Savvy business owners know that every expense should be meticulously tracked so each payment can be properly accounted for at tax time. Virtually every dollar of expenditures can be used to offset your income, which decreases your company’s income tax obligations. Ensuring you are properly tracking costs will help you take full advantage of one of your most valuable tax-savings tools. But with regard charity and tax deductions the question, can businesses deduct donated services?, has been unclear with many small business owners.
One expense that often gets overlooked, however, are your donations to charity. Businesses donate in a variety of ways to local charities in their area. It is not only a great way to give back to the community, but it can also be an effective advertising method, as well.
However, not all of these donations are tax-deductible. Donating services, for example, has some very restrictive limitations that should be aware of before you attempt to deduct those time donations in your business.
Businesses and Charitable Giving
Donations come in all shapes and sizes. Although money is likely the most well-known donation, other types of donations can also be useful for charities, too. Products and services can be just as helpful for some service organizations.
The IRS defines a charitable contribution as “money or property you [give] to, or for the use of, a qualified organization.” The definition is broad, but it actually has some pretty significant limitations. You will note, for example, that the way the IRS defines charitable contributions does not include donated services or volunteering.
Some of the most common examples of charitable donations from businesses include:
- Money donations. Money donations are, by far, the most common way that businesses give back to the community. It is flexible and easy to track. Some companies will also encourage their employees to donate and match those donations, as well.
- Products and inventory. When a business has a specific product that a charity needs, it can provide that product directly to the charity. The company can also offer products for things like auctions or raffles, for example, too.
- Donated services. Some service businesses provide services directly to a charity. Others can donate those services as part of a fundraiser or auction, too.
- Donating time in the form of volunteering is different from donating services because the actions that take place are likely not the same thing that the business does on a day-to-day basis. Employers may ask employees to donate their time serving a particular charity, for example.
While donating in any form is an excellent way to get involved in the community, not every type of donation is tax-deductible.
Deducting Charitable Involvement: An Overview
Small business owners may not realize that they have pretty severe limitations when it comes to donations as a tax deduction. There are restrictions on the type of donations, amounts, where they can donate, and a lot more. Below are some of the need-to-know restrictions for small businesses.
What is a “Qualified Organization”?
Businesses can only deduct donations to “qualified organizations.” If the entity does not meet this definition, then that does not restrict donations, but it does affect whether you can deduct that donation.
Only certain organizations will meet the requirements of a “qualified organization” for tax purposes. Examples of commonly acceptable charitable organizations include:
- Churches and other religious organizations
- Federal, state, and local governments if the purpose of the gift is for public use (such as donating to create or maintain a public park)
- Nonprofit schools and hospitals
- War veterans’ groups
- Nonprofit organizations (American Red Cross, Goodwill Industries, Boys and Girls Clubs of America, etc.)
In general, the organization must be a 503(c)(3) nonprofit for it to be considered a “qualified organization.” If you are unsure if the particular charity that you are working with meets this definition, you should ask—these organizations keep careful records of this qualification for donation and tax purposes.
While donations to school fundraisers, civic leagues, sports clubs, individuals, and political groups can be beneficial, they are not tax-deductible.
Types of Donations: Can a Business Deduct Donated Services?
While serving your community is certainly admirable and encouraged, it is, unfortunately, not tax-deductible. Of course, that does not mean that your services are not valuable. Instead, the IRS does not permit this type of deduction simply because it would be challenging for the IRS to audit service hours provided to others or the value of those services. As a result, donated services are not tax-deductible at all for businesses or individuals.
Other types of donations, such as products, inventory, and cash donations, can be deducted. Businesses should use the fair market value of those donations when including them on their tax returns.
Need-to-Know Tax Deduction Limitations for Small Businesses
Only certain types of businesses can deduct charitable contributions. If you do not file a separate return for your company, then those philanthropic contributions are not deductible. That is, if you use a Schedule C to track the income and expenses for your business (your company is a pass-through entity), then you cannot deduct donations to charity. C-corporations, as a result, are the only entity that can deduct charitable contributions.
Pass-through entities that cannot deduct charitable contributions include:
- Sole proprietorships
- Limited Liability Companies (LLCs)
That means that the most common type of business in the United States, the sole proprietorship, cannot deduct charitable donations. As a sole proprietorship, your donation is considered part of your individual return. It will be included on your Schedule A, which is only used if you itemize your deductions.
You should also keep in mind that donations cannot be more than 60% of your Adjusted Gross Income. Lower limits sometimes apply, as well. You can only take advantage of the deduction in the year that the donation is made.
While these overall AGI limits are often not an issue, they can be a problem if the company is attempting to decrease their overall tax obligations using donations. You and your tax professional will be able to work through the best way to take advantage of gifts as a tax deduction without reaching the limitation that applies to your company.
Available Deductions Related to Donated Services
While the value of the donated services themselves are not tax-deductible, you may be able to take advantage of deductions for regular business items that are related to the donated services. Consider a few examples.
Products and Costs Related to the Service
Imagine that you are a photographer. You donate an outdoor photography session for a family to be raffled off at a fundraiser for a qualified charitable organization. As part of the services you provide, you also get the photos developed and printed. Although you cannot deduct the time you spent taking photos, you can deduct:
- The costs related to printing
- Costs relating to getting the photos to the client, such as the cost of the CD or USB drive
- The mileage that you drove to get to the photo session
- The cost of having your assistant on the session with you (his hourly pay, even though that was for services)
- Any costs related to creating a display for the raffle
Keep in mind that mileage driven for charitable can be deducted at less than the business rate. For 2020, the charitable mileage rate is 14 cents per mile. While this may not seem like much, it can add up if you are frequently traveling to volunteer or provide services.
In some cases, charitable sponsors will get some advertising space in exchange for their donations to an organization. Although the money is characterized as a donation, it is actually an advertising expense, too.
Keep in mind, however, that the IRS may not permit you to deduct the entire amount as an advertising expense. You are allowed to deduct the fair market value, rather than the total donation. This distinction is important if you know that the advertising cost is overpriced because it is a donation. In many cases, however, the only estimate you may have of the fair market value is the donation amount itself.
Documenting Your Donations and Contributions
Like all of your expenses, it is important to keep good records of your donations. Many qualifying organizations will send you an itemization of your contributions during tax time each year. Nonetheless, it is a good idea to keep track of these donations yourself.
Examples of potential documents that you should keep might include things like:
- Canceled checks
- Credit card statements showing donations
- Email confirmations of the payment
- Any other type of receipt for payment
- An itemized list of the products or other items that you donated
In many cases, if you are donating the costs related to services, only you will have that information. Keeping good records will be very helpful if you or your company gets audited.
You can get help with determining the appropriate deductions by talking to an experienced CPA. Learn more about how we can help by requesting free five-minute consultation or reviewing our FAQ section.