Final regulations on business payments to state-sponsored charities
Final regulations provide a safe harbor and define the quid pro quo principle for business entity payments to certain charities in return for consideration.
The Treasury Department and IRS released final regulations on the deductibility of payments made by businesses and individuals to §170(c) charitable organizations in return for consideration. The regulations further define the “quid pro quo” principle for donors who receive something in exchange for their payments. They largely adopt earlier guidance and mainly serve to update the regulations on business deductions under §162 to reflect the applicable tax treatment of business donations to §170(c)(1) state-sponsored charities. The regulations also provide safe harbors for business and individual donations to charitable organizations.
The quid pro quo principle and charitable contributions
Quid pro quo (literally, something for something) as it relates to charitable contribution rules means that a business or individual has received or expects to receive consideration in exchange for their donation. In general, a business entity that makes a contribution to a state-sponsored charity in exchange for a tax credit has received a direct benefit in the form of state or local taxes the business would otherwise have to pay. Similarly, an individual who itemizes deductions and makes a contribution to a state-sponsored charity in exchange for a tax credit has received consideration and must reduce any charitable contribution deduction accordingly.
Although “consideration” may often refer to state or local tax credits, the final regulations define consideration in this context as the goods or services a taxpayer may receive from the charitable entity or any third party in return for the donation. Goods or services means cash, property, services, benefits, and privileges. This definition is applicable to amounts paid on or after December 17, 2019.
Example 1. Carlotta is a sole proprietor who sells musical instruments through an online site. She makes a $1,000 payment to a local church that is a §170(c) organization for a half-page advertisement in the church’s program for a concert. The advertisement includes the URL to Carlotta’s website and she reasonably expects the ad to attract new customers. Carlotta may treat the payment as an expense of carrying on a trade or business.
See the January 9, 2019 and June 19, 2019 editions of TAX in the News for discussion of earlier guidance for businesses and individuals and the quid pro quo principle.
Payments to charitable organizations as business expense deductions
The final regulations adopt earlier guidance with some clarifications for businesses. A payment for the use of a §170(c) organization that bears a direct relationship to the taxpayer’s trade or business and made with a reasonable expectation of financial return may constitute an allowable trade or business expense deduction under §162 rather than a charitable contribution. The business expense rules apply to payments or transfers made on or after December 17, 2019, but may be applied to payments or transfers made on or after January 1, 2018.
Safe harbors for businesses. A C corporation that makes a contribution to a §170(c) organization in exchange for a state or local tax imposed on the C corporation may treat the payment as an ordinary and necessary business expense. Likewise, a specified passthrough entity that makes a contribution in exchange for a state or local tax imposed at the entity level may treat the payment as an ordinary and necessary business expense. Here, a specified passthrough entity is a business entity other than a C corporation, such as a partnership, S corporation, or LLC.
The safe harbor applies if the business entity receives or expects to receive a state or local tax credit. Safe harbors apply only to cash payments.
Example 2. Able Corp., a C corporation, makes a $1,000 donation to a §170(c) organization and receives a dollar-for-dollar state income tax credit. Able may treat the $1,000 as an expense for carrying on a trade or business. If instead Able Corp. received only an 80% credit toward taxes owed by the corporation, then $800 of the payment is treated as an ordinary and necessary business expense. The treatment of the remaining $200 depends on facts and circumstances not covered by these regulations.
For specified passthrough entities, the safe harbor does not apply to state or local income taxes.
Example 3. Parker LLC is classified as a partnership for federal tax purposes. Parker makes a $1,000 donation to a §170(c) organization and receives a dollar-for-dollar credit against excise taxes imposed at the partnership level. The tax is imposed at the partnership level, not the owner level. Parker may treat the $1,000 as an expense for carrying on a trade or business. Similar to Example 1, if Parker had received only an 80% credit, then $800 of the payment is treated as an ordinary and necessary business expense.
Safe harbor for individuals to deduct payments as state and local taxes
An individual who itemizes deductions and makes a donation to an eligible state charity in consideration for a state or local tax credit may treat the portion for which a charitable deduction is disallowed as a payment of state and local taxes.
Example 4. Alex makes a $1,000 contribution to an eligible state charity and receives a credit against his state taxes for 70% of the donation, thus limiting his charitable contribution deduction to $300. Even though Alex made the payment to a §170(c) organization, he may treat the disallowed portion of the donation of $700 as a payment of state and local taxes for itemized deduction purposes, subject to the $10,000 SALT limitation.