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Are charitable donations made by your law firm direct business tax deductions?

Navigating charitable donations within the legal structure of a law firm can be complex, with tax benefits depending largely on the type of tax return your firm files.
Are charitable donations made by your law firm direct business tax deductions?
Written by
Paul W Carlson, CPA
Published on
Oct 21, 2018

In this article, we explore the intricacies of tax deductions related to charitable donations for C Corps, S Corps, Partnerships, and Sole Proprietors. We also dive into the differences between charitable donations, marketing expenses, and entertainment expenses, providing valuable insights for law firms looking to make informed decisions.

Most likely, no.  The exact answer depends on the type of tax return filed for the law firm.

Firms that file as C Corps (Form 1120)

Firms that file as C Corps are able to directly deduct donations made to charity.  However, charitable donation deductions are limited to a maximum of 10% of net income.  Since most small C Corps are run to report nearly $0 taxable income each year, they are unable to deduct charitable donations.  Disallowed charitable donation amounts are lost and cannot be carried forward or transferred to shareholders.

Firms that file as S Corps (1120S), Partnerships (1065), and Sole Proprietors (Schedule C)

A little better news, but still not the answer most people expect.  For these firms, charitable donations are transferred from the firm and reported as itemized deductions for the owners.  The donation can be reported on the law firms financial statements, but the donation amount is removed from deductible expenses when the income tax return is prepared.

Example, LLC owned by two partners.  The operating agreement specifies Partner A receives 60% of all costs and Partner B received 40% of all costs.  The LLC donates $10,000 to a qualified charity.  The donation is made from the firm’s checking account and in the name of the firm.  Partner A will report a $6,000 charitable donation and Partner B will report a $4,000 charitable donation on schedule A of their personal tax returns.  If one of the Partners does not itemize, they will not receive a tax benefit from the donation.  Alternatively, if the partners have high income, the itemized deduction can be phased out and provide little to no tax benefit.

Charitable Donation or Something Else?

According to the IRS, a “charitable contribution” is a voluntary transfer of money or property made by the transferor without receipt or expectation of financial or economic benefit.  If however, your business receives or can reasonably expect to receive, sufficiently substantial financial or economic benefits in excess of those that would accrue to the general public, the transfer is a business expense.

The keys to a business expense classification is ensuring it’s clear to the charity that you want business from the payment and documenting where your customers are coming from.

Charitable Donation or Marketing?

If a payment is expected to build brand recognition or attract new customers, the payment is a marketing expense even though the recipient might be a charitable organization.  Buying a listing in the church directory to attract new customers is an advertising expense, not a charitable donation.

Charitable Donation or Entertainment?

What if  a business payment was for you and a customer, employee or business prospect to attend or participate in a charitable event such as a golf, tennis, fishing or ski tournament?  Just like all business entertainment, as long as you talk business in a business setting before, during or after the event, the payment is a business entertainment expense, limited to face value of the ticket and subject to a 50% limitation.  Most sporting events are subject to these limits.

However, expenses for tickets to fund-raising charitable sporting events are not limited to face value, and not subject to the 50% limit for meals and entertainment [IRC section 274(l)(1)(B) and (n)(2)].  If all of the following additional three criteria are met, the payment is a 100% deductible business entertainment expense:

  1. The event is organized for the primary purpose of benefiting a Section 501(c)(3) organization,
  2. All the net proceeds are donated to the charitable organization, and
  3. The event uses volunteers for “substantially all” the work performed in carrying out the event.  “Substantially all” isn’t defined in the Ta x Code and has been defined in Regulations differently ranging from “more than 80%” to “ more than 95%”.  Most PGA Tour events pass the “substantially all” test.  Local events are less likely to qualify.  And “scholastic events” such as college or high school football or basketball games generally don’t meet the “substantially all” requirement because they pay individuals to coach, recruit and perform various services.  If the event’s marketing materials are silent on this requirement, ask the event coordinator for a confirmation in writing to protect your business deduction.

The rule applies to the amount paid both for seating at the event and for related services, such as parking, use of entertainment arenas, contestant positions and meals furnished at and as part of the event.