Taking a tax deduction for items donated to charities is a common practice for millions of individuals. But what about tax deductions for donating business property? This process is a bit more complex.
A personal income tax return is where most business owners deduct the charitable contributions of their companies. Only a regular C corporation deducts donations on the income tax return of the business. Sole proprietors, partners in partnerships, shareholders in S corporations, and everyone with a limited liability company (LLC) treat charitable contributions by the business as if they had been made personally.
The amount of tax deduction that an individual takes for donating personal property is typically the fair market value of the donated item. Fair market value is simply what an ordinary buyer would pay for the item and what an ordinary seller would agree to accept for selling the item. In other words, the tax deduction is whatever amount of money the charity receiving the donated item can get from selling it.
A general exception, however, is that the individual cannot deduct more than what was originally paid for the item. This amount is known as the basis of the property. For example, donation of business inventory results in a tax deduction for the cost rather than the fair market value of the items. Likewise, the tax deduction for donations of art, literature, or music is limited to the cost of creating it.
Conversely, an asset specifically held for appreciation in value may, in most cases, be treated as if it were sold and the proceeds donated. The deduction in these instances is the fair market value, not the basis. This is true, for example, of investments in qualified shares of stock.
What about accounting?
Thinking about the bookkeeping for a business, it’s easy to see the complexity of deducting fair market value for a donated item. Unlike inventory, the basis for most items is $0, because the business already deducted the cost at the time of purchase. Therefore, the charitable deduction is limited to $0. Office supplies and most small equipment fit this description.
Long-lived fixed assets are generally not expensed when purchased. Their cost is depreciated over time. If the original cost has not yet been fully depreciated, these items have a basis above $0. Basis for these items is the part of original cost not yet depreciated.
The basis for fixed assets is found on the company’s balance sheet, which is the financial statement showing assets balanced against liabilities and equity. When a charitable donation is recorded, the asset’s basis is removed, the expense lowers profit, and equity decreases.
However, the bookkeeping technique is different if the deduction is not limited to the asset basis.
For example, what if the fair market value of the donated item is lower than its basis? In these instances, the business deducts the part of the basis that is not deducted as a charitable donation as a loss on asset disposal.
In rare cases, if the fair market value is more than basis, the business may choose to report a gain on disposal of the asset.
Do you need to record a charitable donation from your business? To ensure proper navigation of these bookkeeping measures, consult with your tax adviser for assistance with business asset donations.