LawFlash

Benefit Corporations May Expense Payments to Charities

November 14, 2016

In a General Information Letter addressing the tax treatment of benefit corporations, the Internal Revenue Service (IRS) stated that a taxable benefit corporation may deduct payments to charities as business expenses (and thus not subject to the 10% limitation on corporate charitable contributions) when the payments are for institutional or goodwill advertising to keep the corporation’s name before the public.

On June 2, 2016, the IRS issued General Information Letter 2016-0063, which clarifies the tax treatment of a benefit corporation’s payments to charitable organizations.[1] This clarification is particularly important for benefit corporations, certified “B Corps,” taxable nonstock corporations, low-profit limited liability corporations (L3Cs), and other business entities that benefit the public as a means of generating goodwill for their businesses, because such organizations may desire to make payments to charitable organizations in excess of the 10% limitation on corporate charitable contributions.

Background

The General Information Letter addresses a benefit corporation, which is a type of corporate entity—available in an increasing number of states—explicitly authorized to pursue financial returns while at the same time generating a material positive impact on society and/or the environment (i.e., a public benefit). Benefit corporations are taxable like other for-profit corporations. Importantly, the directors of benefit corporations are allowed to consider not only the profit-maximizing interests of their shareholders, but also the public benefit the corporation seeks to generate. They are also generally required to have a high degree of transparency. Many benefit corporations are also certified “B Corps,” a certification that B Lab issues to companies that meet various social sustainability and environmental performance standards as well as accountability and transparency standards. Typically, benefit corporations have shareholders, although the corporate form depends on the law of the state of jurisdiction.

For federal income tax purposes, a benefit corporation is treated the same as other taxable corporations, including the tax treatment of payments to charitable organizations. A significant tax issue is whether payments by a taxable corporation to charitable organizations are deductible as charitable contributions under Section 170 (with the 10% limitation), or as business expenses under Section 162 (which is not limited).[2]

Under Section 162(a), corporations may deduct “all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business.” These include payments for “‘good will’ advertising which keeps the taxpayer’s name before the public” if the payments “are related to the patronage the taxpayer might reasonably expect in the future.”[3]

Business expense deductions are not allowed for payments that would be deductible as charitable contributions under Section 170.[4] Payments are deductible as business expenses under Section 162 rather than as charitable contributions under Section 170 if they

  1. “bear a direct relationship to the taxpayer’s trade or business” and
  2. are “made with a reasonable expectation of financial return commensurate with the amount of the transfer.”[5]

This two-part test is illustrated by the following example: A transit company donates money to an organization intending to hold a convention in the city in which the transit company operates. The transit company has a reasonable expectation that the convention would augment the company’s income because the company expects a greater number of people to use its transportation facilities as a result of the convention.[6]

Courts have found repeatedly that the consideration or other return benefit in exchange for a payment is what determines whether a payment is deductible as a business expense or as a charitable contribution.[7] In each case, the key for classifying payments as business expenses is to examine the expected return benefit (e.g., how, precisely, the payment is likely to lead to additional business for the corporation).

The IRS has ruled that whether payments to charity are deductible as charitable contributions or as business expenses depends upon whether the payments are completely gratuitous, without consideration, or whether they bear a direct relationship to the taxpayer's business and are made with a reasonable expectation of a financial return commensurate with the amount of the payment.[8]

General Information Letter 2016-0063

The General Information Letter summarizes the relevant rules:

  • Charitable contributions are voluntary transfers to charitable organizations that are made with no expectation of procuring a financial benefit commensurate with the amount of the transfer.[9]
  • Ordinary and necessary expenses include institutional or goodwill advertising which keeps the taxpayer’s name before the public provided the expenditures are related to the patronage the taxpayer might reasonably expect in the future.[10]
  • Ordinary and necessary expenses may include transfers to charitable organizations which bear a direct relationship to the taxpayer’s business and are made with a reasonable expectation of a commensurate financial return.[11]

The letter concludes that a “benefit corporation making an expenditure for institutional or goodwill advertising to keep the corporation’s name before the public is generally treated as an expense under § 162(a). This rule applies even if the payment is made to a § 501(c)(3) organization.”

Structuring Deductible Business Expense Payments to Charitable Organizations by Benefit Corporations

A benefit corporation may distinguish itself from its competitors by providing its customers with premium goods and services while also generating community benefit. As part of its marketing campaign to keep its name before the public, the benefit corporation could also commit to distribute a portion of its profits or revenues to charitable organizations.

