When you make charitable donations, you want to get the maximum benefit for tax purposes. Now that you have a business you may wonder if you should run those donations through the business. Will you get extra tax benefit? This article will explain how this works for most LLC’s including partnerships and S Corporations. For an LLC taxed as a sole proprietorship, the only way to claim this deduction is on Schedule A of your personal return, so you don’t have other options.
Partnerships and S Corporations are both Pass-Through entities and charitable donations are one of the items passed through to the owners. Whether you make the donation personally or out of your business, either way it will flow to your Schedule A if you have more itemized deductions than the standard deduction. If your charitable donations plus your other itemized deductions are less than the standard deduction, then your charitable donation won’t save you taxes even if you make it from your business. In certain very rare circumstances, charitable donations can be a way to move money out of a partnership or S Corporation without reporting any distributions. However, distributions from these entities are by default not taxable, so having less distributions won’t typically save you any tax.
Sounds like it doesn’t matter then, right? Keep reading because under the new PTE tax laws in Alabama and 35 other states, donating from the wrong place can trigger extra taxes.
The Alabama PTE tax election allows a pass-through entity—such as a partnership or S corporation—to pay state income taxes directly at the business level. In turn, the business owner receives a credit for the taxes paid by the entity, and the tax payments are deductible on the entity’s federal income tax return. This approach enables the owner to bypass the federal SALT deduction limit of $10,000, which applies to individuals, or to benefit from a SALT Deduction even when not itemizing. The relevant point is that PTE tax is calculated based on all of the entity’s income and deductions, including charitable donations.
Impact of Charitable Donations on the PTE Tax Benefit
The Alabama PTE tax election allows a pass-through entity—such as a partnership or S corporation—to pay state income taxes directly at the business level. In turn, the business owner receives a credit for the taxes paid by the entity, and the tax payments are deductible on the entity’s federal income tax return. This approach enables the owner to bypass the federal SALT deduction limit of $10,000, which applies to individuals, or to benefit from a SALT Deduction even when not itemizing. The relevant point is that PTE tax is calculated based on all of the entity’s income and deductions, including charitable donations.
When a pass-through entity makes a charitable donation, the deduction reduces the amount of the entity’s taxable income subject to the Alabama PTE tax. While this might seem beneficial at first glance, it also reduces the amount of tax paid at the entity level, thereby diminishing the federal tax savings provided by the PTE tax strategy.
If the business owner makes the same charitable donation personally, the entity’s taxable income remains higher, and the full PTE tax payment becomes deductible at the federal level. Meanwhile, the owner can still claim a charitable deduction on Schedule A, provided they itemize deductions. This allows the owner to maximize both the PTE tax benefit and the charitable deduction on their individual return.
Example: Donation Through Entity vs. Personal Donation
Assume an S corporation earns $100,000 in taxable income and is subject to Alabama’s 5% state tax.
- Scenario 1: Donation by the Entity
- Income: $100,000
- Charitable Donation: $10,000
- Taxable Income After Donation: $90,000
- Alabama PTE Tax: 5% × $90,000 = $4,500
- Federal Deduction: $4,500
- Scenario 2: Donation by the Business Owner
- Income: $100,000
- Alabama PTE Tax: 5% × $100,000 = $5,000
- Federal Deduction: $5,000
- Charitable Donation: $10,000 deducted on Schedule A
In the first scenario, the PTE tax payment is reduced by $500 because of the donation, resulting in less federal tax savings from the PTE deduction. In the second scenario, the full $5,000 PTE tax is deductible, and the owner can still claim the $10,000 charitable deduction on their personal return if they itemize.
The difference is even bigger for partnerships that have self-employment income because the PTE tax deduction reduces not only income tax but also self-employment tax for the partners.
Conclusion: Maximize the PTE Tax Benefit with Personal Donations
For businesses that elect the Alabama PTE tax, making charitable donations personally rather than through the business may be the smarter strategy. Personal donations allow the entity to report higher taxable income, leading to a larger PTE tax payment that is fully deductible on the federal return. Meanwhile, the owner can still benefit from a charitable deduction on Schedule A either way if they itemize.
By carefully evaluating whether donations are best made by the entity or the owner, business owners can maximize both federal and state tax savings while continuing to support charitable causes. Schedule a meeting with Bearden Stroup CPAs if you want to start getting high-quality tax planning advice.