October 26th, 2016
The IRS just released Information Letter 2016-0063, confirming that a “benefit” corporation may deduct payments to charity as an ordinary business expense. This is newsworthy for two principal reasons. First, it confirms that payments made to a charity may be fully deductible as a business expense rather than as a charitable contribution which is subject to a 10% limitation. Second, it makes a potentially important distinction between a traditional business corporation and a “benefit” corporation. As a legal entity, “benefit” corporations differ from the typical corporate entity in that they are required to benefit the public as part of its corporate purposes.
Benefit corporations are a unique kind of business corporation. The first benefit corporation statute was passed in Maryland in 2010. Currently, 31 states have passed benefit corporation statutes under various designations, including public benefit corporations, social purpose corporations, and special benefit corporations. While there are some differences from state to state, benefit corporation statutes generally require that the corporation be operated in such a manner as to provide general or specific benefits to the public, and require the board to give the accomplishment of public benefits the same priority it gives to generating returns for stockholders.
So far, as federal tax laws pertain to benefit corporations, they are regulated as any other for-profit corporation. Many benefit corporations make payments to charity, either to purchase goods or services, or simply to generate goodwill and benefit the public, as they are obligated by their charters to do. One issue that has long vexed tax lawyers and accountants is whether these payments constitute business expenses, charitable contributions, or both. The recent IRS Letter answers this question, at least for benefit corporations.
Some Background on the Regulations of Benefit Corporations & Charitable Contributions
The leading legal decision regarding the deduction of payments to charity as a business expense is Marquis v. Commissioner, a tax court case from 1968. In Marquis, the tax court examined three sections of the Internal Revenue Code. Section 162(a) of the Code states that “ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business” are deductible from taxable income. Section 170(b) states that charitable contributions by corporations are subject to a limit of 10% of taxable income. Finally, Section 162(e) states that “no deduction shall be allowed under Section 162(a) for any contribution or gift which would be allowable as a deduction under Section 170 were it not for the…limitations set forth in such section.” In other words, the Code says that a business cannot deduct a payment as a business expense if the payment could be treated as a charitable contribution, and the 10% limitation applies to all such deductions.
The court in Marquis, finding that Section 162(e) applies only to payments which are “pure” contributions or gifts (i.e., payments for which the company receives no direct benefit in return,) held that where a payment is made with some business purpose in mind, the payment is not necessarily a charitable contribution, and, where the business receives some benefit in connection with the payment, it may be deducted as a business expense not subject to the 10% limitation of 170(b).
The Information Letter just released by the IRS confirms this principle and then applies it to the unique characteristics of a benefit corporation. Relying on the fact that a benefit corporation is formed at least partially to benefit the public, the IRS concluded that benefit corporations have greater leeway in determining that payments they make to charity have generated a sufficient benefit to justify treating such payments as business expenses.
The Letter goes on to state that, whereas traditional business corporations must establish the presence of “a direct relationship to the taxpayer’s business…made with a reasonable expectation of a commensurate financial returns” to justify a business expense deduction, benefit corporations need only show that the payment constitutes “institutional or goodwill advertising to keep the corporation’s name before the public” in order to qualify it as such.
This truly significant development confirms that benefit corporations can use pre-tax money to support charities in ways that traditional business corporations most likely cannot. For corporations that seek to use more than 10% of their taxable income to support charities as a way to create public benefit, or to become associated with good causes, foster social change, or mitigate the negative social or environmental impact of their business operations, this prospect provides a clear advantage. It also provides a substantial financial incentive for corporations that want to include charitable giving within the scope of their business activities to organize as benefit corporations, or to convert to that form, in order to take advantage of this ruling. [Note that “pass-through” LLC’s, which are taxed as partnerships rather than corporations, aren’t subject to the percentage limitations of Section 170(b), and therefore may not need to convert in order to take full tax advantage of their charitable giving.]
Lawyers interested in the advantages of benefit corporations may want to consider joining the Benefit Company Bar Association, a new group formed specifically to address legal issues related to “triple bottom line” companies. For more information on BCBA, please visit their website. For more information about benefit corporations in general, visit www.benefitcorporation.net.
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