The corporation could make both charitable contributions and promotional payments to charitable organizations, even if they are to the same charitable organization in the same tax year. What distinguishes the payments for tax purposes is that when it makes charitable contributions deductible under Section 170, the corporation has donative intent, and when it makes promotional payments deductible under Section 162, the corporation has a business purpose such as the generation of goodwill to raise its profile in the community and/or nationally, thereby increasing sales, improving client and employee retention, attracting talent, and otherwise building its business. A corporation seeking to deduct promotional payments under Section 162 should document the basis for its expectation of financial return at the time it makes each payment. The documentation should be in the corporate minutes, in the transmittal letter to the recipient, or in other contemporaneous documentation.

If the facts substantiate a corporation’s good faith intent that promotional payments to charities are for “institutional or goodwill advertising to keep the corporation’s name before the public,” then such payments should generally be deductible as business expenses.

Practical Considerations

  • If a corporation makes payments to charitable organizations that bear a direct relationship to the corporation’s business and are made with a reasonable expectation of a commensurate financial return, such as to promote its brand, increase its sales, or for other business purposes, then it should consider deducting the payment as an ordinary and necessary business expense under Section 162.
  • If a corporation makes payments to charitable organizations without adequate consideration, then the corporation should consider deducting the payment as a charitable contribution under Section 170 (provided that the contribution meets the other applicable legal requirements).
  • A corporation’s status as a benefit corporation does not affect its ability to deduct such payments as business expenses.
  • Facts matter. Corporations seeking to claim a business expense for payments to charitable organizations should carefully document the business and financial rationale for making such payments, and such documentation should be contemporaneous with the payments.

Conclusion

General Information Letter 2016-0063 provides a welcome clarification and greater certainty with regard to the activities of benefit corporations and other corporations that seek to “do well by doing good.” It also represents one of the first times the IRS has considered the tax treatment of benefit corporations and their activities.

Contacts

If you have any questions or would like more information on the issues discussed in this LawFlash, please contact any of the following Morgan Lewis lawyers:

Washington, DC
Alexander Reid
Matthew Elkin
Celia Roady



[1] Specifically, organizations described in Section 170(c). Unless otherwise indicated, “Section” refers to sections of the Internal Revenue Code of 1986, as amended (the Code).

[2] The percentage limitation for charitable contributions by corporations is 10% of the corporation’s taxable income for the year, determined without regard to the charitable deduction, net operating loss carrybacks to the current tax year, dividends received deductions, dividends paid deductions (if applicable), and capital loss carrybacks to the current tax year. There is also a special rule for qualified conservation contributions that qualify for more generous contribution limits and carryforward periods.

[3] Treas. Reg. § 1.162-20(a)(2).

[4] See Section 170(b)(2)(A) and (C).

[5] Treas. Reg. § 1.170A-1(c)(5); Treas. Reg. § 1.170A-1(h) (disallowing charitable deductions for contributions in consideration for goods and services).

[6] See Treas. Reg. § 1.162-15(b).

[7] See, e.g., Hernandez v. Commissioner, 490 U.S. 680 (1989) (“In ascertaining whether a given payment was made with ‘the expectation of any quid pro quo’ the IRS has customarily examined the external features of the transaction in question. This practice has the advantage of obviating the need for the IRS to conduct imprecise inquiries into the motivations of individual taxpayers”); United States v. American Bar Endowment, 477 U.S. 105 (1986) (“The sine qua non of a charitable contribution is a transfer of money or property without adequate consideration [by demonstrating] that that he purposely contributed money or property in excess of the value of any benefit he received in return.”); Singer Co. v. United States, 449 F.2d 413 (Ct.Cl. 1971) (“[I]f the benefits received, or expected to be received, are substantial, and meaning by that, benefits greater than those that inure to the general public from transfers for charitable purposes (which benefits are merely incidental to the transfer), then in such case we feel the transferor has received, or expects to receive, a quid pro quo sufficient to remove the transfer from the realm of deductibility under section 170”); Sarah Marquis v. Commissioner, 49 T.C. 695 (1968) (payments by travel agency to charitable organization clients were business expenses not charitable contributions because there can be an expectation of a benefit even in the absence of an enforceable contractual quid pro quo).

[8] See, e.g., Rev. Ruls. 72-314, 72-542, and 77-124.

[9] See United States v. American Bar Endowment, 477 U.S. 105 (1986); Rev. Rul. 67-246, 1967-2 C.B. 104.

[10] See Treas. Reg. § 1.162-20(a)(2).

[11] See Treas. Reg. § 1.170A-1(c)(5); Marquis v. Commissioner, 49 T.C. 695 (1968).