sec. 1.162-15(a) states that "[n]o deduction is allowable under section 162(a) for a contribution or gift by an individual or a corporation if any part thereof is deductible under section 170." (Emphasis added.)

If a business is operated as a sole proprietorship or partnership, the charitable contribution is deductible by the taxpayer on Form 1040, Schedule A. These contributions are limited by Sec. 170(b)(1) to a percentage of the taxpayer's adjusted gross income (AGI) without consideration of net operating loss (NOL) carrybacks. A taxpayer operating a business with start-up losses must have another source of income resulting in positive AGI or the deduction will not be allowed.

If the business is operated as a corporation, the deduction is limited to 10% of taxable income without regard to the charitable deduction, NOL carrybacks, capital loss carrybacks and some special deductions.

For many businesses (regardless of form) these limitations are not a problem. However, for a business that incurs losses, Sec. 170(b) will eliminate a current charitable contribution deduction (although the deduction may be carried forward for five years).

Not all payments made to a charitable organization are gifts within the meaning of Sec. 170. The key to deductibility is to structure the payments made to the charity, school or civic group so that the...