If you're like most small business owners, giving back to the community is high on your list of priorities.
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Charitable contributions provide a perfect vehicle for you to do something good and do something beneficial for your company at the same time. Although you can't deduct everything, you might be surprised by how much money your good works can save your business at tax time.
But if saving money on taxes is your primary motivation for giving to charity, you are probably going to be disappointed. Since limitations apply to the deductibility of charitable contributions, your reasons for giving to charity need to be altruistic. Once you've made the decision to donate, then you can begin to structure your donation in a way that conforms to IRS standards.
The IRS requires contributions to meet several qualifications before they can be legitimately included in the calculation of a charitable deduction. First, the contribution must be an actual donation of either cash or property. Pledges and volunteer hours do not generally meet deductibility requirements. The donation must also be made to a qualified organization such as a church, educational institution, or other nonprofit. The IRS approves qualified nonprofits as 501(c)(3) organizations, so it's important to make sure the recipient has received this designation.
The deductibility of cash donations is relatively straightforward. As long as the receiving organization is qualified under IRS guidelines, cash donations can be included in the calculation of your charitable deduction.
Property donations – which represent a significant portion of small business donations – are a little more complicated. The value of non-cash contributions is determined by their FMV (Fair Market Value). If the contribution represents an item you would normally sell to customers, the FMV is the item's retail price. But if you donate something you don't typically sell, you will need to document your basis for valuation. Written appraisals aren't required unless the value of the donated item exceeds $5,000.
You should also be aware that the deductibility of a donated item that would result in a capital gain (if sold) is subject to additional restrictions. Similarly, the total value of a charitable deduction is limited to a percentage of the business' AGI (Adjusted Gross Income). The calculation of deductibility restrictions can be complex, so it's a good idea to consult your tax preparer for details.
Maximizing Charitable Deductions
Adherence to a few common-sense guidelines goes a long way toward maximizing the amount of your charitable deduction. The IRS requires taxpayers (including businesses) to maintain documentation verifying the legitimacy of the contributions claimed on their return. These documents can be in the form of canceled checks, acknowledgement letters from charities, or appraisals of non-cash donations. Unless you are meticulous about maintaining contribution records, you could lose a substantial part of your charitable deduction.
You may also want to consider making a charitable deduction at year-end, especially if you are planning to contribute in the near future. By moving your contribution up a few months, the deduction could be used as a painless, yet effective, tool for tax planning.