How to Shift Charitable Deductions into Business Deductions

A different approach could mean increased tax reduction

When a taxpayer makes a payment to a §170(c) charity, there are two possible deductions available for that payment:

1. A charitable contribution deduction under §170, or

2. A trade or business deduction under §162.

A §162 trade or business deduction is generally superior to a charitable deduction. It is above-the-line, reducing adjusted gross income (AGI), income tax, and self-employment tax for sole proprietors and partners. Reducing AGI can also unlock other tax credits and deductions limited due to the taxpayer’s income.

On the other hand, a §170 deduction for individuals is an itemized deduction (which does not reduce AGI) limited to a certain percentage of AGI depending on the contribution category. Excess contributions can typically only be carried forward for five years. A taxpayer who does not itemize deductions receives no tax benefit from charitable deductions; this is quite common since the standard deduction increased significantly under the Tax Cuts and Jobs Act (TCJA).

For C corporations, §170 deductions are allowed against their income and treated as any other corporation deduction; however, they typically are limited to 10% of the corporation’s taxable income, and excess contributions can normally only be carried forward for five years.

Therefore, for sole proprietors, partnerships, S corporations, and certain C corporations making significant charitable contributions, there are possible tax savings opportunities from converting them into §162 deductions versus §170 deductions.

Charity Payments as Business Deductions

Treas. Reg. §1.162-15(a)(1) provides the relevant rule:

A payment or transfer to or for the use of an entity described in section 170(c) that bears a direct relationship to the taxpayer's trade or business and that is made with a reasonable expectation of financial return commensurate with the amount of the payment or transfer may constitute an allowable deduction as a trade or business expense rather than a charitable contribution deduction under section 170.

The following example (based on Treas. Reg. §1.162-15(a)(2)(i)) provides a straightforward example of paying a charitable organization for business advertising:

Aaron is a sole proprietor who manufactures musical instruments and sells them through a website. He makes a $1,000 payment to a local church (a §170(c) charitable organization) for a half-page advertisement in the church's program for a concert. In the program, the church thanks its concert supporters, including Aaron. The advertisement includes the URL for Aaron’s business website. Aaron reasonably expects that the advertisement will attract new customers and help him sell more musical instruments. Aaron may treat the $1,000 payment as a §162 expense.

The following example (based on Treas. Reg. §1.162-15(a)(2)(ii)) demonstrates that an intangible business benefit can allow for a §162 business expense:

Pop Foods, a partnership, operates a chain of supermarkets, some located in Nebraska. It operates a promotional program that sets aside the proceeds from 1% of its sales each year, which it pays to one or more §170(c) charities. The funds are used in projects that improve conditions in Nebraska.

Pop Foods makes the final determination on which charities receive payments. It advertises the program and reasonably believes it will generate a significant degree of name recognition and goodwill in the communities where it operates, thereby increasing its revenue.

Pop Foods makes a $1,000 payment to a §170(c) charity as part of the program. It may treat the $1,000 payment as a §162 expense. This result is unchanged if, under Nebraska's tax credit program, Pop Foods expects to receive a $1,000 income tax credit on account of their payment, and under Nebraska law, the credit can be passed through to the partners.

Tax Planning Example

Ryan operates the Crazy Cat, a pet store. It is a sole proprietorship, and Ryan anticipates net business income of $150,000 in 2025. As an animal lover, Ryan donates approximately $5,000 personally to various local cat-related §170(c) charities; however, since Ryan does not itemize deductions, he gets no tax benefit.

A tax advisor should discuss with Ryan the possibility of creating a program in which Ryan donates 1% of his gross sales to local cat-related §170(c) charities. Ryan can promote his business’s support of local cat charities and increase name recognition and goodwill, thus increasing customers and revenue.

Assuming 1% of sales is $5,000, Ryan can deduct the $5,000 donations as a §162 expense, reducing income and self-employment taxes. This would save him approximately $1,150 in federal tax in 2025.

QBI Deduction Considerations

I want to close with one note about the §199A deduction. If an individual can deduct most or all of their charitable contributions as itemized deductions, attempting to shift them into §162 deductions may not make sense due to the §199A deduction impact.

A §162 deduction reduces qualified business income (QBI) and taxable income, while a §170 deduction reduces taxable income but not QBI. Making charitable contributions has always been a strategy to boost the §199A deduction. Reducing taxable income may reduce the effect of the §199A phase-outs, which are based on taxable income after the standard or itemized deduction, not AGI.

In this case, the only way to make an informed decision is to run nuanced projections. Of course, since 2025 is scheduled to be the last year of the §199A deduction, future planning is challenging until we have clarity on the emerging tax law from Congress.

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